Unit economics
YOO-nit ek-uh-NOM-iks
The revenue and cost associated with a single customer. Profitable unit economics mean each customer generates more revenue than they cost to acquire and serve.
Unit economics answers a simple question: do you make money on each customer? Take the lifetime revenue from a customer (LTV), subtract the cost to acquire them (CAC) and the cost to serve them. If the result is positive, your unit economics work. If not, every new customer makes you poorer.
The classic unit economics equation: LTV/CAC ratio should be 3:1 or better. If a customer generates $30,000 in lifetime revenue and costs $10,000 to acquire, the ratio is 3:1. That customer is profitable. If the ratio is 1:1, you are spending $1 to make $1. That is a charity, not a business.
Startups often have negative unit economics early. They spend heavily on sales and marketing to acquire customers while the product is still developing. That is acceptable if the trajectory is improving. Unit economics that are getting worse over time, or staying flat at negative, indicate a fundamental business model problem.
Examples
A SaaS company calculates unit economics.
Average customer pays $500/month and stays 30 months. LTV: $15,000. CAC: $4,000 (marketing spend divided by customers acquired). Gross margin: 80%. Gross profit per customer: $12,000. LTV/CAC: 3.75:1. Unit economics are healthy.
Unit economics reveal a problem.
A company spends $8,000 to acquire each customer through outbound sales. Average customer pays $200/month and churns after 8 months. LTV: $1,600. LTV/CAC: 0.2:1. Every customer costs $6,400 more to acquire than they generate. The company is growing itself into bankruptcy.
Improving unit economics over time.
A startup's LTV/CAC was 1.5:1 at Series A. By Series B, it improved to 3.5:1. They did it by reducing churn (extending average lifetime from 18 to 36 months) and improving marketing efficiency (reducing CAC from $6,000 to $4,500). Investors funded the improvement trajectory.
In practice
Read more on the blog
Frequently asked questions
What is a good LTV/CAC ratio?
3:1 or higher is the benchmark. Below 1:1 means you lose money on every customer. Between 1:1 and 3:1 is workable but tight. Above 5:1 might mean you are underinvesting in growth and could afford to spend more on acquisition.
When should unit economics be positive?
By Series B. Seed and Series A companies can have negative unit economics while finding product-market fit. By Series B, investors expect positive and improving unit economics. A company raising a $30M Series B with negative unit economics will get tough questions and a lower valuation.
Related terms
The total cost of sales and marketing divided by the number of new customers acquired in a period.
The total gross profit expected from a customer over the entire relationship. LTV determines how much you can spend to acquire them.
Revenue minus the variable costs of serving that revenue. What each dollar of revenue contributes toward covering fixed costs and profit.
How fast a startup spends cash each month. Gross burn is total spending. Net burn subtracts revenue. The clock on your runway.
Revenue minus cost of goods sold, expressed as a percentage. For SaaS, this is revenue minus hosting, support, and delivery costs.
Want the complete playbook?
Picks and Shovels is the definitive guide to developer marketing. Amazon #1 bestseller with practical strategies from 30 years of marketing to developers.