In any business, medium or small; understanding and implementing unit economics is very important. It is the fundamental concept regarding the financial aspects of any business. It might sound complicated and overwhelming to study unit economics, but in order to analyze the performance and growth of your business or company, one has to go through this fundamental aspect of finances. Any company’s financial performance is measured in terms of unit economics. All business stakeholders, analysts, investors and management have to understand and have to go through the financial aspects of the business, regularly.
All businesses have to work around a unit economics model, and all the key resources are utilized to keep track of the financial model, so that it helps in determining the return of investment ROI in the business.
What is unit economics; understanding the key terms
So, what is the meaning of unit in this business model? Unit in a business model depends and varies according to the type of business. For example, for any retail company or e-commerce store, customer is the ultimate unit, and this unit is used to measure the finances of a business. For example, if it is a clothing store, the customer that buys the clothes, is the unit. This unit refers to the unit economics in business.
Once a unit of any business has been identified, it is time to measure the unit economics of that business. While studying this key aspect of a business, we have to go through certain technical financial terms, in order to understand this, fully. One such important key term is Cost per acquisition CPA, which is the cost company spends to acquire one user, or unit.
This cost depends and varies with different businesses, for example, for an internet service provider, or a telecommunication company, acquiring a user may involve different factors for acquisition, and the costs would be different for another type of business. The amount company spends to get that one user is, “cost per acquisition or acquisition cost”.
Acquiring a customer involves many factors, and a company will have to oversee the marketing and selling expenses; it involves both search engine marketing and social media marketing (which is most successful in today’s time). Therefore, CPA measures all the factors that were utilized to acquire a new customer.
Now the user has been acquired, next the measurement of unit economics, involves determining customer lifetime value LTV. The revenue a company or business generates after acquisition of that one user until the user keeps using the services of the company, is known as “customer lifetime value”. Companies also take into consideration, the average of monthly and weekly revenues generated by a customer. For example, a retail or e-commerce store, takes into consideration how active a user/customer was during a particular week, or a month, and how much revenue was generated. Check our article and learn how Customer Lifetime Value is calculated.
Therefore, it’s easier to see that customers make or break your business, the number of a costumers a business has, the number of long-term and re-occurring customers a business has, determines the success of a business - whether small or medium. Having loyal, customers that keep coming back, establishes trust and reliability of a business, and it is set to thrive more. Long-term customers provide the most revenues to a business, and in a business financial model, it has two key aspects.
Input revenue of a business is determined by the number of customers you have, the number of orders placed, and purchases made by a customer and the size of the transaction. The output expenditure is determined by the expenditures company has to make to run its business. It also has two types; one is the capital investment which involves setting up a company office or a warehouse, the other type is payment of salaries and dues to the employees of a company. Therefore, output expenditure should not exceed input revenue.
Unit economics examples of well-known Unicorn Companies
Especially the companies who grow exponentially during the last few years were keeping track of their unit economics. To give you an idea of different industries, products and business models, we researched for some of them.