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MVP Lab
26 June, 2024 • 5 minutes

UNIT ECONOMICS METRICS

The essence of unit economics is simple – we need to understand how much we spend on acquiring a user and how much we earn from them on average. If revenue exceeds costs, the economics work out. However, in reality, it’s more complex. This article will cover the main ideas and metrics of unit economics.

UNIT ECONOMICS METRICS

The essence of unit economics is simple – we need to understand how much we spend on acquiring a user and how much we earn from them on average. If revenue exceeds costs, the economics work out. However, in reality, it’s more complex. This article will cover the main ideas and metrics of unit economics.

BUSINESS UNIT

In unit economics, the profitability of a business is determined by calculating the profitability of a business unit. A business unit is considered to be a single user or customer, and unit economics revolves around these entities.

A user refers to someone who has submitted an application, installed an app, or visited a website but has not made any purchases. A customer is a user who has signed a contract, made a purchase, or subscribed.

The nuances in economic modeling depend on how people become users and customers in the business.

BUSINESS UNIT

In unit economics, the profitability of a business is determined by calculating the profitability of a business unit. A business unit is considered to be a single user or customer, and unit economics revolves around these entities.

A user refers to someone who has submitted an application, installed an app, or visited a website but has not made any purchases. A customer is a user who has signed a contract, made a purchase, or subscribed.

The nuances in economic modeling depend on how people become users and customers in the business.

BASIC FORMULA

The framework uses a basic formula to calculate the profit a business makes:
CM = UA × (ARPU − CPA)

CM (Contribution Margin) – This metric shows how efficiently we are working with the unit.
UA (User Acquisition) – The number of users in the flow.
ARPU (Average Revenue Per User) – The average revenue per user over a period.
CPA (Cost Per Acquisition) – The costs of acquiring a user.

Users don’t appear out of nowhere. Even with word-of-mouth, there are costs associated with sales managers. To calculate CPA, you need to understand clearly where the customers come from.

By substituting values into this formula, you can understand whether the business is profitable. It’s useful for making managerial decisions on user acquisition and retention. For this, ask yourself: “How will the contribution margin change in this case?”

Let’s break down each metric in detail.

BASIC FORMULA

The framework uses a basic formula to calculate the profit a business makes:
CM = UA × (ARPU − CPA)

CM (Contribution Margin) – This metric shows how efficiently we are working with the unit.
UA (User Acquisition) – The number of users in the flow.
ARPU (Average Revenue Per User) – The average revenue per user over a period.
CPA (Cost Per Acquisition) – The costs of acquiring a user.

Users don’t appear out of nowhere. Even with word-of-mouth, there are costs associated with sales managers. To calculate CPA, you need to understand clearly where the customers come from.

By substituting values into this formula, you can understand whether the business is profitable. It’s useful for making managerial decisions on user acquisition and retention. For this, ask yourself: “How will the contribution margin change in this case?”

Let’s break down each metric in detail.

CPA AND CAC

CPA (Cost Per Acquisition) reflects the costs of acquiring one user.

CPA = Total Acquisition Costs/UA

But what costs should we consider in the calculation? Acquisition costs include everything necessary for people to install the app, submit an application, or visit the website.

After a contract is signed, a subscription is paid, or a product is purchased, the user becomes a customer. The metric for customer acquisition costs is CAC (Customer Acquisition Cost).

CAC = Total Acquisition Costs/B

B (Buyer) — The number of customers.

CPA and CAC are linked by the conversion rate C1 (conversion from users to customers).

CPA = CAC × C1

CPA AND CAC

CPA (Cost Per Acquisition) reflects the costs of acquiring one user.

CPA = Total Acquisition Costs/UA

But what costs should we consider in the calculation? Acquisition costs include everything necessary for people to install the app, submit an application, or visit the website.

After a contract is signed, a subscription is paid, or a product is purchased, the user becomes a customer. The metric for customer acquisition costs is CAC (Customer Acquisition Cost).

CAC = Total Acquisition Costs/B

B (Buyer) — The number of customers.

CPA and CAC are linked by the conversion rate C1 (conversion from users to customers).

CPA = CAC × C1

CONVERSION RATE (C1)

This metric shows the percentage of users who become customers. It reflects how well the lead process is set up.

C1 = B / UA

It does not account for repeat sales. C1 helps distinguish new customers from all buyers, which is important as communication with these groups differs. The first buy belief, while the second buy successful experience.

