Is your business making enough profit selling to a single customer (or a single unit)?
It’s a simple question, but a crucial one for any finance team concerned with long-term profitability, scaling, or sustainability.
It’s also the fundamental question that unit economics aims to address.
By focusing on how much your business makes by selling a single unit, you can make data-backed financial decisions for your business’s long-term profitability. If you calculate unit economics, then you’ll know when to address pricing strategies, invest in scaling, or cut costs to improve margins.
In this article, we dive deep into unit economics. We cover what they are, how to calculate them, and how to improve them for your business. Let’s start with a unit economics definition.
What Are Unit Economics?
Unit economics are the direct revenues and costs of selling a single unit of your product or service.
Think of it as a method to calculate your business’s profitability on a per-unit basis. It simplifies financial metrics, helping you assess your business’s health and make strategic decisions.
Through regular evaluation, unit economics helps you answer a crucial question:
Can you make more revenue from a customer/product/session than the total cost of acquiring/creating/providing them?
Why Do Unit Economics Matter to Businesses?
Unit economics helps companies assess how profitable they are, how profitable they will (or won’t) become, and when they can expect to reach a specific level of profitability.
With a clear view of all this, finance teams can make data-backed decisions when it comes to their business’s pricing, scaling, and cost management. Along with other financial analysis methods, like budget reporting and cash flow analysis, unit economics gives you a look into your company’s financial health.
While beneficial for businesses big and small, this calculation is especially important for startups. Young companies often adopt a growth-first strategy to attract investor interest, initially overlooking core profitability—leading them to later discover the product or service wasn’t a profitable venture in the first place.
Calculating unit economics also helps determine:
- Pricing: It helps you understand both the cost and revenue of each unit. Using this information, companies can identify a profitable price point that covers costs.
- Product viability at scale: It helps you understand if your product will remain profitable as you scale it. By analyzing if your product can cover production costs and make a profit in larger quantities, you can settle on optimal pricing and customer acquisition strategies.
- Effective investment: It breaks down costs and revenue on a granular level, helping companies identify inefficiencies. This allows them to eliminate low-return activities and focus on high-performing areas that can drive a higher ROI.
Unit Economics in Different Businesses: What Is A Unit?
In unit economics, a “unit” refers to any quantifiable item that brings revenue to your business. Different organizations will have different units depending on their business models and their products or services.
For example, a clothing store will identify a unit as a single product, such as a sweater. Their main question for analyzing unit economics is: "Can we make more from selling a sweater than we lose by making one?”. In this case, it’s all about the product.
A SaaS service, on the other hand, will typically identify the unit as a customer who subscribes and generates recurring revenue for the company. The question then becomes: “Can we make more from a customer before they unsubscribe than the amount we spent acquiring them?” In this case, measuring revenue and costs on a per-unit basis centers around the customer, rather than the product.
You also might find that what you originally measured as a unit isn’t what you should measure as a unit. This was the case for SaaS solution Numeric—as we heard from Parker Gilbert, CEO and Co-Founder:
“At Numeric, our unit is a customer—more specifically, a customer that signs an annual contract. Early on, we considered a “customer” as a unit regardless of contract value or term, but we quickly realized that wasn’t granular enough to give us a clear picture of our business.
Why?
Because we were seeing a huge range in the amount of work required for different customers. Now, we look at an annual contract as our unit because it standardizes for both the value and the time commitment, making it a more stable foundation for our unit economics.”
Now, we look at an annual contract as our unit because it standardizes for both the value and the time commitment, making it a more stable foundation for our unit economics.
Unit Economics Metrics to Consider
Before you can calculate unit economics, you need an in-depth understanding of the metrics involved.
Customer Lifetime Value (LTV) and Customer Acquisition Cost (CAC) are the two most important because they’re directly related to the revenue and costs associated with a single unit. We cover the unit economics formula shortly, but it essentially compares LTV to CAC.
That being said, you can enrich your unit economics calculations by including more metrics. For example, a higher retention rate indicates higher LTV and lower CAC while a high churn rate negatively impacts LTV.
