How to Calculate Lifetime Value

Mar 7, 2022

How to Calculate your LTV:CAC Ratio

The thing you want to know in building out your subscription model is understanding the Key Performance Indicator (KPI) that subscription operators use in order to measure the performance of their business. Understanding how to calculate lifetime value is the KPI equation you’ve been looking for.

The first number you are going to want to know is your Customer Acquisition Cost or CAC. This is usually calculated on a monthly basis, and it is what it costs you to win new subscribers. So to figure this out you are bucketing and summarizing all of your sales and marketing expenses for the month, and you are dividing it by the number of customers you won in that month. So if you spend $1,000 on sales and marketing, and you win 5 new customers, your CAC is going to be $200.

CAC = (Total Sales & Marketing Expenses) / (# of new customers won)

The next number you are going to want to know is your Monthly Recurring Revenue per subscriber or MRR. Here you are looking at the amount of monthly recurring revenue you have for the month and dividing it by the number of subscribers you have to figure out the average MRR per subscriber.

MRR = ($ Monthly Recurring Revenue) / (# of subscribers)

Next up is your revenue Churn Rate. This is usually looked at on a monthly basis. Here you are going to figure out how much of your revenue you are losing from people canceling or downgrading. You are going to take your lost MRR from downgrades and then divide by your total MRR, then multiply by 100 to create a percentage.
For example, let’s say your total MRR is $100, and you lose $3. Your lost MRR is $3, your total MRR is $100. 3 divided by 100 is .03 then multiply by 100 to get 3%. This 3% would be your revenue churn rate on a monthly basis.

% Churn Rate = (($Lost MRR) / ($Total MRR)) x 100

Your Margin looks at how much money is left over after you pay the expenses that you incur for each new subscriber you win.
Here you are looking at your MRR per customer and you are subtracting out your COGS – the money you spend to serve that customer.

So let’s say you get $100 from a subscriber but subscriber you win, you have to pay $30 for raw materials. Your MRR per customer – COGS would then be $70. Then divide that by your MRR per customer, or $100, then you are going to get a percentage representing your margin which will be important as we go.

Margin = ((MRR per customer – COGS) / (MRR per customer)) x 100

With these statistics, you are able to figure out the Lifetime Value of a subscriber or LTV. With this specific calculation, you are going to take your MRR per customer, multiply it by your margin, then divide that by your monthly revenue churn rate.

LTV = ((MRR Per Customer) x (Margin)) / Monthly Revenue Churn Rate

Lifetime value calculator

Now using these statistics, We’ll show you this in a real-life scenario. Let’s use the company HubSpot and compare its numbers in 2012 and then again in 2013. So we can see the difference between a successful company in 2013, and its predecessor in 2012 with a company that was not performing very well. You’ll see the statistics and how they impact the overall performance of the business, and outlook for the business.

So for HubSpot in 2012, its customer acquisition cost was $6,025 per subscriber. the MRR per customer was $429. Churn rate was 3.5% per month and their margin was 83%. That allows you to figure out the LTV for a HubSpot subscriber of $10,074.
If you look at these numbers on a statistical basis, again, you have MRR which is $429, multiply it by your margin, 83%, then divide it by your churn rate of 3.5%. using that calculation, you arrive at $10,074 LTV.

The most important number on the page is the relationship between the lifetime value you win from a subscriber and costs associated with winning her as a customer.

That is called your LTV:CAC ratio. In this case, it was a 1.6:1. meaning the lifetime value is $10,074, but it costs $6,025 just to win the customers. so you are only getting $1.60 for every $1 that it costs you to win that subscriber. That’s how you calculate lifetime value.

Most investors and most people that evaluate these types of businesses are looking for a minimum of a 3:1 LTV:CAC ratio. So when we see a 1.6:1, we know that is not a viable or successful subscription company.

Hubspot made some changes in 2013, and they made much better progress. Their CAC actually went up a little bit to $6,880 – they started targeting bigger customers. but so too did their MRR per customer, to $583. They made the most progress however on their churn rate, getting it from 3.5% a month to 2% a month. Their margin was a little flat, slightly down, but because they did so much better on their churn rate, their LTV boomed up to $23,775. Then the relationship between LTV and CAC was a healthy 3.5:1 and HubSpot went on to raise hundreds of millions of financing, and ultimately has a valuation of north of a billion dollars – a successful subscription company. It all comes down to measuring the right stats.

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