Unit economics refers to the cost and revenue generated by each individual unit of a company's product or service. This metric is a simple reality check for business owners and important data point for investors when assessing the financial viability of the business.
For example, a Fin-Tech startup in Nairobi, Kenya, costs may include expenses such as technology infrastructure, employee salaries, and marketing campaigns. Revenue, on the other hand, would come from fees charged for financial services such as mobile money transfers or loans.
In order to determine the unit economics of the business, it's necessary to calculate the cost of goods sold (COGS) as well as the revenue generated by each transaction. This calculation provides a snapshot of the financial health of the business and helps the company make informed decisions about scaling, pricing, and product development.
To be more specific, if the fin-tech company has a COGS of KES 50 per transaction and generates 100 in revenue, its unit economics are strong. However, if the COGS per transaction is 80 and the revenue is only 60, the unit economics are weaker and the company may need to re-evaluate its operations in order to become profitable.
Two main risks a poor unit economics puts a business in:
- Cash flow problems: Negative unit economics can result in a consistent cash flow deficit, making it difficult for the company to pay its bills and meet its financial obligations.
- Complexity when scaling: A company with negative unit economics will find it difficult to grow, as the cost of producing more units will continue to exceed the revenue generated by those units.
Investors recognise that what is considered a good unit economics ratio can vary greatly from a business to another. For example, the ratio of a mobile money transfer service may be different from that of a micro-lending platform, so it is important to understand the sector, average market performance and the long term potential of your business when fund raising - check out this article from Sam Altman:
unit economics play a critical role in the success of any business, big or small. By understanding the costs and revenue associated with each transaction, companies can make informed decisions about scaling, pricing, and product development. Investors also use unit economics to assess the financial viability of a business and determine whether it is a wise investment, which is extremly important if you are running an early stage startup.
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