LTV, or customer lifetime value, is one of the most important metrics for your business to understand. It equates to your ability to turn your proposition and customer relationships into monetary value over time. When combined with your Cost Per Acquisition (CPA), the LTV:CPA ratio demonstrates the fundamental unit economics of your business, and how efficiently you can grow.
To help bring the theory of LTV and the LTV:CPA ratio to life, I wanted to take three real-world examples and offer some thoughts that may help you to interpret the data that is being presented. There is no standard methodology used, so knowing how to critique an individual example is important before you draw conclusions and/or make comparisons. This is something I've done many times when reviewing Information Memorandums and Management Presentations as an investor.
I need to stress that the examples I’m going to share are only for information and education rather than for any kind of financial advice. I think it is also important to note that very few public companies disclose this type of information, and I think that all three examples should be praised for the fact that they do. They just happen to be good examples that help us to think about the questions we might ask the Management team if we want to better understand a specific LTV or LTV to CPA ratio analysis.
Example 1 – Wix
Wix, the website builder & CMS provider, presents a version of the LTV to CPA ratio called ‘Time to Return On (Marketing) Investment’. This looks at the cumulative ‘cohort bookings’ compared to marketing costs, citing a ratio of 4.8x after 19 quarters (4.25 years) based on the Q1 2018 cohort.
On the face of it, this chart shows a positive trend – but that isn’t particularly meaningful, as it just relates to the allowing more time for a cohort to generate revenue before comparing against the customer acquisition costs. I would be asking to see a comparison between different cohorts over the same time period, e.g. the Q1 2022 cohort compared to the Q1 2021 cohort and the Q1 2020 cohort for the equivalent first three quarters of their
relationship with Wix. This will tell us whether ROI is increasing, decreasing or is stable.
Reading the small print, my interpretation is that the ‘cohort bookings’ is a revenue figure rather than a profit figure – I’m sure Wix has healthy software margins but I would want to look at a profit level ROI, having deducted direct costs as well as variable personnel costs such as their customer success team.
The marketing costs are described as ‘direct acquisition marketing costs’. I would be asking whether this includes things like martech, agency and employee costs, as well as media costs that are most readily allocated to customer acquisition activities (vs. customer retention or partner marketing). Getting a true picture of Cost Per Acquisition (CPA) is in my experience the most overlooked aspect of analysing the LTV to CPA ratio.
Example 2 – Vimeo
Vimeo, the video hosting provider, goes a step further than Wix in showing the progression of its LTV to CPA (LTV/CAC) ratio over time, split between its two main customer segments. It uses this analysis to support the fact that it has ‘efficient [customer] acquisition’, which the ratios certainly support.
Digging into the definition provided, a positive is that Vimeo is taking a gross margin level view of customer lifetime value – but I would be asking the Management team how they extrapolated value over the customer lifetime. I would guess that they’ve used a current measure of net revenue retention. I always treat this with caution as it implicitly assumes that the current rate of retention can be sustained indefinitely, which understates the risk of innovation and competitive disruption over the longer term. I prefer using a fixed time ‘window’ of time, for example five years. Looking at the timing of the big step-up in ROI through Covid for self-serve customers, it is possible that this was driven by a big positive change in net revenue retention which may or may not be sustained.
As with the Wix example, I’d also be asking about the impact of variable personnel costs such as their customer success team, if these aren’t already factored into the gross margin.
The customer acquisition costs here seem to encompass all sales and marketing costs, I would check that these include personnel costs and also ask whether we should be taking any costs out that are more related to servicing existing customers or partners – i.e. are we overstating Cost Per Acquisition?
Example 3 - Remitly
Remitly doesn’t show a trend over time for their LTV to CPA ratio, but they do use a fixed five-year window, which is the most common comparison period in my experience. Reading the small print, they say that they project future periods ‘based on robust statistical models that source thousands of existing customer observations’. This is a perfectly reasonable thing to do, but I would be asking how this might compare to the actual observed historical data as you may find that there has been a notable change in their proposition or customer behaviour which has led Remitly to adopt this projected approach to lifetime value.
As with the above examples, I would also be digging into the definition of CPA here, which Remitly defines as ‘direct marketing expenses deployed to acquire new customers’. The same question applies around the inclusion of martech, agency and employee costs.
One thing that I would also be curious to learn more about is the statement that there are ‘corridor-specific targets based on customer lifetime value’. This might shed some light on which corridors have the most potential for efficient growth, which would clearly be interesting to know.
In conclusion – there are some common threads here. Make sure to read the small print to understand (i) the time period over which the LTV to CPA ratio is being calculated, (ii) whether lifetime value is based on profit (good) or revenue (bad), (iii) and how customer acquisition costs are being calculated. As I said above – these three examples are in the minority of public companies in sharing these metrics in the first place, and all look healthy. You are now hopefully armed with some questions that can be applied to any LTV to CPA ratio you see before you draw conclusions or make comparisons.
If you’d like to discuss how you can better understand and use Customer Lifetime Value in your business, please Contact Me.
All views expressed in this post are the author's own and should not be relied upon for any reason. Clearly.
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