Think of unit economics as the foundation of your direct-to-consumer (DTC) brand’s profitability. When left uninspected, cracks are likely to creep up and compromise the sustainability of your business model.
Now put that in perspective: It’s hard enough to run a profitable ecommerce brand these days. It’s that much harder when your unit economics don’t check out. (Just look at the slew of slumping IPOs and valuations lately.)
Luckily, unit economics can ensure your brand is sturdy enough to scale and do so profitability. All without needing any outside (read: venture capital) funding. That way, you can go public at a higher valuation (if you choose to exit) and actually maintain that listing price.
Here’s how unit economics can help you get there.
Unit economics is how a company’s revenue relates to the sale of a single unit. In ecommerce, a unit is considered either one customer or one product.
Meaning, unit economics is just a fancy term for the revenue that comes in when you sell a single SKU or to a single customer.
For DTC beauty upstart Glossier, a unit might be a bottle of their best-selling cleanser. Or, a unit might be a loyal customer living in California.
You can analyze each unit to determine how much profit or loss it produces. For example, Glossier can examine individual product (or customer) data to determine how much money that product or customer makes monthly.
Sound like just another KPI in a sea of “crucial metrics?” Well, that single piece of financial data makes it much easier to gauge things like profitability, product potential, and more.
Although experts often talk about unit economics for startups or SaaS businesses, it also benefits ecommerce brands.
Calculating unit economics helps retailers measure profitability per unit, make long-term growth projections, and ensure they get the highest return on investment for every product on their shelves.
It’s no secret that an ecommerce business needs most (if not all) of its orders to be profitable if it wants to stick around. While there are a few exceptions to this rule—like fulfilling a small number of orders at a low cost to secure new customers—they’re very rare.
So, how do you know if all your orders are turning a profit? Simple: Just dig into your unit economics.
Unit economics gives you a clear, granular picture of your profitability per, well, unit. This way, you have a much better idea of:
Whether you’re measuring profitability per product or per customer, this information can guide lots (most?) of your decision-making down the line. For example, if you notice a SKU’s profits dipped from March to April, you can run a new promotional campaign for that product in May.
In other words, you can make proactive moves to raise profits (per unit) once you know how each item is performing.
📝 Note: Often, spending on marketing means you’ll also increase your profits (and improve unit economics as a result).
For example, free shipping based on an optional minimum order quantity (MOQ) is a low-cost campaign that boosts average order value (AOV) and unit economics by increasing revenue while lowering operational costs.
Beauty brand Freck offers customers free shipping if they spend $50+ and live within the United States. This way, they increase AOV while protecting their unit economics (after all, international shipping costs a lot more and $50 might not cover the incentive).
Because unit economics clearly identifies revenue and SKU profitability, it can also help with your long-term growth projections. That is, unit economics helps you accurately forecast demand for individual products.
When you know your monthly sales and revenue per item (or per customer), you can tease out buying trends to inform your long-term forecasts.
From there, you can use these forecasts to budget your initial working capital (as in, how much money you’ll need to fulfill the forecasted order).
On top of all that budgeting guidance, unit economics can determine how many units you need to sell to break even or reach profitability (which can inform your marketing efforts).
You can also compare your per-unit profits against your supplier’s per-unit cost. That way, you can negotiate down vendor pricing (or raise your own prices as needed).
🤿 Dive deeper: How to negotiate better vendor terms.
Whatever your revenue goals, unit economics ensures you have the money to make your projections a reality.
The calculation gives you all the necessary details on incoming revenue. So, you can see whether there’s enough cash flow to pay for inventory replenishment on schedule or whether you need to adjust your order volume.
👉 Cogsy can help you build inventory plans with pinpoint accuracy up to 12 months out. You can even run “what if” scenarios to ensure you’re prepared for anything. Learn more.
Unit economics also gives you more power when assessing your products. Meaning, you can determine if a specific product is overpriced or undervalued.
For instance, is a SKU not selling as well as a similar item from your competitors? Your target customers might think the product is too pricey. In that case, you’ll need to find ways to increase demand so that inventory doesn’t wind up as dead stock.
Alternatively, is a SKU bringing in a lot of recurring revenue for your brand month after month? It might be time to adjust your pricing to maximize profits.
Not to mention you’ll need an inventory plan that keeps enough of that SKU on hand so you don’t stock out (and disappoint your customers).
Essentially, unit economics identifies where there’s room for inventory optimization. Spotlighting these opportunities means you can refine your inventory strategies to retain as much revenue as possible.
