Per-Sale Economics

Variable expenses are directly linked to sales volume. Fixed expenses do not change with revenue.

To find the number of items that need to be sold for the business to become profitable, find revenue and variable expenses per item sold. Divide fixed expenses by that number.

This is called per-sale or unit economics. The goal is to determine what sales volume is needed to make a profit.

Per-Sale Economics: Building a Model

How to assess the health of a business:

1. Find the business's profit margin per sale. Only account for variable expenses.
2. If the profit margin is negative, the company's finances are off.
3. If the profit margin is positive with respect to variable expenses, add fixed expenses. Calculate the sales volume necessary for the business to become profitable.

You can use the following function to calculate unit economics for an already defined budget.

COPYpython
1def unit_economics(marketing):    
2    items_sold = marketing / one_unit_var_costs['marketing']
3    revenue = one_unit_revenue  * items_sold
4    var_costs = one_unit_var_costs * items_sold
5    return revenue - sum(var_costs) - sum(fixed_costs)

Per-Customer Economics: LTV and CAC

The per-sale economics approach has a big disadvantage: it doesn't take repeat purchases into account. But it's not actually orders that companies buy. When a business is growing fast, it's essential to account for repeat purchases in analysis. Expenses often exceed revenue, which is quite natural: to sell something, we have to buy it first.

To solve this problem, you'll have to calculate the per-customer economics. LTV and CAC are the most important metrics for this.

LTV (lifetime value) is the total amount of money the average customer brings to the company by making purchases. When calculating LTV, analysts usually consider the gross profit from a customer per period.

CAC (customer acquisition cost) is the cost of attracting a customer—the money a new customer costs a company.

In healthy per-customer economics, LTV is greater than CAC.

Per-Customer Economics for an Online Store

Calculating LTV by cohort is convenient. Here is how we do it:

1. Find the date of each customer's first purchase
2. Calculate the number of new customers for each date
3. Add the date of the first order to the table of orders
4. Group the table and calculate the revenue

For purposes of cohort analysis, LTV is a cohort's cumulative revenue, accounting for the number of people in the cohort.

Sometimes you'll need to make your conclusions easier. Analysts usually study the average cohort by averaging ROMI or LTV for all cohorts for every lifetime month.