---
title: Lifetime Value Calculation
summary: How to calculate customer lifetime value across business models and use it to set budgets and optimize economics.
est_minutes: 20
sort: 8
---

#### LESSON 1: The LTV Formula and Components

Lifetime Value (LTV) is the total profit a customer generates over their entire relationship with your business.

It's the single most important metric for understanding customer economics and making acquisition decisions.

Here's how to calculate it.

**Why LTV Matters**

**Reason 1: Determines What You Can Spend to Acquire Customers**

Without knowing LTV, you can't answer:

- How much can we afford to spend on ads?
- Is this marketing channel profitable?
- Should we hire more salespeople?

Example:

If customer LTV = $1,000, you can spend up to $333 to acquire them (3:1 ratio) and remain healthy.

If you don't know LTV, you might spend $500 acquiring customers worth $200. Bankruptcy follows.

**Reason 2: Identifies Which Customers to Focus On**

Not all customers are equal value.

Example:

- Segment A: LTV = $5,000
- Segment B: LTV = $500

You should spend 10X more acquiring Segment A customers.

Without LTV calculation, you treat them equally and waste resources.

**Reason 3: Guides Retention Investment**

How much should you spend to retain a customer?

Example:

- Customer LTV = $10,000
- Cost to retain = $500

Easy decision: Spend $500 to save $10,000.

Without knowing LTV, you might let $10,000 customers churn to save $500 in retention costs.

**The Basic LTV Formula**

Simple formula:

LTV = Average Purchase Value x Purchase Frequency x Customer Lifespan x Gross Margin %

Each component:

1. Average Purchase Value = How much customer spends per transaction
2. Purchase Frequency = How many times they buy per period (usually per year)
3. Customer Lifespan = How long they remain a customer (in years)
4. Gross Margin % = Profit after cost of goods sold

Example calculation:

- Average Purchase Value: $100
- Purchase Frequency: 4 times/year
- Customer Lifespan: 3 years
- Gross Margin: 60%
- LTV = $100 x 4 x 3 x 0.60
- LTV = $100 x 12 x 0.60
- LTV = $720

This customer is worth $720 in profit over their lifetime.

**Component 1: Average Purchase Value**

How to calculate:

Average Purchase Value = Total Revenue / Number of Purchases

Example (e-commerce), last 100 orders:

- Total revenue: $15,000
- Number of orders: 100
- Average Purchase Value = $15,000 / 100 = $150

For subscription businesses:

Average Purchase Value = Monthly/Annual Subscription Price

Example (SaaS):

- Monthly plan: $99/month
- Average Purchase Value = $99

Important notes:

- Use median, not mean, if you have outliers
- Segment by customer type if values vary significantly
- Update regularly as pricing changes

Example of why segmentation matters. All customers combined show an average order value of $200. But segmented:

- Enterprise customers: $2,000 average
- SMB customers: $100 average

Treating them as one segment ($200) is misleading.

**Component 2: Purchase Frequency**

How to calculate:

Purchase Frequency = Total Number of Purchases / Number of Unique Customers

Over a defined period (usually 1 year).

Example (e-commerce), in 2025:

- Total purchases: 5,000
- Unique customers: 1,000
- Purchase Frequency = 5,000 / 1,000 = 5 purchases per year

Average customer buys 5 times per year.

For subscription businesses:

Purchase Frequency = 12 (monthly) or 1 (annual), because subscription = recurring, predictable.

Example (SaaS):

- Monthly subscription = 12 purchases per year (if they stay all year)
- Annual subscription = 1 purchase per year

Important notes:

- Only count active customers (purchased in time period)
- Exclude one-time buyers if calculating repeat customer LTV
- Different for new vs. existing customers

New vs. existing customer frequency:

- New customers (Year 1): 1.5 purchases
- Existing customers (Year 2+): 4 purchases

Don't average these together. Calculate separately.

**Component 3: Customer Lifespan**

How to calculate:

Customer Lifespan = 1 / Churn Rate

Churn Rate = % of customers who stop buying

Example (subscription):

- Monthly churn rate: 5%
- Annual churn rate: 5% x 12 = 60% (approximately, though actual math is more complex)
- Customer Lifespan = 1 / 0.05 = 20 months = 1.67 years

Alternative calculation: track actual customer cohorts.

