The startup ecosystem in India has begun to take formidable shape in recent years, leading to it becoming the third largest startup ecosystem in the world. Factors such as government initiatives, massive funding, an ever-flourishing domestic market, among other things, have all played their part in this stellar rise. Some are rightly calling it a startup revolution. However, in a rush to become the next big thing, founders often forget to establish strong economic and financial principles with regard to the business, which, at some point, results in them drowning in quicksand. More often than not, the missing component in their business plan, a rather significant one at that, is the concept of unit economics.
What is Unit Economics?
Unit economics, in simple words, are the direct costs and revenues associated with a business model on a per-unit basis. A unit refers to any quantifiable item that creates value for a business. If we’re talking about a retail store, its unit economics is the amount of revenue it’s able to generate every month from each single customer.
Importance of Unit Economics
- Optimisation of Product
Unit economics helps the startup understand whether the product it is offering is overpriced or undervalued. It answers questions such as:-
- Are the expenses incurred with regard to marketing worth every dime?
- Are there any costs that can be reduced?
- Can the product be optimised in any specific way?
- Assessment of Market Sustainability
Since attention is given to detail, the future potential of the product can be very well estimated with the help of unit economics. It is particularly beneficial to the startups that make the most use of it at the early stages of business. Unit economics is what gives these startups their running start.
- Forecasting profits
The focus of profitability on a per unit basis leads to a more realistic picture of the timeline necessary to achieve the said profitability. Unit economics measures cost down to their bare minimum unit, thus improving the accuracy of these forecasted profitability levels.
Importance of Tracking Unit Economics
Unit economics comprises two important terms, namely customer lifetime value (LTV) and customer acquisition costs(CAC). The generally accepted ratio is on a 3:1 basis where the value of acquisition obtained is at least three times. In other words, the value obtained from a customer must be at least three times the costs incurred to acquire the customer.
Another important aspect of unit economics is the payback period of the CAC. This refers to the time period that a company takes to pay back the cost of acquiring a customer. However, the shorter the payback period, the better since funds required for working capital are relatively lesser.
The sooner this ideology is implemented, the easier the path that follows. Unit economics solidifies the business’s position in the market and aims at consistency in growth levels. Long term financial projections that are better structured shall also follow. Moreover, a startup must be constantly aware of the respective movements of costs and revenue associated with the relevant business model.
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