If you invest smartly and maintain optimal inventory levels (which ties up the minimal working capital needed for the maximum returns), you’re already well on your way to lower unit economics.
Best part? Lower unit economics means higher profits. And higher profits mean more working capital to put into product development, testing a new sales channel, or funneling into more marketing campaigns.
👉 Cogsy makes maintaining optimal inventory levels a no-brainer with personalized restock recommendations. That way, you always know exactly how much to restock to meet demand and avoid dead stock. Learn more.
By paying attention to unit economics, you can quickly see which products customers love and which ones they don’t.
Gauging a product’s potential this way helps determine future product development and which SKUs to sunset. That’s why so many retailers use unit economics in the early stages of growth to inform a product’s scalability.
As a rule of thumb, you can expect unit economics to get better to a point (if your brand is just starting out). But down the line, unit economics tend to worsen as your brand continues to scale.
So, while your unit economics might eventually take a dive (like when you add another supplier to your roster to satisfy demand and have to meet both suppliers’ MOQs), it happens as part of a larger bell curve.
Meaning, if the unit economics for a product isn’t that great right now, it could still improve – like if you can generate enough demand to justify the additional supplier.
But it won’t necessarily get better later on. Keep this in mind as you figure out which SKUs to keep or cut from your product catalog.
You can calculate unit economics in a few different ways. Your formula will depend on whether you base your math on units as one item or customer (we’ll walk you through both in more detail below).
If you’re defining units as one item sold, you can determine unit economics by calculating the contribution margin for each product.
📝 Note: Contribution margin is the difference between your price per item and variable costs per sale. The sum reveals your revenue for individual SKUs.
The formula for contribution margin is:
contribution margin = (price per unit – variable costs per sale)
Price per item is what you charge customers to purchase individual products. Meanwhile, variable costs encapsulate any expenses that change depending on the number of SKUs you produce. Raw materials are just one example of variable costs.
So, let’s say your company sells sunglasses, and your best-selling pair costs $200. If the variable costs for those sunglasses are $50, the contribution margin per item will be:
$200 – $50 = $150
Meaning, your brand generates $150 in revenue every time it sells those specific sunglasses.
🤿 Dive deeper: What are good ecommerce profit margins.
If you’re defining units as one customer, you can determine unit economics with two metrics:
The formula for customer lifetime value is:
CLV = (average purchase value x number of purchases per year x average length of customer relationship in years)
Let’s say a typical customer for your sunglasses brand spends $100 per visit, and they buy from you once a year over an average customer lifespan of 10 years. Their CLV will be:
$100 x 1 x 10 = $1,000
Meaning, the customer will spend $1,000 throughout their relationship with your brand.
On the flip side, the formula for customer acquisition cost is:
CAC = (sales and marketing costs ÷ number of new customers acquired)
So, say your sunglasses company spent $5,000 on marketing in 2022 and acquired 125 new customers from those campaigns. Your CAC will be:
$5,000 ÷ 125 = $40.
In other words, your brand spent $40 to attract each of those new customers.
With both these calculations in hand, you can calculate your unit economics per customer using the following formula:
unit economics per customer = (CLV ÷ CAC)
Going back to the sunglass brand example, your brand generates $25 in revenue every time that customer buys a product from you:
$1,000 ÷ $40 = $25
Most experts agree that an ideal CLV to CAC ratio is 3:1. Meaning, the lifetime value of your customers should be three times what it costs to acquire them.
If your ratio is lower (like 1:1), you’re probably spending too much to acquire new customers.
If your ratio is higher (10:1), your revenue from that customer is far more than what you paid to onboard them. In this case, you might be spending too little on marketing and acquisition and missing out on potential customers.
Some retailers might want to look at customer acquisition over the long term. If this is you, you can calculate your CAC payback period. This approach focuses on how many months it takes to start making money from a new customer.
Typically, brands with a high customer churn rate use the CAC payback period because they need more time to adapt their product to customers’ needs. As a result, these brands have a hard time trusting CLV.
Calculating the CAC payback period is pretty simple. You just divide your CAC by monthly recurring revenue (MRR):
CAC payback period = (CAC ÷ MRR)
For example, let’s say your brand sells razors and offers a refill subscription. You spend $50 to acquire new customers. And your refill packs cost $10.
If those customers buy one refill pack every month, then your brand will break even on month five:
$50 ÷ $10 = 5
A shorter payback period (under a year) is beneficial since you’ve spent less time and money encouraging a customer to purchase. That way, your brand can grow faster and retain more revenue simultaneously.
But say customers are churning before the break-even point. This indicates something’s likely off with your pricing, marketing, or product-market fit.
