Unit Economics for the Financial Projections of your Startup

In this article, we'll explore a fundamental concept for any entrepreneur: unit economics. We'll break down what they are, how to calculate them, and why they're so important to the success of your business.

Unit economics are the foundation on which to build sound financial projections and make informed strategic decisions.

What are Unit Economics?

In the business world, unit economics refers to the analysis of revenue and costs associated with selling a single product or acquiring a customer. It is a fundamental approach to understanding the financial viability of your startup. There are two main approaches to calculating unit economies: per unit and per customer.

Each one is suited to different types of businesses.

Unit Economics by Unit

This approach is particularly well suited to transactional sales of physical goods. Imagine you run a lemonade stand. You sell cups of lemonade for $2 each, and your variable costs per cup, which include ingredients and a napkin, are $0.75.

By subtracting these variable costs from revenue, you get what is known as contribution margin, which in this case would be $1.25 per glass.

The importance of contribution margin lies in its ability to cover the fixed expenses of your business. If you have fixed costs of $100, such as renting a space at a market, you can use this information to calculate how many units you need to sell to cover those costs.

The formula is simple: divide fixed costs by contribution margin. In this case, you would need to sell 80 glasses of lemonade to break even.

Unit Economics per Client

This approach is best suited for subscription-based business models or long-term customer relationships. Here, customer lifetime value (LTV) and customer acquisition cost (CAC) are assessed.

LTV (Customer Lifetime Value) : This value represents how much money an average customer will generate over the course of their relationship with your business. An example could be a coffee shop where customers return often. If a customer spends $3 on their first visit and $100 over their lifetime as a customer, their LTV would be $100.

CAC (Customer Acquisition Cost) : This value represents how much it costs to acquire a new customer. Let's say you spend $100 on advertising and attract 10 new customers. Your CAC would be $10 per customer.

The general rule in the startup world is that your LTV should be at least three times higher than your CAC. This ensures that you get an adequate return on your investment in customer acquisition.

Real World Examples

Now that we've covered the theory, let's look at two real-life business cases to better understand unit economies and how they impact the viability of a business.

Uber case

Uber is an example of a company that has grown enormously but has unit economics problems. Despite its popularity, it has never made money from rides.

Every ride costs them money, as the cost of drivers, bonuses and operating expenses exceeds what passengers pay. This raises an important question about the long-term sustainability of their business model.

Two Paths to Success

In the startup world, there are two main paths to success:

1. Revenue and Profit : The first approach is to generate revenue and make a profit from the beginning. This means that every unit sold or customer acquired is profitable from the start. This approach creates a solid and sustainable financial foundation for your business.

2. Potential Loss Growth : The second approach involves aggressive growth, even if it means incurring initial losses. Uber is an example of this, as they have been willing to lose money on every ride in order to expand rapidly and dominate the market. However, this path requires significant investment and does not guarantee profitability.

The Apple Case

An example of success based on profitability and sustainable growth is Apple. They started with niche products, such as personal computers, and perfected their unit economics before expanding. Once they made sure that every product sold was highly profitable, they gradually conquered more areas of the market.

How to Get Data for your Unit Economics

A common question is how to obtain the data needed to calculate your unit economies. The answer is simple: use online resources and search for publicly available information.

For example, if you need the gross margin for a company like Netflix, simply search for “Netflix gross margin” on Google. This will give you access to key data for your calculations.

Experimentation and Learning

Don’t be afraid to experiment and learn as you go. You can estimate the lifetime of a customer initially, but you’ll only get real data after a while. Adjust your projections as you learn more about customer behavior and retention.

Written by Moises Hamui Abadi : I am an entrepreneur, founding partner of Viceversa and SoyMacho. After leading several digital businesses and advising several other businesses, I decided to form MHA Consulting, a digital marketing consultancy dedicated to growing and empowering digital businesses in more than 7 countries and generating more than 1,500 million pesos.

If you want more information on this topic or are looking for other options to profile your ideal client, at MHA you will find the solution you need. Schedule a call