Unit economy: formulas and examples of calculation



The article explains:

What is unit economy in simple termsA brief history of the unit economyHow to choose a unit economyUnit Economy IndicatorsFormulas for unit economy calculationUnit Economy Calculation CalculatorsRough edges for unit economy calculationFrequently asked questions about unit economyWhat to do to make the company more profitablePros and cons of unit economy calculation
Unit economy: formulas and examples of calculation

What is it? Unit economics is a way of calculating profit per unit of product or per customer. This very unit is called a unit. You can use anything as a unit: a mobile app, a banking service, a pack of chewing gum, etc. Both for a start-up that is about to conquer the market and for an established company, you need to calculate the unit-economy.

The result will tell you how much it will cost you to reach the break-even point, how many customers you will have, and how many sales channels you will have.

How to calculate? There are formulas for calculation. By substituting your figures in them, you will learn the income per client, income per user (yes, it's different types of people!), income per user, taking into account the advertising shown to him (targeting, contextual, etc.).

But do not rush to grasp the metrics, there are many nuances in calculating unit economy, without taking into account that your results will "go wrong" and even be negative. You can, of course, use ready-made calculators, but even they will not show reliable data without knowing the specific rules.




What is unit economy in simple words

Unit-economy is the estimation of the profitability of a unit or unit of something: a product, a customer or a user.

You can apply unit economy to any business, be it a furniture factory, a bar, a startup or a private clinic. The unit-economy can be applied in any business, be it a furniture factory, a bar, a start-up or a private clinic.

The unit economy is counted both before and after the launch of a new venture. At any rate, it should be done so as to estimate at the outset whether the business will be profitable, and if it is not, at least to identify growth areas and weaknesses. The unit economy indicators are very clear and convincing because they are based on factual data: they clearly reflect the tendency of the business - to earn or, conversely, to spend.

The financial evaluation of units is of interest to a wide range of stakeholders - management and owners of the firm and investors. With the help of the unit economy, it is possible to:

Calculate the optimum number of clients to reach the break-even point.Determine how much it costs to win one customer.Analyze the price of a service or product to see how much it pays for itself.Evaluate the effectiveness of all your marketing channels and whether your marketing strategy is successful.Determine the growth potential of the business and whether it can be scaled up.
Unit economy: formulas and examples of calculation

What is unit economics in simple terms, and who does the calculation?

If we are talking about a startup, at least the majority of the team must understand the basics of unit economics, if not the whole team.

If the project is already in development, a product manager or an analyst will take care of the calculation of unit costs. The latter has all the information about the product, its customers and features, while the former can help with the calculation (especially with a complex financial model).

In addition, it is sometimes necessary to involve financiers in the creation of the model in order to uncover any non-obvious costs. It is good practice to consult with an independent expert who will look at your calculations, confirm that they are realistic, or point out errors.
The unit economy should be calculated if:

you need to attract external investment;business is about to scale;a start-up is about to start;advertising, promotion and customer attraction costs have a large share in the cost structure.



A brief history of unit economics

There are several views on the emergence of the unit economy. Adherents of one of them call the author of the idea American investor David Skok, who invested in start-ups and waited for precise business plans and specific figures, but the starting entrepreneurs had to make up all those figures because they had no real data (the products were new). These sketched figures could not satisfy the investor and provide answers as to how much:

it would cost to make and sell a product;to be invested in attracting one customer;the profit to be made from the sale of one item.

Unit economics gave the key to all these questions.

The unit economy was formed between 1995 and 2010. Then, in 2014-2015, it gained widespread popularity and spread along with cohort analysis (which segments consumers by specific parameters and helps to analyse them).
In conjunction with cohort analysis, the unit economy for a particular audience segment can be calculated using spreadsheets and a large set of metrics to calculate it.




How to choose the units

So what is a unit in unit economics? Essentially anything: one transaction, one sale, one customer or subscriber. It is customary to select units according to the goals of the firm: what exactly are we going to scale.

The area in which the company operates is equally important in selecting a unit. For catering, the unit will be the cost of a meal, and for digital, the revenue per subscriber or user.

Unit economy: formulas and examples of calculation

The formulas for calculating profitability, the metrics are determined by the unit under study. For example, if our unit is a subscriber, we have to determine the LTV (Lifetime Value) - the period during which it generates profit and its total forecast; CAC - its attraction price. And if we consider the unit-economy of the commodity, we will be interested in the marginal profit (sales minus the full cost of producing the commodity or providing the service).




