Customer Lifetime Value - It's not that simple - SaaS Talk with the Metrics Brothers

Live from Schenectady, New York, it's SaaS Talk with the Metrics Brothers, Growth and CAC.

I'm Growth, better known as Ray Reich, the founder and CEO of Benchmarkit.

And I'm CAC, better known as Dave Kellogg, independent consultant, EIR at Balderton Capital, and author of Kellogg.

And together we are the Metrics Brothers.

And how are those brothers doing, Ray? I know we had a little argument last episode. Can't remember exactly what it was about. How's the brotherhood doing between CAC and growth?

Well, even though I still think I want to call you NRR versus CAC, I think we're doing okay because you were taking a CAC conversation and wanted to talk about NRR, Dave.

Yeah, I do that sometimes. Sorry, Ray, but I remember it was a brief blowup on the episode. If you didn't hear it, check it out. We were talking about usage-based pricing. and how it impacts customer acquisition costs. And I got us off in left field there a little bit, but it was fun. I listened to the episode this morning, Ray, and I thought it came out pretty well in the end.

Great. Well, even though a lot, a lot of times you make it seem like it's my idea and we did spend 4 episodes on your namesake, CAC, I thought let's move from the expense side of the ledger cost, customer acquisition cost, to the revenue side, or dare I say, the gross profit side of the ledger. As measured by customer lifetime value. What do you think of that one, Dave?

I think it's a good segue from the last episode, Ray. But before we jump into the details, let's hear a word from our presenting sponsor, Maxio.

The Metrics Brothers is proudly sponsored by Benchmarkit, the B2B AI and software industry's largest, broadest, and most contextualized benchmarking index. Dave Kellogg and Ray Grote have put the Metrics Brothers podcast on hiatus for the remainder of 2026. All episodes we have ever recorded are still available in your favorite podcasting app. You can reach Dave at Kellogg and Ray on LinkedIn at Ray Reich. Thank you so much for listening to the Metrics Brothers podcast. Oh, okay, Dave, let's start with something really basic that even you will probably get right, and that is CLTV or LTV? Which one are you a disciple of?

Yeah, to see or not to see. I'm— I say LTV because I don't know what else. I don't know who else's lifetime value I'd be measuring, our employees or partners. I'm not sure. So I find the C redundant. So I say LTV. I think you say CLTV. You say tomato, I say tomato.

I see the light and it is all about customers. So I must admit, One of the biggest debates I ever got into with a fellow executive was whether the C stood for client or customer.

See, when you just call it LTV, you get to avoid that. So, but look, for the sake of the audience, we won't rabbit hole on this one, but we will say we're going to use the terms interchangeably on this episode. I'm probably going to say LTV and Ray is probably going to say CLTV, and we mean them as synonyms.

Well, let's talk about what LTV means. What does it mean?

So LTV means lifetime value or customer lifetime value, or I guess some people think client lifetime value, but LTV means lifetime value. And it is what I would call an absolute SaaS metric, like CAC versus CAC ratio. CAC is absolute. It costs us $25,000 to acquire a customer. CAC ratio is relative. It's a ratio. So if it costs us $25,000 to acquire a customer whose ARR is $12,500, then our CAC ratio is 2. LTV works the same way. LTV is an absolute dollar figure like this customer. If it's $25,000 a year and they last 10 years, then their LTV, their lifetime value, is $250,000. Or you can make it relative. And the question is, to what? And most people make it relative to the CAC. So they say the LTV to CAC, i.e., the lifetime value of the customer relative to the CAC ratio, is in this particular case $250,000 divided by $25,000, which is 10. So those are my definitions. Ray, how's it sound to you?

I hate absolute metrics because they don't inform me of anything. Because if someone tells me their customer lifetime value, the C-word, is $100,000, I'm like, so? If I spent $200,000 to get that, it's a bad deal. If I spent $20,000 to get that, it's a good deal. So we'll totally align on this one. I want to see LTV in context of CAC. But then there's a question. If you see it in context, one of the biggest disagreements I've seen on this calculation model is lifetime value based upon revenue, recurring revenue, or gross profit that's contributed.