Example, January 2023 cohort (100 customers):

- Still active after 1 year: 60 customers
- Still active after 2 years: 40 customers
- Still active after 3 years: 30 customers
- Average lifespan = Calculate actual retention curve

This is more accurate than using churn rate.

For non-subscription businesses, measure time between first and last purchase.

Example (e-commerce), Customer #1:

- First purchase: Jan 2022
- Last purchase: Dec 2024
- Lifespan: 3 years

Customer #2:

- First purchase: Jan 2023
- Last purchase: Jun 2024
- Lifespan: 1.5 years

Average lifespan across all customers = Sum all lifespans / Number of customers

Important notes:

- New businesses: Estimate based on industry benchmarks
- Don't confuse contract length with lifespan (customers may renew)
- Customer lifespan differs by segment

Segment example:

- Enterprise customers: 5 year average lifespan
- SMB customers: 1.5 year average lifespan

Calculate LTV separately for each.

**Component 4: Gross Margin**

How to calculate:

Gross Margin % = (Revenue - Cost of Goods Sold) / Revenue

Example (e-commerce):

- Product sells for: $100
- Cost to produce/deliver: $40
- Gross Margin = ($100 - $40) / $100 = 60%

What to include in COGS. Include:

- Product cost
- Shipping cost
- Payment processing fees
- Direct labor (for services)

Exclude:

- Marketing/sales costs (that's CAC)
- General overhead
- R&D

SaaS example:

- MRR per customer: $100
- COGS (hosting, support): $20
- Gross Margin = ($100 - $20) / $100 = 80%

SaaS typically has 70-90% gross margins.

Why gross margin matters: you can only spend profit (not revenue) on acquisition.

Example:

- Customer pays $1,000
- COGS = $600
- Gross margin = 40%
- Profit = $400

You have $400 to cover acquisition, retention, and overhead.

If you calculate LTV using revenue ($1,000) instead of profit ($400), you'll overspend on acquisition and go bankrupt.

**Complete LTV Calculation Example**

E-commerce company:

- Average Order Value: $150
- Purchase Frequency: 4 times/year
- Customer Lifespan: 2.5 years
- Gross Margin: 50%
- LTV = $150 x 4 x 2.5 x 0.50
- LTV = $150 x 10 x 0.50
- LTV = $750

Each customer is worth $750 in profit.

SaaS company:

- Monthly Subscription: $200/month
- Purchases per year: 12 (monthly recurring)
- Customer Lifespan: 3 years (1/churn rate)
- Gross Margin: 80%
- LTV = $200 x 12 x 3 x 0.80
- LTV = $200 x 36 x 0.80
- LTV = $5,760

Each customer is worth $5,760 in profit.

Service business:

- Average Project Value: $10,000
- Projects per year: 2
- Client Tenure: 4 years
- Gross Margin: 40%
- LTV = $10,000 x 2 x 4 x 0.40
- LTV = $10,000 x 8 x 0.40
- LTV = $32,000

Each client is worth $32,000 in profit.

**The Advanced LTV Formula**

For more precision, add discount rate:

LTV = Sum of (Margin x Retention Rate^t) / (1 + Discount Rate)^t

What this accounts for:

- Money now is worth more than money later (time value)
- Retention rate changes over time
- Margin changes over time

When to use:

- Financial modeling
- Investor presentations
- Multi-year projections
- High-value customers where precision matters

When basic formula is fine:

- Quick calculations
- Early-stage businesses
- Comparing segments
- Setting rough acquisition budgets

**Common LTV Calculation Mistakes**

**Mistake 1: Using Revenue Instead of Profit**

- Wrong: LTV = $100/month x 12 months x 2 years = $2,400
- Right: LTV = $100/month x 12 x 2 x 70% margin = $1,680

Impact: Overstates LTV by 43%, leads to overspending on acquisition.

**Mistake 2: Not Segmenting Customers**

Calculating one LTV for all customers when they have vastly different values.

Reality:

- Segment A: LTV = $10,000
- Segment B: LTV = $500
- Combined average: LTV = $2,000

Problem: You might spend $1,500 to acquire Segment B customers (worth $500). You lose money.

Fix: Calculate LTV by segment.

**Mistake 3: Using Incomplete Cohorts**

Calculating lifespan using customers who just started.

Example: customers who joined last month have only been around 1 month.

- Wrong: Customer lifespan = 1 month
- Right: Use older cohorts (12+ months old) to calculate actual lifespan.