Here are seven metrics that can help you calculate your unit economics accurately, starting with the two most important.
Customer Lifetime Value
Customer lifetime value is the total revenue your business can expect to receive through its entire relationship with a single customer.
The formula: LTV = Customer Value x Average Customer Lifespan
With it, you can measure whether the average revenue generated from a single customer exceeds the per-unit cost of your product or service.
Customer Acquisition Cost
Customer acquisition cost refers to all the costs your business will incur to acquire a new customer.
The formula: CAC = (Total Sales and Marketing Costs) / (Number of New Customers Acquired)
CAC is yet another essential metric for unit economics because it directly relates to the profitability of a single unit. If it’s higher than the revenue customers generate (LTV), then the business will have problems in achieving long-term profitability.
Churn Rate
Churn is the percentage of customers that stop doing business with you over a specific time. If you're a SaaS company, this refers to customers who unsubscribe from your service.
The formula: Churn Rate = (Customers Lost During Period ÷ Total Customers at Start of Period) x 100.
Unlike LTV and CAC, it isn’t necessary for directly calculating unit economics—but it is helpful for improving the accuracy of your calculations.
Retention Rate
The opposite of churn, the retention rate is the percentage of customers that remain using a product or service during a given period.
The formula: Retention Rate = (Customers at End of Period - New Customers During Period) / Customers at Start of Period x 100
The higher it is—the more customers that stick around—the higher your LTV and the lower your CAC.
Number of Customers
This is the total of customers that are using your service during a specific period. More customers spread out over acquisition costs lowers CAC, and gives you clarity on how scalable and sustainable your business model is.
Number of Transactions
The number of transactions refers to how often your customers make purchases with your business in a given period. More transactions per customer increase the total revenue from each customer, altogether improving profitability while offsetting CAC.
Total Revenue
Total revenue refers to the amount of money your business makes from all its customers in a specific period.
The formula: Total Revenue = Number of Customers x Average Order Value x Number of Transactions
Total revenue gives you a broad look at your business’s financial health, and by breaking it down into unit economics such as per transaction, you can assess if each contributes to long-term profitability.
How to Calculate The Unit Economics of Your Business
You can calculate your unit economics in two different ways depending on what you consider to be a unit. In most cases, it’s either a specific product or a customer acquired.
Let’s take a look at both of these major methods for calculating unit economics.
The Customer Unit Method: LTV / CAC
SaaS companies and other subscription-based businesses should count a single customer—not user—as a unit and use the LTV / CAC method. This is because they don’t generate income through selling a physical product or service, but rather by receiving recurring revenue through subscriptions.
By measuring the overall value your business can expect to receive from customers against the cost of acquiring them, finance teams can determine exactly how profitable a single unit is.
What does a positive LTV / CAC ratio look like?
Generally, most businesses strive for a ratio of 3:1. Getting three times the value of acquisition from each customer means your business is profitable.
But every company is different. Cledara’s CFO Christian Rasmussen explains:
"We target an LTV/CAC ratio of 3.5x, reflecting a scalable and efficient growth engine. This ensures every dollar invested drives sustainable and profitable expansion."
We target an LTV/CAC ratio of 3.5x, reflecting a scalable and efficient growth engine. This ensures every dollar invested drives sustainable and profitable expansion.
A 1:1 ratio means that you’re paying as much to acquire a customer as they're spending on your product. In other words, you’re breaking even. A ratio lower than that puts you in negative profit. If your ratio is much higher than 5:1, you could be missing out on growth opportunities. Making five times the value of the cost of a single customer, you’re safe to reinvest a considerable amount in your sales and marketing.
Let’s say you’re a SaaS that provides project management solutions to businesses. You charge $50 per month for every customer, and your average customer uses your software for two years (24 months).
Since the formula for calculating LTV is Customer Value x Average Customer Lifespan, that gives us:
LTV = $50 monthly x 24 months = $1,200
Next, let’s say you spent $30,000 on sales and marketing over a period and acquired 100 new customers in that time. That gives us:
CAC = $30,000 / 100 = $300
Finally, you divide your LTV by your CAC to get your unit economics ratio.
