Core Principles for LTV Calculation

A foundational principle is that LTV should be based on

contribution margin

, not just revenue, especially for transactional businesses with high costs of sales. Contribution margin represents what remains after all variable costs of a transaction are deducted, providing a clearer picture of the value available to reinvest in the business

. Robust data tracking is crucial, enabling the monitoring of churn, average order value (AOV), and gross margin, which can then be rolled up into an LTV calculation

Components of LTV for Each Revenue Model

To calculate LTV for customers acquired through specific channels, it's necessary to understand how value is generated from each revenue stream:

Subscription-based LTV: For subscription products, LTV is derived from the Average Monthly Revenue Per Subscriber (AMRPS) multiplied by the average subscription duration, factoring in retention. New subscribers are acquired through various channels, with conversion rates from traffic to trial/freemium and then to paid subscriptions being critical . A cohort-based approach can be used, involving:

Starting with the subscription term and corresponding retention rate for a given customer cohort.
Calculating the churn rate for each subscription term.
Determining the Average Revenue Per User (ARPU) for users who remained for that specific number of terms.
Calculating the LTV Contribution per Term by multiplying the subscription term, ARPU, and churn rate.
Summing the LTV Contribution per Term to get the cumulative LTV for that cohort .

Transactional LTV: For transactional models, such as marketplaces or e-commerce, LTV is based on the average order value (AOV) and the number of transactions over a customer's lifetime, multiplied by the take rate (for marketplaces) or contribution margin percentage (for DTC/e-commerce) .

Two-sided Marketplaces: In such models, LTV calculation involves predicting the future value of users based on their early behavior and features. This can include leveraging hundreds of features like device information, sign-up details, channel information, and volunteered user data. The LTV formula might look like projected net revenue multiplied by projected lifetime transactions, further multiplied by a driver or rider split, which is crucial in a two-way marketplace .

Combining Subscription and Transactional Revenue for Total LTV by Channel

For a company with both models, customers acquired through a specific channel might engage with both subscription and transactional offerings. The LTV calculation for that channel should aggregate the contribution margin generated from both revenue streams over the customer's lifetime

. This involves:

Segmenting customers by their initial acquisition source, such as social media ads, organic search, referrals, or specific marketing campaigns .

Tracking all revenue generated by each customer within that segment, including both recurring subscription fees and individual transactional purchases over their lifetime .

Accounting for gross margin by applying the appropriate gross margin for each revenue stream to arrive at a profit contribution .

Considering customer longevity and churn to understand how long customers acquired through different channels tend to stay active and their likelihood of churning .

Aggregating the total profit contribution from all subscription and transactional activities for customers within each acquisition channel segment .

This process requires tracking customer behavior from each acquisition channel: how many convert to subscriptions, how many make transactional purchases, their retention rates for each, and the associated contribution margin

. The complexity lies in accurately attributing the incremental value from each revenue stream, especially if a customer's journey involves both

Attributing Acquisition Costs (CAC) by Channel

Each acquisition channel will have its own associated cost. To calculate LTV by channel, the Customer Acquisition Cost (CAC) for that specific channel must be accurately determined

. For marketplaces, CAC calculation is more complex, requiring a dual-sided CAC that loads costs from both the buyer and seller sides in proportion to how much of each side is being acquired, along with an incrementality assumption for supply acquisition

The Role of Payback Period

While LTV/CAC is a common metric, the

payback period

is often a more valuable measure for evaluating paid marketing performance. This metric measures how fast it takes to recoup acquisition costs, allowing for reinvestment into growth loops

. Optimizing the payback period by reducing CAC, increasing paid conversion rates, increasing ARPU, and reducing paid conversion time allows for analyzing performance by channel, cohort, and use case separately

. For companies relying on paid acquisition, the speed at which money is recouped to acquire another customer has a greater bearing on how fast the business can grow than just the raw LTV to CAC ratio

Conclusion

In summary, calculating LTV by acquisition channel for companies with both subscription and transactional revenue models involves:

Focusing on contribution margin for both revenue streams.

Segmenting customers by their initial acquisition channel.

Tracking all subsequent subscription and transactional revenue and associated gross margins for each customer.

Aggregating these profit contributions over the customer's lifetime for each channel.

Accurately attributing acquisition costs to each channel.

This granular approach allows businesses to understand which channels bring in customers with the highest overall value, whether that value stems from consistent subscriptions, frequent transactions, or a combination of both, ultimately informing strategic investment decisions. While LTV is a valuable long-term indicator, the payback period often serves as a more actionable metric for optimizing short-term growth and reinvestment, especially for paid acquisition channels

How should LTV be calculated by acquisition channel in companies with both subscription and transactional revenue models?