At Hack & Hustle we believe that genius is global & hate that opportunity isn’t. Despite the potential of the European Single Market, start-ups have difficulties in growing as fast as their American counterparts. The availability of capital is a key catalyst for a thriving start-up ecosystem. In this respect, Europe lags behind. The European venture capital industry is smaller, less attractive and barriers to cross-border investment persist.
As you can probably tell, the development of venture investing in Europe is one of our main passions. We are hustling to become leaders of tomorrow and play a strong role in fostering a borderless European venture-investing ecosystem. We want to push boundaries; but being a leader is also about giving the future a voice. It’s about empowering talent to grow and develop. It’s about collaborating to write the history of the future. It’s about challenging people to become the best version of themselves.
This is why we are constantly working and supporting young talents by letting them join us in the trenches and learn about this wonderful world of venture. If you are looking to break into venture, do reach out to us. The “Breaking Into Venture” series is the result of us challenging our interns and trainees to develop an article on some of the basics of the venture world they learned whilst working with us.
Matilde is a student of the Integrated Master in Industrial Engineering and Management at NOVA School of Science and Technology.
She’s interested in learning outside of the box ways to improve in different areas, such as industrial management, sustainability, and human rights, and ready to explore innovative and different ways to see and experience the world.
To make your idea thrive you need to learn how to make it profitable. Having that said, as good as the product or service you are offering might be, that is just not enough on its own. It is crucial to understand how to generate income, how to retain clients and how to attract new ones.
I am going to talk about Unit Economics and what it can do for your business. Most importantly, I will do my best to explain why the hell you should have it implanted yesterday.
First things first, what does Unit Economics mean?
Unit Economics are a fundamental financial basis of a successful business. The goal is to easily manage your company’s revenues and, through your business model, help to understand if you are generating profit or losing money.
This will turn a complicated analysis into more manageable tasks, divided by areas and specific pins of your business. It’s the perfect method for startups, to easily understand the growth or potential growth of your company.
Why are Unit Economics so important?
Unit Economics will make it easier to reach essential values needed for a better understanding of your company’s growth, such as:
- Break-even point: this is where production costs will equal revenue, meaning that you do not have either a profit nor a loss;
- Contribution margin: how much a unit sale can contribute to even out fixed expenses;
- Return on investment: relation between the money earned from an investment and the quantity spent on that investment;
- Forecasting profitability of your business: predict if your company is it being viable, this means, if you are getting profit. It is also important to forecast the likelihood of success in the long term and decide if it is better to cut it short before you start losing money.
This analysis can make you understand where and why you are failing or flourishing. All of this makes Unit Economics the perfect key metric. It’s a way you can predict the behaviour of your business in order to improve it.
The main question is: are your customers costing you more than what’s entering in your pocket?
Are you interested in how you can use Unit Economics?
As the name says, Unit Economics works on a unit basis. The first thing needed is to decide what will the main unit be.
Some examples of different Units can be the buyer (in a store/retail environment) or even the infrastructure (more applicable to a telecommunications company, which has both the customer and the infrastructure as a unit).
After identifying the unit basis, you’ll need to identify the fundamental unit economic.
Companies that have the client as a unit have two fundamental unit economics, CAC (Customer Acquisition Cost), which are the costs associated with attracting clients, and LTV (Lifetime Value), how much does a client bring to the company during the period of this association.
In some other cases, we talk about the average monthly revenue per customer, where the main concern is the monthly revenue for every buyer that had been acquired.
You need to consider inflows, such as revenue, the duration of that inflow and, also outflows, such as capital expenditures, CAC, marginal operating costs, and maintenance capital expenditures in the case of infrastructure businesses.
How to calculate Unit Economics? (It’s about to get geeky, scroll through this chapter if you’re not a maths lover)
Units can be defined as one of the following:
- One item sold, in this case, we focus on CM (Contribution Margin) calculated through:
- One customer, and in this case, we have two possible approaches:
- Predictive LTV: helps to forecast how the average customer is likely to act hereafter and can be calculated through:
- Flexible LTV: This one can facilitate the prediction of potential chances in revenue, immensely helpful for new business where they are still under constant changes and development, you can calculate them though:
But wait. What does this mean?
The values that we reach previously, are taken into consideration so we can analyse and evaluate the ratio of the Lifetime Value with the Cost of Acquisition.
We already know how to calculate the LTV. So, for the CAC we use a simple method:
Afterwards, the evaluation is separated into 3 possible intervals:
- If LTV/CAC > 1, well done! You have a well-structured and balanced business that leads to profit growth.
- If LTV/CAC = 1, pay more attention to your business! Your business is stagnant, you should revise your pricing models, your sales and your client acquisition.
- If LTV/CAC < 1, act, now! You are losing money, you should think about your budget distribution and revise your marketing game.
The established perfect value is a ratio of 3 to 1, the lifetime value should be 3 times the value of the acquisition, this meaning that a customer brings you more than 3x money than what it costs you.
As a new company, analysing LTV may be tricky. You should start focusing on the customers who are able to bring more profit and use a growth lever to fast track analysis.
Instead of analysing the ratio of LTV for CAC, we can analyse the business through the payback period on CAC. Through this method we evaluate how long it takes to earn as much as you are spending, shorter payback times equal fewer capital requirements and faster profit-making. On average, startups have a 15-month long payback period.
It’s up to you…
The use of Unit Economics only brings benefits to your company, you will be able to understand if your company is viable if you’re business is growing or has prospects of growing, this means if it’s bringing profit or if it’s dragging you down.
With such an easy metric to apply, go ahead and find ways to improve and get that 3 to 1 ratio.
Start applying unit economics as soon as you can in your company, as it will help you thrive.