… nailing Unit Economics
This post was first published on the Crunchbase blog.
Every startup begins as an idea. And as a founder, your idea needs a powerful story that wins the support of two key audiences:
- The customer. The story to a potential customer is all about what product or service you offer them, why they should care, how and when you plan to deliver it, and at what price.
- The investor. The story to an investor is simply how the money they give you will grow into more value, how fast and how big. It is also why you and your team are best placed to execute on that.
Oftentimes, the customer story is solidified. However, the story founders tell investors, which should focus on what they get out of their investment, is typically underdeveloped. To fix that, you need to understand your startup’s unit of value, unit economics, scalability, and growth rate.
Unit of Value
Define what it is you’re building that has economic, not emotional, value. Coca Cola’s unit of value is a can of fizzy drink; a movie theatre’s unit of value is a seat at an event; Google’s unit of value is a paid click (CPC, CPA or CPM); and Uber’s unit of value is a paid ride or delivery.
All companies have a unit of value. Tell investors what it is.
All units of value have a sale price, a cost of sale, and a gross profit. These make up unit economics. Uber charges per mile for a ride, the driver gets a percent of that charge, and the app itself has some costs associated with it (COGs/COS/CAC). If the sale price per mile is $1, and the cost of sale is $0.50, then gross profit is 50%. Your operating income (cash needed to run the business) comes from this gross profit, as does your actual profit (net earnings). This can be calculated per business model or unit you sell.
Successful companies aim for positive unit economics and the ability to scale them to produce large gross revenues. Netflix sells a subscription (unit of value) at a profit margin of 75% (unit economics). They have 137 million subscribers driving $15 billion of annual revenue ($109 per subscriber per year). Their overall gross profit is about 10% or $1.5 billion annually.
The final piece of the story is how fast your unit of value will be sold. If you project your product will reach $10m revenue over 10 years it will be valued less than another company projecting to reach the same revenue in three years. Netflix annual gross profit for the quarter ending September 30, 2018 was $1.587B, a 60% increase year-over-year.
What can you know from the start?
You can never accurately forecast revenue and growth when you are just at the start of your company, so your story is just that — a story. A model. It is not a forecast or a plan. It tries to set out the potential of the business idea before you start building it and spending cash on it.
Where can I test this out?
To help you calculate, project, and play around with your unit economics, we’ve built a simple tool. Check it out and enter your own numbers to see how it works. We’ve also published a template pitch deck to show how we think this fits into your narrative to investors.
Not sure where to start with your investor story? Use the case study below to help.
At launch in 1997, Netflix’s unit of value (a subscription) and unit economics will have looked something like this:
- 100 million US households — 20% have a DVD player (in 1997).
- These 20m homes spend avg $10 a month renting DVDs.
- Most pay late fees.
- In 10 years the household/DVD ratio will grow to 70%.
- Netflix subscriptions to every home within 10 years — one million in first year.
- Charge $10 a month for the subscription (no late fees and unlimited rentals)
- $10 x 70m is $700m a month or $9.6 billion a year.
- Gross profit 10% and growth will be 100% a year.
- Need to source content and distribute it via a software platform that scales.
- This team can do this and will scale globally fast.
The story is grounded on a thesis made up of real-world modelling using actual numbers. You are able to do the same, showing what your idea can become, and how that idea will come to fruition in terms of velocity (how fast) and scale (how big).
Here are the two tools we’ve built to help you tell your investor story better: