When starting a new B2B software company, or growing an existing one, tracking success and sustainability can be an extremely daunting task, but it’s crucially important nonetheless.
Where should you start? The answer is simple: unit economics. Unit economics are simple but powerful data that allow you to understand your company’s financial health, viability, and sustainability.
Why should I track unit economics?
The earlier you begin measuring your unit economics, the better. They will help you better think about product market fit, pricing, customer acquisition, and general financial strategy. Each of these will also help inform your financial projections, allowing you to better understand growth and your track to profitability.
Even once your company is profitable, tracking unit economics allows you to keep an ongoing eye on your revenues and costs. Watching these measurements will help you identify new opportunities, optimize your product, as well as solve new problems as they arise.
What are unit economics?
Unit economics measure a business’s revenues and costs as individual units, a simple way of deciphering a business’s profitability. “Units” refer to anything that brings in revenue for a business. So, for example, a unit for an airline company may be a seat sold or a unit for a software company may be a single subscription to a software product.
Unit economics help answer a fundamental question: are you making more money off your customers than you are spending to acquire them? This measurement is a key part of financial planning for businesses. Unit economics measurements allow you to:
- Forecast profits by understanding how profitable your business is now or project when your business may become profitable
- Optimize your product by determining whether your product is too expensive or valued too low
- Assess market fit through analyzing your product’s potential in a given market
How should I analyze unit economics?
As a B2B software entrepreneur, there are a few key metrics you should be looking at:
- Customer lifetime value (LTV): Customer lifetime value is an important metric, since it can be directly affected by your customer service and customer success metrics. Customer lifetime value measures the total revenue your business can expect from your average customer. This measurement is impacted by the typical purchase amount of your customers, your renewal rates, and the average length of your customer journey. You can calculate your customer lifetime value by multiplying your customer value and average customer lifespan.
- Customer acquisition cost (CAC): Customer acquisition cost, as the name implies, is the cost of bringing on a new customer. In the case of SaaS companies, it’s the cost of bringing on a customer to buy your initial software product. Measuring CAC allows you to track how effective your marketing campaigns are and the overall efficiency of your customer acquisition strategy. Reducing CAC by optimizing marketing spend or through other means allows you to increase the profit margin of your product. To calculate CAC, find the total costs you spend on acquiring customers, scale this number to a certain timeframe, and divide this number by the number of new customers brought on in that same time period.
- LTV to CAC ratio: A 1:1 LTV to CAC ratio means it costs you as much to acquire one customer as a customer spends on your product. In this case, you may want to focus on lowering acquisition costs, improving your sales process to increase customer spend, or raising prices. A higher LTV to CAC ratio allows you to dedicate more time to sales and marketing, since your customer spends far more than it costs to acquire them.