What many startup founders are getting wrong
‘Fully Loaded’ Unit Economics
“Unit economics are the direct revenues and costs associated with a particular business model expressed on a per unit basis”
UPDATE MAY 11, 2020: Created a video clinic on this topic for those left wanting to learn more. Check it out here.
One of the areas of opportunity that I often encounter being surrounded by early stage companies are founders who are not dialed in to their unit economics. All founders understand what unit economics are, but few are accurately looking at their unit economics through the right lenses periodically. The reality is that during the early stages of building a company the focus is rarely on financial analysis, which is sometimes compounded by the fact that in most companies a finance role is usually a later stage hire.
More of a reason why doing a proper ‘fully loaded’ unit economics analysis should be a strict requirement early on is that it can help you better understand how your business works. I’ve been on the shitty side of this, and having a company with negative unit economics, where the more you sell the more you burn is a founder’s nightmare (and investors)—😱.
Why the term ¨fully loaded¨? Because a lot of unit economics analyses that I come across only include some of the costs associated with each sale, which means that founders are not operating their companies with all of the correct data necessary to understand what is really going on. Should you include customer support? What about marketing? Payment processing? What to include and what to exclude is not an easy exercise, but it is one that will help you gain a better understanding of how your business actually works, and let you paint a more accurate picture of the business’ economics.
Sometimes this practice of not having your unit economics “fully loaded” is used as a strategy to paint a more optimistic picture of your model to potential investors—and sometimes even to fool ourselves. I’ve heard a fair share of arguments why a specific cost should not be included in your units, arguments which rarely make sense, but do improve the optics. It’s important for founders and investors to question each others’ unit economics and we must be pragmatic about the reality of our models. We have to help founders achieve a tight grip on their current economics, and if currently operating with negative unit economics, then have an actionable path to profitability.
What else can your Unit Economics tell you?
For one they can let you know how the health of your unitary gross margins, which often times is an exercise a lot of founders don’t prioritize early on. There’s nothing worse then spending considerable and valuable time on a project to later realize the gross margins are slim. They can also help you understand monthly break even points, as well as help you understand what the maximum amount is that you should be spending to acquire customers (this is easier to grasp in models without recurring customers, if your contribution margin is $60, spending more than that to acquire a one time customer does not make for a good business). It will also help you understand what the most important costs and drivers are that you will need to closely manage to MAKE MONEY.
How often should you be tracking the changes in your Unit Economics?
This depends a lot on the company. Some companies have unitary costs that will not fluctuate much, while other more operational companies have unit costs that will be constantly changing. If your business fits more into the latter case and your unit gross margins are far from ideal, you should be looking at your unit economics on a weekly basis. This will give you time to react, time to understand what should be prioritized, and allow you to measure changes on a weekly basis. The common practice of looking at your financials the first or second week after the month ends does not allow for you to be responsive and generate fast change versus staying on top of your units on a weekly basis, which will allow for experiments to improve your units.
An example of the less than ‘fully loaded´ way founders oftentimes view their unit economics:
Fully Loaded:
Quick closing takeaways
Going from thinking you were making a 29% contribution margin to only 3% is news you would have to digest sitting down. Worse, imagine having to give that investors update. Now let’s assume you had a Customer Acquisition Cost of $25. In the fully loaded model your break even point is 25 sales vs. 2.8 sales — not a small difference. Now if your monthly fixed G&A expenses are 15k, in the fully loaded model you would need 15,000 orders to break even (this number could potentially be better with the impact of scale on the variable costs) vs. 1,714 orders — again, not a small difference. Get the point?
This is why I urge all founders early on to question and improve how you are viewing your unit economics to ensure you have the most accurate snapshot of your model possible. #fullyloaded 🙏
**Very special shoutout to @Esteban Hopenhayn & @Sam Nadler (RIP Washio) who made me the evangelist I am for UE.
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