Unit economics measures the direct revenues and costs associated with a single unit of your business model, typically one customer, one transaction, or one product sold. The fundamental question it answers: does each additional customer make or lose money? A company can grow revenue impressively while losing money on every sale if unit economics are broken.
How It Works
For subscription businesses, the primary unit is a customer. Unit economics compares LTV (total expected revenue from a customer) against CAC (cost to acquire them) plus the cost to serve them. If a customer pays $100/month for an average of 20 months (LTV = $2,000) and costs $500 to acquire with $30/month in support and infrastructure costs (total cost = $1,100), the contribution margin per unit is $900.
For marketplaces, the unit might be a transaction. A food delivery order generating $5 in revenue (commission) but costing $8 to fulfill (driver pay, subsidies, support) means negative unit economics, and you lose $3 per order. Volume makes the problem worse, not better.
Contribution margin is revenue minus variable costs per unit. Fixed costs (office, executive salaries, R&D) are excluded because they do not scale linearly with customers.
Why It Matters
Positive unit economics means growth is inherently profitable, as each new customer adds to the bottom line. Negative unit economics means growth accelerates losses. "We will make it up on volume" only works if scale actually reduces per-unit costs (network effects, fixed cost amortization). If variable costs per unit remain constant, volume just amplifies losses.
Investors evaluate unit economics to distinguish sustainable growth from subsidized growth. A company growing 100% year-over-year with healthy unit economics is building value. The same growth with negative unit economics is buying revenue with investor money.
In Practice
A SaaS startup discovers that their SMB customers cost $200 to acquire and churn in 4 months ($50/month plan = $200 LTV). Unit economics are break-even with no margin to cover operations. Their enterprise customers cost $2,000 to acquire but retain for 30+ months at $300/month ($9,000 LTV). The data drives a strategic shift toward mid-market and enterprise segments where economics support the business.
Pro Tips
Calculate unit economics by segment, channel, and cohort because averages hide important variations. Monitor trends; improving unit economics indicate maturing product-market fit. If CAC rises faster than LTV, sound the alarm. Aim for payback periods under 12 months so capital is not trapped in unprofitable growth for too long.