Calculate Lifetime Value (LTV)

Why LTV Matters

Lifetime value is obviously important for running a successful business, so how can it be calculated?

The Simplest Way

Recommendations

1. Start with yearly granularity

I recommend starting with yearly, because it compresses information more than quarterly or monthly — thus lowering the error caused by variance (e.g., if there's a sudden influx of newly acquired customers).

2. Trend-adjust the revenue component

The limitation of the simple approach is the risk of using a stale average revenue figure. If average revenue has been increasing (or decreasing) over time, and you want the figure to apply to new customers to drive acquisition, it's advantageous to use more recent customers' average revenue per period.

The key insight: it's valuable to think about how average revenue and churn have changed over the company's lifetime.

3. Build confidence intervals via bootstrapping

At this point, the calculation produces a single number, but realistically the actual realized values will be above or below that figure. So — how much?

Figuring out if the range is material requires taking random samples of customers with replacement (bootstrapping) and calculating LTV as above for each sample to produce multiple estimates. Then you can characterize the range you're likely to experience.

This is important for:

• Downside protection — guarding against over-investment in acquisition
• Upside capture — preventing under-investment that causes disappointing revenue growth

4. Graduate to econometric models

A trend-adjusted, bootstrapped range is better than most companies can produce and can be extremely valuable. But there's often a lot more ROI to be gained by continuing to improve the LTV calculation's quality.

Using advanced econometric and statistical methods, it's possible to create a model that uses fewer and more reliable assumptions. That means fewer ways for the calculation to fail and a higher degree of accuracy. With a higher degree of accuracy, it's possible to:

• Calibrate customer acquisition cost (CAC) more finely
• Invest more confidently in advertising
• Generate more revenue through better-calibrated decisions

Many critical business decisions depend on LTV, which makes it all the more valuable to have an accurate estimate.