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

by Moises Hamui July 8, 2024

Unit economics is a way of knowing how much money we make 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 like price, cost, margin, the cost of acquiring a customer, the value that a customer gives us .

Unit economics are important to know if our business is doing well or badly, because they show us whether each sale is making a profit or a loss . 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 best or give us more opportunities.

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MHA and unit economics

Let's remember that MHA is a digital marketing consultancy that offers strategy, design, development and optimization services for websites, social networks, SEO , SEM and email marketing .

MAH can work with companies in the following ways:

Helping companies define and measure their unit economics, i.e. 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, 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. Estimating what their revenues, costs and profitability will look like in the future based on different scenarios and variables.

This is achieved through analysis and modelling tools that allow different options to be simulated and evaluated and informed decisions to be made.

What are the components of unit economics?

The key components of unit economics are:

Unit price : the revenue generated by 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 over a given period of time.

To calculate unit economics, you need to estimate the LTV and CAC of each unit, and then compare them to get 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.

In addition, the CAC payback period, which is the time it takes to recover the cost of acquiring a customer, should be calculated. A shorter payback period implies greater business efficiency and liquidity.

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What is a good CAC payback 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, it is estimated that SaaS companies currently have a CAC payback period of approximately 5 to 12 months.

This means 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 a profit is reduced.

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

To reduce the CAC payback 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 gross margin or the difference between unit price and 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 referrals.

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 Cuna Mágica's website and found several issues that affected conversion, such as a lack of information on product pages, poor communication of the value proposition, and difficulties with payment methods.

MHA proposed to improve these aspects and also to optimize the paid 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, as 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, the cost per user and customer acquisition cost (CAC) were reduced. This improved the margin per user and the LTV/CAC ratio, which are some of the measures of profitability and business growth.

How do Unit Economics apply to different types of businesses?

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

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

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

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

You can also measure the LTV and CAC of each user, taking into account the number and duration of their sessions.

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Challenges and opportunities posed by Unit Economics

As we already know, unit economics are a way of knowing whether we make 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 of the benefits they offer us.

For example, we need 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 badly.

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 item 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 need to imagine unit economics , that is, think about what our revenues, costs and profits will be in the future depending on what we do or what happens. This can be achieved with analysis and modelling tools that allow us to test and evaluate different options and make smart decisions. This poses 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 empowering digital businesses in more than 7 countries and generating more than 1,500 million pesos.