Yeah, you're getting ahead of me, Ray. Let's come back to that in one second because there is one case to argue against my normal point of view. So I'm with you that in general, I like kind of relative metrics like CAC ratio and LTV to CAC. Better than their absolute counterparts, i.e., CAC and LTV. There is one exception though I have, which is the more homogeneous your business is, the more all your customers look the same, the more it actually might make sense to say, look, just imagine we sold something for $10,000 a year and every customer paid us between like, you know, $9,500 and $10,500. So there's a super tight distribution and there's only one mode. Then it's like, you know what? If we know that a customer is worth $10,000 a year, we might say, well, our CAC is $15,000 to get one of them and our LTV is $100,000. So our LTV to CAC is 8-something years, right? It can make sense to me in that environment. Or if you're taking each individual segment of a blended business, you might say, hey, our SMB ASP is this, our SMB CAC is this many dollars, our SMB LTV is that many dollars. So I think it can make sense either in kind of a one-hump business or when you're talking about segments. But, but look, overall, I like to start with the relative versions just like you do.

Ah, you see what you just did there? You actually do like CLTV, but it's cohorted lifetime value.

Oh, oh, did I sneak it in? I was— I try not to, but I do like cohorts. Let me answer the question you asked, right? Because you said basically, okay, we have this metric called lifetime value, and the question is, what does value mean? And there's 2 camps, as you talked about. There's the revenue camp, That says, oh, value, if they give us $100 a year, they're worth $100. And then there's the, I would argue the CFOs would say, no, no, no, if we spend $20 a year to deliver that $100, you know, $20 in COGS to deliver that $100, their actual value to us is $80. So those are the 2 camps, revenue versus gross profit. I am in the revenue camp personally. Which camp are you in? Or you could argue there's an ARR camp too. So what camp are you in on this one?

We're going to get into spat number 2 here on the podcast. I'm big time with the CFOs. I really think it's gross profit because to me it's another pseudo-proxy for cash generation potential of your customer base and your customer acquisition process. So I like gross profit.

So now we're going to have a little spat here, but hopefully these spats are good for the audience and they enjoy them. Look, I hear I have 2 counterpoints to your argument. One, if I want to factor in gross profit, I can look at CAC payback period. Because that is kind of universally acknowledged to be done on a gross profit basis. So I would argue, hey, I've already got a good metric and a very standard metric that works on a gross profit basis. The other argument is slightly more intellectual, but as these lifetimes get longer, gross profit or gross margin is going to change. Because as we hit scale, say we're a $1 million company, then a $5 million company, then a $50 million company. And if we're actually arguing that our lifetimes are 10 years, can't you tell me your gross margin isn't going to improve You know, from now where it's 75% up to where it might be 85% or 95%. So we're going to talk about this general issue of with these long lifetimes, what moves. But that's, to me, it's an argument. You could argue the revenue moves as well, I guess. But in any case, my cheap shot is, hey, won't gross profit change over time? So let's just look at revenue.

See, I am going to take the revenue counterpoint because I use in the equation, I look at the ARR, right, at the end of the year. So next year, that ARR per account is going to be higher. So whether it's the revenue or the gross profit side, they're both going to change. And don't I want a customer lifetime value that over time increases, it doesn't decrease?

But look, when you calculate this metric, you don't actually inflate the revenue by NRR every year, do you? I don't want to confuse the audience because the short answer here is if you tell me your average customer today is 100 units of ARR, our churn rate is 10%, therefore we have a 10-year lifetime, therefore the lifetime value is 10 times 100 equals 1,000. Do we agree on that math? Or are you actually going to inflate? You're going to say, oh, it's a 10-year lifetime, therefore it's 100 in year 1, 110 in year 2, 121 in year 3, blah, blah, blah.

Well, let me tell you what I do do. Okay, this is an important nuance. If it's $100 at the end of this year, I'm only going to do the calculation with $100, which is the average ARR per account. But when I calculate CLTV at the end of next year, at the end of next year, I'm going to look at the average ARR per account at the end of December '24, and it might have changed, Dave. Maybe we raised our pricing. Maybe we actually have more expansion. So my average revenue per account could change year over year, don't you think?

