In Louisiana cooking we have a concept of the Holy Trinity: celery, onions, and bell peppers. All of the complex flavors in a dish like gumbo or jambalaya start with those ingredients as the base. Whether you’re doing a classic recipe or trying a new spin, you still start with the same foundation.

When you’re building a company or working for a growth startup, there’s a ton of reports and metrics you can bury yourself in.

But just like Louisiana cooking, there’s three basic ingredients every startup should start with: lifetime value (LTV), customer acquisition cost (CAC), and total addressable market (TAM).

Note: Most of my experience is in B2B and I speak that language here, but much of this applies to B2C as well.

1. Lifetime Value (LTV)

Lifetime value is the total estimated value of a customer to your business (typically in revenue) over the expected life of that customer. If you charge customers $12,000 per year on average and you believe a customer’s average life will be 5 years, that customer is worth $60,000.

One difficult aspect for a young company is figuring out the average lifetime of a customer. Even for a company that’s been around 10 years, if they’ve been in growth mode for the last three and acquired most customers in that period, it’s tough to nail down.

The simplest approach is to look at churn rate and hold it constant. Let’s say 30% of customers churn after one year. That gives you an average monthly churn rate of 2.5% (30% over 12 months). This is simple linear math and not precisely how churn compounds, but it’s good enough for planning purposes.

Given a churn rate, the way to estimate total customer life is: 1 / churn rate

At 2.5% monthly churn, the average life of a customer is 1 / 2.5% = 40 months (3.3 years).

Here’s how different churn rates affect customer lifetime:

If you know your average revenue per customer per month, you can calculate LTV. Assuming $1,000 per month:

One thing that should stick out: LTV is highly sensitive to churn rate.

A note on gross margin: many investors prefer LTV calculated on gross margin rather than revenue. If your gross margin is 70%, your “true” LTV is 70% of the revenue-based number. I’m using revenue here because it’s simpler, but be prepared to discuss this with your board or investors.

How to use LTV to improve your business

Let’s say your monthly churn rate is 5% and your average monthly revenue is $1,000. This gives you an LTV of $20,000.

Now let’s say you need to get to an LTV of $30,000 to take your business to the next level.

You have two levers: decrease monthly churn (to increase average life) or increase revenue per month.

You can get there by decreasing monthly churn 33% or increasing revenue per month by 50%.

Which should you focus on? It depends on your business. Most likely you should work on both and double down on what’s succeeding. If you make progress in both directions, you can outperform your target:

A caveat on churn

Using 1/churn assumes a linear churn rate, meaning 5% per month stays constant forever.

In reality, churn is often higher in the first year and slows down after. The churn rate could be 50% in year one, but customers who make it through might churn at only 12% per year after that. This significantly increases your average life and LTV.

When I’ve had the data to support it, I’ll do a blended LTV: “value in first 12 months” plus “value beyond 12 months.” This works, but you need to really understand your data and be able to defend it.

The nice thing about 1/churn is that it’s simple and conservative.

2. Customer Acquisition Cost (CAC)

Customer acquisition cost is the total all-in cost to acquire a customer.

Sum all your expenses related to acquiring customers over a period and divide by the number of customers acquired. If you spent $500,000 in a quarter and got 100 new customers, your CAC is $5,000.

Include any sales and marketing expenses: salaries (don’t forget commissions and benefits), advertising, events, travel, and software.

Sometimes expense attribution gets tricky. If sales and marketing uses 20% of your office space, should you include part of rent? What about a VP who only partially oversees sales and marketing?

In the early days, keep it simple. The conservative approach is to include more expenses rather than fewer. But I’ll add this: if you’re spending more time engineering the perfectly calculated CAC than working on things to actually improve CAC, you’re focused on the wrong stuff.

What CAC doesn’t tell you

CAC is an average, and averages can hide important variation. If you’re acquiring customers through multiple channels (paid ads, content marketing, outbound sales, referrals), each channel likely has a different CAC. A $5,000 blended CAC might include $2,000 referral customers and $8,000 paid acquisition customers.

