The critical importance of unit economics in determining ad budgets

The critical importance of unit economics.

To determine the health of your business and whether you can scale and grow, you need to have a deep understanding of your unit economics.

Quickly defined,

Unit economics refers to the direct revenues and costs associated with a single unit or transaction of a business. It measures the profitability of each individual sale or customer acquisition.

There is some overlap with Key Performance Indicators (KPIs) but unit economics focus specifically on the profitability of each transaction, while KPIs cover a broader range of operational and financial metrics that gauge overall business performance and progress towards goals.

Key components of unit economics include:

1. Customer Acquisition Cost (CAC): The cost of acquiring a new customer
2. Average Revenue Per User/Customer (ARPU/ARPC): The average revenue generated per user or customer
3. Gross Margin: The revenue left after deducting variable costs like cost of goods sold

Good unit economics means that the lifetime value of a customer exceeds the cost of acquiring them, indicating a profitable business model.

Here are some examples of unit economics that are crucial for you to understand in this exercise:

1. Cost Per Lead (CPL): Calculated by dividing the cost of advertising by the number of leads received for a particular campaign or marketing activity.
2. Customer Acquisition Cost (CAC): What it costs you in advertising to acquire new customers.
3. Cost per Acquisition (CPA): The cost of acquiring a desired action or conversion, such as a lead, trial signup, or app install.
4. Lifetime Value (LTV): Projected net profit a customer will generate during their life as a customer of your business.

With this info you can aggressively market and grow your business as you understand fundamentally how profitable your customer acquisition strategy is.

This info is key because without it, you might look at a particular channel, like say Google Ads or LinkedIn Ads and see a CPC (Cost Per Click) that you might consider hugely “expensive”. While in reality, the CPC you see might be making you 10x profit versus the cost of that channel.

What should your Customer Acquisition Cost (CAC) be?

How do you figure out your CAC and what is a good benchmark? In other words, how much should you be spending to get a new client or customer?

The answer is of course, every marketer’s favorite response; “it depends”. More specifically, it varies by what your Average Revenue per Customer (ARPC) is.

There’re different ways to calculate ARPC but a good starting point is to take your total revenue over a period (year or month) and divide this by the number of customers you had during the same period.

(Revenue)/(Customers) = ARPC

To keep things simple, let’s say your revenue for the year is $1M and you had 1k customers. This gives you an ARPC of $1000.

If you know how much you make from a customer, you’ll know how much you can spend to get one. So, in the above example, you can spend up to $999 to acquire a customer and you’ll still make a profit. Of course, you’d want to account for Gross Margin and operating costs, and you’d probably want to make more than $1 in profit, but you get the picture.

Using this data, take a look at your current marketing activities to see which channels are presenting the greatest opportunity and plan to start with one.

Over time you’ll want to optimize to increase your ARPC while decreasing your CAC on each channel.

Don’t put your eggs in one basket

It’s important to stick to the channels that make the most sense for your audience. In the B2B space, that often means choosing LinkedIn over Facebook or Instagram for example.

But remember, you don’t directly control LinkedIn, Facebook, or Google. Any of these networks can and often do make changes to their platform and sometimes these changes can negatively impact your results.

This is why the most successful businesses build multiple flows of traffic to maintain their flow of leads.

This is how you can approach it:

1. Start with one channel (SEO, Google Ads, LinkedIn Ads, Facebook Ads, YouTube, etc.) Your budget will determine where you start.
2. Get clear on your Cost per Lead (CPL) and Customer Acquisition Cost (CAC).
3. Keep at each channel until you gain momentum and receive a minimum of 50% ROI.
4. Roll additional profits into experimenting on a new channel.
5. Compare your CPL and CAC on your previous channel as a benchmark for your new channel.
6. Keep adding as many channels as possible, stacking one on top of the other.

This way, if something changes in one, you can shift your ad budget to the others while you figure out how to get stood back up in the one that was adversely affected due to any platform changes.

I run AndZo Consulting, LLC

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