So the question— so this is a really interesting question, right? Because you're hitting on what am I measuring LTV to CAC for, the whole customer base or a cohort? And if you're measuring it for the whole customer base, I think you're right, which is, hey, wait a minute, it costs us— now it's kind of a weird metric because we're saying, hey, last year it cost us this much, right? The— I'm getting caught on LTV to CAC. But you're saying if our average customer is this big and the average lifetime is this long, then the value is A times B. I agree with that. So I think you're right. The interesting thing is you're not— you're getting it, but in a subtle way, because you're not inflating it every year by the NRR. But you're saying for any given period, I'm just going to take at the end of that period, the average value, and that will tend to go up over time by the NRR. That's really interesting. I hadn't actually thought about that before.

Yeah, like last episode, you talked about 12 months trailing spend, right? Well, that's really what the value of that customer is on December 31st, 2023. It's the average revenue per account over that trailing 12 months, right?

Yeah, yeah, I got it. I mean, look, I'll tell you what my thinking was doing, and this is, this is where I think we got separated. And it's interesting, I tend to think of this as a quarterly metric, frankly. I'd say, hmm, this quarter— and when I say this, I actually mean LTV to CAC, because that's the one I care about. Because as we just talked about, neither one of us particularly likes lifetime value by itself. So I'm always thinking about LTV to CAC in this conversation and I'm saying, hmm, the lifetime is coming from the last quarter's churn rate, right? And then I'm multiplying it by this quarter's average new customer size. So I'm doing it for a quarterly cohort in my head. But, but if you do it for a year, you're doing it for basically the whole customer base, I guess. I don't know. It's an interesting point, right? But the question is, what are you doing this for? And I think companies do it for the whole company and they'll do it on a quarterly basis. So you're like many SaaS metrics, the meaning changes whether you're calculating on a quarter or a year. I think that is—

and that's why this conversation is so important. These are the conversations going on in executive rooms every quarter, every month, right? And at least we can have this discussion here and help the audience kind of think about, oh, do I think this is the way we want to do it, that way? I still don't like CLTV to CAC on a quarterly basis. And the reason I don't like that is you can have spikes even on a quarterly basis, especially if you have a business that kind of grows over the year and your quota performance in Q1 is 20% of the year, but in Q4 it's 32% of the year, your CAC and CAC ratios are going to differ. That's why I love to always do it on an annual basis in addition to quarterly, Dave. I always think you need to look at an annual calculation of all these relative metrics.

Yeah, I got it. I, I think the big difference is, are you doing it for the whole base or you're doing it for the customers you got in last period? And I tend to do it for a set of customers I got last period to say, hey, here's— because that's who I spent the CAC on. I didn't spend the CAC on the whole base. I said, I just got this set of customers, whether it's last quarter or last year, they cost me this much to get. Now we're related to how much I think they're going to be worth. So it does work regardless of the period definition. And the most important thing, right, because I don't want to confuse people, is you do do it on the average customer size for that period, whether it's a year or a quarter, it doesn't matter. And what you don't do, which, look, you could argue, it's fun to argue about, should I explicitly say it's 100 this year, therefore 110, and do some sort of discounted cash flow analysis, right, where I'm expanding the NAR, where I'm discounting them at an inflation rate, right? Because if you're going to do one, you have to do the other. And the answer is no, nobody does that. Maybe people like you and I talk about it for fun over a beer. But, but the way you calculate this is you take the the current kind of ARR, ASP, and you multiply it by the lifetime, and the lifetime is 1 over the churn rate. Now, there is a question as to which churn rate, but I'm pretty sure we'll get there.

I was going to say, if we had that much problem on deciding what the revenue per account was, what are we going to do when it comes to churn rate?