**Mistake 4: Ignoring Expansion Revenue**

Customer starts at $100/month, expands to $300/month by year 2.

- Wrong: LTV = $100 x 12 x lifespan x margin
- Right: Include expansion in calculation or calculate separately.

**Mistake 5: Using Industry Benchmarks Instead of Your Data**

"SaaS companies have 3-year average lifespan, so we'll use that."

Problem: Your retention might be better or worse.

Fix: Calculate your actual retention and lifespan.

#### LESSON 2: Calculating LTV for Different Business Models

Different business models require different LTV calculations.

Here's how to calculate LTV for major business types.

**Subscription Businesses (SaaS, Membership)**

Basic formula:

LTV = Monthly Recurring Revenue x (1 / Monthly Churn Rate) x Gross Margin %

Or annually:

LTV = Annual Recurring Revenue x Customer Lifespan in Years x Gross Margin %

Example: monthly SaaS

- MRR per customer: $500
- Monthly churn rate: 3%
- Gross margin: 85%
- Customer lifespan = 1 / 0.03 = 33.3 months = 2.78 years
- LTV = $500 x 33.3 months x 0.85
- LTV = $14,152

Or using annual method:

- LTV = ($500 x 12) x 2.78 years x 0.85
- LTV = $6,000 x 2.78 x 0.85
- LTV = $14,178

(Slight difference due to rounding.)

With expansion revenue: many SaaS customers expand over time (add seats, upgrade plans).

Method 1: Include in MRR calculation. Use average MRR including expansions, not just starting MRR.

Example:

- Starting MRR: $500
- Average MRR over lifetime (including expansions): $650
- LTV = $650 x 33.3 x 0.85 = $18,397

Method 2: Calculate separately.

- Base LTV: $14,152
- Expansion LTV: Calculate expansion revenue separately
- Total LTV: Base + Expansion

**E-commerce / Retail**

Formula:

LTV = Average Order Value x Purchase Frequency per Year x Customer Lifespan x Gross Margin %

Example: online apparel

- Average order value: $120
- Purchase frequency: 3 times/year
- Customer lifespan: 2 years
- Gross margin: 55%
- LTV = $120 x 3 x 2 x 0.55
- LTV = $120 x 6 x 0.55
- LTV = $396

Cohort-based calculation is more accurate for e-commerce with variable repeat rates.

Track actual cohort, Month 1 cohort (1,000 customers):

- Month 1 revenue: $120,000 (first purchase)
- Month 3 revenue: $30,000 (25% repurchased)
- Month 6 revenue: $24,000 (20% repurchased)
- Month 12 revenue: $18,000 (15% repurchased)
- Month 18 revenue: $12,000 (10% repurchased)
- Total: $204,000
- Average revenue per customer = $204,000 / 1,000 = $204
- LTV = $204 x 55% margin = $112.20

This accounts for actual purchase patterns, not averages.

**Service Businesses (Consulting, Agency, Professional Services)**

Formula:

LTV = Average Project Value x Projects per Year x Client Tenure x Gross Margin %

Example: marketing agency

- Average project value: $15,000
- Projects per year: 3 (quarterly retainers or projects)
- Client tenure: 2.5 years
- Gross margin: 45%
- LTV = $15,000 x 3 x 2.5 x 0.45
- LTV = $15,000 x 7.5 x 0.45
- LTV = $50,625

Retainer-based services are similar to subscription.

Example:

- Monthly retainer: $8,000
- Average client tenure: 18 months
- Gross margin: 50%
- LTV = $8,000 x 18 x 0.50
- LTV = $72,000

Project-based services (variable project size): calculate based on actual client spending patterns.

Example:

- Client #1: $10K project, then $5K, then $20K over 2 years = $35K
- Client #2: $50K project, then $30K over 3 years = $80K
- Client #3: $15K project only = $15K
- Average = ($35K + $80K + $15K) / 3 = $43,333
- LTV = $43,333 x 50% margin = $21,667

**Transaction/Marketplace Businesses**

Formula:

LTV = Average Transaction Value x Transactions per Year x Customer Lifespan x Take Rate (Gross Margin)

Example: food delivery platform

- Average order value: $35
- Orders per year (active user): 24
- Customer lifespan: 3 years
- Take rate: 20%
- LTV = $35 x 24 x 3 x 0.20
- LTV = $35 x 72 x 0.20
- LTV = $504

Two-sided marketplace: calculate LTV for each side.

