With the failure of high profile hardware companies like Jawbone, there is a renewed focus on the unit economics of fast-growing businesses. Unlike most financial metrics of a business (see Money Metrics) that look at the business as a whole, unit economics focus on each product sale individually.
It might seem strange to evaluate a company by each transaction instead of using overall revenue and cost, since each product might only cost a few dollars but the business generates many millions of dollars in revenue a year. For most businesses this is true, but for high growth businesses that are losing money, the unit economics can tell you whether the business has the potential to become profitable in the future.
For example, if a company that is losing money is selling a product for $5 when it costs $2 to make, they might become profitable as their volume grows. However, if that same company is selling a product for $5 when it costs $10 to make then they may not be able to become profitable at any scale. It seems obvious when I frame it this way, but in reality it can be hard to calculate and evaluate unit economics.
“Unit economics” is actually a broad term for a number of different metrics you can use to evaluate individual transactions. We’ll cover some of them this week.
Tomorrow we’ll get started with some examples of unit economics, across a few different industries, to highlight how challenging they can be to calculate.
Quote of the Day: “There are 10¹¹ stars in the galaxy. That used to be a huge number. But it’s only a hundred billion. It’s less than the national deficit! We used to call them astronomical numbers. Now we should call them economical numbers.” ― Richard Feynman