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UNIT ECONOMICS © 2017 Rick Rasmussen
UNIT ECONOMICS
Fundamental building block of any financial model
Unit RevenueUnit CostsFixed Costs (overhead)
MODULE OBJECTIVES
Revenues
minus Costs
equals Gross Profit
Fundamental building block of any financial model
Unit RevenueUnit CostsFixed Costs (overhead)
MODULE OBJECTIVES
Gross Profit
minus Expenses
equals Net Profit
Revenues
minus Costs
equals Gross Profit
Fundamental building block of any financial model
Unit RevenueUnit CostsFixed Costs (overhead)
WHAT ARE UNIT ECONOMICS?
A microscopic view into the transactions that make up your business
Understanding the basics of what it costs to produce and sell one unit of goods
One pizzaOne job doneOne client servicedOne clicker delivered
REVENUE MODELS DRIVE UNIT ECONOMICSType Business Revenue Model Example
PrimaryProduct Sales One time sale Presentation ClickerService Sales Hourly Rate ConsultantTrade Upcharge Retail Sales
Derivative
Subscription Monthly Revenue Software as a ServiceMarketplace Transaction Fees Ebay, EtsyBrokerage Commission Fees Real EstateEcosystem Combination Apple
Example: Product Sales
Behold the lowly clicker
Getting into theClicker business
What type of business?
Existing? Re-segmented? New?
Getting into theClicker business
What’s the TAM?
Retail price: $35Channel Margin: $19
Wholesale price $16
Retail price: $35Channel Margin: $19
Wholesale price $16
You typically don’t control this…
Revenue that comes to the company
UNIT ECONOMICS
1. Unit Price à $16
2. Each unit has a CostThis is your variable costAlso called COGS for Cost Of Goods Sold
UNIT COST
Subsystem Cost
Housing $1.50
Electronics + Laser $2.50
Battery $0.25
Packaging, manual $1.00
Wireless Module $1.75
Total Unit Cost $7.00
Draw a Circle around the Unit. What does it directly cost to produce?
UNIT PROFIT
This is the profit you make per unit sold
Unit Price minus Unit Cost
UNIT PROFIT
UNIT PROFIT
This is the profit you make per unit sold
Average Selling Price (ASP): $16.00
Average Unit Cost: - $7.00
Unit Profit: $9.00
Unit profit is often called unit margin
Unit Price minus Unit Cost
UNIT PROFIT
UNIT PROFIT MARGIN %
Percent profit margin =
(Revenue – cost) / Revenue =
Profit / Revenue =
$9 / $16 = 56.25%
Is this good?
43.75% 56.25%
Revenue
Unit Costs
Unit Profits
GROSS PROFIT
Assume we’ve sold 100K units…
Gross Revenue: $1,600K (same as $1,600,000)
COGS: - $700K
Gross Profit: $900K
Notes:
1. US uses period as a decimal point
2. Larger numbers always expressed as $K ($1000) or$M ($1000K)
UNITS SOLD à GROSS PROFIT
Units Sold (K) 100K
Average Selling Price (ASP) $16
Gross Revenue ($K) $1,600Average Cost $7COGS ($K) $700Gross Profit ($K) $900
Step 1
FIXED COSTS
Generally includes:
Rent, Insurance and UtilitiesSalariesMarketingOther (Interest payments
All stay the same whether you sell one or 1M units
DO YOU HAVE FIXED COSTS?If you have a physical building, you probably pay Rent, Insurance, Utilities
If you have employees, you have Salary costs
If you promote, add Marketing and Sales as a primary expense
* Exception to both would be large factories where Capital cost considerations need to be added
SALARIES
How many people needed to run the business?
ManagementEngineersMarketing, Sales, etc.
MARKETING
Expenses relating to promotion and selling
Can be significant for B2C and B2B2C companies
Use 30% to 55% of revenues if you need to build a brand
TOTAL FIXED COSTS
Add Salary, Marketing and Sales and other Fixed Expenses
Category Expense
Salaries $360K
Marketing $370K
Rent, etc $190K
Total $K $920K
WHAT ABOUT OTHER COSTS?… It depends
Yes:If we can attribute marketing costs on a per-unit basisExample is a coupon redeemed for a given unitThis is a Unit Cost.
No:If we are running a general campaign and cannot attribute to specific unit salesThese are Fixed Costs
A UNIT COST EXAMPLE: COUPONSWe run a coupon campaign for $2 off
For every unit sold with a coupon - $2 is added to the cost of that good sold.
We can attribute the coupon to the cost of selling that specific clicker
This is a Variable or Unit Cost.
A FIXED COST EXAMPLEGeneral Advertising
We run radio ads, We attend trade shows
Increases sales but can’t attribute our expenses to any specific unit sales.
This is a Fixed Cost
?
VARIABLE VS. FIXED COSTS
Variable Costs
Direct Materials
Direct Labor
Fixed Costs
Corporate Expenses
Rent
Salaries
Insurance
Training
Research
It Depends
Shipping, Delivery
Marketing Campaigns
Sales Commissions
Utilities
Scrap
Recalls
EXAMPLE: AMAZON AND AMAZON PRIME
Standard Amazon CustomerPays Shipping on every item purchased
Shipping expenses are known for each item
These are Variable CostsThese are Fixed Costs
Amazon Prime CustomerPays $100/year membership and getsFree shipping
Shipping expenses are not correlated for each item
EXAMPLE BUSINESS MODELSProduct Business
Retail Business
Online Business
SaaS Business
B2B Direct Sales
Franchise Model
Licensing Model
ConsultingSales CommissionsB2B2CDonationsNot-for-ProfitSocial EnterpriseTwo-sided-markets
Everyone has different sets of fixed and variable costs
ALLOCATING FIXED COSTS
For tech companies, normally summarized as:
M&S Marketing & SalesR&D Research & DevelopmentG&A General & Administrative
ZONES OF REASON
Once a company reaches “steady state”, you can compare expenses vs. industry norms.
For tech companies, normally summarized as:
M&S Marketing & Sales R&D Research & DevelopmentG&A General & Administrative
Category Expense
Marketing 20% to 55%
R&D 10% to 30%
G&A 8% to 15%
FINAL RESULTS
Our Clicker Business…!!!
Here is everything lined up for one period
Are these good results?
Results %
Revenues $1,600 100.00%
COGS $700 43.75%
Net Revenue $900 56.75%
Marketing $480 30.00%
R&D $320 20.00%
G&A $120 7.50%
Total Fixed Costs $920 57.5%
Net Profit ($20) -0.75%
NEXT… BUILDING A P&L
Revenue minus COGS = Gross Profit
Gross Profit minus Fixed Costs = Net Profit
1. Start with assumptions 2. Build a timeline3. Unit economics used to derive gross profits4. Add in fixed costs / expenses5. Construct your P&L table
Unit Economics Gross Profits Fixed Costs Full P&L
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