Key Takeaways

• Unit economics help you to break down key metrics like revenue, COGS, gross profit, marketing, etc. on a per-customer basis. They are a crucial business health indicator for all businesses. If you can't make a profit on one customer, you can't do it at scale.
• First you need to break down your numbers on a per-order basis, and next you need to break down these same numbers but for the entire lifetime relationship that each customer has with your business. These are your customer lifetime economics (customer lifetime value, revenue, etc).
• To design the optimal subscription program, unit economics help you decipher which incentive programs (like discounts, gift with purchase, and shipping thresholds) will maximize revenue and customer lifetime value.
• Subscribers are especially valuable because they unlock additional revenue and profits which allow you to scale faster with lower marketing costs.

Introduction

This course is a special one! Guest-authored by Ordergroove's resident eCommerce expert and Director of Growth and eCommerce Strategy, Eric Andrews; this course will explain the fundamentals of Unit Economics, and why they're the foundation to understanding the subscriber lifecycle. Eric comes with a decade of experience in the startup ecosystem and boasts a near 65,000 subscribers to his financial modeling Youtube channel, where he works with businesses of all sizes to drive real impact and growth using unit economics as square one.

What makes Eric so special to us and all Ordergroove customers is his driving mission: to empower millions of business owners and stakeholders to master the core levers of growth and profitability that drive financial success. We're certainly lucky to have him, and this likely won't be the last you see of him on Academy. So without further ado, let's get into it!

💡TIP: We like to think this course is pretty easy to follow along, but understand that visuals can be really helpful when it comes to understanding Unit Economics. Feel free to follow along with Eric in his video on Unit Economics here, and book some time with your designated Ordergroove CSM to run through a personalized Unit Economics exercise for your business.

Glossary:

• Unit Economics
• Average Order Value (AOV)
• Cost of Goods Sold (COGS)
• Gross Profit per Order (GP)
• Customer Acquisition Cost (CAC)
• Customer Lifetime Value (CLTV or LTV)
• Customer Lifetime Revenue (LTR)

What are “unit economics”?

Hey everyone - Eric Andrews here! Unit economics are the #1 most important predictor of business success and profitability, and the first thing I look at when I’m trying to understand a company. Today, I’m going to teach you how to break down your unit economics so you can optimize your business, let’s get started!

The “unit economics” framework is the idea that you should measure all your most important financial metrics (revenue, profit, marketing, retention, etc) on a per-customer basis and over their entire lifetime relationship with your company. 

They really should be called “customer lifetime economics”, but we didn’t name them!

Why do they matter?

Fundamentally, if you cannot make a profit on your relationship with each individual customer, you cannot make money as a business. By focusing the magnifying glass on improving the economics of your relationship with each customer, you will optimize your entire business.
In addition, subscriptions multiply the impact of your unit economics. While subscriptions have the potential to increase the length of your customer lifetime significantly, you must be careful and make sure you are generating additional profit from the additional revenue. The unit economics framework can tell you which incentives (discounts) will make you more profit, and which will make you less!

How do you calculate unit economics?

You need two main pieces of information to calculate your lifetime unit economics. One is the economics of each order, and the other is the total orders in a customer's lifetime. 

Per-order economics

The first thing you need to do is collect the order economics, which would include:

1. Average order value (AOV) = average revenue per order
2. Cost of goods sold (COGS) per order = product & fulfillment costs
3. Gross profit per order (GP) = AOV - COGS 
4. Customer acquisition cost (CAC) = the total marketing cost to get 1 new customer to purchase for the very first time

The AOV - COGS = the average gross profit per order. That is the % of your revenue that you convert into profit.

Example:

• AOV = $100
• COGS = $30 product + $15 fulfillment = $45
• Gross Profit = $100 - $45 = $55
• CAC: $75

CAC we will use, but only once we can see the full customer lifetime!

Lifetime economics

Now that we have our per-order economics, we need to convert them into lifetime economics. 

The customer lifetime is the total time active & value purchased you expect from your average customer, whether you acquired them 3 years ago, or you acquire them tomorrow. 

