Understanding your Unit Economics and Why it is Critical
All revenue is equal, but some is more equal than others. The famous author George Orwell wrote this famous line in his novel Animal Farm - whilst he was better known for political and social commentary, his legacy has left businesses with a valuable business lesson.
You work hard to secure, service, manage and retain your revenue - but what is it all for at the end of the day? How much of every dollar you earn (or extra dollar you earn) do you retain in the business?
When it is all said and done, we know that there is a cost of doing business. All units of revenue have a sale price, a cost of sale, and a gross profit. But what is that cost and, more importantly, what is your margin?
What happens to every dollar of revenue that is generated in your business. Where does it go? More importantly, how much do you keep and how much should you be keeping?
This number should be ingrained in your mind. Permanently.
Unit economics is not a new concept but one that many business owners (and advisors) seem to glaze over in all their financial reporting. Understanding your unit economics is critical to support growth and business performance as it is the basic financial building blocks of a business.
In fact, global consulting firm McKinsey sees this as part of a clear recipe for success that has increased the scale-up success rate of their businesses to 60 percent, from 22 percent.
Breaking it down into simple percentages gives you a snapshot of your business health and potential performance - allowing you to forecast profits and make capital allocation decisions with far more confidence. It also allows you to check very quickly the overall soundness or long-term viability of a product before you try to scale. At Nine Advisory, we call it the ‘postage stamp P&L’, as it simplifies the complexity of financial reporting by measuring profitability on a per unit basis.
Scalability
Understanding your company’s unit economics is essential for scalability. Especially in adverse economic conditions, smart leaders reign in their costs and drive innovation based on what they see in their data. Having your finger on the pulse in these areas will help you make business decisions fast.
Positive unit economics creates a foundation for scaling rapidly - if you can observe a profit at this smallest of metrics, when multiplied it amasses a large gross revenues and profits. I’m sure you know how exponential growth works.
Once you are able to calculate the margin on every new dollar of revenue, you are confidently able to assess when you are onto a winner at a minute metrics level and can effectively assess the sale price, a cost of sale, and you are able to scale-up with confidence.
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