It’s also important to understand how the conversion rate compares to market benchmarks. For example, if your conversion rate is three times higher than the market average, you need to understand why. Without identifying the cause, there is a risk of losing this advantage when scaling.

CONVERSION RATE (C1)

Of course, the result of CustDev isn’t a guarantee of product success in the market. It serves a different purpose—determining which hypotheses need to be tested further using an MVP.

Based on the insights from CustDev, determine the functionality to include in your MVP and start developing it. We discussed how to do this in another article.

AVERAGE CHECK (AvP)

AvP (Average Price) – The average check.
If the product has a single price, just use that value. If a user buys a mix of products, this metric becomes composite.

AvP = iCount × iPrice

iCount — Number of items in the cart.
iPrice — Average price per item.

By breaking down the metric into two entities, we can more precisely influence the average check by managing each separately.

COGS (Cost of Goods Sold) — The costs of selling.

These are the costs without which the sale itself would be impossible. For example, to sell a product, you first need to buy it from a supplier, deliver it to the customer, and process the payment.

In some cases, there is a separate metric for 1sCOGS – first sale costs. For example, to start receiving internet service payments, a provider first needs to connect the service to the apartment.

AVERAGE CHECK (AvP)

AvP (Average Price) – The average check.
If the product has a single price, just use that value. If a user buys a mix of products, this metric becomes composite.

AvP = iCount × iPrice

iCount — Number of items in the cart.
iPrice — Average price per item.

By breaking down the metric into two entities, we can more precisely influence the average check by managing each separately.

COGS (Cost of Goods Sold) — The costs of selling.

These are the costs without which the sale itself would be impossible. For example, to sell a product, you first need to buy it from a supplier, deliver it to the customer, and process the payment.

In some cases, there is a separate metric for 1sCOGS – first sale costs. For example, to start receiving internet service payments, a provider first needs to connect the service to the apartment.

ARPC

ARPC (Average Revenue Per Customer) – Revenue that the company earns from one customer over a period.

ARPC = (AvP − COGS) × APC − 1sCOGS

(AvP - COGS) — Profit from one transaction.
APC (Average Payment Count) — The number of transactions made by a customer over a period.

The first term shows profitability, and the second term shows costs to make the first sale. If the first term is less than the second, the business is not profitable.

This formula helps determine how many sales are needed for revenue to exceed costs.

ARPC

ARPC (Average Revenue Per Customer) – Revenue that the company earns from one customer over a period.

ARPC = (AvP − COGS) × APC − 1sCOGS

(AvP - COGS) — Profit from one transaction.
APC (Average Payment Count) — The number of transactions made by a customer over a period.

The first term shows profitability, and the second term shows costs to make the first sale. If the first term is less than the second, the business is not profitable.

This formula helps determine how many sales are needed for revenue to exceed costs.

ARPU

ARPU (Average Revenue Per User) – Average income from one attracted user.

ARPU = ARPC × C1

Why shift from a customer-centric to a user-centric system? Our goal is to make decisions that result in a positive Contribution Margin. For this, we compare acquisition costs and revenue per customer, CAC, and ARPC.

However, their value depends on many factors: product quality, communication setup, service level, etc. These are difficult to calculate and impossible to measure at the early stages.

User acquisition costs are marketing budgets. With analytics services, we can determine their exact value. Therefore, at the early stages, it’s better to compare CPA and ARPU for decision-making.

ARPU

ARPU (Average Revenue Per User) – Average income from one attracted user.

ARPU = ARPC × C1

Why shift from a customer-centric to a user-centric system? Our goal is to make decisions that result in a positive Contribution Margin. For this, we compare acquisition costs and revenue per customer, CAC, and ARPC.

However, their value depends on many factors: product quality, communication setup, service level, etc. These are difficult to calculate and impossible to measure at the early stages.

User acquisition costs are marketing budgets. With analytics services, we can determine their exact value. Therefore, at the early stages, it’s better to compare CPA and ARPU for decision-making.

Conclusion

Unit economics allows for decision-making based on a simple formula:

CM = UA × (ARPU − CPA)

If the hypothesis leads to an increase in Contribution Margin, it can be implemented.

Conclusion

Unit economics allows for decision-making based on a simple formula:

CM = UA × (ARPU − CPA)

If the hypothesis leads to an increase in Contribution Margin, it can be implemented.
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