“Unit economics is the direct revenue and costs associated with a particular business model expressed on a per unit basis.”
The opinions expressed by collaborators are personal.
Being surrounded by startups at an early stage in my day to day, I have noticed that many of its founders are not seeing the real unit economics of their companies. Most of them understand the meaning of unit economics, but few are looking at it with the right approach.
The reality is that during the early stages of a company it is rare for the founders to pay the correct attention to the analysis of their financial model, many times this is because the team of founders does not have the experience in finance and traditionally this role is usually a recruitment later.
Why the term ” fully loaded “? Next, I find many unit economics analyzes that do not include all the costs associated with each sale, which means that these founders do not operate their companies with the correct and necessary data to understand what is really happening in their business. Should they include the cost of customer support? The marketing one? The payment processing one? Knowing what to include and what to exclude is not easy, but it is what will help you better understand how your business really works and will allow you to have a more precise idea of the finances of your company.
That is why doing an in-depth analysis of a startup's unit economics at an early stage should be a requirement from the start and thus be able to understand how the business works in its entirety.
I've been on both sides of the table, and as a founder it's a nightmare to have a company with negative unit economics, where if you sell more you lose more money.
Sometimes the bad habit or lack of experience of not having your unit economics “fully loaded” is used as a strategy to present a more optimistic image of your financial model to potential investors, and even sometimes to deceive ourselves. I have heard multiple arguments why a specific cost should not be included, which rarely make sense, but do improve optics.
It is important for founders and investors to question each other about the startup's unit economics and to be pragmatic about the reality of its financial models. As investors we must help startups to have strict control of their finances, and if they are operating with negative unit economics they should have an actionable plan towards profitability.
What else can your Unit Economics tell you?
On the one hand, they show you the current state of your gross margins, something that many founders do not pay attention to at first. There is nothing worse than spending considerable and valuable time on a project and then realizing that gross margins are very low.
They can also help you understand monthly breakeven points, as well as understand what is the maximum amount you must invest to acquire clients. This is easier to understand in business models without recurring clients, if your profit margin is $ X, spending more than that acquiring a single client is not a good business.
And the most important thing is that it will help you understand what are the most important costs that you will need to analyze closely to MAKE MONEY.
How often should you be monitoring your Unit Economics?
This depends a lot on each company. Some have unit costs that do not vary much over time, while others have unit costs that are constantly changing. If your company is closer to the last case and the gross margins of your unit economics are not ideal, you should analyze them weekly. This will give you time to react by implementing changes and continue analyzing them with the same frequency.
The common practice of looking at company finances the first or second week after the month is over will not allow you to react and make changes with the necessary speed compared to reviewing them weekly to improve your units.
Example of how many founders are seeing their Unit Economics
Example “fully loaded”
Based on the example, going from thinking that you had a 29% profit margin to actually only having 3% is news that is not easy to digest. Worse yet, imagine having to update your investors on this news.
Now suppose you had a Customer Acquisition Cost of $ 25. In the “fully loaded” model, the break-even point per customer is 25 sales against only 2.8 sales, not a small difference. Now, if your monthly fixed General and Administrative expenses are 15k, you would need 15,000 orders to break even against 1,714 orders, again not a small difference.
That is why I encourage all founders to question and improve the way they are calculating their unit economics to ensure they have the most accurate picture of their startup's finances.