Lifetime Value of Life

Possibly the ultimate mental model

As much as athleisure, TikTok and Formula-1 have permeated the mass American public consciousness, so too has the term mental model. It is a somewhat vague and confusing term, but once you run into it enough, you can define and appreciate it.

Mental models are basically cooler, more applicable, customized frameworks. As young children, we learn the alphabet and starter pack of three-letter words as a framework, but The Cat in the Hat, that’s the money. That’s what gets you up and out of your nap sesh. 

I…am not sure why I care about these things. What I am sure of is that upon learning a nifty new model, I tend to use it as the hammer that can answer lots of life’s big questions. 

The following is an attempt to extend one of my favorite models way outside its designated scope. Maybe there are actual nails to be hammered; maybe it’s a waste of time; maybe we violently crack a few eggs and discover a novel recipe for green omelettes (or something like that).

---

Customer lifetime value (sometimes shortened to CLV or LTV)¹ is a metric that seeks to capture the financial profit contribution of a specific customer to a business. This is much easier to conceptualize with a formula and an example, which we will do, but before diving into that, let us embark on a Seussian word breakdown to set a few parameters:

WARNING: there are a million variations to how exactly LTV is calculated, since it’s not a GAAP metric and usually tweaked to fit different business models. The definition below is no more official than any other you’d find on the Internet.  

Customer: We are talking about a single customer, from the business’ point of view. This can be an individual consumer who signs up for a specialty coffee bean subscription or it can be Tesla buying raw lithium – the customer is the one buying something.

Lifetime: When using LTV, we typically assume the customer will have a relationship that spans many years and includes many transactions. (If it were a single transaction, we wouldn’t need all this jargon – we’d just take the revenue and subtract the costs and voila, we have calculated gross profit.) 

Value: One of the lamer things about executivespeak is that “value”, which is a beautiful word in some contexts², simply means “profit” 90% of the time, including right now. Here we are simply taking the net profit, or bottom line, of all the revenue and all the costs involved with the customer – from customer support to how much it cost to make the widget you sold them.  

Now that we have the ingredients, we can begin arranging them in a simple formula.

LTV = [profit in year 1] + [profit in year 2] + [profit in year 3] + ....+ [profit in year n]

where n = lifetime of the customer, in years

From this abstract, we can get to a more usable formula by:

1. Breaking down various revenue and costs, by year, to determine the contribution profit in each year

2. Determining the appropriate lifetime of the customer

3. Applying a discount rate to when the profit is realized, to account for the time value of money

OR we can simplify things by:

1. Determining average annual revenue and profit margin 

2. Determining a churn rate (ie, the probability a customer ceases to be one)

3. Ignoring step 3

Thus, a crude yet useful formula for LTV becomes:

LTV = [Contribution Profit / Churn Rate]  

Going back to the specialty coffee subscription business (more relatable than lithium mining), we might assume they charge $30 per month; have costs in the form of beans, packaging materials, shipping and customer support; and have a customer lifetime of about five years until peoples’ credit cards expire or their shipping address changes or they transition to matcha.

And running those assumptions through our model, we see that the lifetime value of one customer is $720:

In summary, customer lifetime value is what it sounds like: how much monetary benefit does a business expect to accumulate over the span of a relationship with a single customer.

Final note: I have not mentioned LTV’s sister metric, CAC (customer acquisition cost), because it will overcomplicate what has already become a fairly complicated post. But if you’re curious, the GOATs got you covered. 

---

Ok, so we now have this shiny awesome hammer called the Lifetime Value Mental Model. A minute ago, we were applying its formula to a coffee venture, but now, imagine we apply the formula to…drum roll…life. 

Lifetime Value of Life (LTVoL). Think about it. What is life, if not a series of conscious experiences over time? 

We can map the inputs of life onto the shorthand formula of LTV = [Contribution Profit / Churn Rate] as follows:

Contribution Profit: This is where we capture value, which again, in a business context, is just revenues less costs. For LTVoL, we can replace revenues with “good things” and costs with “bad things”. Obviously not all good things are created equal, and the same goes for the bad, so a more appropriate breakdown is Value = [Total Goodness - Total Badness] = Net Goodness. 