Unit-economy indicators

Unit economics is needed to give an estimate of the profitability of a business. These are the key metrics:

ARPC (average revenue per client) - profit per client.ARPU (average revenue per user) - profitability of a user.ARPU - CPA - profit per user, including advertising.

These parameters are calculated on the basis of other business metrics: average receipt, average number of purchases, conversion from visitor to client, additional expenses, prime cost of the order.




Formulas to calculate unit economy

COGS

COGS (cost of good sales) - cost, variable costs. Those costs which are directly determined by the number of clients or transactions: the more clients or transactions, the more money a company spends.

The cost of good sales includes the costs of raw materials, acquiring and logistics. If you usually order more than one item at a time, add up the costs of all the items in the basket and add shipping.

Here is an example of a unit economy calculation, looking at a takeaway and delivery burger shop. The inputs are as follows:

groceries to make one burger = $8;
delivery = $10.
Customers usually take three burgers each. We get COGS: $8 × 3 + $10 = $34.

There is no single formula for calculating COGS, everything is determined by the specifics of the business and the end product, its components.

ARPC

ARPC (average revenue per client) is a profit per client or revenue per customer during a certain period (usually a month). The calculation is as follows:

ARPC = (AvP - COGS) × APC - 1s COGS

AvP (average price) is the average cheque obtained by dividing all monthly revenues by the number of orders. That is, it is the money usually brought in at one time by one customer:

Average payment cost = Revenue / Number of orders

APC (average payment cost) is the average number of purchases. It is calculated as follows: the number of all orders divided by the number of clients. Of course, some have only one order in a month and some have five, but the average is two and is calculated as follows.

Average number of purchases = Number of orders / Customers

You do not have to calculate the average number of purchases and the average bill yourself; they are usually already available in your online acquiring and accounting system.

COGS, the cost price of the order, has been calculated earlier: These are all costs related to the order and their volume grows proportionally to the order.

1s COGS are any additional costs for the first purchase: a gift for the order, a promotional code discount, a free trial period. But they are not always there.

So let's put all the relevant indicators together in a formula and project the company's revenue from burger delivery. We take the following figures:

The average bill (AvP) is $45. It is common to take about 3 burgers at $15 each.

The average number of purchases (APC) is 2.

Cost (COGS) is $31, made up of delivery and the cost of the burger multiplied by 3.

The additional cost of the first purchase (1s COGS) is $5 (this was a promo code)

ARPC = ($45 - $31) × 2 - $5 = $23

In other words, each customer brings our diner an average of $23 in marginal profit every month. What about the revenue per user?

ARPU

UA (user acquisition) is the consumer's knowledge of the company. If such a person visits the website, they do not necessarily immediately place an order. For example, you run a targeted advertising campaign and find out the exact number of people who have visited the café's website.

Profitability per user, ARPU, according to the formula is identical to revenue per customer, but conversion must be taken into account:

ARPU = ARPC × C

C here is conversion, or the percentage of potential buyers who have taken the targeted action (left a contact, paid the order). Let's calculate it:

C = Customers / Users × 100%.

Now we can find out the revenue per user and the conversion rate for the cafe.

Let's say customers came to the site from search ads. The campaign statistics show that there were 2,000 clicks in a month, and only 150 of them ended in a purchase.

Revenue per customer (ARPC) = 230 ₽.

Conversion (C) = 150 / 2000 × 100% = 7.5%.

Revenue per user (ARPU) = 230 ₽ × 7.5% = 17.25 ₽.

That is, each person who visited the site provided the burger house with a profit of ₽17.25. Everything looks good and the firm is earning revenue, but our calculations do not involve advertising costs and there is no profit per user.

Revenue per customer, taking marketing into account

CPA (Cost Per Acquisition) includes all marketing and advertising costs and finally it includes the cost of acquiring the customer. It may be, for example, the price per click on an ad, a blogger's post, printing of brochures, etc. As a rule, the figures are stored in the advertiser's personal account.

This revenue per consumer necessarily includes advertising costs. For unit-based business economics, this indicator is key: if the CPA is minuscule, it means that the firm is not making any money. The formula is simple: Advertising costs (CPA) are subtracted from normal revenue per user (ARPU):

Revenue per user including advertising costs = ARPU - CPA

Let's calculate this metric for our café.

Ad clicks leading to the burger shop's website cost $1.2 each, and the company gets $1.725 per user. Does it have any income at all?

ARPU - CPA = $1.725 - $1.2 = $0.525.

