The Case for Unit Economics
When I was a kid, one of the big muffler companies ran TV ads where the final line, delivered by the journeyman muffler fixer guy to his understudy, was, “first you get good, then you get fast.”
For some reason, this has always stuck with me, such that over the years I’ve adopted and modified the saying as a metaphor for many business concepts, most often when a startup should turn on the jets and start to scale:
“First you get good, then you get big!”
– Brad Poulos
Developing an intimate understanding of your unit economics is one of the smartest things you can do in the early days of your business. Before you start scaling, spending heavily on marketing, or chasing investors, you need to know whether your core offer makes money. And not just overall. You need to know if it makes money one unit at a time.
Unit economics is about simplicity. It’s the revenue and cost associated with a single “unit” of your product or service. That might be one physical widget, one burger, one hour of service, one customer, or one subscription. It’s your business in miniature. And if the math doesn’t work at the unit level, it certainly won’t work when you grow.
What Are Unit Economics, Really?
The “unit” depends on your business model, but the core principles are the same. Unit economics focuses on what happens each time you sell one more unit. At a basic level, you’re tracking:
- Revenue per unit: What you earn every time you deliver one unit.
- Variable cost per unit: What it costs to make and deliver that unit.
- Contribution margin: The amount left over after subtracting variable costs from revenue. This is what contributes to covering your fixed costs and, eventually, generating profit.
Fixed costs such as rent or salaries are not a factor until later when we look at breakeven point.
Why You Need to Nail This Early
Too many early-stage entrepreneurs skip this step. They assume that growth will solve their problems. But if you haven’t nailed your unit economics, growth can just multiply losses. Even more insidious is when it’s clear that there’s some positive contribution margin, but you find out that it’s so low that i you’ll have to sell 49 bajillion whatevers to cover fixed costs.
When you understand your cost structure early on, you:
- Price your offer with confidence (and not guesswork).
- Choose better marketing and sales channels.
- Spot red flags before they turn into disasters.
- Show credibility to investors and lenders.
It’s not about having perfect data from day one. It’s about having directionally correct numbers that help you make better decisions.
A Simple Example
Let’s say you sell a product for $100. Your cost to produce and ship it is $40. That means your contribution margin is $60. That $60 goes toward covering your rent, paying your team, promoting the product, and eventually, building profit.
Now imagine you reduce your cost by $5 or raise your price by $5. That’s an extra $5 of margin per unit. Sell 1,000 units and you’ve found $5,000 in extra profitability.
The same applies for services. If you charge $150/hour and pay your subcontractor $90/hour, you’ve got $60/hour in contribution margin. If that doesn’t feel like enough to cover your overhead, you’ve got a pricing or efficiency problem.
Don’t confuse contribution margin with gross profit. The latter includes only Cost of Goods Sold (COGS) which are often called “direct” costs. It doesn’t include all of the company’s “variable” costs which are things that will increase with sales volume, but fall into fixed costs if you listen to the accountants. This would include such things as customer support, returns, and customer onboarding.
Solid Unit Economics Looks Like…
Shoot for at least three out of the following:
- A strongly positive contribution margin.
- A realistic breakeven point (a reasonable sales level will cover fixed costs).
- Some degree of scalability (costs don’t rise 1:1 with revenue).
- An ability to profitably acquire a customer over time.
If your numbers don’t reflect this yet, that’s okay. It’s better to know now than later, before you waste valuable resources trying to scale an inefficient operation. Work on lowering costs or increasing customer value so you can raise your price until you have something worth scaling.
Be careful and avoid these common mistakes.
- Including only Cost of Goods Sold as opposed to all of the variable costs;
- Forgetting to factor in discounts, freebies, and other revenue-reducers; and
- Assuming growth automatically brings profitability.
Tune the Engine Before You Hit the Gas
Scaling a company without understanding your unit economics is like trying to build speed in a car without checking if the engine actually works. You might make noise, burn fuel, and even move forward, but you’re more likely to sputter across the line than win the race.
That’s why “first you get good, then you get big” isn’t just a clever saying, it’s a survival strategy. Good means profitable, at the unit level. Big only makes sense when the math works.
So before you step on the gas, pop the hood. Run the numbers. Tune the engine. Then, when it’s time to scale, you’ll know you’re driving something that can actually win.
If you liked this, you might like this related post about the small business health check.
