TRC 012: Unit Economics - 5 common mistakes to avoidJun 22, 2023
Read time: 5 mins
OK - so what the hell are unit economics?
They are a method of calculation that assesses the profitability of a business on a per-unit basis.
With startups, it’s typical to look at it per customer.
i.e. how much margin can you make from one customer if you take into account all of the costs of acquiring and servicing them when compared to the amount they will pay for the length of time they are a customer.
It’s important because, in the early days of a fast growing business, you unlikely to be profitable as a company.
So knowing how you perform on a unitary basis is an important assessment of your ability to make money in the future.
If you can’t make money on a per customer basis, you will never be profitable as a company.
So..it’s a key measure of current progress and future success, but it’s easy to present figures that don’t chime with investors.
Here are the 5 most common mistakes we see.
1. Basing lifetime value on revenue.
Revenue is a key business measure, but it tells only part of the story when trying to work out unit economics.
If you present revenue as the basis of your lifetime value, you are immediately reducing investor confidence in your commercial abilities.
It is much better to base your lifetime value on contribution margin, which means you need to subtract your direct cost (or Cost of Goods Sold / COGS) and the cost of servicing a customer from revenue to get a more useful picture of your lifetime value.
2. Overlooking Churn.
This one is easily done when you are forecasting what things will be.
You look at how much somebody will pay on a regular basis and look at how many customers you will acquire over time, but forget to look at the rate at which they will leave.
Look at benchmarks for churn within your sector and make sure you have factored something into your model (or have very good reasons why yours will be better).
3. Customer Acquisition Costs (CAC) that are not detailed enough.
If you only ever calculate CAC as a "blended" cost - including both organically acquired users and those acquired through paid channels, it could mean that you are running paid campaigns that aren’t profitable.
It can also be more difficult to drive new organic growth outside of paid channels, so you may be reflecting an inaccurate picture of how scalable your marketing efforts could be.
It’s crucial to isolate and understand the different channels when calculating your LTV to CAC.
4. Ignoring Cross-Selling and Upselling Opportunities.
In many businesses, the initial sale might not be profitable, but subsequent upselling or cross-selling can lead to profitability.
Founders often overlook this aspect, focusing only on the initial transaction and thus missing out on an important aspect of the unit economics.
5. Overlooking Indirect Costs.
Founders often fail to account for all the costs involved in delivering a product or service.
They usually focus on the direct costs, like the cost of goods sold (COGS).
It’s important to look at all the costs that scale in line with the growth in the numbers of customers.
Examples of these are the cost of customer service, payment processing fees and, if you are an ecommerce startup, the cost of warehousing.
Now that you know what the common mistakes are, you can go back to your numbers and make sure yours are all in order.
I hope that was helpful.
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