Why Startups Need to Take their Unit Economics Seriously

unit economicsThis guest column is by Manavjeet Singh, Founder & CEO of Rubique

For startups, the year 2014 and 2015 brought unrealistic valuations for numerous online players. Money was pouring in easily through venture capital and private equity firms, with the emergence of food-tech startups, hyperlocal and aggregators, in addition to e-commerce platforms. Although ASSOCHAM now predicts the e-commerce market to touch a whopping USD 38 billion mark, 2016 has had a placid beginning. The easy money flow as compared to the previous year is showing a significant decline this year. This decrease in the inflow of funds is resulting in startups either shutting down or merging with other companies.

Bumps in valuations as investors shift focus from GMV to Unit economics

A startup business needs funding to propel its operations, business growth and sustain in the competitive ecosystem. In the initial years of operations, this need is fulfilled by investors who pump in money to make it happen. However, after a specific period, every business is expected to generate cash through operations. According to a joint report by KPMG and a New York-based startup research firm, investments in Indian startups declined by 24 percent every next quarter.  The halt in investments was driven by the business’s unit economics and an outstanding attentiveness to their exhibited valuations.

Every startup, no matter the scale, needs to have an idea about its unit economics.  Business models can change with the permutations in the target market or service offering, pricing strategy, cost model and other factors in an effort to boost revenues and profits. With so many changes taking place, entrepreneurs might lose track of how profitable their business model is. Unit economics is what helps in this scenario. But before moving ahead, let us understand what Unit Economics for a startup means. Unit economics refers to the direct revenues and costs associated with a particular business model of a startup expressed on a per unit basis. The company needs to pick a unit on which the most significant level of marginal investment has been made. For a SaaS company, the unit is a user whereas the revenues generated are defined as the Customer Lifetime Value (CLV), and the cost per unit is the Customer Acquisition Cost (CAC). As SaaS companies record high gross margins, the true cost to compare is the CAC.

Unit Economics: A profitable guide to breathe life into new generation businesses

For new age startups, irrespective of the business line they are in, unit economics provides value not only to their potential investors but also the stakeholders. It’s a standard evaluation of basic profitability calculated through several inputs like the Life Time Value (LTV), duration of the unit, capital expenditure, Cost per Acquisition (CPA) or Cost to Acquire a Customer (CAC), marginal operational cost and maintenance capital expenditures. Unit economics has always been used as a measure to verify the success and profitability of a business model and all things being equal, investors consider companies with the most attractive unit economics.

Many a times, with certain types of business models, it can be difficult for an investor to assess whether the company will be able to make a profit at scale. Matters become worse when companies that appear to be doing well are just masking their flaws in terms of their ability to generate long-term profits. It is crucial for an investor to know that if a business is not minting money at the smallest data point, chances are that it will not make any at any given point.  In such cases, investors can analyze the unit economics of the concerned business and make more informed decisions. In fact, most investors today have started paying attention to the investment core, showing a keen interest in knowing the traction the platform is generating, gross revenue per transaction, variable cost and finally its contribution margin. A combination of these is what investors look at to ensure returns on their investments. Meanwhile, such evolved scrutiny has generated an increased awareness among startups. They have started putting across practical projections and realistic figures, whereas the businesses looking for capital, are including unit economics in their investment teasers and pitches.

Startup failure stories make Unit Economics the sole metric that matters

A much-speculated concept in the investor circles today, unit economics is not new to entrepreneurs and investors. It has been existent in the industry for a very long time but the reason it has managed to grab the limelight recently is the sudden spate of shutdowns and downfalls in the Indian startup ecosystem. For the fast-paced startup industry with heightened expectation on quick returns, this conversion becomes a crucial factor and that is why from the number of visitors, the focus has now shifted to the number of transactions. From spreading mass awareness through marketing campaigns and burning cash, no wonder the attention is now on how best a single penny spent in marketing can help the startup get a quality customer. Thus, instead of judging the startup based on its popularity, investors are leaving no stone unturned in carefully assessing the viability & sustainability of a company in the long run along with its ability to make profits.

Disclaimer: This is a guest post. The statements, opinions and data contained in these publications are solely those of the individual authors and contributors and not of iamwire and the editor(s).

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