LTV, the lifeblood of your business

The three most important letters for any social game company, and arguably any B2C or B2B company, is LTV, or “lifetime value.” Although most social game industry professionals acknowledge the importance of LTV, they often fail to realize it is the determinant to a company’s, product’s and / or game’s success and survival. It is the primary factor in why companies fail or are sold for tens or hundreds of millions of dollars.

What LTV consists of

LTV is a function that shows the present value of a new customer, how much that customer is worth to your company. Although I will be focusing on its application for social games, LTV can be used for any business, from valuing new customers for a restaurant using a GroupOn promotion, to a car dealer deciding how (and whether) to motivate buyers to visit the showroom.

There are three categories of variables used to calculate LTV:

• Monetization is how much customers spend over their lifetime in the game; this includes ARPDAU (average revenue per daily active user), ARPPU (average revenue per paying user) and ARPU (average revenue per user).
• Retention (which also includes engagement) is how often people come back to your game, how frequently within a certain period of time (e.g., every day, every week, every month) and how often they stay in the game when they play.
• Virality is how many additional (free) users each user will bring in (also often measured over a specific period of time). Every company has a slightly different equation for LTV, but they all include variable from these macro-categories.

Why LTV must exceed CPI

For a social or mobile game company, however, the equation takes on more importance because we rely on performance marketing such as cost per install (CPI) and cost per click (CPC) advertising, and a firm number for the cost of a new customer. Given that LTV provides the total value of a customer, as long as you can acquire new customers for less than their LTV, you should continue to use your current methods of customer acquisition (in a future blog post I will discuss how customers from different sources have different LTVs). Once the cost of an acquisition exceeds the value of the new customer, it is unprofitable to acquire that customer. The difference between the LTV and CPI is the long-term profit—or loss—from the new customer (including revenue they bring in by acquiring other users for free).

For example, If you have an LTV of $1 and a CPI of $.85, you should continue to advertise; as long as your CPI does not exceed that $1, you are making a profit on each new customer. Conversely, if you have an LTV of $0.50 and a CPI of $.85, it does not make sense to advertise at all (if you are aiming for a profit), since you lose $.35 on every new customer.

This relationship explains why most social/mobile game and media companies do not have set advertising budgets (beyond the budget needed to seed the market and obtain sufficient data to derive a reliable LTV). There is no reason to arbitrarily cap advertising expense as long as each new customer is profitable. If you can spend an additional $5 million and acquire customers worth $6 million, that makes sense even if your ad budget was $100,000. That is why you see companies like Zynga, GREE and Playdom all spend millions per month on some of their games. Conversely, if you have an advertising budget of $1 million but your LTV is significantly lower than your CPI, you should stop spending even if you have budget left. There is no reason to spend a million to get $200k back (you can take it to Las Vegas or Wall Street and get a better return).

Why LTV is so important

LTV tells you if a new customer or player is worth more than the cost of acquiring them. Simply put, if bringing in new customers is not profitable, there is no reason to bring in customers. If there is no reason to bring in customers, you have a game or business without customers. If you have a business or game without customers, you do not have a business or a game, at least not for long. This logic is why LTV is so important; it is the ultimate determinant of success.Yet, the impetus for this post (and series of posts on LTV) is that many really consider LTV secondary to other metrics. I recently heard a sophisticated investor say, “LTV is great, but why are we worrying about it now rather than focusing on increasing revenue?”

The answer? Think of an example in which a social game has an ARPDAU of $0.10, and if the company were to spend all its efforts to increase this number (which, by the way, most non-Japanese social game companies would be okay with) and after a month of work they were able to increase it by 20 percent. Now, say most players played the game for two days and never came back. Thus, originally, a player was generating $0.20 and after the month of work on monetization, that increased to $0.24. Now assume it costs this company $1 to acquire a player. Even after that month of effort they are not close to having a profitable game. Instead, they should have been working on impacting how often people come back to the game (retention) because there is almost certainly no way they could increase monetization enough by itself to create a profitable game.

Why you should focus on LTV

The example of the ignorant investor shows why LTV should be central to a social media or game company’s decision-making. Success is not about how much your product generates in a day but how much each customer will be worth over the long term. If that customer will be worth more than the cost of acquiring them, you have a major success. Thus, LTV should be the driving force for all of your product decision-making:

• You should base green-light decisions on potential LTV for the product
• Design and development should focus on how the design will optimize LTV (and this is not counter to creating a great game, as a great game would have high retention)
• Beta and pre-launch testing should look at how the three categories that make up LTV are performing
• Live services and continued development should be centered on the fixes that will have the greatest impact on LTV (as opposed to simply improving monetization, as the example above shows)

By focusing on LTV, you also see other issues that have an impact on profitability. Rather than only caring about customers who monetize, understanding the LTV equation shows the value of all the players. It is often better to have a player who will bring in 10-20 friends but does not spend money rather than one who generates $2-$3. Once you understand your determinants of LTV, you get a good picture of the true value of each users.

It also shows how the categories are related, and a change in one might adversely or positively impact other metrics. Thus, you might increase monetization only to find it has such a negative on virality that your customers are worth less even if they are spending more. Seeing the relationship between these determinants of value help you understand the impact and prioritization of changes to the product.

More to come on LTV

Given the importance of LTV, this is the first of several posts on the topic (including a guest post). I plan on going into more detail on the determinants of LTV and how to improve these metrics, how you create a reliable LTV calculation, how you apply LTV outside the gaming space and how segmentation is a key element in analyzing LTV.