Unit economics and contribution margins
It’s easy to define a company’s unit economics. It’s the revenue that the company earns on each transaction minus the costs associated with performing that transaction.
However, what should be included in the costs of performing the transaction? For example, should customer service costs be included? While they may not be incurred on every transaction, if removing customer service would lead to a steep drop in the number of transactions performed by the company, customer service costs need to be included in the unit economics calculation.
Similarly, when calculating a company’s contribution margin after customer acquisition costs, what marketing costs do you include? Do you only include the costs of online marketing channels where you can measure the number of transactions that these channels produced, or also the costs of offline channels used to build brand recognition? If stopping the offline marketing would produce a steep fall in the number of transactions, you should include at least a part of these offline marketing costs in your contribution margin calculation.
It’s important for entrepreneurs and investors to question each others’ unit economics and contribution margin calculations rather than accept them at face value. Deciding what costs to include and exclude from these calculations helps you gain a better understanding of how a business actually works. And this lets you paint a more accurate picture of the business’ economics.
Originally published at Thoughts of a VC.