What is Lifetime Value (LTV)?

Lifetime Value (LTV) is a prediction of the net profit attributed to the entire future relationship with a customer. It tells you exactly how much a specific user is worth to your business from the moment they buy until they stop buying.

For a founder, this is more than just a financial metric. It is a tool for survival.

New entrepreneurs often focus entirely on the first sale. They celebrate a fifty dollar purchase without realizing it cost them seventy dollars in advertising to get it. That is a quick path to bankruptcy.

LTV forces you to look at the long term. It shifts your focus from a single transaction to the cumulative value of a relationship.

To understand LTV you need to look at the mechanics behind it. There are a few ways to calculate it depending on your business model. The most straightforward method involves three variables.

• Average Order Value: How much does the customer spend per transaction?
• Purchase Frequency: How often do they come back?
• Customer Lifespan: How long do they stick around before churning?

You multiply these three together to get the total revenue. However, you must factor in gross margin. Revenue is not profit.

If you sell a software subscription for $100 but it costs $20 to service that account, your contribution margin is 80%. Your LTV calculation must reflect that margin. Founders often inflate their numbers by using revenue instead of gross profit.

This leads to dangerous spending decisions. Always calculate LTV based on the profit left over after the cost of goods sold and service delivery costs.

LTV cannot be viewed in isolation. It effectively becomes a vanity metric unless it is paired with Customer Acquisition Cost (CAC).

CAC is the money you spend to convince a potential customer to buy a product or service. This includes advertising spend, sales team salaries, and creative costs.

The relationship between these two numbers dictates the viability of your startup. This is often expressed as a ratio.

• 1:1 Ratio: You are losing money. You spend a dollar to get a dollar of value. After operating expenses you are in the red.
• 3:1 Ratio: This is the industry standard benchmark for a healthy business. You make three times what you paid to acquire the customer.
• 5:1 Ratio: You might be growing too slowly. This suggests you could be spending more to acquire customers faster.

Understanding your LTV allows you to make evidence-based decisions rather than guessing.

It informs your product roadmap. If you see that increasing retention by two months raises LTV significantly, you should focus engineering resources on features that keep users engaged.

It dictates your marketing channels. You might find that customers coming from organic search have a 2x higher LTV than those coming from paid social ads. Even if the paid ads bring in more volume the organic users build a more stable foundation.

There are unknowns to consider here. LTV is a prediction based on historical data. Early stage startups often lack the data to make accurate predictions.

Are you assuming today’s customers will behave exactly like last year’s customers? Markets shift and competitors emerge. Founders must constantly update their LTV models to reflect current reality rather than past success.