What is Unit Economics and how it matters to your business?


While running a business, your eyes are always on the total revenue, total expenses, and profitability of your organization. It is difficult to look at individual units manufactured, or individual customers – the expenses incurred in acquiring that one customer, and the profitability that one ‘unit’ can bring in. That is precisely what Unit Economics focuses on:

UNIT ECONOMICS involves understanding your business expenses and revenues for one individual unit.

It delves into the profitability of the smallest unit sold, and thus helps in assessing the profitability and sustainability of your business model. The smallest unit varies for different types of businesses. For an FMCG company, an economic unit might be a box of toothpaste or a sachet of shampoo. For Swiggy, it could be a single delivery made to a customer. For Netflix, it is each customer who takes a subscription.

You might wonder why it matters to you as a business owner to look at each individual unit and calculate the profits it brings in. Pricing your product right, cost optimization at different stages of production or creation, controlling variable costs – all these crucial elements of your business can be understood by understanding Unit Economics.

In short, comprehending unit economics, calculating it accurately, and recognizing its importance are all essential for the long-term success and growth of your business.

How is Unit Economics Calculated?

There is a standard formula for Unit Economics, though many companies might have different interpretations of it.

Unit Economics = Price per unit – Cost incurred per unit

The formula looks simple enough. However it is not easy to arrive at this number in an organization setup. Let’s look at these elements a little closer and see what they mean.

Price per unit – This metric is quite straightforward. This is the price at which you are selling the product, subscription, or service. But if you have multiple products, subscription options, or services, you will need to take a weighted average of the price.

For example, if you are selling Subscription A at Rs. 5,000, Subscription B at Rs. 7,500, and Subscription C at Rs. 10,000. And if you have sold 55 Subscription A, 35 Subscription B and 20 Subscription C, your weighted average Price per unit would be:
(5000*55) + (7500*35) + (10000*20) / (55+35+20)

Cost incurred per unit – This part is tricky. Do you include only the costs directly associated with the production of your product, or service? Or do you include other costs like infrastructure, utilities, salaries, marketing, etc.? Here, it is better to go with general wisdom.

Most organizations only include costs directly associated with the product or service. For products, you include materials, labor costs, and equipment running costs that are likely to change when your scale of production changes. For services, you include software expenses, salaries of staff directly associated with the service and vendor expenses directly connected with the service.

Expenses like rent, salaries of support staff, utilities, and marketing are not included since they do not vary much when your scale of production goes up.

Once again, this depends on how lenient or how strict you want to be in measuring your Unit Economics. You could choose to include certain expenses in your Variable costs, and choose to skip a few based on your understanding of what matters the most.

The graph above shows a very basic representation of why Unit Economics matters. The greater the gap between the two lines, the better your profitability. So your business strategy should be to keep your Unit Economics as high as possible, without affecting your sales.

Customer as a unit

Some organizations consider ‘a customer’ as a unit and not a product or service. In this case the formula for Unit Economics will be:

Unit Economics = Customer Lifetime Value / Customer Acquisition Cost

Customer Lifetime Value or CLT – This is the revenue a customer is likely to generate for your company over the years. If a customer subscribes to your product or service, they are likely to continue with you for a certain period of time and keep generating revenue. This is easier to calculate for subscriptions, or software products, as opposed to FMCG, where it is more difficult to track the LTV of a customer.

Customer Acquisition Cost or CAC – The same dilemma of variable costs arises here. Which expenses to include in this number? And which ones to exclude? Once again, the general wisdom is to include costs that can vary a lot when your customers increase – like software expenses, marketing costs, sales expenses, salaries of developers directly connected to the product, and so on.

As you can see, the method of calculating Unit Economics varies based on your industry, service, product, subscription type, expenses, and interpretation of costs. The key is to be consistent with categorizations so that you are sure which expenses to include and which ones to not include.

If you need help with calculating Unit Economics for your business, reach out to Finavi CFO today. We have years of experience in working with small and medium businesses to make crucial decisions based on Unit Economics.

Why Unit Economics Matters for Your Business?

Understanding Unit Economics is essential to understanding your business’s financial health. Here are some ways Unit Economics can help:

1. Pricing your product or service

Pricing your product or service is a crucial decision that business owners must make. Unit Economics can help you price your product or service just right, making sure it covers your expenses and yields a good profit. Also, when your number of customers increases, you could reduce pricing or offer discounts easily if you know the contribution of each product towards your company’s profitability.

2. Understanding profitability

It goes without saying that you should have a positive Unit Economics value at all times. But you can play around with margins to increase sales or acquire new target markets. Knowing Unit Economics values can help you take risks to grow, or be conservative when you need to make money urgently.

3. Identifying Efficiency and areas for Improvement

Pricing your product or service is a crucial decision that business owners must make. Unit Economics can help you price your product or service just right, making sure it covers your expenses and yields a good profit. Also, when your number of customers increases, you could reduce pricing or offer discounts easily if you know the contribution of each product towards your company’s profitability.

This deeper understanding can reveal inefficiencies, areas for improvement, discrepancies, or loss-making units, helping you make course corrections very quickly. Whether it is reducing production costs or optimizing marketing plans, understanding unit economics can help you in strategic decision-making.

4. Better Business Decisions for Sustainable Growth

With a better understanding of Unit Economics, you can make better business decisions about competitive pricing, expansion, acquiring new audiences, and cost optimization, while ensuring that each decision contributes positively to the financial health of your company.

5. Investor Confidence

If you are looking at investments for your organization, it is crucial to project a positive Unit Economics model, as well as a good understanding of your unit pricing. This will reassure investors that you are on the clear path towards profitability, and also help them understand how scaling your business can impact expenses as well as revenues.

Unit Economics in your organization

Unit Economics is not just about looking at all your revenues and expenses, it gives you a deeper understanding of your business model, and how it can grow. For business owners, Unit Economics is essential to drive sustainable growth and profitability.

Calculating Unit Economics is definitely not a one-time exercise. As your business grows, there will be changes to your pricing as well as expenses, and this impacts Unit Economics. Ideally, it should be done every year, or after every major change in products or service offerings to ensure that you understand your costs, revenues, and margins at a granular level.

Finavi CFO has over 15 years of experience in helping organizations understand Unit Economics, and its impact on business health. Reach out to us today!

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