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Why Your LTV is Wrong: Gross Margin Matters

Why Your LTV is Wrong: Gross Margin Matters. Most LTV calculations ignore gross margin, dramatically overstating customer value. Learn to calcula...

February 12, 2025By Michael Rodriguez

Most LTV calculations ignore gross margin, dramatically overstating customer value. Learn to calculate LTV correctly.

The Gross Margin Problem

LTV = Revenue / Churn Rate ignores that not all revenue is profit. Without gross margin, you overstate the value you actually capture from customers.

Correct LTV Formula

LTV = (ARPU x Gross Margin) / Churn Rate. For a $100 ARPU with 80% margin and 5% churn, LTV = ($100 x 0.8) / 0.05 = $1,600, not $2,000.

Gross Margin Calculation

SaaS gross margin = Revenue minus cost of goods sold (hosting, support, third-party costs). Typical SaaS gross margin is 70-85%.

LTV:CAC Implications

Using revenue-based LTV inflates LTV:CAC ratio, potentially leading to overspending on acquisition. Margin-adjusted LTV provides accurate unit economics.

Frequently Asked Questions

What gross margin should I use?

Use your actual gross margin. If you do not track it, 75-80% is a reasonable SaaS estimate, but calculating your actual margin is better.

Does this change LTV:CAC benchmarks?

Yes. The 3:1 LTV:CAC benchmark assumes margin-adjusted LTV. Using revenue-based LTV means you need higher ratios to be healthy.

Key Takeaways

LTV without gross margin is misleading. Always use margin-adjusted LTV for accurate unit economics and better business decisions.

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