Unit economics is the calculation of profit & loss for a business model on a per-unit basis. Generally, it gives you information about the real value that every item and unit creates for your business.
Unit economics is the fundamental and measurable piece that creates value for your business that will be measured. The airline may look at the seats sold. For the car dealership, the unit will simply be the car. Whereas Uber takes its revenue per hour as a unit of measurement and we will talk about the digital products, and, the unit is generally the customer or user. In the terms of various software products, unit economics is generally considered as a ratio of the Customer Lifetime Value & Customer Acquisition Cost.
The unit economics calculates the total value the customer brings on your business during a time they are loyal, related to how much you are keen to invest and get that customer. The desired ratio may depend upon the company and industry that you function in, thus even though numbers do not look very good, this makes a little sense to compare this to the benchmarks.
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Knowing Which Costs Are Fixed or Variable
One biggest mistake that people make while performing the unit economic analysis generally relates to the cost side of an equation. As we saw, no matter whether you are just calculating the contribution margin or if you are doing ROI-based CLV and CAC analysis, an important part of an equation is the cost you select to discount from the revenue. In law, this rule is quite simple: Unit considers the variable costs and not the fixed costs. However, in practice, the distinction between the fixed and the variable costs is not very straightforward.
Understanding the Significance of Tracking the Unit Economics
The primary purpose to work out the unit economics will be to know the revenue model of the business on a ‘per unit basis. It means we have to understand how each transaction appears regarding its revenue & cost. It is a basic measure of how you propose in making revenue out of a thing (or unit) you are planning to sell. The unit comprises 2 important terms, called customer lifetime value & customer acquisition costs. The accepted ratio will be on the 3:1 ratio where the value of the acquisition obtained is 3 times. Also, the value obtained from the customer should be 3 times its costs incurred for getting the customer.
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The next important feature of unit economics is the payback period of a CAC. It refers to the period that the company takes for paying back its cost of acquiring the customer. But, the shorter the payback time, the better as funds needed for the working capital are lesser.
Textbook definition of the variable cost is variable costs are one directly linked with the sales. Thus, variable costs differ as per the volume of the output. Some common examples of the variable costs will be the cost of the goods sold, things such as shipping & packaging costs for the eCommerce startups, and sales costs for the enterprise or B2B startups.