Yes, there is: it earns $0.525 per user. That's not bad. At the very least, the diner is recouping its production and marketing costs.

Calculating the marginal profit in unit economics

Marginal profit is the difference between revenue and variable income. Unit Economics has just helped us calculate this figure per customer (namely, revenue per user minus advertising).

Unit economy: formulas and examples of calculation

Now let's get the total marginal profit of the firm:

Marginal profit = Revenue per user minus advertising costs × Users

Let's fill the formula with numbers. As we already know, the monthly flow of visitors is 1500 people, and earnings from each is 5,25 rubles.

Marginal profit = 2000 × $0.525 = $1,050.

That is, if you subtract expenses, the burger joint's net monthly earnings are only $1,050. And that's without taking into account fixed costs (they don't appear in the marginal profit formula)! If these fixed costs are less than the marginal profit, it can be stated that the breakeven point has been reached.




Calculators for calculating the unit economy

Of course, you can calculate the unit economy in Excel or even on paper, but it is better to use a handy online calculator.

There are many of them and here are the best:

Qagency, designed to calculate LTV. It's a simple service, with clear instructions on how to collect the figures for the calculation. You simply paste in the numbers and the software will give you the LTV.Qby. With this tool it is easy to calculate the total, based on various metrics, and predict revenue in future periods.Rru. It is designed to calculate the income from marketing campaigns.Ujet.style. It calculates the unit economy according to seven indicators. It is based on a complex formula for unit economy, which takes into account a lot of nuances, so you don't have to worry about the accuracy of the calculation.

However, whatever formulas we use, the general point of such calculations is an in-depth analysis of the resources spent and the profit that can be extracted from sales. The essence of the unit economy model is a correct and accurate calculation of actual costs. While sales are made in all businesses, the cost of meeting a customer, the amount of discounts and promotions available to make him or her order a service or product are different everywhere and will affect the overall success of the business.




Nuances of calculating the unit economy

Here are some important points in calculating the unit economy of a product and anything:

Each segment and channel has a different economy. It often happens that the results for Direct do not add up, while the traffic from Facebook is fine. Or one segment of the target audience is difficult to calculate, while another is not.Cohorts - groups of customers over a certain period - also yield different results. For September customers, the economics are converging, but October customers are starting to have problems. Cohorts is a term that describes only customers, but the approach is relevant for any unit. For example, for Christmas trees in December, the unit economy is fine, but just a month later it is not so fine. Obviously, this is an effect of seasonality (although there are other factors as well).In the unit-economy tables, only the services and goods actually sold are entered! And also the profits and costs of the units sold. For example, if you have purchased spare parts for 200 products and spent money on the production of the same amount, but you have only sold a hundred, calculate the unit economy for this hundred.We are not interested in turnover, but in sales. This means not the actual flow of money from one account to another, but the "virtual" money during the time period in which the product was sold or the service was provided. If you spent money for components and device production in September and the distributor pays for the order only in November, you count it in October (if there were sales of the device in that month).



Frequently asked questions about unit economy

What is the best timeframe to calculate the unit-loss budget? This is specific to each start-up and long-established business. Usually, the units economy is calculated for one year, six months or a quarter, but it can even be calculated for a week or a day, depending on the amount of sales per month.

Does unit-economics replace classic economics?

Or is it a separate field? Both variants are false: unit-economy is just a calculation methodology, providing additional information to evaluate the business efficiency and make management decisions.

Is there always only one unit in a company?

No, there can be more. In large trading firms, for example, the units are both the customer and the product. But this approach is even more relevant for a startup, an expanding business and when introducing new products to the market (for example, the unit economy of a mobile app should be calculated separately from the unit economy of the client).

Best books on unit economy

Readily, here are the main works: "Business from Zero. The Lean Startup Method for Testing Fast Ideas and Choosing a Business Model", "Lean Analytics: Use Data to Build a Better Startup Faster", "Business Plan Template And Example: How To Write A Business Plan: Business Planning Made Simple".




How to make your business more profitable

Spend more on advertising

On the face of it, increasing advertising budgets seems like a great idea: more advertising means more customers. But it is also a big expense.

From the point of view of project unit economics, you may make such a decision only if you have positive income per client (taking into consideration the advertising costs) and if you have the necessary facilities to handle the increased client flow.

But a more rational solution is to achieve higher profits per customer. There are several ways to do this.

Increase the average order value

Sometimes you simply have to raise prices. For example, in order to keep a fast-food business from losing money, you can set a minimum order price for delivery or make it payable.

