|This week’s concept: Unit EconomicsWhat is it: |
Unit economics is the amount of additional revenue minus the additional costs for each additional unit of product sold.
Unit economics does not take into account fixed costs (costs that need to be spent no matter how many units are sold) like rent, wages, etc.
To properly find out your unit economics, first come up with the definition of “an additional product sold”.
For example, in a SaaS company, it might be an additional person using the software while a restaurant would be an additional dish sold.
Next, it is to determine the revenue and cost of each additional product sold.
The revenue of each unit is usually easier to determine. It can be made more complex but more accurate by taking into account the retention rate of a customer or the probability of a customer repurchasing your product.
This will help you calculate your customer lifetime value – the amount an average customer will pay you over the entire lifetime of interacting with your company.
The cost can be more complicated to determine as this will depend on the cost structure of your product.
This is any cost that can be attributed to getting an additional sale – the average marketing costs, the costs of producing an additional unit, the costs of delivery etc.
Once all that is determined, you can find how much each additional unit will bring into your business – the unit economics of your product.
Why it is important:
If you want to run a profitable business (and I hope you do), you will need to know how many units you have to sell to breakeven, i.e. the number of products you have to sell such that the fixed costs are offset.
Without calculating the unit economics of each of the products you are selling, you could actually be offering products that are hurting your business.
An example of this could be certain dishes in a restaurant where although on a per dish basis is profitable, when you take into account the marketing costs to acquire the customer, it might actually have be negative in terms of unit economics.
Related topics I will cover in future weeks:
Cost StructureCustomer Lifetime ValueFixed Costs