20 Unit Economics

So you’ve presented the perfect pitch to a Business Angel or Venture Capitalist who is obviously impressed that you have a stellar team, identified a real customer need, defined your “just enough” version and know how to get traction for your product.

Then comes that most tricky of questions: “how do you intend to make money?”

The knee-jerk reaction is to turn to the page with your financial model with 50 rows of numbers, three growth scenarios and with even the price of the water cooler factored into the financial model. After all, surely your future shareholders want to see you can handle all the detail, right? This approach however doesn’t reveal an appreciation of the highly important and yet dynamic situation faced by startups where far more is at stake depending on the assumptions you make surrounding the three key issues:

1. Unit price or revenue per customer
How much money will you charge one customer for one product? The simpler the answer to this question, the quicker your business will be understood. Whether you charge a price per user, server or download early-stage businesses will need to set a price, or a range of prices for various product packages. If you offer several different packages each with a different price then I would discuss average prices. Nevertheless, simplicity is the objective. In fact, early-stage businesses are most effective in winning those first key supporters when the revenue plan can be calculated in your head with some simple mental arithmetic.

2. Cost to acquire a customer
How much does it cost you to acquire a new customer? Regardless of whether your sell direct to consumers or to enterprises, winning those customers will have a direct or an indirect cost. If you sell direct, you will need to factor in the costs of attracting customers to use and purchase your product as well as a discussion on how those costs will change over time. Even better, you can discuss how you might influence the acquisition costs to your advantage. If you sell to enterprise customers, you will face the costs of the sales process though the same discussion can be had around the change over time.

3. Cost to serve a customer
Once a customer has signed on, how much customer care is needed to keep that customer? The cost of serving a customer base needs to be added to the cost of acquisition in order to estimate the profitability of each new customer relationship. Internet based business, especially those with a high degree of self-service, have enabled the cost-to-serve to decline dramatically. If you are providing any ongoing service requiring incremental effort, however, that cost may make some levels of revenue per customers unprofitable. And again, the same goes here as for the cost-to-acquire, the most interesting aspects are how it will develop and how it can be influenced over time.

Another way to describe this analysis is per-customer economics. These three elements sometimes seem too simplistic, though they’re often made overly complicated or simply overlooked. Their usefulness in explain your business can’t be underestimated. Breaking down a venture into a few key assumptions will aid you enormously in convincing early supporters of the viability of your business idea. Separating out these numbers will strengthen the aggregated business plan and also engage anyone evaluating the business in thoughtful discussion. Only when the interplay of these revenues and costs are understood, even if only as assumptions, can an evaluation of the viability of the business model really begin.

About Eoghan Jennings ()

A few months into my 3rd career. First one - banker - OK at that, but not great. Second, finance guy helping a few geeks build a company called XING. Raised money mainly from customers, but also angels/VCs. IPO’d 3 years later - a little early, though still going strong.

This time 'round, it’s about building great companies, as advisor and investor. Oh, and I have three kids and still don’t know what hit me…

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