Glossary
What are unit economics?
Unit economics: Unit economics measure the revenue and costs of a single unit of the business, usually one customer, to show whether each additional unit makes or loses money.
Unit economics describe what one unit of a business earns and what it costs. In a software or subscription company the unit is one customer. The question is whether each new customer returns more than it costs to win and serve. If it does, growth creates value. If not, growth makes the losses bigger.
A subscription company usually reports these numbers:
| Metric | What it shows | Formula |
|---|---|---|
| Average contract value (ACV) | Yearly revenue per customer | ARR ÷ customers |
| Gross margin | Share of revenue left after delivery costs | (revenue − cost of revenue) ÷ revenue |
| CAC | Cost of winning one customer | sales and marketing spend ÷ new customers |
| CAC payback | Months until a customer has repaid its CAC | CAC ÷ (monthly revenue per customer × gross margin) |
| LTV | Gross profit from a customer over its lifetime | yearly gross profit ÷ annual churn |
| LTV/CAC | How many times a customer repays its CAC | LTV ÷ CAC |
CAC and LTV have their own entries. Here they work together.
A worked example
A software company has 46 customers paying €23,700 a year (ARR of €1.09m) at an 84% gross margin. Over the last twelve months it spent €638,750 on sales and marketing and won 35 customers.
- Gross profit per customer: €23,700 × 84% = €19,908 a year, or €1,659 a month.
- CAC: €638,750 ÷ 35 = €18,250.
- CAC payback: €18,250 ÷ €1,659 = 11.0 months.
- LTV: €19,908 ÷ 35% yearly churn (an assumption) = €56,880.
- LTV/CAC: €56,880 ÷ €18,250 = 3.1.
A common rule of thumb for subscription software, popularized by David Skok (SaaS Metrics 2.0, 2013), asks for an LTV/CAC of at least 3 and a payback under 12 months. This company meets both. Treat the thresholds as a starting point, not a law.
How to use unit economics well
- Work with gross profit, not revenue. Revenue ignores the cost of delivering the product.
- Put every sales and marketing cost into CAC, including salaries and commissions.
- State the period and the sales mix, for example "trailing twelve months, direct and partner sales".
- Show your assumptions, above all the churn rate behind LTV.
- Split by segment or channel when the numbers differ. A blended figure can hide a weak channel.
Typical mistakes
- LTV on revenue instead of gross profit, which overstates it.
- CAC with ad spend only, leaving out the sales team.
- A blended average over customers who differ widely in price or churn.
- Optimistic churn. A young company has little history, so an assumed churn rate must be cautious and labeled as an assumption.
- Mixed time frames, such as lifetime value of old customers against last quarter's CAC.
How many customers you can win comes from TAM, SAM and SOM. The cash you need to win them shows up in the burn rate.
FAQ
Frequently asked questions
What are good unit economics?
There is no universal threshold. A common rule of thumb for subscription software, popularized by David Skok (SaaS Metrics 2.0, 2013), is an LTV/CAC of at least 3 and a CAC payback under 12 months. The right levels depend on churn, margin and how much cash you have to fund growth.
What is the difference between unit economics and profitability?
Unit economics look at one customer, before shared costs such as development, management and rent. A company can have healthy unit economics and still lose money overall, because those fixed costs are not yet spread over enough customers.
Do unit economics only apply to software?
No. Any business with a repeatable unit can use them: a restaurant per table, an online shop per order, a delivery company per shipment. The formulas change, but the question stays the same: does one unit earn more than it costs?
Which unit economics should a pitch deck show?
Four numbers are usual: average contract value, gross margin, LTV/CAC and CAC payback. Add a note on the period and the sales mix, and keep the split by channel for the appendix.
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