The Problem With LTV in Subscription Businesses

There is a lot of love about the concept of "Life Time Value" or "LTV" for all businesses.

It is beautiful in its simplicity.  It allows you to easily:

• Understand how much you can pay to acquire a customer
• Project financial returns on user growth
• Quickly calculate your current total revenue based on your users base

With so much to love about it, why does LTV get messy for subscription businesses?

E-commerce vs Enterprise Sales vs Subscription

By definition, to understand the lifetime value of a customer, you need to:

1. See how long it takes most of your customers reach the end of their lifecycle
2. Count up all the money they paid you

This works really well when you have either have short lifecycles and/or you collect most of the money upfront.

E-commerce is the former.  The vast majority of customers will only purchase once, so you just tally up the average cart size and that basically is your LTV.

Enterprise sales is the latter, where you sign long term contracts that customers are locked into, so you can say that average contract size is your LTV.

Subscriptions business sit kinda awkwardly in the middle.

• Customers stay around for multiple month/cycles
• You typically collect the value across the lifecycle and not upfront

Even if you have found a way for most of your users to pay via annual plans, you still don't know exactly how many years they'll be around. Without knowing that you can't really know their LTV

Where did LTV come from?

LTV is a concept most directly used by online advertisers.  For the vast majority of the internet, online ads have focused around direct response style campaigns.

This means that advertisers are trying to attract your attention and convert you to a sale immediately.

Advertisers tally up the Customer Acquisition Cost or "CAC" and ensure that their CAC is less than their LTV, with the "standard" rule being to have a 3:1 CAC to LTV ratio.

Assuming that works, then profit?

I'd argue that the online advertising was so shaped by direct response ads that the concept of CAC and LTV is almost baked in as a fundamental assumption in online ads.

What makes this so much harder in the subscription world, is that whenever you change any part of your monetization engine, such as:  

• Raise or lower your prices
• Open up new acquisition channels
• Add a higher tier of service
• Create geographic pricing

You need your customers to reach the end of their lifecycle in order to really understand what this did to their LTV.

As we ​mentioned a few weeks back​, the best subscription businesses sit in the long term use cases so this probably actually gets worse for them.

For a company such as Spotify, who has no annual plan and therefore we can assume that they have an LTV over 12 months, they will probably take years to really understand what the LTV of a new price package is.

So What Do You Do With This Information?

While there is no real way of "solving" this problem, I have come across ways of making it less painful.

1. Time Window Based LTVs - Instead of measuring to the end of "lifetime", which can be a while, instead measure to 3, 6, 9, 12 month periods and base your acquisition math on those.

Which window you choose really will impact how much you are choosing to spend in CAC (as most user bases are likely worth less at month 3 than month 6)

2. Focus on Payback Velocity instead of CAC - Instead of focusing on the total amount of cost in a channel, focus on how quickly you are making your acquisition cost back in profit that you can re invest back into acquisition.

This ​blog post​ (paywalled) by Elena Verna mentions ~3 months as a good benchmark for consumer apps & 8 months as a good benchmark for B2B.

Needless to say, the faster the better.