Either way, the CAC payback period is useful for monitoring the effectiveness of your customer retention programs and marketing strategies.
If your ecommerce brand wants to stay competitive, there are a handful of key unit economics metrics to monitor. And we’ve already brought up a few.
The most valuable key performance indicators (KPIs) include lifetime value, customer acquisition cost, churn rate, and retention rate.
As a refresher, customer lifetime value (CLV) is the amount of money you get from a single customer before they churn and stop purchasing from your brand.
This metric helps you get the most out of every customer relationship. That way, you can improve the customer experience so people stick around a little longer.
Again, the formula for customer lifetime value is:
CLV = (average purchase value x number of purchases per year x average length of customer relationship in years)
And as you already know, your lifetime value should be (at least) three times greater than your CAC. So, if you spend $200 on marketing to acquire a new customer, they should have a minimum CLV of $600.
🔥 Tip: Your CLV has to cover all the expenses associated with each customer (including shipping and customer service). So, without a 3:1 CLV to CAC ratio, scaling your brand will be difficult since you’ll be operating on razor-thin margins.
Some easy ways to increase your CLV include product bundling, creating custom product recommendations for customers, and maintaining an MOQ that unlocks free shipping.
All of these tactics incentivize customers to keep coming back for more, thanks to the convenience and cost savings.
As discussed earlier, customer acquisition cost (CAC) is the cash you spend to attract new customers. This includes total sales and marketing costs like salaries, campaigns, and the specific technology you use.
Again, the formula for customer acquisition cost is:
CAC = (sales and marketing costs ÷ number of new customers acquired)
Acquisition costs can be significant because they determine how expensive (and ultimately, how profitable) growth is for your brand.
After all, growth won’t be sustainable if your CAC is too high relative to CLV. Why? Because acquiring more customers costs more than that customer spends with your brand.
With that in mind, CAC is on the rise for DTC retailers. In fact, it’s increased by 20-30% in the last five years due to the anti-tracking challenges introduced by iOS 14.5.
Essentially, Apple’s iOS 14.5 update (released in early 2021) introduced new privacy protections for iPhone users. Apps now have to ask people for permission to track their activity online.
As of April 2022, only 25% of consumers allowed apps to track their online activity weekly.
What does all this mean? Well, for years, DTC brands relied on third-party channels (like Facebook and Instagram) to drive paid traffic to their websites and acquire new customers.
But this iOS update makes reaching their target audience tougher for many brands. And without efficient ad targeting, CAC goes way up.
To combat these rising costs, some retailers have turned to “free” or lower-cost ad channels like referrals, influencer partnerships, and affiliate tracking links.
Other DTC brands have moved toward omnichannel selling. For instance, DTC clothing brand Ministry of Supply started selling on Amazon in the last few years. Meanwhile, the digitally-native hair care brand Function of Beauty now sells wholesale at Target.
Although these moves come at the expense of direct customer relationships (and first-party data collection), they still increase brand awareness while lowering CAC.
Churn rate is the percentage of customers who stop buying from your online store over a given period. And two types of churn directly affect ecommerce brands: voluntary and involuntary.
Voluntary churn is when a customer actively decides to stop buying from you. Maybe they had a bad experience with support or no longer love your products.
Meanwhile, involuntary churn is when something like a payment failure (often expired credit cards) prevents a customer’s purchase from going through.
That said, voluntary and involuntary churn are measured together when calculating your total churn rate. This formula looks like this:
churn rate = [(customers at beginning of period – customers at end of period) ÷ customers at beginning of period] x 100
Understanding your churn rate is important because, after all, losing customers means losing revenue. But reducing churn is almost impossible if you don’t track churn.
Acquiring new customers costs five times more than retaining existing ones. So, it literally pays to reduce churn and hang on to current customers. That way, you maximize the value of the customers you already have.
Today, single-purchase ecommerce businesses (like skincare and fashion brands) average about a 75% churn per cohort. That means only 25% of customers purchase from these brands a second time. Those numbers really leave a lot of room for improvement.
Some of the most effective strategies for reducing churn include:
After all, when you know what customers say about you, you can address their concerns and enhance the customer experience.
Your retention rate is the percentage of existing customers who continue buying from your brand over a designated period of time. So you can think of retention rate as the opposite of churn.
To calculate your retention rate, use the following formula:
retention rate = [(customers at end of period – customers acquired during period) ÷ customers at beginning of period] x 100
Customer retention rate gives insight into your ability to sustain customer relationships and turn them into recurring revenue.
