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What is Customer Lifetime Value?

cus - to - mer life -time val - ue 
noun

Customer Lifetime Value (CLTV) measures the total revenue a company generates from its customers over the course of their relationship, making it a valuable metric. The longer a customer continues to make purchases from the company, the higher their CLTV becomes. CLTV is particularly important for businesses that rely on renewal sales, such as SaaS and subscription-based companies. By calculating CLTV, businesses can make informed decisions and identify their most profitable customers. It's crucial to understand customer expectations regarding your company's products or services and how they envision their interactions with your business.
 

How does customer lifetime value work?

 
The simplest way to calculate CLTV is by multiplying the expected customer lifetime by the average revenue per account (ARPA) and then subtracting the customer acquisition cost. However, this formula may not account for various factors, such as changes in customer revenue over time or differing ARPA and gross margin figures based on your business model. To obtain a more accurate CLTV estimate, you can use a more complex calculation. Venture capital experts David Skok and Stan Reiss have proposed the following comprehensive CLTV formula: CLTV = a / c + [m(1 – c)] / c^2

Here are the variables:

"a" represents the initial ARPA per month multiplied by the Gross Margin percentage.
"m" stands for the monthly growth in ARPA per account, multiplied by the Gross Margin percentage (note that this is a dollar figure, not a percentage).
"c" signifies the Customer Churn Rate percentage, indicating the percentage of revenue not renewed at the end of a subscription term.
In addition to being a vital reference metric for SaaS businesses, CLTV can help you assess the viability of your business model when compared to the cost of acquiring customers (CAC). Another useful measure involving CLTV is the CAC return, which is calculated by dividing CLTV by CAC. To gauge the efficiency and effectiveness of your sales and marketing spending, you can also use the CLTV-to-CAC ratio, often referred to as RAC.