As an advisor to startup founders, investors and corporates, I have realized that in-depth understanding of the principle of unit economics is critical to growing or scaling any business venture(s).
By way of introduction, Unit economics refers to the financial metrics and indicators that evaluate the profitability and viability of a business model on a per-unit basis. Though the unit economics tend to vary significantly depending on the industry, market, and specific business model, this article is designed to provide a general overview on a few considerations for early-stage founders, investors and other stakeholders doing business in Africa.
- Revenue Generation: there is a critical need to carefully and periodically analyze the revenue streams and pricing models to ensure that they generate sufficient revenue per unit of product or service sold. This involves determining the price customers are willing to pay, understanding the volume of sales, and estimating the average revenue per unit.
- Cost of Goods Sold (COGS): COGS refers to the direct costs incurred in producing or delivering a product or service. For startups, it is crucial to optimize their supply chain, production processes, and procurement strategies to minimize COGS per unit. This may involve negotiating favorable contracts with suppliers, optimizing inventory management, or exploring cost-effective production methods.
- Customer Acquisition Cost (CAC): CAC is the cost associated with acquiring a new customer. It includes marketing and advertising expenses, sales commissions, and any other costs incurred during the customer acquisition process. Early-stage startups should strive to keep their CAC as low as possible while ensuring the acquisition of quality and returning customers who generate sufficient revenue over their lifetime.
- Customer Lifetime Value (CLTV): CLTV represents the total revenue a business can expect to generate from a customer throughout their relationship. Founders and business owners should analyze CLTV to ensure it exceeds the CAC. Increasing CLTV can be achieved through various means, such as upselling (i.e. sales technique for encouraging customers to purchase more premium or higher-priced product than the initial product the customer intended to buy), cross-selling (i.e. sales and marketing technique in which the founder encourages customers to purchase additional products/services related to their expressed needs), and fostering customer loyalty through excellent service.
- Gross Margin: Gross margin is the difference between revenue and COGS, expressed as a percentage. It is important to pay attention to various macroeconomic and microeconomic factors that consistently influence your gross margin. Hence, to become a profitable business owner, you need to regularly ensure that gross margin is healthy enough to cover other expenses and contribute to profitability. Needless to say that - by optimizing production costs and pricing strategies, you will resultantly improve your gross margin.
- Operating Expenses (Opex): Early-stage startups should carefully manage their operating expenses, including salaries, rent, utilities, technology, and administrative costs. The relationship between Opex and business profitability cannot be overemphasized. Effectively managing and keeping these expenses in check is essential to maintaining a healthy bottom line and achieving profitability.
- Cash Flow Management: For early-stage startups, cash is king. For any successful or growing business, managing cash-flow efficiently is a top priority. It is crucial to closely monitor your cash flow, ensuring that the timing of revenue collection aligns with the expenses. Efficient cash flow management is crucial for the sustainability and growth of a startup.
Summarily, for founders and business owners with core focus of building scalable business models that can efficiently handle increased volumes without incurring significant additional costs, it is advisable to leverage technology and automation of processes with a view to optimizing operations, conduct detailed market research, collect relevant data, set up financial management process and analyze their financial metrics so as to ensure unit economics are sustainable and lead to long-term profitability.