Life Time Value

by Neel Desai

Your LTV represents the total amount of money you can expect from each of your customers throughout their time with you.

The simplest —and most naive— way to calculate it is dividing your Average Revenue Per User (ARPU) by your Churn Rate. Now, because this formula makes for a highly volatile number —even a tenth of a percentage change in churn will send this number reeling—ours is a little more complicated.

The reason is that the denominator for the LTV formula is Churn (i.e. LTV = ARPU/Churn). Now given that churn, depending on the stage and the nature of your business, can swing widely (i.e. going from 2% to 3% is a huge swing in relative terms, right? it's a 50% increase), we needed a way to sort-of bound the LTV formula.

Here's a quick thought exercise: imagine that your ARPU is $10 and, for the past six months, your churn has been stable at 4% month, which makes your LTV $250. Now say that, for some reason, your churn climbs to 6% on the current month.

Did your LTV just decrease %40? And most people, use this number to help determine how much money can be spent on customer acquisition, are you really re-thinking your entire strategy based on one month worth of churn data?

We believe that the answers to these questions are "No, your LTV did not really take a 40% hit (at least not yet!)" and "No, you shouldn't yet re-think your entire CAC budget". And because we see the job of ProfitWell to be to give you accurate, actionable data (i.e. data that you can use to make every-day business decisions), we decided to do some modeling work around "bounding" (you could think of this as "taming") the LTV calculation.

In other words, we take a look at more than the current month ARPU and churn rate: we take a look at the whole ARPU (typically stable) and churn (usually volatile) trends, apply some magic (math, really!), and go from there.

Getting this number right is extremely important, as it drives the amount of money you can spend acquiring customers. Small variations have been known to wreak havoc on the most sophisticated growth teams. 

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