Example: freelancer platform, buyer side LTV:

- Projects posted per year: 4
- Average project value: $2,000
- Buyer lifespan: 2 years
- Platform fee: 15%
- Buyer LTV = $2,000 x 4 x 2 x 0.15 = $2,400

Seller side LTV:

- Projects completed per year: 12
- Average project value: $1,500
- Seller lifespan: 3 years
- Platform fee: 15%
- Seller LTV = $1,500 x 12 x 3 x 0.15 = $8,100

Total platform LTV = Buyer + Seller (though usually focus on one for acquisition).

**Freemium Businesses**

Calculate separately for free and paid users.

Example: freemium SaaS, free users:

- Conversion to paid: 5%
- Value if convert: $0 (while free)

Paid users (former free users):

- MRR: $50
- Churn: 4% monthly
- Gross margin: 80%
- Paid LTV = $50 x (1/0.04) x 0.80
- Paid LTV = $50 x 25 x 0.80 = $1,000

Blended LTV (including free users):

- Blended LTV = (% who convert x Paid LTV) + (% who don't x $0)
- Blended LTV = (0.05 x $1,000) + (0.95 x $0)
- Blended LTV = $50

Implication: You can spend up to ~$17 to acquire a free user (assuming 3:1 LTV:CAC ratio).

**Usage-Based / Consumption Businesses**

Revenue varies based on usage.

Example: cloud infrastructure

- Average monthly spend: $1,200 (but varies widely)
- Customer lifespan: 4 years
- Gross margin: 70%

Problem: Usage grows over time for most customers.

Better approach: track cohorts and actual spending pattern.

- Month 1 average: $1,200
- Month 12 average: $2,000 (expansion)
- Month 24 average: $3,000 (further expansion)
- Month 36 average: $3,500
- Month 48 average: $4,000
- Average monthly spend over lifetime = Calculate weighted average

Or use expansion-adjusted calculation:

LTV = (Starting monthly spend x Net Revenue Retention rate x Months) x Margin

If NRR = 120% (20% expansion annually):

- Year 1: $1,200/month
- Year 2: $1,440/month (1.20 x $1,200)
- Year 3: $1,728/month (1.20 x $1,440)
- Year 4: $2,074/month (1.20 x $1,728)
- Total = Sum all months x margin

#### LESSON 3: Using LTV to Set Budgets and Optimize Business Economics

Once you know LTV, you can make informed acquisition and optimization decisions.

Here's how to use LTV strategically.

**The LTV:CAC Ratio**

Formula:

LTV:CAC Ratio = Customer Lifetime Value / Customer Acquisition Cost

What the ratio means:

- 3:1 or higher = Healthy business (industry standard)
- 1:1 to 3:1 = Warning zone (thin margins, risky)
- Below 1:1 = Losing money on every customer (unsustainable)

Example:

- LTV = $1,200
- CAC = $400
- LTV:CAC = $1,200 / $400 = 3:1

Healthy ratio. For every $1 spent acquiring customers, you get $3 back in profit.

Why 3:1? The other $2 needs to cover:

- Operating expenses (salaries, overhead, rent)
- Retention costs
- Growth investment
- Profit margin

If ratio is 1:1: you break even on acquisition. No money left for operating costs. Business fails.

If ratio is 10:1: you're underleveraged. Could grow faster by spending more on acquisition.

**Setting Customer Acquisition Budgets**

Maximum CAC formula:

Maximum CAC = LTV / 3

(Using 3:1 ratio as target.)

Example:

- LTV = $900
- Maximum CAC = $900 / 3 = $300

You can spend up to $300 acquiring a customer and maintain healthy unit economics.

Channel-specific budget allocation: different channels have different CACs.

Example, LTV: $1,200, Target CAC: $400 (3:1 ratio). Channel performance:

- Organic: CAC = $50 (24:1 ratio), max out investment
- Content marketing: CAC = $200 (6:1), invest heavily
- Paid search: CAC = $350 (3.4:1), invest but monitor
- Display ads: CAC = $600 (2:1), reduce or eliminate

Budget allocation: invest most in channels with best LTV:CAC, reduce investment in channels below 3:1.

**Segment-Specific Acquisition**

Calculate LTV by segment, spend accordingly.

