Ultimate Guide to SaaS Metrics.

The Ultimate Guide
to SaaS Customer
Lifetime Value (LTV)
Customer Lifetime Value (LTV) is an estimate of
the average gross revenue that a customer will
generate before they churn (cancel).
A “basic” LTV formula
This basic formula for LTV is commonly accepted as a useful starting
point for estimating the LTV of SaaS customers. However, it’s only a
rough estimate, and doesn’t properly account for Monthly Recurring
Revenue (MRR) expansion, contraction or the fact that churn doesn't
occur linearly (see pages 2 & 3).
Your Product
Activation
Free
Trial!
Customer Lifetime
Buy
$50
Renew
+
$50
Renew?
X
# of months to
examine
Churn
Renew
+
LTV = ARPA x
$50
Σ
(1 - Customer churn rate) ^ n
n=0
= $150 Lifetime Value
A User
This can be simpliﬁed to the following formula, which will trend to
the same result:
ARPA
LTV =
Why should I care about LTV?
Primarily to apply a limit to your Customer Acquisition Cost (CAC) if you're spending more on acquisition than you anticipate to earn
from the customer in revenue, you're going to be in a bad place
very soon (unless you have a bottomless pot of money to spend
on acquisition).
i
Cust.
Churn Rate
Important: Make sure that both
these values are from the time range
for which you are measuring LTV.
ARPA (aka ARPU, ARPC) = Average Revenue Per Account (in
MRR). For this guide we are only focussing on subscription
revenue. If you are a SaaS that has additional revenue such
as setup fees, metered charges or any other type of one
time payment you will need to decide how to account for
this.

Customer churn rate and LTV
Customer churn rate is the rate at which a business is losing customers due to cancellations (proactive churn) or failures to renew (passive
churn), and is usually measured on a monthly basis.
How churn rate affects LTV
One diﬃculty with estimating LTV is factoring in customer churn rate. The “simple” LTV formula assumes that churn happens linearly over the
lifetime of a customer. However this is never really the case in most real-world scenarios.
What does your customer churn pattern look like?
Here are a few typical churn patterns presented by Tomasz Tunguz:
Annual Renewals churn fairly evenly over time, with a larger churn at each contract renewal.
Cliff churn patterns have the majority of their churn within the ﬁrst month, and then a small constant churn thereafter.
Constant is a steady, constant churn rate (shown here as 3.5%).
Declining demonstrates a churn rate starting at zero and increasing 0.25% each month.
Effect on LTV:
Percent of cohort remaining under 4 diﬀerent churn patterns
% of Cohort Remaining
100%
75%
The “Cliﬀ”
pattern results
in 75% lower
than the
average LTV
estimate
suggests!
1000
50%
500
25%
Month 0
3
6
9
Annual Renewals
12
15
Cliﬀ
18
21
24
27
Constant
30
33
Declining
Source: tomtunguz.com/churn-fallacies
0
Annual Renewals
Cliﬀ
Constant
Declining
Source: tomtunguz.com/churn-fallacies
Adjusting your LTV formula for varying churn
patterns
Other ways to account for varying churn in your
LTV calculation
If your customer churn contains a mixture of Annual Renewals,
Constant, Declining and Cliﬀ patterns, an easy way to adjust our
simple LTV formula is to account for the variance by applying a
discount:
Adopt a more advanced LTV estimation formula
You can use statistical models such as Bayesian Probability, which
take a probabilistic approach to predicting LTV.
2
(
ARPA
Cust.
Churn Rate
(
LTV =
x 0.75
Leads to a more
conservative LTV
estimate
The Complete Guide to SaaS Lifetime Value (LTV)
Calculate LTV per customer segment
Diﬀerent customer segments can have widely varying LTV. It’s a
good idea to segment your customer base to get more meaningful
results, e.g. calculating LTV separately for customers paying
monthly vs annually is highly recommended.

