In any business, understanding your data and knowing which data is valuable, helps manage risk, performance and value.
Understanding your unit economics begins this process. Unit economics simply evaluates how much profit you make from selling one unit of service or product. It’s easier to calculate in a very early-stage business but much harder in a growing, established business. Listen to Pavlo Phitidis unpack unit economics in this podcast from The Money Show.
Calculating your unit economics
For every one item sold
- Selling price per unit – variable cost to make that sale = contribution margin
For every one customer
Two calculations make this up including;
- Customer lifetime value = how much revenue you make from a customer for how long
- Cost of customer acquisition
Your unit economics aids decision-making on almost all aspects of your business. It helps keep you focused on what counts and puts you in control of your growth and future value.
Unit economics helps you understand your business.
- Forecasting profits:
If you want a profit of X, you know how many units you need to sell
- Optimising your offer:
If you need X units to breakeven, you can lever your offering to increase volume or value to get there
- Assessing sustainability:
Understanding how many units you need monthly, weekly, daily to survive and breakeven
- Understanding scale levers:
Understanding how many units your business can cope with before you need to invest in more plant, equipment, people, space etc
- Creates investor and buyer interest:
In 15 seconds, you can rattle off your economics like this “We sell our widgets for $30, they cost $10, giving us a profit of $20 and I have orders for 1,000 over the next 6 months. To make this happen, I need $500 for a 20% stake”. It helps an investor understand how long it will take to get back their money and over time, get a return; $4,000 in 6 months means an 800% return– it’s a no-brainer and you’ll have their attention and money.
Consider these two examples
If you had a tie shop and your average sale was one tie at an average sales price of $20, you can now understand your shop in terms of ties which are logical and tangible to the tie maker. For example, how many ties do you need to sell to breakeven in a month, week, day? That information is powerful in deciding when you need to market, how to structure the retail assistants’ incentives, when to run specials to move stock and many other such levers that affect survival and growth.
If you have a hair salon, what is your average sale and how many hairdo’s do you need to breakeven? This lets you improve training for your stylists to sell more colour, braids and higher value services if you are in an area with fewer clients. Alternatively, you might want to add more styling stations and stylists if in a high demand area.
As an investor, I always ask about the company’s unit economics – it helps separate story from value and gives valuable insight into understanding the extent that the founder understands their business.