Unit economics is extremely critical to the survival of any business. I will attempt to keep this as simple as I can. I hope it passes the “Moms test”.
One of the biggest lies startups can ever tell themselves is, “we will lose a little money on every customer, but we will make it up in volumes”, it’s as good as pouring more water into a leaking bucket hoping it would hold, cos now we have poured a lot of water into it. If you are losing money at a smaller stage, it amplifies when you are bigger if the holes are not fixed.
Unit economics is the method used to determine whether a business model can be successful or profitable. It looks at the direct revenues and costs associated with that revenue acquisition.
2 questions at the core of understanding unit economics are:
i- How much does it cost to acquire a customer?
E.g. If Accounteer provides accounting services to companies on a subscription basis, let’s assume companies pay N10,000 annually for access to this service. Sounds good? But for them to get companies to pay N10,000, the companies need to have heard about them, so they do several ads on Facebook, Google, and maybe newspapers, they spent N250,000 doing all that. They got 20 companies from this exercise. In essence their CAC (customer acquisition cost) is N250,000/20 customers =N12,500.
ii- How much is a customer worth?
Here, there is a concept called LTV (lifetime value), simply put, it means how much you can make from that customer over the lifetime of their relationship with your product.
Bullshit Alert: Startups are usually quick to say the customer is going to use their product forever. That’s not true, as there would be competing options, the company might go out of business, or they build the same solution internally the list goes on and on.
So let’s assume each customer stays for 2 years here. So you make N10,000(annual subscription fee) x 2years= N20,000, whereas you spent N12,500 to acquire them. So in an actual sense, you are making N7,500 from the customer.
This is a simple way to understand Unit Economics. As long as the customer gives you more money than what you spent on getting that customer, you have a deal (LTV > CAC). If your CAC is higher than your LTV, that’s a death alert. You need to stop whatever you are doing and head for your war room and figure out a way to acquiring customers for cheaper or maybe charge customers more (this works if customers really want your product) or both.
General advice, you should be making at least 3 times what it cost you to acquire a customer.