Understanding CAC by channel helps you decide where to invest. But again, don’t over-engineer it early on. Get the basics right first.

The LTV:CAC Ratio

Like good Louisiana cooking, the trinity works best when you combine the ingredients. Now that we have LTV and CAC, the most important thing is the ratio: for every dollar spent acquiring a customer, how many dollars do you get back?

If your LTV is $20,000 and your CAC is $5,000, your ratio is 4:1 ($20,000 / $5,000).

For every $1 spent on acquiring customers, you get $4 of value over the customer’s lifetime.

4:1 is generally excellent. 3:1 is considered good. Different investors will have varying opinions, and it may differ by industry or customer segment.

When you’re starting out you may be upside down (0.5:1, meaning you get 50 cents for every dollar invested). Track this carefully over time.

What do you do when the ratio is too low? The instinct is often to push harder on sales and generate more customers. But consider:

• Look at churn by cohort. Is there a certain type of customer dragging down your economics? Maybe you should stop acquiring them.
• Examine marketing spend by channel. Online advertising can sometimes be a major expense that delivers few or low-value customers.

If you find yourself with a really good ratio like 5:1 or 10:1, that’s a dream scenario. But it shouldn’t last long, because it suggests you could grow faster by investing more in acquisition.

Which brings us to the third part of the trinity.

3. Total Addressable Market (TAM)

With your LTV:CAC ratio understood, you need to contextualize it against the total addressable market. TAM represents the total size of the opportunity for your business.

If you’ve achieved a great 4:1 ratio but only 50 people would ever buy your product, your revenue and company value are severely limited.

Your goal is to honestly figure out how many people or firms would spend money on your business. This is an art, and if you’re raising money, VCs will want to carefully understand your assumptions.

A quick TAM example

Let’s say you sell software to locksmiths. A quick search says there are about 25,000 locksmiths in the US.

Now let’s say you sell left-handed tools for locksmiths. About 10% of people are left-handed. Assuming that ratio holds for locksmiths, you have 2,500 potential customers. That’s a pretty limiting niche.

What if you sell software only useful to larger locksmith firms with 3 or more people on staff? Unlike the left-handed example, you probably can’t search for that answer. You’ll need to dig in and feel confident about what you find.

If I’m building a business for locksmiths (or considering investing in one), I’d be thinking about:

Is demand for locksmiths growing or shrinking? Lock technology is hundreds of years old, but is there anything that might shift demand?

What about the supply of locksmiths? Like most trades in the US (plumbers, electricians), I assume it’s shrinking and the average locksmith is older than other professions. What does that mean for technology adoption? Maybe there’s a generational shift where younger locksmiths are more likely to adopt software. Maybe the shrinking supply is actually an opportunity: fewer locksmiths may charge more and thus spend more on software, or need software to better manage their business.

Can you sell the same software to other types of companies? This could drastically improve TAM.

TAM vs. serviceable market

Unlike CAC and LTV, TAM isn’t something you monitor monthly. But you should think about it, look for trends that may grow or shrink it, and consider ways to make more of it addressable.

A common path for startups is selling to smaller firms (SMBs) first. The sales cycle is quicker and they have fewer roadblocks to adopting new products. However, targeting SMBs almost certainly limits your addressable market.

If you’ve calculated your TAM to be $100 billion, the vast majority might be locked up with a small number of large players. Maybe $70 billion is with 500 companies (average $140M each) and $30 billion is spread across 5,000 SMBs (average $6M each).

So although you have $100B of TAM, your initial product might only have a serviceable market of $30B. Be honest with yourself: when and how do you expand to the enterprise segment? Or do you position yourself as the champion of SMBs and own that market?

Putting it together

These three metrics work together. LTV tells you what a customer is worth. CAC tells you what it costs to get one. The ratio tells you if the unit economics work. And TAM tells you how big the opportunity is if everything goes right.

Just like the trinity in Louisiana cooking, you can build a lot of complexity on top of these fundamentals. But you have to get the base right first.

Good luck out there.