Unit economics
The contribution a customer produces across their whole relationship with the business, discounted for the fact that it arrives later.
Also called Lifetime value · CLV · Customer lifetime value
Formula
LTV = AOV × Purchases per year × Gross margin × Expected years
- AOV
- average order value
- Purchases per year
- orders per retained customer per year, not per visitor
- Gross margin
- as a fraction — the part of revenue that survives cost of goods
- Expected years
- 1 ÷ annual churn rate, for a business with steady churn
For a subscription the same thing is usually written LTV = ARPA × Gross margin ÷ Churn rate. It is the same statement: revenue per period, kept only in the part that is margin, for as many periods as the customer stays.
LTV is the most over-stated number in most companies, because every term in it is optimistic by default: margin before returns, frequency measured on the customers who stayed, and a lifetime inferred from a business that has not existed long enough to observe one.
Use gross margin, never revenue. An LTV in revenue terms compares a number that includes cost of goods against a CAC that does not, and the ratio it produces is meaningless.
- Average order value
- AED 420
- Orders per year
- 2.4
- Gross margin
- 45 %
- Annual churn
- 30 % → expected life 3.3 years
LTV = 420 × 2.4 × 0.45 × 3.3 = AED 1,497. Against a CAC of AED 400 that is a ratio of 3.7 : 1 — healthy, provided the churn figure is measured rather than assumed.
A two-year-old business quoting a four-year customer lifetime has not measured anything — it has extrapolated a curve past its own data. Where history is short, cap the horizon at something observed: twelve or twenty-four months of realised contribution, stated as such.
The definitions are the easy part. Whether the figure on your dashboard was computed this way is a different question, and usually the more expensive one.