Unit Economics: What are they and why are they important?
When starting and growing your B2B software company, tracking success and sustainability can be an extremely daunting task. Unit economics are simple but powerful data that allow you to understand your company’s financial health, viability, and sustainability.
Why should I track unit economics?
The earlier you begin measuring your unit economics, the better. Unit economics help you better think about product market fit, pricing, customer acquisition, and general financial strategy. Each of these will also inform your financial projections, allowing you to understand growth and your track to profitability.
Even once your company is profitable, tracking unit economics allows you to keep an ongoing eye on your revenues and costs. Watching these measurements will help you identify new opportunities, optimize your product, and solve problems as they arise.
What are unit economics?
Unit economics measure a business’s revenues and costs as individual units, a simple way of deciphering a business’s profitability. “Units” refer to anything that brings in revenue for a business. So, for example, a unit for an airline company may be a seat sold or a unit for a software company may be a single subscription to a software product.
Unit economics help answer a fundamental question: are you making more money off your customers than you are spending to acquire them? This measurement is a key part of financial planning for businesses. Unit economics measurements allow you to:
- Forecast profits by understanding how profitable your business is now or project when your business may become profitable
- Optimize your product by determining whether your product is too expensive or valued too low
- Assess market fit through analyzing your product’s potential in a given market
How should I analyze unit economics?
As a B2B software entrepreneur, there are a few key metrics you should be looking at:
- Customer lifetime value (LTV)
- Customer acquisition cost (CAC)
- LTV to CAC ratio
A 1:1 LTV to CAC ratio means it costs you as much to acquire one customer as a customer spends on your product. In this case, you may want to focus on lowering acquisition costs, improving your sales process to increase customer spend, or raising prices.
A higher LTV to CAC ratio allows you to dedicate more time to sales and marketing, since your customer spends far more than it costs to acquire them.