Importance of Unit Economics for Gen-Z Founders

25 January 2022

It’s well said by Bob Parson that, “Anything that is measured and watched, improves.” Same goes with Unit Economics if you are a founder of a startup as data driven decision making is the basics to ensure that the company is in the right direction.

Moving ahead with this blog, we will take a sneak peek at Unit Economics and it’s application for building a sustained business model.

Unit Economics

Economists describe it as the direct revenues and costs associated with a particular business model expressed on a per unit basis or in layman terms, we can say that it is the profit:loss calculation/customer.

Each product or each business unit owned by the founder shall have it’s own calculation of unit economics in order to understand and have in depth knowledge about the financial projections of the business unit as a whole.

Unit Economics works or has two words basically which helps us in calculating each and everything involved in a business which are:

1. Lifetime Value (LTV)

– It is basically the profit which you make from a customer over their lifetime

2. Cost of Customer Acquisition (COCA/CAC)

– It is basically the cost required to acquire a particular customer

Approaching Unit Economics

As mentioned above, unit economics have two pillars on which a castle of a $100 million dollar can be built which are the LTV and CAC respectively. We usually take the ratio between the LTV and CAC to determine the dynamics of any startup or a business.

Generally, experts say that if you LTV > CAC, your business is a scalable one and it would be more easy to raise funds or grow that business in any terms, whereas, if your LTV < CAC, your business will end up burning money.

In order to reduce the CAC, the founders must follow these steps:

• Increase the number of organic customers
• Try referral networks
• Optimize the marketing spends
• Increase the conversion rates

Why Unit Economics

As the vice versa of my opening proverb is to be proven right, we can say that if anything cannot be measured, it cannot be improved as well. Therefore, unit economics is the measuring tool used when we calculate the risk factor, the scalability and the stability of the business.

The less time you take to analyze the financial projections using unit economics, the brighter are your chances to be the next giant in the startup industry. Getting the unit economics right can help you make long term goals or plans for your business to not only sustain, but grow. It even predicts your revenue trajectory.

In layman terms, if you want to burn less cash and want to be profitable and reach the breakeven faster, you need to get the unit economics right.

Exceptions

Exceptions come into play where we let go of the LTV:CAC ratio and the LTV-CAC comes into play.

There are classic examples as well in which you can let go of the LTV:CAC ratio and use the LTV-CAC such as the Ferrari and the Toy Car model.

You see, if you sell one Ferrari, the LTV isn’t that high if you compare it with the CAC, but the value of the product is expensive which will increase the LTV-CAC thing which is the profit involved in one unit sold, which in this case is very high. As compared with the Toy Car, the LTV:CAC ratio can be 8 times higher than the first case, but you wouldn’t be able to make that much profit as compared to the Ferrari case, therefore, it really depends on the nature of product and the nature of service in your business too.