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15 March 2017

Unit-economy. Inception

Most businesses die in the first year of work, because they run out of money. At the same time, the death of business directly depends on the decisions made in this business. The ability to correctly choose the solutions that allow the business to develop and grow, become profitable, it is important. To make decisions, you need a tool that would allow you to choose from the list of solutions only those that you will do, and those that will have the greatest impact on business performance. Unit-economy, just such an instrument.

The unit-economy shows how business earns from the flow of users. Scheme of business: at the entrance we accept users who pass through the black box of business and bring money. At the same time, we remember that money can be either a plus sign or a minus sign.

If we know how much we spent on each visitor who got into our «black box» and calculate how much he brought money, then we can calculate the amount of money the business brings from the flow of users.

Gross Profit = UA x (ARPU-CPA)

Where, Gross Profit (GP) — the amount of money that we earn from the flow of users, taking into account our costs for the cost of the transaction. User acquisition (UA) — the number of users in the flow. Average Revenue Per User (ARPU) — the amount of money that each user brings in the flow. Cost Per Acquisition (CPA) — the cost of attracting one user to the flow.

Analyzing these parameters, we can only talk about the effectiveness of our business on the flow of users. If ARPU is larger than CPA, then we earn, if less — we are loss. However, these metrics do not say anything about why we are at loss or how to grow 10-times. In order to make decisions, we link these metrics with the product metrics that change when making decisions.

Let’s look at the ARPU metric. This is the income that every user of a product brings, whether he pays or not. Let’s also agree that we will talk about the Internet business, which means that we will mean the site, and the user will be called the visitor of the site. And so, ARPU is the visitor’s income for a while. In other words, ARPU is a function of time.

ARPU30 = ARPU (30 days)

LTV = ARPU (LT)

An easy way to calculate the value of this function is to take the money received for the selected period of time and divide by the number of visitors during this time.

ARPU = Revenue / UA

However, this approach does not say anything about the product, and how to grow 10-times. The second way to get ARPU value is through ARPPU — the income from the paying visitor, these values ​​are connected as well as visitors with paying visitors, through the conversion of C1.

ARPU = ARPPU x C1

Where C1 is the conversion in the first purchase. It is important to understand that we are interested in the conversion in the first purchase, since it divides visitors into ordinary ones and those who at least once paid.

Now let’s look at what ARPPU is — income from one paying customer for a certain period of time, a function of time. However, unlike ARPU, this function is calculated through product metrics.

ARPPU = (Av.Price — COGS) x APC — 1sCOGS

This is a simplified view of the function that is suitable for most business models. Av.Price is the average check that our customers paid for the selected period of time. COGS — the cost of goods or services sold. APC — the average number of sales per customer, just this number includes repeat transactions that our customers are committing, the higher this number is, the better. This means that customers are willing to pay again and again. 1sCOGS — special costs for the first transaction, and those that are not included in COGS. For example, the cost of connecting the client to the service, test periods, etc.

As you can see, now our formula GP takes the following form

GP = UA x (ARPPU x C1 — CPA)

GP = UA x (((Av.Price-COGS) x APC — 1sCOGS) x C1 — CPA)

What links product metrics to growth metrics.

To grow, you need to know what product metrics affect growth. It can be seen that if ARPU is less than CPA there will be no growth, but there will be losses, moreover, scaling the audience will lead to scaling of losses.

The value of APRU is related to the conversion of the visitor to customer C1 and tells how our product sells. How understandable are the processes necessary for this, how do we communicate our value, etc. Av.Price — how much the price corresponds to how much our customers are willing to pay. This parameter, together with COGS, determines how correctly the monetization model of our product has been selected. 1sCOGS shows how we communicate the value of the product to our customer, for example, we bear the cost of integration with the client software.

So we got a simple function for GP, which depends on a set of simple metrics that depend on the processes and decisions made in the business, which allows you to focus on bottlenecks and multiply.

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