When I say “lifetime”, I’m referring referring one or a combination of the following ideas:

• Total lifetime orders of your average customer
• Total lifetime revenue of your average customer
• Total time your average customer is active (continues to purchase)

To calculate your lifetime economics, the easiest way is to multiply your order economics by your lifetime orders. 

Example: 

The lifetime orders of your average customer is 2.8 orders. 

Lifetime economics:

• Lifetime revenue = 2.8 * $100 AOV = $280
• Lifetime gross profit AKA customer lifetime value = 2.8 * $55 = $154

Now, that’s not the only way to do it. 

You can also often pull lifetime revenue from your analytics or, the best is to look at your customer cohorts (my favorite and the most accurate way). 

So, the customer lifetime value is just the total gross profit you expect to make from your lifetime relationship with one individual customer. 

Did you forget about CAC?

Lifetime economics including CAC

Now, the interesting thing about CAC is that we only have to acquire the customer once, and that is on the first order. After that, we already started the relationship with the customers so we generally have to do little to no paid marketing (more likely on channels like email/organic social) to drive subsequent orders. 

So CAC only applies to the first order in the customer's lifetime. 

What that means is that if the total gross profit we make on one customer (the customer lifetime value) is higher than our CAC, we make a profit on that customer.

Example, continued:

• Customer lifetime value: $154
• CAC: $75

LTV - CAC = $154 - $75 = $79 

So we expect to make a lifetime profit of $79, after marketing, on our average customer. Often LTV & CAC are also compared using a ratio, the LTV: CAC ratio.

Example:

Our LTV: CAC ratio is $154 / $75 = 2.1

When calculating this for your business, you can put this into perspective. Benchmarking LTV:CAC ratios is very common. Strong LTV:CAC ratios are often in the 3-5 range, with exceptional businesses sometimes in the 5-10X range.

How do discounts & incentives factor into unit economics & lifetime orders?

So how do we apply this understanding to crucial components of your subscription program? Recurring subscription incentives like discounts come directly out of the revenue you collect from customers, so they do decrease your AOV.

Example:

If my regular AOV is $100, but I decide to run a 30% discount, my AOV will drop to $70, and my gross profit will drop from $55 to = $70 - $45 = $25 of GP per order. 

However, while your GP per order might be going down; usually you can incentivize higher customer retention and higher lifetime orders with subscription discounts. So as discounts increase, lifetime orders usually increase simultaneously. 

As an operator, your goal is to find the optimal balance between discounts and lifetime orders to generate the highest possible customer lifetime value. 

Sometimes short lifetimes will be more profitable at higher margins, sometimes longer lifetimes will be more profitable at lower margins. You need to be able to explore these scenarios to find the optimal plan.

📝 Try it now!

Scenario A - high discounts, high lifetime orders

• AOV with no discount = $100
• Discount = $30
• AOV = $100- $30 = $70
• COGS = $45
• GP = $70 - $45 = $25
• Lifetime orders = 4.6
• Customer lifetime value = 4.6 * $25 = $115

In this scenario, a brand saw high lifetime orders, 4.6 on average, but significantly lower GP / order, with a larger discount. 

Scenario B- low discounts, low lifetime orders

• AOV with no discount = $100
• Discount = $0
• AOV = $100 
• COGS = $45
• GP = $70 - $45 = $55
• Lifetime orders = 1.8
• Customer lifetime value = 1.8 * $55 = $99

In this scenario, the brand runs no discounts, so also sees weak customer retention. 

Between these two scenarios, scenario A generated higher LTV. Finding the maximum LTV will involve testing different offers and incentives to find the right combination of lifetime orders and gross profit that produces the highest profit.

Takeaways and Next Steps

Now that we’ve discussed Unit Economics and taking your first steps toward the optimal subscription program design for your business, you’re ready to start optimizing all components of your subscription program for the optimal subscriber experience.

Suggested Next Modules

• How to Style Your Enrollment Offer to Maximize Enrollment