Unit Economics Flashcards
What is unit economics?
The concept of unit economics implies understanding the the profitability of the base unit of activity for a business.
For example, if you wanted to understand the unit economics of an ice cream retailer. You would start thinking about of the unit economics of an individual store. The idea is that the unit economics of a store provide meaningful insight into the economics of the whole company.
Unit economics comprise two key components: the base unit of activity of the company and the economics or profitability of that unit.
Examples of base units for different businesses include a store for a retailer, an online purchase or oder for an e-commerce shop, a ship for an ocean shipping company, and a subscription contract for a SaaS.
Evaluating base units may involve discretion, such as differentiating physical and e-commerce operations for a retailer such as Walmart.
Understanding the unit economics involves identifying revenue and expense drivers, fixed and variable costs, and potential capital expenditures.
The term unit economics refers to the base unit of activity for a given business and the profitability / economics of that unit.
Unit economics consist of two conceptual pieces:
the base unit of activity and
the economics or profitability of that unit.
Base Unit of Activity
The base unit of activity for a given business is the smallest logical piece that helps you understand the business as a whole.
For a retail company, like J.Crew, the smallest unit of business is an individual store.
For an ecommerce company, like Amazon, the smallest unit of business is an individual online purchase
(could consist of multiple items).
For an ocean shipping company, with a fleet of ships, the smallest unit of business is an individual ship.
For an upstream oil & gas company, the smallest unit of business is an individual well.
For a home builder, the smallest unit of business is an individual home.
For a SaaS business, the smallest unit of business is a subscription.
For a power generation business, the smallest unit of business is a power plant.
Choosing the base unit(s) of activity requires some discretion. You must disaggregate how many base activities the company is engaged in. For example, many retailers are working to strengthen their ecommerce operations. You might choose to evaluate such a company as two separate businesses: (i) a physical retailer and (ii) a supplemental ecommerce business.
The base unit of the retailer would be a single store, and the base unit of the ecommerce business would be a single transaction.
Understing Profitability / Economics of the base unit of activity
The second step is understanding the economics for the selected base unit(s) of activity.
You need to understand the revenue & expense drivers:
What variables determine revenue? What do they depend on?
What variables determine expenses?
How fixed / variable is the cost structure?
You also need to understand any CapEx associated with the unit:
Does this base unit require a big investment to build / bring online?
How long does it take?
For example, power plants take a long time and a lot of money to build. But for the marginal software subscription, there’s no cost, and it could be instantaneous.
Unit economics encompass all the variables and information needed to build a simple financial model for the base unit(s) of activity.
What are the financial drivers to evaluate the unit economics of a retail store?
Sales per sq. ft. ($)
Store size (sq. ft.)
Build-out cost
Rent, financing & other fixed costs
Gross margin
What are the financial drivers to evaluate the unit economics of a ecommerce store?
Financial drivers for a transaction:
Transaction size ($)
Gross margin
Any attributed marketing spend (e.g., online ads)
What are the financial drivers to evaluate the unit economics of a ship?
Financial drivers for a ship:
Utilization percentage: what % of time is the ship under contract?
Average fee / contracted day
Fuel & other variable costs
Maintenance costs & schedule
Rent, financing & other fixed costs
What are the financial drivers to evaluate the unit economics of a oil and gas well?
Financial drivers for a well:
Forecasted production curve (volume)
Opex
Capex
Transport costs
Oil / gas price
What are the financial drivers to evaluate the unit economics of a Saas Company?
Financial drivers:
Churn / expected customer lifetime
Customer acquisition cost (CAC)
Price
Any variable costs associated with subscription (e.g., dedicated support rep)
What are the financial drivers to evaluate the unit economics of a Power Plant?
Financial drivers for a power plant:
Forecasted production (volume)
Price
Variable production costs
Maintenance costs & schedule
Cost to build & timeline
Financing & other fixed costs
Why are unit economics important?
Unit economics help us think about the profitability and growth potential of a business.
Going back to our examples, a retail company is really just the sum of all its stores and some corporate overhead. Likewise, a shipping company is the sum of all its ships and some corporate overhead. You get the idea. Understand the part, and you understand the whole.
