We see unit economics almost everywhere, and yet most businesses use the concept without even knowing what it is. Unit economics is a basic metric and one of the most important for running a business. It gives you insight into the profitability of your business. It gives your investors and stakeholders a baseline to work with. It is so much more important for a startup because of the potential effect of market dips. More so, for SaaS companies. Since there is no tangible product or service. And that is why it is important to understand unit economics in SaaS marketing. Read More: 10 Books on SaaS Marketing that are a Must-Read
What is unit economics?
We can define unit economics as the cash in-flow and out-flow associated with a single unit of a business model. It is used to determine the profitability of a business model solely relying on calculations done per unit of goods or service.
Snov.io defines unit economics as “a method applied to analyze a company’s cost to revenue ratio in relation to its basic unit.”
Altexsoft.com defines it as “a calculation of profit and loss for a particular business model on a per-unit basis. It tells you how much value each item or unit creates for the business.”
With unit economics, you can calculate your profit estimates as said by Altexsoft.com. Moreover, it can be used to predict break-even points and gross margins of the business. Hence, the unit part of the phrase refers to a unit of goods or services. Whereas the economics part refers to the investment and revenue generated by that unit.
It is a simple tool that packs a lot of power. In terms of ease of calculation and the insight it provides long-term business sustainability. Additionally, you can use this tool to make financial plans for the future using cash flow to analyze business performance. Read More: 10 SaaS Growth Strategies Worth Trying
What is the importance of unit economics in SaaS marketing?
In the SaaS business, we consider the user or the customer as the unit. So when we talk about unit economics in SaaS marketing, we talk about how much the company is investing to get that customer vs how much revenue that customer is giving the company. You can consider these to be the customer acquisition costs and the value that a particular customer brings, LTV (lifetime value). So, why is this important? You can use the unit economics in SaaS marketing to understand the sustainability of a product, how you can improve it, and the financials of a company.
Optimization of product and service
By adopting unit economics in SaaS marketing, you can analyze the business' performance per unit. It gives you insight into the types of costs and how much the costs are. Identifying such areas will help you strategize for optimal prices and marketing tactics. This is especially important for SaaS marketing since the marketing budget should be a percentage of your revenue. Most SaaS companies spend 40-50% of their revenue on marketing. However, the marketing budget will vary from business to business and there is no hard percentage that you must spend.
Areas of improvement in market sustainability
If you are spending more on marketing than you are generating, then your business model is not sustainable and will not work in the long term. It is one thing to have low introductory prices and a high marketing budget to generate leads. However, it is a whole other ball game to hemorrhage funds. If your current marketing strategy is not getting you any results, look into developing another strategy that focuses on conversion.
Helps in calculating profits and gross margins
With the revenue generated per unit and the money you put into it, you can figure out the profit per unit. To increase the profit margin, you can look into what costs are the highest and what you can do to decrease them. You can analyze if you under-priced or overpriced the product and its ideal marketing strategy. Your customer acquisition costs should be much lower than the capital the customer brings in. If you know these values, then you can identify any areas that you can improve on.
Important Metrics for Unit Economics in SaaS Marketing
Customer acquisition costs (CAC):
The costs related to acquiring a single new customer. It included the resources used as well as the capital spent. We can also define it as the average money you spent gaining a new customer.
Formula: marketing expense/number of new customers
Lifetime value (LTV):
The estimate of the revenue a customer will generate for you through their entire lifespan as your customer. LTV can help you determine how long a customer stays with you and how much money they regenerate in that period.
Formula: average revenue per unit/user churn
Average customer lifetime (ACL):
This is the average duration that a customer stays with you. It is the average number of days between their first and last order date. Usually, the ACL is indicated in the number of years you have tried a customer. Having a high ACL is ideal since it will also increase LTV.
Formula: average number of days/365
Gross margin per customer lifespan (GML):
This is very similar to LTV. However, in this, we use the gross profit margin instead of total revenue.
Formula: average profit margin per unit/user churn
Churn rate:
The rate at which customers either cancel a subscription or stop using a product. This is a very important metric. Since it lets you know how many customers you are losing. According to woopra.com, the average monthly churn rate of a SaaS company is 3-8%.
Formula: (customers lost per month/total number of customers at the beginning of the month) x 100 Read More: 10 SaaS Marketing Metrics You Should Absolutely Use
How to calculate unit economics in SaaS marketing?
The formula to calculate unit economics in SaaS marketing is LTV/CAC. However, using LTV/CAC does not always give insight into the big picture. Because you are using past data to decide the future. There are two ways you can predict your unit's economic value. One is the Predictive LTV (better suited for well-established businesses) and the other is Flexible LTV (new businesses or products).
Predictive LTV:
This factors in the changes in a customer's preferences over time. And therefore it is better suited to a well-established company since they have significant past data available on customer behavior.
Formula: (TR x AOV x AGM x ACL) / C
Where,
TR = total revenue
AOV = average order value
AGM = average gross margin
ACL = average customer lifespan
C = number of customers
Flexible LTV:
The calculations are accurate when the revenue generated is stable. It factors in retention and discount rates, which is in line with newer businesses and products.
Formula: GML x R / ( 1 + D - R)
Here,
GML = gross margin per customer lifespan
R = retention rate
D = discount rate