So yeah, I can do this one if you want, because this, this one I know in my sleep. I promise not to confuse you or the audience. This one's very simple. I think of churn rate as a 2x2 matrix. And we've got net and gross, and we've got done against the whole ARR base or done against available to renew, right? Because just say it's a company that does half 2-year deals, half 1-year deals. Actually, I'll make it simpler. Half 3-year deals, half 1-year deals. Oh God, it means the mean is 2. So every year only half the base is coming up for renewal. That's why I'm trying to make it simple. So in that scenario, there's a factor of 2 difference between whether I'm dividing whatever the churn is. We can talk about whether it's net or gross in a minute, but But am I dividing it by the size of the whole ARR base, or am I dividing it by that portion of the ARR base that came up for renewal? So my argument is, and always been, I did a talk on this at SaaStr a couple of years ago called Churn is Dead, Long Live NRR. And the start of that talk goes through this 2x2 matrix, net gross versus ATR and ARR. And the answer is you're going to get very different rates depending on what you do. If you do it on a net basis, hopefully you're going to get infinite lifetimes, right? Because hopefully your net churn is negative, right? I.e., your NRR is positive. So I'll let you say which, which rate you pick and which one you like, Ray. But, but when we say, gosh, it was hard to figure out what the ASP or the average contract value of the accounts is, well, it's also hard to figure out what the lifetime is because the lifetime is 1 over churn that we agree on. But then the question is, well, which of the 4 churn rates and maybe you have even more are we supposed to use in that calculation? Okay.

So first of all, I use gross revenue retention. And then I do 1 minus gross revenue retention, and that's my churn rate. So if your gross revenue retention is 86%, you have a 14% churn rate. And at a 14% churn rate, you know that your life, not lifetime value, but life is right around 7.2.

And you're doing what I would call gross ARR churn, by the way, just to map our 2 worlds. That's what I would call gross ARR churn. I agree with you that gross is correct. And for financial modeling exercises, which this is, Using the whole ARR base is correct. If I signed you to a 3-year deal, you are effectively auto-renewing, and that should be reflected in the metrics. If you want to use churn or gross retention as a CSAT proxy, then you should look at based on available to renew, but different conversation. Yeah, different.

But I'm actually a big ATR, available to renew, fan. I always do gross revenue retention on an available to renew basis, Dave, because if you've got all these 3-year agreements, I don't think it's fair to do your GRR on your entire ARR base.

Oh, wow. So we have yet another spat occurring here. Spat number 3. I'm going to disagree with you on this one, Ray. Look, I'm a big believer in using ATR as well. I use ATR, available to renew, when I'm trying to figure out— when the question is, given the chance, what percent of my customers renew? Then I use ATR because the other people are effectively auto-renewing. But I want to argue we're trying to project the value of the install base of customers. I need to reflect the reality that a lot of them don't get the chance not to renew. And by the way, that churn rate, when they do get to— if you ever look at a 3-year renewal rate on an ATR basis, it's usually pretty bad, right? Because 0.9 cubed is what, 0.81, 0.72, right? You might be running a 28% churn ATR basis on 3-year contracts. But it's okay because that's equivalent, right, to 10% churn on an annual basis.

Got it. So I'm not going to disagree with you. I understand that logic. I'm just telling you that I became a disciple of NTR. So I apply it to customer lifetime value calculation also.

You're like Frank Perdue. It takes a tough, tough man to make a tender SaaS metric. I mean, that's a high bar you're setting. So I got it. Okay. There is a difference there. And I don't think we're going to— we're going to— we're not going to agree on this one. But I want people to just think about the arguments that you could do it on ATR. It's going to increase the rate, right? The rate is going to be higher. The churn rate will be higher because you're excluding auto-renewing contracts, which means you're going to get a shorter lifetime. So it's a bit, it's actually a big issue for the calculation.

It is. It is. And I've never done both and looked at them side by side in different environments. So it'd be interesting to do someday.

Homework exercise for both of us.

Yeah. Well, we're coming up on our time already. I think we've really done a really exhaustive job on what lifetime value is. And why the relative measure comparing it to CAC, we both agree, is superior. Anything else you want to leave our audience with, Dave?