It’s also important to prioritize retention since the cost of acquiring new customers is so much higher than retaining existing customers.
For reference, the average customer retention rate for ecommerce brands hovers around 31%. But repeat customers spend 67% more than new customers.
In fact, it costs 16 times more to get newly acquired customers to spend as much as existing ones.
With that in mind, increasing retention is definitely in your best interest. Some brands have found success through personalized shopping experiences and collecting customer feedback to learn more about customers’ preferences and buying habits.
For example, accessories brand Bellroy emails customers a survey about a month after their purchase, asking them to rate their satisfaction level.
These feedback surveys are a useful way for Bellroy to gather customer insights. The Australian accessories brand then uses these insights to create a better brand experience and greater customer loyalty. In turn, this increases retention and boosts the brand’s bottom line.
Average order value (AOV) measures the average dollar amount customers spend on each online order.
This metric is critical to your DTC brand’s financial health since AOV highlights how well your pricing strategy works.
While AOV can be tracked for any period, most retailers monitor this amount on a daily or weekly basis using the following formula:
AOV = (total revenue ÷ total number of orders)
📝 Note: AOV is determined by sales per order, not per customer. So, even if the same customer makes multiple purchases, each order factors into AOV separately.
The higher your AOV, the more your brand gets out of every customer and every dollar spent to acquire those customers. Currently, the AOV for general ecommerce brands sits at $97.
While increasing AOV isn’t a one-size-fits-all approach, there are many ways you can go about this. For instance, you can encourage customers to add more to their cart by cross-selling and upselling complementary products, offering unlockable free shipping, or creating product bundles.
Men’s skincare brand Huron has seen incredible success with a build-your-own bundle (BYOB) approach.
This strategy gives customers the power to select products based on their preferences. And the more products they add to their cart, the more benefits they get (discounts, free shipping, and free gifts included).
In the five days following their BYOB launch, Huron’s AOV increased 85-110% (on average) for new and repeat customers alike.
🤿 Dive deeper: Steal Huron BYOB strategy.
Your discount rate is what the name would suggest—the amount a product’s been marked down compared to the original price.
For example, if an item is listed as 20% off, the discount rate for that SKU is 20%.
The formula for your discount rate is pretty straightforward:
discount rate = (discount amount ÷ original price) x 100
While discounts can be a “quick fix” to gain customers and increase revenue in the short term, they’re not as effective for long-term growth.
Occasionally offering a discount to return to optimal inventory levels (like when you’re overstocked on a SKU) or to compete during deep discount periods (like the leadup to the holidays) is one thing.
But offering discounts to generate demand can be problematic for your brand’s bottom line and unit economics. If you have to constantly discount your products to increase demand, your “regular” price is probably too high.
Not to mention that customers might grow accustomed to those discounts and lower price points.
Meaning, unless an item is on sale, your customers won’t follow through with a purchase. So, be wary of offering too many promotions since constantly marked-down products can do more to hurt your revenue than help it.
Revenue is one of the more straightforward calculations on this list. It’s simply the amount of money a company generates from sales.
To calculate revenue, simply multiply the number of units sold by the selling price:
revenue = (number of units sold x selling price)
📝 Note: Because revenue doesn’t account for costs or expenses, your revenue will always be higher than your profits (more on that in a minute).
On the other hand, recurring revenue refers to company earnings that will continue in the future. Unlike one-off sales, recurring revenue is predictable, stable, and occurs at regular intervals moving forward.
Subscriptions are a prime example of recurring revenue. Ecommerce subscriptions mean brands send customers products on an ongoing, automated basis (often monthly or quarterly).
While subscriptions are a great way to guarantee cash flow for your brand, they also help build strong customer relationships.
Subscriptions turn customers—who already see the value your company provides—into loyal followers and reliable sources of recurring revenue. The longer someone uses your products, the higher their lifetime value.
👉 Cogsy’s subscriptions feature ensures you always have enough inventory to fulfill your subscription and one-off order. That way, you can increase retention and revenue. Learn more.
Even better, having higher recurring revenue means having lower acquisition costs in the long term.
Today, fashion, health, and beauty brands are some of the biggest players in the subscription game.
Take beauty brand Birchbox, for example. They send subscribers a selection of cosmetics and skincare products every month, which translates to consistent revenue and consistently satisfied customers.
🔥 Tip: If you sell consumable goods (like razors or toothbrushes), customers will always have to come back and restock at some point anyway. So, why not nudge them toward a subscription and increase your CLV?
Gross profit (AKA, gross income) is what your company keeps after deducting what it costs to make and sell your products.
