Unit Economics are simply a measure of how profitable your business is for each unit you sell. To understand them you simply need to understand the cost in producing a unit and how much the unit is bought for, right? Wait, what in the world is a ‘unit’?
Let’s review unit economics, aka contribution margin, for a few different types of businesses.
Each meal you serve is a unit, so the costs include the food you purchase and the time it takes to prepare the meal. The revenue is how much you charge for the meal, so your per unit contribution margin becomes:
You would not include the cost of the location or the cost of your furniture, as those are fixed costs that stay the same regardless of the number of meals you serve.
Subscription Software (SaaS)
Each subscriber is a unit, so the costs include how much you spend to acquire a customer (Customer Acquisition Cost) and how much it costs to provide the service to them (likely $0). The revenue for a customer is their Lifetime Value (LTV), which you can either estimate or calculate depending on your customer tenure (see Customer Lifetime Value for more details).
You would not include the costs of your servers, unless you need to add new servers for every customer. Similarly, assuming each customer uses the same software you would not include the cost of developing the software.
Each delivery is a unit, so the cost is primarily the payment you make to the courier who makes the delivery. More complex is the revenue you make from a given delivery, which may either be a separate fee or an increase in the value of the product being delivered.
Note that many high profile delivery services have failed in recent years because their delivery fees were always lower than the wages they had to pay for delivery.
As you can see, the challenge lies in separating your fixed costs from your variable costs and mapping those to your individual unit of business. Tomorrow we’ll talk about that mapping and how it can help you understand changes in your unit economics over time when we discuss Amortization.
Quote of the Day: “Most writers regard the truth as their most valuable possession, and therefore are economical in its use.” ― Mark Twain