What is Unit Economics?

Whether you’re a new business owner or a savvy veteran, having the appropriate information and business model in place is crucial for success. Since there are numerous models and methods you can use to run your business, it’s important to choose one that will help you achieve the results you’re looking for. 

Take unit economics, for example. Companies that utilize this business method base many of their decisions around the “basic unit.” More specifically, unit economics takes a closer look at a company’s revenues and costs related to a single unit of production. 

Unit, in this sense, refers to an element that the organization can create and sell that will add value both internally and externally. 

If your organization plans to make business decisions based on unit economics, you’ll want to have a firm understanding of its equation. 

Here’s a look at how to calculate unit economics. 

Contents:

1. Calculating unit economics

• “One Item Sold” Model
• “One Customer” Model

2. The metrics of unit economics

• Lifetime value (LTV)
• Customer acquisition cost (CAC)
• Other important unit economic metrics

Calculating unit economics

Before you can start calculating unit economics for your business, you need to decide which model you’d like to use — “one item sold” or “one customer.” As you’ll see below, both models have their benefits and approach unit economics from a slightly different angle. 

Let’s see what makes each model different. 

“One Item Sold” Model

One way to model unit economics is to approach it from the unit side. In this method, you would accept that a unit is “one item sold” and determine the unit economics by calculating the contribution margin.

To calculate the contribution margin of a unit, you’d use the following formula:

Contribution margin = price per unit – variable costs per sale

This method provides a direct result and helps the leadership team quickly determine the revenue/cost of a single unit. 

“One Customer” Model

The “one customer” unit economics model requires more calculations and considers metrics such as customer lifetime value and customer acquisition costs. Since it uses additional data, companies often use the “one customer” model more frequently. 

To calculate unit economics with the “one customer” model, you’d use the following formula:

Unit economics = customer lifetime value / customer acquisition cost

The metrics of unit economics

Depending on the model you use, there are several metrics you’ll need to complete the calculations. Since most companies use the “one customer model,” LTV and CAC will be the most critical metrics. However, other factors such as churn rate, gross profit, and retention rate are important to know. 

Lifetime value (LTV)

One of the two components of “one customer” unit economics is lifetime value or LTV. This equation provides insight into the average amount of money a business makes per customer throughout the client relationship. For instance, the LTV for a subscription company would be from the initial sign-up to the date the customer cancels their subscription.

Customer acquisition cost (CAC)

Customer acquisition cost, CAC, equates to the total investment required to acquire one customer and makes up the other half of the “one customer” model. Even though customer acquisition cost is essential for unit economics, it can be a valuable metric for business owners outside of the model too. 

Other important unit economic metrics

Even though lifetime value and customer acquisition cost are two of the most significant metrics in the unit economics equation, there are other factors you should consider. Below are some of the most common secondary metrics that companies often use in their unit economic method.

• Average customer lifetime (ACL)
• Number of transactions (T)
• Churn rate
• Retention rate (R)
• Number of customers (C)
• Gross profit (GP)
• Total revenue (TR)
• Average order value (AOV)
• Average gross margin (AGM)
• Gross margin per customer lifespan (GML)
• Discount rate (D)