Customer Life-time Value (CLTV)

What is it?

CLTV is the Contribution Profit a customer will generate over the course of your relationship with them. Contribution Profit = Revenue LESS Cost of Revenue (COR) LESS Sales and Marketing Costs (S&M). Other variables in this equation include Customer Count and Churn.

​NOTE: it is common to calculate CLTV using Revenue only. This approach uses Annual Recurring Revenue (ARR) and determines how much Revenue a customer will generate over the course of your relationship with them.

​How is it calculated?

CLTV can be calculated for individual customers and groups.

​To understand the mechanics, see below for one customer example. Simply put, this customer generated $20,200 of contribution profit over 4 years before they churned. CLTV for this customer is = $20,200.

​Now let’s get more complicated and see Exhibit 2 below for group calculation. The additional variables include churn % and active customers. CLTV for these 120 customers = $410,400.

Why is it important?

CLTV helps answer the question, “How much money will the relationship with my customers generate?”

​It is most effective when used to compare groups of customers. For example, if the CLTV per customer of marketing channel A is $50k and marketing channel B is $10k, one should seek to understand why channel B is lower and think about allocating future investment to grow channel A.

​CLTV can also be tracked over time to see if a company has made progress growing long-term value and potentially its valuation. This can be accomplished by analyzing monthly and comparing current month to prior months.

​CLTV helps to quantify the net impact of trends across several variables worth monitoring such as Churn, Customer Count, Upsell, CAC, Gross Margin, and ARR.

What does good look like?

CLTV success greatly depends on the business goals at the time.

At a minimum you want Contribution Profit CLTV to be positive because you want to generate profit and cash over the life of a customer relationship.

If a company is in hypergrowth mode lower CLTV may be more acceptable given large CAC investments and Cost of Revenue scaling.

​How do I improve this metric?

The simple math answer is increase ARR, lower Cost of Goods Sold, mitigate Churn, and keep the CAC ratio lower than 1.

​The practical things we have seen executed to drive the above are…

1. Keep your customers happy and retain them for as long as you can assuming they are profitable relationships. You worked hard (and spent a lot of money) acquiring them.

2. Focus on pricing, specifically around the handling of renewals and pricing language in your contracts. Price increases can be tricky to execute, but when done right are understood by your customers and a key profit driver.

3. Understand how much your products and services cost to support ongoing customer use (also known as Cost Plus Analysis). This enables you to create Deal Calculators to predict future customer Gross Margins as deals are being negotiated.

4. Assess Customer Gross Margin to learn which product, industry, marketing channels drive profitable relationships.

5. Identify opportunity to upsell your existing customers (aka Whitespace), if you understand what they currently cost you will know what price to charge to drive Gross Margin higher.

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