Account expansion / contraction and LTV
$
Account expansion refers to any increase in recurring
revenue after the initial purchase, usually occurring from
a plan upgrade.
$
Account contraction refers to any reduction in recurring
revenue occurring after the initial purchase. This could be
due to a customer downgrading their plan or adding a
discount.
Example: How account expansion affects LTV
Customer X is on a $100 monthly plan. We expect them to churn
after 1 year.
LTV = $1200
Customer Y is also on a $100 monthly plan, also expected to
churn after 1 year. But Customer Y upgrades their plan to a $150
monthly plan in month 4, and then again to a $180 plan in
month 8.
LTV = $1800 (Pretty significant difference!)
LTV with
expansion
Expansion
Expansion
LTV without
expansion
Should I consider account expansion or contraction in my LTV formula?
Case
Characteristics
Formula
B2C
Usually expansion or contraction is less relevant with B2C products. Most
customers generally subscribe on a speciﬁc plan and stay on that plan for
the lifetime of their subscription.
Here we can simply use
the standard formula:
B2B
Your B2B business model doesn’t involve signiﬁcant expansion in MRR during
the lifetime of a customer, i.e. customers aren’t likely to move to a higher tier.
ARPC
(No expansion)
LTV =
Cust.
Churn Rate
Accounts for basic (linear) expansion
B2B
(With expansion)
Your business model leads to a steady expansion in
MRR for existing customers, e.g. because you’re billing
per number of users.
ASP
LTV =
Cust.
Churn Rate
m ( 1 - Churn Rate)
+
Cust.
Churn Rate 2
Note: This addition, proposed by David Skok accounts for some basic and consistent revenue expansion. Here, m is the
monthly growth in ARPA per account. We've also replaced ARPA in the initial section of the formula with ASP (Average Sale
Price) - the average initial price (in MRR) that customers pay at the time of conversion.
Some precautions when calculating LTV
In some scenarios, estimating LTV may not be so useful - for businesses with a small number of customers, the estimated value is likely
to ﬂuctuate from month to month due to the small sample size.
The LTV metric covered here only measures subscription revenue. If your business has any other signiﬁcant revenue such as one-time
payments, setup fees or metered charges in your product, you should think about accounting for these too.
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The Complete Guide to SaaS Lifetime Value (LTV)

Conclusion: a modular LTV formula
Here’s the complete formula for Customer Lifetime Value, with the optional components covered in previous pages - you can add or
remove them according to the characteristics of your business:
Our “base”
LTV formula.
Add this to allow for some
linear account expansion.
ARPA
Customer Lifetime Value (LTV)
=
0.75 x
Cust.
Churn Rate
+
(
m ( 1 - Cust. Churn Rate)
Cust.
Churn Rate 2
(
Add this to compensate for variable churn,
for a more conservative LTV estimate.
ASP Also swap out the ARPA
in the 1st part for ASP.
m = the monthly growth in ARPA per account.
ASP (Average Sale Price) = the average initial price (in MRR) that customers pay at the time of conversion.
3 ways to use LTV
So you have an estimate of your customer lifetime value that you’re happy with, based on the characteristics of your business. How do you go
about applying it in the situations where it’s useful?
1
Tracking your LTV to Customer Acquisition Cost ratio
Look at your Customer Acquisition Cost. How much on average are you spending to acquire a user? According to Dave Kellog
(kellblog.com), if your LTV/CAC ratio isn’t 3.0 or higher, you could be spending too much on customer acquisition.
2
Evaluating your most valuable marketing channels
Measuring LTV for each marketing channel can be a highly eﬀective way to prioritise those channels which acquire the most
valuable users.
3
Focus on retaining your most valuable customers
Minimizing churn is a critical activity in any SaaS startup, particularly through rapid growth. Looking after the customers
belonging to the segment with the highest average LTV could have a large impact on your ability to maintain MRR growth.
References
We couldn’t have produced this guide without the leading work of the following people:
Tomasz Tunguz - http://tomtunguz.com/churn-fallacies/
Christoph Janz - http://theangelvc.net
David Skok - http://www.forentrepreneurs.com/saas-metrics-2-definitions/
Corey Pierson (Custora) - http://blog.custora.com/2011/08/why-average-retention-rates-can-lead-to-50-error-in-clv/
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The Complete Guide to SaaS Lifetime Value (LTV)
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