LTV: From Zero to Hero (The Definitive Guide)
Avoid the 4 most common LTV traps and master the formula, from basic to advanced.
LTV (Customer Lifetime Value) is the most inconsistently calculated metric in marketing. I’ve seen every possible version of it, even at public companies.
If you’re calculating yours today, you are likely falling into one of four traps:
Using Revenue instead of Margin: To represent value, the numerator must be contribution margin (revenue net of COGS, fees, and variable costs).
Unrealistic Time Horizons: Calculating a 10-year LTV for a non-subscription e-commerce brand is a recipe for bankruptcy.
Ignoring Survival Probability: You cannot assume 100% of customers stay forever. You must adjust each period by the probability of a customer being active.
Ignoring the Time Value of Money: $100 received in two years is not worth $100 today.
Knowing what to avoid is only half the battle. To be a “Hero,” you need to know which formula to deploy for your specific business model and requirements. Here are the three ways to calculate LTV.
1. Basic: The Perpetuity Formula
Best for: Stable businesses with predictable churn and no major fluctuations in margins.
This is the “back of the envelope” calculation. It assumes that the customer relationship could theoretically last forever, but it’s limited by the churn rate.
The Formula:
CM: Contribution margin per period.
CR: Churn rate (percentage of customers who leave each period).
Real-World Example:
Imagine a boutique gym. The member pays a monthly fee that results in a $50 contribution margin (CM). Their monthly churn rate is 5% (CR).
LTV = ($50 / 0.05) = $1000.
2. Intermediate: The Probability-Adjusted Formula
Best for: Businesses with high early-stage churn or non-contractual relationships (e.g., e-commerce).
This method recognizes that 100% of customers are active the day they are acquired, but that number drops over time. You adjust the margin of each period by the “Survival Probability”.
The Formula:
CM: Contribution margin per period.
CR: Churn rate per period (percentage of customers who leave each period).
s: Survival probability per period (percentage of active customers per period, i.e. retention rate).
Real-World Example:
Let’s look at a fashion e-commerce business.
Year 1: 100% Retention Rate. Expected Margin: $50.00.
Year 2: 50% Retention Rate. Expected Margin: $25.00.
Year 3: 30% Retention Rate. Expected Margin: $15.00.
Year 4: 20% Retention Rate. Expected Margin: $10.00.
By summing these “decaying” margins over a set horizon, you get a much more realistic view of what a customer is actually worth.
LTV (4 Years) = ($50 + $25 +$15 +$10) = $100.
LTV (2 Years) = ($50 + $25) = $75.
Choosing a lifetime cap: For most e-commerce businesses, it’s best practice to truncate LTV calculations between 2 and 5 years, to ensure projections remain grounded in realistic market conditions and avoid the "infinite value" trap.
Calculating survival probabilities in practice: To calculate survival probabilities in practice, you should track customer cohorts over time and determine the percentage of users who remain active at each specific interval (e.g., month 1, month 2, etc.). If you’d like me to cover how to run these calculations with an example, let me know in the comments.
3. Advanced: The Net Present Value Formula
Best for: High-growth startups, SaaS, or companies with very long customer lifecycles.
This is how you connect CMO thinking with CFO thinking. It incorporates the Discount Rate, the annual interest rate or opportunity cost of capital.
The Formula:
CM: Contribution margin per period.
CR: Churn rate per period (percentage of customers who leave each period).
s: Survival probability per period (percentage of active customers per period).
(1+i)^t: Discount rate.
i: Annual interest rate or opportunity cost of capital.
Real-World Example:
Let’s look at a SaaS business with yearly contracts with upfront payments, and add a e.g. 12% annual discount rate to account the fact that $1,000 in 10 years is not the same as $1,000 today.
Suppose this business offers yearly contracts at $1,000 contribution margin and the churn rate is stable at 10%.
Year 1: 100% RR. Exp. CM: $1,000. NPV: $1,000 / (1 + 12%)^(1-1) = $1,000
Year 2: 90% RR. Exp. CM: $900. NPV: $900 / (1 + 12%)^(2-1) = $804
Year 3: 81% RR. Exp. CM: $810. NPV: $810 / (1 + 12%)^(3-1) = $646
Year 4: 73% RR. Exp. CM: $730. NPV: $730 / (1 + 12%)^(4-1) = $519
Year 5: 66% RR. Exp. CM: $660. NPV: $660 / (1 + 12%)^(5-1) = $417
Year 6: 59% RR. Exp. CM: $590. NPV: $590 / (1 + 12%)^(6-1) = $335
Year 7: 53% RR. Exp. CM: $530. NPV: $530 / (1 + 12%)^(7-1) = $269
Year 8: 48% RR. Exp. CM: $480. NPV: $480 / (1 + 12%)^(8-1) = $216
Year 9: 43% RR. Exp. CM: $430. NPV: $430 / (1 + 12%)^(9-1) = $174
Year 10: 39% RR. Exp. CM: $390. NPV: $390 / (1 + 12%)^(10-1) = $140
LTV (Non-Discounted): $6,513
LTV(Discounted): $4,519
Once you factor in that future money is worth less today, the lifetime value might drop significantly.
How to choose the interest rate for discounting: You should typically use your company’s Weighted Average Cost of Capital (WACC) or a specific hurdle rate (often set between 8% and 15%). While a standard benchmark of 10% is frequently used for retail and SaaS, you should adjust this upward for highly volatile markets or downward for stable, long-term B2B contracts to more accurately reflect the present value of uncertain future profits.
Why this matters: Taking into account the financial value of time might reveal that you are losing money on customer acquisition in present value terms. For example, suppose CAC is $5,000. Without considering the time value of money, one might conclude that customer acquisition is profitable in this example, when in fact it isn’t.
The Decision Rule
The fundamental rule for any marketing spend is simple: invest only if the projected LTV is greater than or equal to CAC.
Whether you are deciding which segment to target or when to “fire” a low-value customer, let the math, not gut feeling, guide you.
As always, if you enjoyed reading this piece, let me know with a like or a comment.
Thank you for reading,
Enrico
Thanks for sharing Enrico!
thanks for sharing