Unit economics is a calculation of profit and loss for a particular business model on a per-unit basis. Basically, it tells you how much value each item or unit creates for the business.
Depending on how the unit is defined, there are two main approaches. The first assumes that the unit is one quantifiable item or piece sold, so unit economics can be calculated as revenue per unit minus variable costs per unit, showing how much profit a business makes before fixed costs.
In contrast, if one unit is defined as one customer, then unit economics is calculated by dividing Customer Lifetime Value (LTV) by Customer Acquisition Cost (CAC). LTV estimates how much a company receives from a customer during the entire engagement time before this customer churns, while CAC defines how much it costs to attract a client.
In this case, unit economics shows the value a customer brings to the business during the time they stay loyal, in relation to how much was invested to acquire that customer. It’s important to benchmark the calculation results to the industry the business operates in. However, in general, there are three basic scenarios:
- CAC < LTV – strong unit economics, meaning that for every dollar spent on acquiring a new customer, more revenue is generated over the course of their lifetime.
- CAC = LTV – business stagnation. In terms of cash flow, the outcome is negative for a business, as it will take customers their whole lifetime to repay you the initial spend.
- CAC > LTV – poor unit economics. In this case, the more customers are acquired, the greater is the business revenue loss.