How successful is your business?
By nature we determine the success of a business based on profits or return of investment (ROI), however sometimes things are not always as cut and dry.
In fact, sometimes certain financial statistics can be misleading and can cloud the truth behind what your business is really up to.
In order to really determine how healthy your business is and whether or not it can scale and grow into the future, you really need to have a keen understanding of unit economics.
Unit economics are defined as- “the direct revenues and costs associated with a particular business model expressed on a per unit basis.”
In other words, unit economics is how much you put in to gain one “unit” and how much profit you will gain back from it.
Basically, unit economics will help you determine whether putting more money in to acquire more “units” will help you to grow your overall revenue or if it will lead to a substantial loss.
Unit economics can also help you figure out how fast you can grow your business based on how much money you choose to put in.
So, how does this all tie in to e-commerce?
This is where Transactional Unit Economics come into play, which is basically the Cost of Transaction Acquisition (CoTA) in ratio to the Average Order Value (AOV).
For example, say you are selling drink bottles on Amazon and put in $100 to acquiring a transaction, this would be your CoTA.
Then say from that $100 you spent, you receive customers that spend an average of $200 each, that would be your AOV. This would give you a clean ratio of $100:$200 or 1:2.
This of course is an excellent result and shows that basically for every one dollar you put in, you receive two back.
Understanding this statistic then allows you to either scale up your customer transaction acquisition costs or perhaps re-strategise into something else.
As you can see, Transactional Unit Economics look beyond just money in and money out and instead paint a different point of view that will allow you to know if your business is scalable.
Competing with the CoTA: AOV however, is becoming increasingly difficult especially due to marketplaces like Amazon that offer such low costs due to their high volume.
There is always someone out there willing to beat you on price, which is why you also need to focus on Customer Centric Unit Economics.
Customer Centric Unit Economics look at the Cost of Customer Acquisition (CoCA) in ratio with the Customer Life Time Value (LTV).
For example, say you spend $1000 on a PPC campaign and 5 percent of the visitors turn into pre-transactional contacts and then 10 percent of those turn into customers, your CoCA would be $400.
Then if the average spend of the customer is $4,000 over their lifetime then your ratio would be 400:$4000 or 1:10.
Of course, this is an excellent ratio as it shows for every $400 you invest into your company you have the opportunity to acquire and maintain a customer that is likely to spend $4000.
To put this in perspective, the average LTV of a Starbucks customer is $14,099. This means the company must spend less than $14,099 to acquire a new customer in order to be profitable. This also means that even though the customer may not spend $14,099 straight away, spending even $1000 to acquire one customer may be worth it in the long run.
Understanding this ratio can also highlight the growth potential of your business and whether or not it is worth investing more of your time and money to acquiring customers. It also helps open up many more marketing opportunities and provides an incentive for investing into long term marketing strategies.
Just the same, if you ratio is not favourable- for example it costs you $400 to acquire a customer that only has a lifetime value of $40, then perhaps you may want to rethink your strategy.
The benefit of focusing on Customer Centric Unit Economics as well is that it allows your business to really get ahead by focusing on growing the life time value of the customer without worrying about price competition.
Both CoTA:AOV and CoCA:LTV are important statistics to master and understand if you want to really know the true value and success that your business holds.
Especially if you work in e-commerce, it is crucial to understand these statistics in order to create a sustainable and competitive business.
The bottom line to all of this can be summed up perfectly by blogger Sam Altman-
“If you hold yourself to the standard of making a product that is so good people spontaneously recommend it to their friends, and you have an easy to understand business model where you make more than you spend on each user, and it gets better not worse as you get bigger, you may not look like some of the hottest companies of today, but you’ll look a lot like Google and Facebook.”
Do you have a grasp on Unit Economics?