📝 Note: Gross profit differs from net profit, which factors in all company-wide expenses (not just your cost of goods sold).
The formula for gross profit looks like this:
gross profit = (revenues – cost of goods sold)
Understanding gross profit is important to running a DTC brand since this metric reveals how efficiently you use labor and supplies during production.
That’s because your ecommerce profit margins represent the percentage of each dollar you get to keep after expenses. So, the more money you have remaining, the better your margins.
That said, good gross profits vary depending on your industry and niche. But gross margins between 50-70% are widely considered good.
Some of the top ways to increase your gross profits include:
Whatever you do to boost your profits will achieve a high net income and increase your business’s profitability.
The best way to improve unit economics is to increase CLV while decreasing CAC. Here’s how:
While you can improve CLV in multiple ways, some methods work better than others.
For instance, by bundling products together, you’ve increased the perceived value of that purchase and encouraged customers to buy more in a single transaction.
📝 Note: Customized bundles are having a moment right now. They’re a great way to increase CLV because customers appreciate having more control of their shopping experience. Meaning they’re likely to favor your brand over the competition.
In addition, if your brand sells consumable goods (that need frequent repurchasing), you might consider setting up a loyalty program.
A loyalty program can deepen customer relationships and potentially increase lifetime value. In fact, a 2021 study estimated that loyalty increases a customer’s worth 22 times over.
Better yet, it costs less to sell to loyal customers because they’re more likely to buy—with the probability of a sale jumping from 5–20% for a new customer to 60–70% for a returning one.
When customers are incentivized to earn points with your loyalty program, there’s a better chance they’ll buy more consistently over a longer time.
Lastly, subscriptions are another proven way to drive up CLV since they’re a gateway to repeat customers (and recurring revenue). And the longer a customer uses your products, the greater their lifetime value.
To achieve the ideal CLV to CAC ratio of 3:1, you won’t just need to increase CLV—you’ll also need to work on bringing down your CAC.
You can start by creating a referral program to incentivize existing customers to recommend your products to family and friends.
An impressive 84% of customers say they trust word-of-mouth recommendations more than any other form of advertising.
Not only are referral programs an excellent way to expand your reach, but they cost next to nothing to implement.
Alternatively, you can also optimize your conversion rate so you don’t have to go out and look for new customers in the first place.
As mentioned above, offering personalized shopping experiences, collecting customer feedback, and offering a discount after purchase are all ways to lift retention numbers.
You also have the option to narrow your audience. After all, having a broad target audience tends to hike up acquisition costs in the long run.
When you spend a lot of money trying to attract the right audience, you often lose money on experimental marketing that doesn’t lead to sales.
But if you do your research and market to specific regions or demographics (who’ve shown interest in your products), you won’t spend nearly as much on initial acquisition.
Cogsy is the end-to-end purchasing tool that makes it easier to maintain optimal inventory levels across all your locations and improve your unit economics.
With it, you can generate growth plans with pinpoint accuracy. You can even spin up “what-if” scenarios to plan for best case and worst case.
Cogsy then tracks your inventory levels in real-time. As soon as you’re running low on any SKU, we’ll send you a replenish alert so you can restock with plenty of time to avoid a stockout.
You’ll even get personalized restock recommendations. This way, you can streamline the purchase order creation process.
These restock recommendations even take into account various X factors, like upcoming marketing events, the inventory needed to support your subscription models, and SKUs that are sold on their own and as part of a bundle.
That way, you only stock what you need – naturally lowering your costs per unit since you’re not paying extra to hold or write off inventory.
Best part? Cogsy accurately calculates your landed costs by factoring in any necessary adjustments (think: shipping costs). This gets you one step closer to tracking COGS on a per SKU and per vendor basis. So, you can start improving your contribution margins accordingly.
As a result, brands that use Cogsy generate 40% more revenue on average. All while saving 20 hours a week on redundant inventory management tasks.
But no need to take our word for it – try Cogsy free for 14 days!
The ideal CLV to CAC ratio is 3:1. Meaning, the lifetime value of your customers should be three times what it costs to acquire them.
If your ratio is lower (1:1), you might be spending too much on acquiring new customers. If your ratio is higher (10:1), the revenue you get from a customer exceeds what you paid to onboard them (and you might be spending too little on acquisition).
Negative unit economics is where your customer lifetime value is lower than your customer acquisition cost. As you can imagine, this situation is pretty bad for business – since you’re spending more to attract customers than those customers are spending with your brand.
Unit economics describes your company’s revenues and costs for a single unit. In ecommerce, unit economics tells you the revenue generated from a single SKU or customer.