Unit economy: formulas and examples of calculation

Here is a simple example of calculating a customer's unit economy. The minimum order price with delivery is $90 and the variable costs have increased slightly (to $50, including delivery):

Revenue per customer (ARPU) = ($90 - $50) × 2 - $5 = $75.

Revenue per user (ARPU) = $75 × 7.5% = $5.62.

Revenue per user including advertising charges (ARPU - CPA) = $5.62 - $1.2 = $4.425.

Marginal profit: 1500 (number of users) x 44.25 = $6.6375.

The profit per customer has increased from $0.525 to $4.425 and the marginal profit has increased from $1.05 to $6.6375. The firm no longer loses money, can spend more on marketing and extract even more profit.

Increase the conversion rate of website visitors into buyers

Usually enough simple tricks: make a larger button "Order", add a telephone number to the site to order (for some it is much easier to buy).

Suppose the burger comes to the site 1.5 thousand people, and purchase will not make 100, as usual, and 150. Conversion in this case is 10%, and the profits will be calculated according to the methods of unit economics:

Revenue per customer (ARPC) = $25.

Conversion (C) = 150 / 1500 × 100% = 10%.

Revenue per user (APRU) = $25 × 10% = $2.5.

Revenue per user including advertising cost (ARPU - CPA) = $2.5 - $1.2 = $1.3.

So, the eatery now gets $1.1 from each visitor, and that's not a bad result. It will get better if you also raise the average bill.

The list of methods for increasing profits per customer does not end there. You can increase the number of presales by giving a promo code for your next purchase or by promising discounts to those who bring friends (and thereby reducing the company's cost of attracting a customer).




Pros and cons of unit economy calculation

Advantages of unit economy

The business model with unit-economy becomes more transparent and controllable, because the amount of costs for the attraction of customers, the total costs are clear and can be compared to the revenue per unit or per customer.

Unit-economy helps to find risks, predict them and take a more sober view of the company's activity. This is usually hampered by a "margin forgives all" mentality. Profit covers the cost of engagement, things seem to be going well, in practice the financial model matches the calculations. Systemic errors are unnoticeable at this stage, but if you scale such a business, you find that many payments (no matter how many) are deferred and there are cash gaps.

Unit economy: formulas and examples of calculation

The problems of unit economics

The first unit-economy calculation (in Excel or any other way) is always very time-consuming and requires detailed work on each customer and advertising channel. For businesses whose main sales are offline and B2C rather than B2B, it is most difficult. Trying to calculate unit economics for the first time, you may find that you were previously using very inaccurate marketing metrics, with the result that sales to one customer were 'smeared out' over several, and all information was mixed across advertising channels. However, further calculations are simpler: they are automated and contain fewer errors.

It is very easy for a newcomer to make a mistake by getting confused by the numerous formulas. Experts are happy to sell services to startups, such as calculating the unit economy from scratch and auditing the unit economy.
Accuracy is very important in a unit economy. But metrics, in fact, are often adjusted to what is desirable. For example, there is a common opinion that you should strive for a ratio of 3:1 or more between LTV and CAC (moreover, this ratio does not even characterize the viability of a business model), and although you may announce that the firm has 2:6 ratio at the startup presentation to potential investors, the calculations round it down to three. These calculations are of little use.

Some costs are important in the long term, but in the short term they do not seem to have much of an impact. But you can't round them up anyway: it reduces the accuracy of the unit economy and makes it unrealistic.

You need special services to calculate absolutely everything. For example, you need to take into account the conversion rate of customers who come through offline channels, not online, and you need a call tracking service to track phone calls and your own CRM to keep track of all potential and current customers, store information about their order history and their path. Suppose User A visited the shop's website briefly and took a glimpse at the offers, but returned a month later to place an order, not through the website, but by phone. To make sure it's one and the same person, and not different, you need a CRM. Software developers or their contractors also implement end-to-end analytics.




Unit economy training

Calculating the unit-economy with all the necessary indicators is not an easy task and has many subtleties which can prevent you from getting the figures you need for your analysis. For example, selecting a unit in the product, selecting a complex or simplified formula, and forming conclusions based on the metrics.

However, those who want to build a career in IT or product management simply need to be skilled in such calculations.

Unit Economics, its place in business economics and its connection to the various stages of the product lifecycle can be explored in detail in the GeekBrains video course entitled 'Unit Economics and Market Analysis'. You will learn how to identify useful metrics among others, and consider several models for product monetisation.

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