Churn Rate: Apologies for the coldness, but this one’s straightforward – your churn rate is the probability that you die, and thus end the literal lifetime that we’re using as the basis of the LTV. 

…so we’re left with:

LTVoL = [Net Goodness] / [Probability of Death]

An obvious difficulty is quantifying “goodness”. Hold that thought. Here’s what happens when we plot the LTVoL of three imaginary people:

• Lukewarm Luke is the spiritual sibling to the Average Joe or a Steady Eddy. He doesn’t do anything extreme; he’s been working a solid job for 30 years, votes, coaches the occasional season of Little League when asked. He’s an organ donor. He is a human control group.

• Adventurous Alan is, and always has been, the “wild card”. He skydives and generally ignores insurance. He does not drink and drive at the same time, per se, but likes to drink and likes to drive fast machines. He squeezes out enjoyment from every walk of life.

• Healthy Harold is probably going to live to 100. He is about as likely to skydive as he is to consume more than his self-imposed daily carbohydrate limit – ie, never. He’s not necessarily joyless, but prioritizes consistency over spontaneity.

Biases encoded for dramatic effect

As our model shows, LTVoL is highly sensitive to two inputs: goodness margin and churn rate. Intuitively this should make sense, in that your overall accumulated value from life is a product of how much you enjoy each moment / experience and how many of those moments or experiences you’ll be able to have. 

Churn rate is easy to improve – simply do things that will increase your expected life span. I think everyone needs to form their own thinking around health, but my favorite recent nugget came from Peter Attia, who claims you can reduce your risk of an early death by 50% by exercising three hours a week, which is both believable and shocking at the same time. I can’t verify the claim, but I love its simplicity and low-hanging fruit-ness. 

Goodness margin is finicky. I think of this as “relative to everything that you experience, how much of it is good vs bad, or happy vs sad?” Alan, in his thrill seeking ways, juices this way up compared to Harold, who consciously trades off fun for excellence in actuarial tables. While we can wrap our hands around goodness margin as a concept, defining absolute goodness is way too hard, so we’ll treat it as a constant, like pi or the speed of light.

LTVoL optimization will look different for every individual, but broad strokes, it recommends seeking positive experiences over negative ones, and living a long life over a short one. Not earth shattering by any means but it may help justify specific actions. Perhaps that new friend you’re not so sure about will water down your goodness margins for the upcoming summer. Maybe the slight enjoyment of riding a motorcycle is not worth the basis points hit to churn rate. If, on the other hand, getting an Apple Watch extends your implied lifetime, it’s probably worth biting the short term $600 bullet of badness.  

The insight of LTVoL is that there are two basic levers to maximize lifetime value for the customer (aka you): improve margins and reduce churn.

---

Alas, even if we mapped out some utility metric over each individual year of someone’s life, we’d fall woefully short of capturing all the residual, future value from their offspring, their ideas, their imprint on the world and the myriad considerations that go with a real human’s existence. It is impossible to properly run this formula with human subjects, Big Scandinavia’s efforts to quantify happiness notwithstanding.  

Understanding the LTV mental model is not a panacea for living a good life; owning the best hammer doesn’t make someone a competent carpenter. But if an artifact from a less important domain of life, like business, helps bring clarity, well, let’s take it.

1. I’m not sure of LTV’s academic origins, largely because in my lazy attempt to research it, all I got was marketing: “Customer lifetime value” is so popular that the Wikipedia results didn't even show up when you Google it. It’s just an endless menu of how-to articles from various software companies. In fact, there were four sponsored links! Other than really obvious queries like “what is the average cost of home insurance,” it’s hard to imagine a metric so popular that companies dedicated SEO budgets towards it. Also, it’s not really “thought leadership” IMHO if everyone is writing about the same thing but I digress…

2. In 2016, my former employer, a technology consultancy, held a seminar on how to reduce your computing expenses, and called it “Cloudy with a Chance of Value Creation”. This haunts me to this day.