Yeah, let me just run through a couple of closing things here that obviously, what's the use of this metric, right? It's to know what the average value, the average lifetime value of a given customer is. I want to hit explicitly the limitations of the metric, which we've actually talked about already organically. But one, it ignores expansion, right? Because you're just taking today's ARR and saying it's, you know, this customer will be worth 1,000 units over the next 10 years. And yes, Ray is right. When you recalculate at the end of next year, you'll include the expansion then, but you're— then you're projecting that one out 10 years, right? So you are actually forgetting downstream expansion. It assumes a constant churn rate and these churn rates fluctuate. It's highly dependent on which churn rate you pick, as we discussed. The one we didn't hit, Ray, is you get crazy lifetimes. So if you end up with a 2% churn rate, you got a 50-year lifetime. And I don't think those are credible. A lot of people solve that by an even more non-credible thing, which is putting an arbitrary cap. And finally, as we alluded to, you're not really including the time value of money. If you're going to argue you've got a 20-year lifetime, which I'm not sure is good for a 3-year-old company, you better discount it now that we have inflation rates.

Oh my gosh, discount rates. We're going to start using discounted cash flow to value SaaS companies in the future, Dave.

Capital budgeting, Ray.

Exactly. That's a whole other issue. But I still remember doing DCFs, you know, 25 years ago trying to value companies. So, well, what a great discussion. I actually really enjoyed this one, Dave, because I think the debates you and I just had are the same discussions going on in a lot of boardrooms, or at least they should be, because a lot of times it's not discussed. Well, how do you measure it and how does the investors measure it and what does the board really expect, right? Is it ATR-based or not ATR-based? So I thought this was a great discussion.

Yeah, so did I, Ray. I think in one of our future episodes we need to advise the listeners that a lot of the stuff you and I do back Well, I think it's appropriate for talking, you know, at a QBR or maybe a board meeting. When you talk to investors, I do not encourage this kind of conversation, that you want to just do it the standard way, and we'll tell you what the standard way is, and you want to present it that way. Because look, Ray, it won't surprise you, I was pretty good at winning the battle, losing the war on investors, right? We're like, we'd end up battling about how to calculate CAC ratio or CAC payback period, and that's not a great way to raise money. But we could hit that maybe a whole separate effort on like how to talk to investors about SaaS metrics.

Ooh, that's a really good one. And you know what I always lean on, Dave? If the SaaS Metrics Standards Board says this, that's what I go with.

Yeah, I agree with you, Ray. And look, I think that does a great service to people when talking to investors because you say, I'm following a standard. The standard's defined by this group. Here's how we calculate it. And you can avoid— as much as I love this stuff, Ray, when you're trying to raise money, you don't want to rathole on metrics definitions, right? You just want to say, here's how how we calculate it. Here's why we think it's meaningful. Here are the limitations in the calculation. If you calculate it differently, let me know and we can talk about it. But, but you don't want to have kind of metrics wars, which are fun and interesting and enlightening. Just don't do them with investors.

It's really nice that we are the metrics brothers who don't live in the same household because now we can take a week off, not have to worry about this little spat, and cover a new topic next week and get right back to it.

Okay. We'll have at it. Do you know what we're doing next week yet or no? Is it gonna be a surprise?

You know what? I actually don't. So we'll have to talk about this after this episode and queue it up for our listeners.

If we're still on speaking terms.

Have a great week, Dave. Thank you again.

Take care, everybody. See ya. The Metrics Brothers AI, SaaS, and More is a production of The Metrics Brothers Growth and CAC and a member of the Benchmarkit Podcast Network. By accessing this podcast, you acknowledge that The Metrics Brothers make no warranty, guarantee, or representation as to the accuracy or sufficiency of the Information provided or the humor content of the jokes told.

Ray.

Information, opinions, and recommendations presented are, according to our spouses, probably wrong and provided for information purposes only. This podcast should not be considered professional or, for that matter, unprofessional advice. We disclaim any and all liability for any direct, indirect, indirect, misdirect, incidental, special, ordinary, consequential, inconsequential, or other damages arising out of use of, or God help you, reliance upon the information presented here. Ray Grothreich is based in New York City and available on X @rayreich. Dave Kellogg is based in Silicon Valley and available on X @kelblog. Schedectady, which is French for unspellable, is not our actual production location. Thanks for listening.