With our experience of consulting startups, we are certain that unit economics is the most effective method to find ways to maximize your profits. To see how unit economics works, let’s start with the terms.
Unit economics is a method to calculate profits and variable costs per customer. Using data provided by unit economics, you’ll see whether there’s any sense in scaling your business. Also, it allows you to view your product development activity as an investment.
Unit economics is the starting point for analysis of the product’s financial performance. Rest assured: your potential investors, outside analysts, or stakeholders will certainly ask about these metrics indicators. It’s crucial for your own internal decision-making process as well. With unit economics, it’s easier to decompose bigger tasks into smaller and manageable elements.
If you understand unit economics:
- The key points of a business's financial model will make more sense;
- You’ll find a weak spot in your product’s value delivery chain;
- Management team will have more data to determine break-even points and contribution margins, which will aid the decision-making process;
- You’ll find it easier to calculate return on investment and other profitability tests;
- Predicting the company’s future profitability will prove to be more valid.
Let’s look at it in more detail
ARPU — Average revenue per user (sometimes known as average revenue per unit), is a measure used primarily by consumer communications, digital media, and networking companies, defined as the total revenue divided by the number of transactions.
ARPU can be used as a key metric for the evaluation of new changes (especially, financial) in the product.
ARPU also works well when comparing the effectiveness of several projects with similar business models.
ARPU = ARPPU / (CR1)
ARPPU or ARPC — Average revenue per paying user (Average revenue per customer)
ARPPU shows how much we get from sales to one customer. It doesn’t include the marketing cost. This parameter is often confused with ARPU, where all users (free and paid) are taken into account. In the case of calculating ARPPU, only the number of paying users is considered.
ARPPU is usually significantly higher than ARPU.
ARPPU is mainly used for the calculation of the income from one paying customer during its cooperation with the product, service or company:
ARPPU is an important value for business effectiveness estimation. By comparing it to CAC (customer acquisition cost) we can measure the return on marketing investments.
ARPPU is the ratio of paying users to the value of your project. This metric indicates how much a loyal paying user is willing to pay. It can also be interpreted as a user’s response to the prices set in the project.
List of Abbreviations:
ARPPU (ARPC) — Average revenue per paying user.
ARPU — Average revenue per user.
AvP — Average price. (The sum of money our customer paid for our goods or services).
COGS — Cost of goods or services sold.
1sCOGS — Special costs for the first transaction, and those that are not included in COGS. For example, the cost of connecting the client to the service, test periods, etc).
CR— Conversion rate. In different projects with different business models there can be various levels of conversion rates. For example, freemium model has two types: registration conversion and purchase conversion. That’s why in formulas you’ll find CR1, CR2, etc.
CPA (or CAC) — Cost per acquisition or Cost per click or Customer acquisition cost — Cost per acquisition of one User. (It is determined by dividing the entire marketing budget by the number of all Users. Unlike CAC, CPA is an actionable metric. It doesn’t depend on other metrics, such as conversion or User flow).
UA — User acquisition. (The number of Users acquired. It shows how many Users learned about our product through different marketing strategies. For example, how many visitors came to the site through search engine advertising or how many companies were contacted by cold calling).
ARPU and ARPPU , the basic metrics of unit economics
Now let’s talk about unit economics’ basic metrics. They are used to calculate your business efficiency and potential growth points.
In fact, ARPU and ARPPU help us understand how much we can spend on acquisition of users and whether our business model is profitable or not.
By working with the values of the parameters in the formula, you can find your optimal growth points:
UA x (-CPA + ARPU) = Profit
UA x (-CPA + CR1 x ARPPU) = Profit
CR1 = (Buyers / UA) x 100
ARPPU = ( Av.Price — COGS) x APC — 1sCOGS
ARPU = ARPPU x CR1
Unit Economics Calculator by JetStyle
The endless list of formulas may look intimidating. However, unit economics is quite a logical matter. To demonstrate this, we developed our own unit economics calculator. At first, it was for internal use only: JetStyle’s managers and designers used it during business meetings to discuss the ways to scale profits for our clients’ products. Now it’s available to you (find the link above).
Here’s how the calculator works when applied to e-commerce:
Basically, you input all basic economics parameters of your project. The calculator shows if your activity is profitable at the moment or not. Also, you get understanding of your potential profit. Most importantly, you’ll see how sensitive your business model is to fluctuations.
For example, if a 0.5% change of conversion rate makes your business not profitable, your biggest challenge will be to select only the channels with a highly manageable price. At the same time, you’ll have to take care of any changes in the conversion funnel. All in all, with this data you’ll understand whether you need to invest in web/app development or redesign.
Unit economics turns the word ‘innovation’, a buzzword in many cases, into specific knowledge. You’ll know how you can find out what your key business metrics are, and how to make them more effective, so that they complement each other and increase overall profit.
Back to the calculator. After you input all the metrics, you’ll have a schematic visualization of all metrics you need to consider in your activity:
We believe that our calculator is a simple and effective tool for discussing initial hypotheses on product growth & development. We are constantly updating its functionality, so if you feel that a feature is missing, get in touch with us. The current calculator version covers all basic case scenarios. The core variations take place when such indicators as Average Price, Retention or Cost of Goods Sold change. They are the ones reflecting businesses’ individual features. If you’d like to talk with us about this approach and its applicability to your business, get in touch with us. We’re always open to communication and we never charge for primary consultations. firstname.lastname@example.org