How Do You Calculate Customer Lifetime Value?

What Is the Customer Lifetime Value Formula?

Customer lifetime value (CLV, often written LTV) is the gross profit a customer brings you over the whole relationship, and the formula is average yearly revenue × gross margin × the years a customer stays. Each input comes from records you already have, and a spreadsheet with two or three years of history is enough to start.

1. Group your customers by type, using groupings your sales team already recognizes, such as industry, company size or ownership.
2. Find the average yearly revenue per customer in each group, by dividing a year’s revenue from the group by the number of active customers in it.
3. Apply the group’s own gross margin (the share of revenue left after the direct cost of delivering the work), because discounts and service costs differ from one type of customer to another.
4. Work out how many years a typical customer in the group stays, from renewal and repeat-purchase history, or from the churn rate if customers pay on a recurring basis (covered below).
5. Multiply the three to get each group’s lifetime value.

Subtract what it cost to win a customer and you have customer profitability, which our guide to calculating customer profitability covers along with the costs to count. Lifetime value is the figure before that subtraction, the one you compare your acquisition cost against, what is a good customer lifetime value covers how to judge the result, and the lifetime value comparison on our IMPACT Prospect page runs it for your own groups.

Should You Calculate Lifetime Value From Revenue or Gross Profit?

Calculate customer lifetime value from gross profit, because revenue includes the cost of delivering the work, so a revenue figure suggests you can afford to spend money you’ll never keep. A revenue lifetime value is useful for forecasting sales, but any decision about what to spend should use the gross profit version.

The second half of the answer matters as much as the first, because a single average across the three types would sit somewhere in the middle and describe none of them. Marketing using that average would overspend chasing public bids and underspend on property management firms, which is why we calculate it per type, and why the IMPACT Prospect step starts from this comparison.

How Do You Calculate Customer Lifetime Value From Churn Rate?

When customers pay on a recurring basis, the years they stay is roughly one divided by the share who leave each year (the churn rate), so lifetime value becomes yearly gross profit per customer divided by yearly churn. For businesses that sell projects or one-off orders, use purchase history instead, because there’s no renewal to measure churn against.

• Subscriptions and contracts: use the same period throughout, so monthly revenue × gross margin ÷ monthly churn, or the yearly equivalents. Measure churn for each type of customer over at least a year, because a single quarter with a handful of cancellations can swing the result by years.
• Projects and repeat orders: multiply the gross profit per order by the orders a customer places in a typical year and the years they keep buying. Better still, take customers who started two or three years ago and add up the gross profit they’ve produced since, which replaces three estimates with one record.
• Both at once: keep recurring work and follow-on project work as separate lines, because the project line is less certain and usually arrives later.

Why Is Customer Lifetime Value Important for Marketing Decisions?

Customer lifetime value is important because it sets the most you could spend to win a customer and still make money, and it shows which types of customer, and which channels, deserve the budget. Comparing it with customer acquisition cost (CAC) is the idea behind the LTV to CAC ratio, lifetime value divided by what it cost to win the customer.

There is no ratio that’s right for every business, as what is a good customer acquisition cost explains in its look at the common 3:1 rule, because what you can afford to spend depends on how much of the lifetime value arrives early, what your cash flow can carry while you wait for it, and how fast you’re trying to grow. A customer who brings most of their profit in the first year leaves little room to spend most of it winning them, while one who pays steadily for years can justify more, if the business can carry the wait.

Once you have lifetime value by type, use it in four places:

• Set your own ceiling for each type of customer from lifetime value, how quickly the profit arrives and your cash position, and check your customer acquisition cost against it.
• Aim your targeting at the type with the highest lifetime value and describe that buyer so sales would recognize them on a first call.
• Judge each channel by the lifetime value of the customers it brings, because a channel that costs more per customer can bring bigger ones, which the Channel Selection step shows with the contractor’s own channels.
• Recalculate once a year, because margins, renewals and the mix of customers shift, and how to increase customer lifetime value covers which of those to work on.

When Does Customer Lifetime Value Give You the Wrong Answer?

Customer lifetime value gives the wrong answer when it’s taken from a report that counts revenue, when most of it arrives years from now, or when the years a customer stays are estimated from the newest customers. Check these three before the number goes into a budget.

• A lifetime value from an analytics or ecommerce tool. Google Analytics 4, for example, reports lifetime value as revenue, such as the average revenue new users generate in their first 120 days.¹ That’s useful for comparing channels, but multiply it by your margin before deciding what to spend.
• Profit that arrives late. Profit in year seven is worth less than profit today and is less certain, so for long relationships ask finance to discount the later years, or count only the years you’d bet on.
• Churn measured on new customers. In the accounts we review, new customers tend to leave faster than ones who have already renewed, so churn from your first year of customers can understate how long the survivors stay, and churn from your oldest customers can overstate it for new ones.

The profitability guide covers the other cases where the number needs a second look, such as a type of customer with little history or a few large accounts that dominate an average, in its section on how customer profitability differs from lifetime value.