Example, enterprise segment:

- LTV: $50,000
- Max CAC: $16,667

SMB segment:

- LTV: $2,000
- Max CAC: $667

Implication:

- Enterprise: Can afford expensive sales team, events, direct outreach
- SMB: Must use low-cost channels (content, SEO, self-serve)

Without segment LTV, you might spend $5,000 acquiring SMB customers worth $2,000.

**Payback Period**

How long to recover acquisition cost?

Formula:

Payback Period (months) = CAC / (Monthly Revenue x Gross Margin)

Example:

- CAC: $600
- Monthly revenue per customer: $100
- Gross margin: 70%
- Monthly profit: $100 x 0.70 = $70
- Payback period = $600 / $70 = 8.6 months

Why payback period matters:

- Shorter payback = less cash required for growth
- Longer payback = need more capital to fund growth

Healthy benchmarks:

- SaaS: 12-18 months
- E-commerce: 3-6 months
- Services: 6-12 months

If payback is 36 months: you need 3 years of customer payments to recover acquisition cost. Risky. Hard to scale.

**Optimizing LTV: The Four Levers**

Small improvements in LTV components = massive value.

**Lever 1: Increase Average Purchase Value**

Tactics:

- Upsell to higher plans
- Add premium features
- Bundle products
- Raise prices

Example:

- Current: Average order = $100
- Improvement: Increase to $110 (+10%)

If customer buys 4 times over 2 years:

- Before: $100 x 4 x 2 x 50% = $400 LTV
- After: $110 x 4 x 2 x 50% = $440 LTV

+10% AOV = +10% LTV = +$40 per customer. With 1,000 customers = $40,000 additional lifetime value.

**Lever 2: Increase Purchase Frequency**

Tactics:

- Email reminders
- Subscription models
- Loyalty programs
- Retargeting ads

Example:

- Current: 3 purchases/year
- Improvement: 4 purchases/year (+33%)
- Before: $100 x 3 x 2 x 50% = $300 LTV
- After: $100 x 4 x 2 x 50% = $400 LTV

+33% frequency = +33% LTV = +$100 per customer.

**Lever 3: Increase Customer Lifespan (Reduce Churn)**

Most powerful lever for subscription businesses.

Tactics:

- Better onboarding
- Proactive customer success
- Product improvements
- Engagement campaigns

Example (SaaS):

- Current: 5% monthly churn = 20 month lifespan
- Improvement: 4% monthly churn = 25 month lifespan (+25%)
- MRR: $200
- Gross margin: 80%
- Before: $200 x 20 x 0.80 = $3,200 LTV
- After: $200 x 25 x 0.80 = $4,000 LTV

Reducing churn from 5% to 4% = +$800 LTV (+25%). With 1,000 customers = $800,000 additional lifetime value.

This is why retention is so critical.

**Lever 4: Increase Gross Margin**

Tactics:

- Negotiate better supplier costs
- Automate to reduce labor costs
- Optimize pricing
- Reduce waste

Example:

- Current: 50% gross margin
- Improvement: 55% gross margin (+10% relative)
- Before: $100 x 4 x 2 x 0.50 = $400 LTV
- After: $100 x 4 x 2 x 0.55 = $440 LTV

+5 percentage points margin = +10% LTV.

**Compound Effect of Multiple Levers**

Improving multiple levers compounds.

Example, baseline:

- AOV: $100
- Frequency: 3/year
- Lifespan: 2 years
- Margin: 50%
- LTV: $300

Improvements:

- AOV: +10% to $110
- Frequency: +33% to 4/year
- Lifespan: +25% to 2.5 years
- Margin: +10% relative to 55%

New LTV:

- LTV = $110 x 4 x 2.5 x 0.55
- LTV = $605

Result: +102% LTV improvement ($300 to $605). With 1,000 customers: +$305,000 in lifetime value.

This is why LTV optimization is so valuable.

**Prioritizing LTV Optimization**

Which lever to pull first? Priority framework:

1. Impact: Which lever increases LTV most?
2. Ease: Which is easiest to implement?
3. Speed: Which delivers results fastest?

Generally:

- Retention (reduce churn): Highest impact for subscriptions, moderate difficulty
- Purchase frequency: High impact for e-commerce, moderate ease
- AOV: Moderate impact, easiest to implement (pricing/upsells)
- Gross margin: Lower impact, hardest to improve

Start with retention if subscription business, frequency if transaction business.
