Why It Becomes Even More Important To Focus On Unit Economics
Understanding the concept of unit economics quite early in your business start-up will be important in predicting the current financial conditions & future growth. It is associated with the basic principles of the business model, and you may use this concept to calculate your revenues, profits & losses, and more.
For the true unit economic possibility, the company must break per customer transaction. Right from the first day, the company must sell the widget without paying the customer to buy this from them. It is fine and encouraged, and for the high-growth firm to lose their money at a corporate level right at the start as oftentimes such expenses will be front-end loaded, and spending right early on these must lead to explosive growth for a company. That is what we are looking out for!
What Are the Unit Economics & Why Is It Important?
The unit economics are a measure of the possibility of selling or producing or offering a single unit of the product and service. If you are the widget firm selling widgets, then unit economics is the relationship between the revenue that you get from selling the widget and costs that are associated with making the sale. For the companies providing service, for instance, Uber, unit economics would be in the relationship between revenue from service and costs linked with providing and servicing their customer.
At the high level, the point of the unit economics is to know how much profit the business makes before the fixed costs so one will estimate how much the business has to sell to cover the fixed costs. Unit economics is a fundamental part of the breakeven analysis. When volumes increase, earnings before the fixed costs tick up to a right, hence crossing paths with a fixed cost line. And the point where they cross is a breakeven point.
Many people measure the success and failure of the business by its revenue. However, revenues might be a little misleading and when we get more users, we get more people paying that increases the revenue. But, we’re ignoring one important factor and it is the cost. When considering unit economics, you must consider cost & revenue. By decreasing the costs, you will increase the profit. This cost can include the customer acquisition cost, the development cost, the market research cost, and more.
One small number will tell you everything. You do not need any kind of fancy analysis when you know about unit economics. Track if it’s diminishing and increasing. Moreover, if the unit economics makes any sense to you, it can make sense to others too. If it does not justify on the first day, you need to look into your business. You can make hypotheses over your customers’ willingness to pay, product features, target market, and more. Even validating such hypotheses if the unit economics does not improve, something will be wrong with your business. Suppose it fails, then other metrics do not matter much.
Calculating Economics of A Single Unit
If you want to determine unit economics, you should first identify a single unit. This might depend on your industry as well as business model, however, it is generally a single customer. For instance, SaaS startups may know that unit as “software user”. Alternatively; a unit of the brick-and-mortar store will be the customer or buyer. For calculating unit economics, you’re determining 2 important factors:
How much does your business spend for getting one unit?
You might know it as the Customer Acquisition Cost & Customer Lifetime Value, respectively. And these are direct revenues & costs that are associated with the unit economics. To calculate the Customer Acquisition Costs: a total of the costs linked with staff salaries, marketing, as well as sales over the given period. It includes the whole thing right from PPC campaigns to other related wages expenses and much more. After that, you can divide it by the number of units in the given period.
In the service firm, cost, as well as revenue for every employee can be used as the basis of the unit economics. We can increase the revenue for every employee or reduce the cost per employee. Also, you can work on keeping this cost rate constant and the idea is to keep this ratio improving.
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