Customer Lifetime Value (LTV) Explained

• 1. The simple SaaS LTV formula
• 2. Why gross margin matters
• 3. Why churn matters even more
• 4. The big assumption that breaks the formula
• 5. Cohort-based LTV (the better approach)
• 6. When LTV calculations go wrong
• 7. The relationship between LTV and pricing
• 8. LTV at different stages
• Next steps

Customer Lifetime Value (LTV) is the total gross profit you expect from one customer over their entire relationship with your company. The simplified SaaS formula is ARPA × Gross Margin % / Monthly Churn %. That gives you a serviceable number for SMB SaaS with stable churn — but for enterprise, for early-stage companies, or for any business with cohort-varying churn, the simple formula understates or overstates LTV by 30–50%. This article walks through the formula, the assumptions baked into it, and when to use the LTV Calculator versus a more sophisticated cohort approach.

Why LTV matters: You cannot decide what to spend on acquisition until you know what a customer is worth. LTV is the input that anchors every other unit-economic decision you make.

1. The simple SaaS LTV formula

LTV = ARPA × Gross Margin % / Monthly Churn %

Where:

• ARPA = Average Revenue Per Account per month
• Gross Margin % = (Revenue − COGS) / Revenue
• Monthly Churn % = Customers (or revenue) lost / starting base, monthly

If ARPA = $200, GM = 80%, and monthly churn = 2%:

LTV = $200 × 0.80 / 0.02 = $8,000

That $8,000 is the gross profit you expect that customer to produce, on average, over their entire relationship with you.

2. Why gross margin matters

The most common LTV mistake is using revenue instead of gross profit. If you charge a customer $1,000/month but your COGS to serve them is $200/month, the $800 of gross profit is what you actually keep — and what compounds against your CAC.

LTV is conventionally measured in gross profit terms because R&D and G&A are not customer-specific costs. Use gross margin. If your LTV looks suspiciously high, this is the first place to check.

3. Why churn matters even more

LTV is inversely proportional to churn — half the churn means double the LTV. Some illustrations at ARPA = $200, GM = 80%:

This is why churn reduction is usually the highest-ROI activity an early SaaS can run. Dropping monthly churn from 3% to 2% increases LTV by 50% with zero acquisition or pricing changes.

4. The big assumption that breaks the formula

The simple LTV formula assumes constant churn forever. In reality, churn varies by cohort, by tenure, and by segment. Specifically:

• Early-stage companies usually have improving cohorts — newer cohorts churn less because the product and onboarding got better. Simple LTV understates true LTV.
• Some products have honeymoon churn — high churn in months 1–3, then very low churn. Simple LTV with month-1 numbers overstates LTV.
• Enterprise customers often have tenure-decreasing churn — the longer they stay, the less likely they leave. Simple LTV understates LTV.

For any of these, you want cohort-based LTV instead.

5. Cohort-based LTV (the better approach)

Cohort LTV tracks actual retention curves of customers acquired in the same period. Steps:

1. Group customers by the month they signed up (the cohort)
2. Track each cohort's retained revenue month by month
3. Sum the cumulative gross profit retained
4. Project forward using the observed retention curve

The result is much closer to ground truth, especially for businesses where retention improves with tenure. Most BI tools (Looker, Metabase, Mixpanel) can produce cohort retention curves with one query.

6. When LTV calculations go wrong

• You include trial users in churn. Trials are not LTV inputs.
• You compute churn weekly but ARPA monthly. Mismatched units; LTV explodes.
• You blend SMB and enterprise. Same problem as with CAC — the average hides everything.
• You include expansion in ARPA but ignore it in projections. Inconsistent.
• You use a churn rate from a 6-month-old cohort. Out of date by the time you act on it.

7. The relationship between LTV and pricing

If you raise prices 10% with no churn impact, LTV goes up 10%. If you raise prices 10% and churn goes from 2% to 2.4%, LTV goes from $8,000 to $7,333 — a 8% drop despite higher prices.

This is why pricing changes must be paired with churn monitoring, not just an ASP report.

8. LTV at different stages

For most founders reading this article, "cohort by segment" is the right level of rigor.

Next steps

Three steps to get a real LTV number this week:

1. Pull ARPA, gross margin %, and monthly churn → use the LTV Calculator for a quick read.
2. Pull your last 6 months of churn → use the Churn Rate Calculator to compute gross vs net churn and see which one is moving.
3. Combine LTV and CAC in the LTV:CAC Ratio Calculator. The ratio is the punchline, not the LTV.

Then once a quarter, redo the cohort version with actual retention data and see how the simple formula compares. If they diverge by more than 20%, your simple-formula assumptions are off.