Don’t say you don’t have Unit Economics!
In the world of Venture Capital (VC), measuring the unit economics of startups is a fundamental issue. The unit economics are the measurement elements of certain key variables of the startups. They are a guide to measure the current performance of the business at the unit level and allows you to set investors’ expectations. They work as a metric for comparing the progress of your business against your competitors. The result allows you to test the business model and adapt it when a change is necessary in search of an optimal model.
The main unit economics and our suggested approach on how to tackle them is as follows:
1. Customer Life Time Value (CLTV)
Every startup should be ready to measure the Customer Lifetime Value. It represents the sales contribution margin generated by a single customer over the duration of the relationship. The contribution margin is the sales minus the variable costs (ie. sales, administrative and operational expenses) associated with the customer.
Measuring the customer’s life is one of the main challenges; one way to calculate it is through churn. Divide one by the monthly customer churn and you will have the average Customer Lifetime (remember to use the same period for all factors).
If you have clients of different sizes, try to measure them separately according to the type of client. For example, calculate the CLTV for companies and another if they are individuals.
2. Customer Acquisition Cost (CAC)
The Customer Acquisition Cost is the sum of all costs related to the acquisition of a new client.
The CAC must include all related costs including payment for referrals or discounts, in addition to considering the actual cost per customer and not the generation of organic customers.
Never say that you do not have a CAC, calculate the cost even if it is a projection on the channel or the different channels you use to attract customers.
Even if you only have one client, there are expenses related to its acquisition such as the cost of time invested, transportation, meals, advertising, etc.
Consider future CAC projections to determine its behavior and face these costs.
This is one of the most common measures to identify the profitability of the business per unit. Usually an attractive business should have a metric greater than five. Clearly if your payback is below one, rethink your business model. To calculate it, divide the Customer Lifetime Value by the Customer Acquisition Cost.
4. Profitability: Gross Profit and Operating Profit
The profitability of the business is essential, especially post COVID-19. Two useful measures are gross profit and operating profit. The first considers the contribution margin per unit after the associated costs of selling the product or service. The second is the result of the first minus selling, general and administrative expenses related to the operation of the business. Contribution margins of both measures, gross profit and operating profit, vary through industries and business models.
5. Cohort Analysis
A cohort comprises a group of users. It is analyzed over a time period to validate or upgrade the business model. The result of the analysis allows us to understand the customer’s relationship with the product or service. In addition, it is a metric that helps define the traction of the company, especially if it does not yet generate real sales. When doing the analysis, two things are sought: stabilization in customer retention and that the new cohorts perform better than the previous ones.
As a recommendation, select the appropriate metric and period.
Cash Burn (Burn Rate) and Lifetime (Runway)
Although they are not a unit economic, they are an important metric. Cash burn is the measure that indicates how much cash you are using in your operations in a period of time. It is important that you consider the cash available since this will be decisive in your life time. As you burn more cash, the less time to live you will have (ceteris paribus), so you should try to get your business to take off to have additional liquidity or reduce the cash burn (10 steps to extend startup runway https://bit.ly/2ZV5GSk).
All business models have unit economics. Do your research, use your creativity and track your business metrics. These metrics help you raise capital and manage your business seeking optimization every day. Use them today!
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance
Ana Maury Aguilar. Investment analyst at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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