LTV / CAC = $1,200 / $300 = 4
That’s a ratio of 4:1. For every dollar you spend on a customer; you’re getting four times the revenue over that customer’s lifetime.
Nice! Plus, you can even invest some of those dollars back into sales and marketing if you’re keen on growth.
The Product Unit Method: Contribution Margin
If you’re selling physical or digital products, then this unit economics method is your best bet. It involves calculating how much each unit contributes to covering overall costs and generating profit.
The formula to follow is: Contribution Margin = Price per unit – Variable costs per unit
Time for another example. Let’s say you run a bagel shop. You sell each bagel for $3. That’s your price per unit. All the variable unit costs that go into making a single bagel—such as the bread, fillings, labor, and more—amount to $1.50.
Following our formula above:
Contribution Margin = $3 (price per bagel) - $1.50 (variable costs per bagel) = $1.50
That means for every bagel sold, $1.50 is spent on fixed costs and another $1.50 is profit. In this example, those bagels are keeping the lights on and making you some considerable profit. Well done!
How To Improve The Unit Economics of Your Business
What if you’re breaking even with an LTV / CAC ratio of 1:1. Or even worse, maybe the revenue you get from a customer doesn't even cover the cost of acquiring them?
The good news is that you can improve your unit economics. Some of the main strategies are:
- Increasing revenue per unit: Increasing the revenue made from each unit while keeping costs fixed is the simplest way to improve your unit economics. Ways to do this include raising prices (if doing so doesn’t negatively impact demand), upselling and cross-selling your product or service, or increasing customer retention.
- Reduce costs of production: Look for inefficiencies in your production process and find ways to streamline them. Negotiating lower prices with suppliers, automating, and outsourcing activities are all potential ways of lowering production costs and improving your LTV / CAC ratio.
- Increase customer LTV: Enhancing the customer experience, proactive support, and optimizing your product are all methods that increase the chances of your customers sticking around and spending more on your product.
For example, after identifying a unit to be a customer on an annual contract, Parker and the team at Numeric identified some key insights:
“Having a firm grasp on our unit economics has been critical for us, especially when it comes to making decisions about pricing, sales and marketing spend, and even product development. For example, our unit economics analysis showed us that our CAC for enterprise customers was significantly higher than for our core SMB customers.
This didn't necessarily indicate that anything was off—while larger customers cost more to acquire, we should be willing to spend more time and capital to bring them into the door given the contract size.
That being said, it triggered a drill-down into marketing spend for the enterprise segment that ultimately resulted in us rolling out a motion that tiered accounts more selectively based on existing awareness and fit. By being more selective about which accounts we enrolled in our enterprise marketing motion, we could reduce CAC—and subsequently, the unit economics ratio—for the segment, and keep bringing larger customers on board that are a great fit for the product.”
By being more selective about which accounts we enrolled in our enterprise marketing motion, we could reduce CAC—and subsequently, the unit economics ratio—for the segment, and keep bringing larger customers on board that are a great fit for the product.
Make Data-Backed Financial Decisions With Unit Economics
Analyzing your company’s unit economics helps you determine if your business model is profitable. By understanding profitability, your finance team and your executives can make data-backed decisions when it comes to scaling and growth.
For SaaS businesses using a single customer as their unit, calculating unit economics comes down to dividing LTV by CAC. A 3:1 ratio is ideal and means you're generating sustainable value with your business model. If you’re selling products, then calculating the Contribution margin by dividing the price per unit and variable costs per unit is the way to go.
Whether you’re a startup trying to scale or a seasoned business looking for ways to cut costs, analyzing unit economics helps you determine your next steps toward sustainable growth. With a positive, strong ratio, you can focus on driving growth knowing that your per-unit profit is conducive to success.*
*Just make sure you continue checking in on your unit economics to ensure it stays that way as your business (and costs) evolve 😉
