Unit Economics: What are they and what are they for?

Unit economics are a way of knowing how much money we earn or lose with each thing we sell. It's like looking at the price and cost of each product or service and seeing if it suits us or not.

Each type of business has its own ways of measuring unit economics, using numbers such as price, cost, margin, the cost of getting a customer, the value that a customer gives us .

Unit economics are important to know if our business is going well or badly, because they show us if each sale leaves us with profits or losses . They also help us decide how to grow our business, because they give us an idea of ​​what the future will look like and how to best use our money and time.

They also help us compare different types of businesses or markets and see which ones we like the most or which give us the most opportunities.

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MHA and unit economics

Let us remember that MHA is a digital marketing consultancy that offers website strategy, design, development and optimization, social media, SEO , SEM and email marketing services.

MAH can work with companies in the following ways:

Helping companies define and measure their unit economics, that is, the key indicators that allow them to know the profitability of each unit of product or service they sell, such as price, cost, margin, customer acquisition cost (CAC), customer lifetime value (LTV), among others.

Helping companies optimize their unit economics, that is, to improve the relationship between the value that each unit provides and the cost involved in acquiring or producing. These results are achieved through digital marketing strategies that increase traffic, conversion, retention and customer loyalty.

Helping companies project their unit economics. Estimate what your income, costs and profitability will be like in the future based on different scenarios and variables.

This is achieved through analysis and modeling tools that allow simulating and evaluating different options and making informed decisions.

What are the components of unit ecnomics?

The key components of unit economics are:

• Unit price : the revenue generated for each unit sold.
• Unit cost – The cost associated with the production or acquisition of each unit.
• Gross margin : The difference between the unit price and the unit cost, expressed as a percentage of the unit price.
• Customer Acquisition Cost (CAC) – The average cost of attracting and converting a customer.
• Customer Lifetime Value (LTV) – The net present value of future revenue expected to be earned from a customer.
• Retention rate – The percentage of customers who continue to purchase or use the product or service over a given period of time.
• Churn rate – The percentage of customers who stop purchasing or using the product or service during a given period of time.

To calculate unit economics, you must estimate the LTV and CAC of each unit, and then compare them to obtain the LTV/CAC ratio. This ratio indicates how much a customer is worth in relation to what it costs to acquire them.

An LTV/CAC ratio greater than 1 means the business is profitable, while a ratio less than 1 means the business is losing money.

Additionally, the CAC payback period must be calculated, which is the time it takes to recover the cost of acquiring a customer. A shorter payback period means greater business efficiency and liquidity.

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What is a good CAC recovery period?

A good CAC payback period depends on several factors such as business type, revenue model, gross margin, retention rate, and customer lifetime value. However, SaaS companies are currently estimated to have a CAC payback period of approximately 5 to 12 months.

This means that it takes between 5 and 12 months to recover the cost of acquiring a new customer.

A shorter payback period means greater business efficiency and liquidity, as the risk of losing customers before making profits is reduced.

A shorter payback period allows money to be reinvested in new marketing and sales strategies to accelerate growth.

To reduce the CAC recovery period, some measures can be applied, such as:

• Increase unit price or annual recurring revenue per customer.
• Reduce unit cost or customer acquisition cost.
• Improve the gross margin or the difference between the unit price and the unit cost.
• Segment and focus on the most profitable and loyal customers.
• Optimize marketing and sales campaigns to increase conversion and retention.
• Offer incentives or discounts to encourage loyalty and recommendations.

The case of Cuna Mágica

We can talk about the case of Cuna Mágica, a Mexican company dedicated to the production of furniture for infants.

To do this, MHA conducted an audit of the Cuna Mágica website and found several problems that affected conversion, such as the lack of information on the product pages, poor communication of the value proposition, and difficulties in payment methods.

MHA proposed to improve these aspects and also optimize payment campaigns on Google and Facebook , focusing on micro conversions, such as adding to cart, requesting a quote or contacting via WhatsApp. The results were very positive, since traffic was increased, conversions and sales tripled in a period of 7 months.

MHA helped Cuna Mágica improve its key indicators that determine the profitability of each unit sold. By increasing traffic and conversions , revenue per user and customer lifetime value (LTV) also increased.

By optimizing paid campaigns, cost per user and customer acquisition cost (CAC) were reduced. In this way, the margin per user and the LTV/CAC ratio were improved, which are some of the measures of business profitability and growth.

How are Unit Economics applied to different types of businesses?

We can talk more generally, how unit economics can be applied to different sectors. Here are 3 examples:

A subscription-based business, like Netflix or Spotify, can measure its revenue per user as the monthly fee each customer pays, its cost per user as the cost of providing the service and content, and its margin per user as the difference between both.

Additionally, you can measure customer lifetime value (LTV) as the expected revenue each customer will generate during their tenure, and customer acquisition cost (CAC) as the marketing and sales cost to acquire a new customer. .

A transaction-based business, like Uber or Airbnb, can measure its revenue per user as the commission it charges for each ride or reservation, its cost per user as the cost of maintaining the platform and customer support, and its margin per user. like the difference between the two.

You can also measure the LTV and CAC of each user, taking into account the frequency and value of the transactions they make.

And clearly, an advertising-based business, like Facebook or Google, can measure its revenue per user as the amount it receives for showing ads to each user, its cost per user as the cost of providing the service and content, and its margin. per user as the difference between both.

Likewise, you can measure the LTV and CAC of each user, considering the number and duration of the sessions they perform.

Challenges and opportunities posed by Unit Economics

As we already know, unit economics are a way of knowing if we earn or lose money with each thing we sell, but it is not so easy to know them and use them well.

To do this, we have to face some challenges and take advantage of some advantages they offer us.

For example, we have to know what things to measure and how to measure them , that is, what things are important for our business, how much money they give us and how much they cost us, and what numbers help us know if we are doing well or poorly.

This requires a deep understanding of our business model and the metrics that reflect it.

On the other hand, we can improve unit economics , that is, make each thing we sell give us more money and cost us less. This is achieved with digital marketing strategies that make more people know us, buy from us, recommend us and buy from us again.

This requires constant optimization and experimentation to find the best ways to attract and retain our customers.

We have to imagine unit economics , that is, think about what our income, costs and profits will be like in the future depending on what we do or what happens. This can be achieved with analysis and modeling tools that allow us to test and evaluate different options and make intelligent decisions. This represents a challenge of anticipating and adapting to changes in the market and demand.

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 enhancing digital businesses in more than 7 countries and generating more than 1,500 million pesos.