Webcast: Making unit economics work for you and your business in the long term
A lot of what we have talked about at Canaree is how unit economics can be used to initially win investment from funds or VCs.
However, they’re not something to just disregard once your business begins to scale. In fact, they’re something that you should maintain and continue to check in on throughout your business lifecycle.
As we have said in previous blog posts, unit economics act like your fairy godmother, revealing the right times to scale and when to hold back. Knowing when to push forward or pause a little is just as important at all stages, not just your initial growth phase. Thinking of launching a new product? Want to expand into a new market? Sure, you might be turning a profit now, but if you choose to scale, will that remain the case?
Business finances are made up of numbers that are all interdependent. Unit economics work to simply identify how those interdependencies may be affected when you make changes to your business model.
Sara and Andre talk about this relationship between unit economics and management decisions in a bit more detail, so read on to learn how they can help you to not only optimise growth, but your entire business model.
Sara : Okay. It’s quite a complicated aspect and not a lot of founders are used to working with this and I think what we see is that either companies forget to include them in the model or they - on purpose - leave them out. Could you talk a little bit more about how as a founder or as a startup you can use unit economics in a management/strategic decision making process?
“So, if your CAC payback is long, you do not want to be accelerating… You need to focus on shortening the CAC payback, before you accelerate.”
Andre : Yeah, I mean, not just for founders! I’d say that larger companies could use this.
You look at those two ratios we talked about: CAC payback and also LTV:CAC ratio.
The CAC payback tells you, ‘how much money am I burning?’
So, if your CAC payback is long, so two years or whatever, you do not want to be accelerating (or trying to accelerate) the growth of your business at that point, because it just means you’re going to be burning a lot more money. So, you need to focus on shortening the CAC payback, before you accelerate.
Similarly, I remember reading an analogy online about the LTV:CAC ratio. So, someone said, ‘it’s like a slot machine’.
So the LTV:CAC ratio tells you, if you put a pound in at the top, it tells you how much you’re going to get out at the bottom. So, if it’s 3:1 and you put a pound in at the top, then you get three pounds back. And if you’re not getting at least three pounds back, then you need to spend time tuning the machine. Which in hindsight, sounds like we’re rigging a slot machine, haha!
“If your LTV:CAC ratio is 3, 4 or 5, you need to go for it. Assuming you’ve got a big enough opportunity, you need to get as much market share as possible when your unit economics look that good.”
It’s like a car, it tells you when to accelerate or when to slam on the brakes. So, if your CAC payback is long, you need to slow it down and work on improving that.
If your LTV:CAC ratio is not there yet, then you need to work on tuning the elements of it. But the big thing is - and this is why it’s so helpful - it gives you the right timing. It tells you when to really, really slam on the accelerator. To mix metaphors with slot machines.
So, if your LTV:CAC ratio is 3,4, or 5, you need to go for it. Assuming you’ve got a big enough opportunity, you need to get as much market share as possible when your unit economics look that good. If your LTV:CAC ratio is 20 or more, you have waited too long. There’s a balance between that. If it’s below three, you should not be thinking about scaling. So, those are the rules of thumb that help founders figure out when they need to raise money, or what they need to do.
Sara : And do unit economics change over time? Is that how you work with them?
“So, unit economics look awful at the beginning. But, once you start moving towards product-market fit, then all those things start improving.”
Andre : Absolutely. Even in our modelling for Canaree, it starts out looking awful, beyond awful, because your customer acquisition costs are massive. You’re not making any revenue, but you’ve still got the COGS in there, your churn, even when you start, is going to be high. So, unit economics look awful at the beginning.
But, once you start moving towards product market fit, then all those things start improving. You’ve found your pricing model, so your ARPU might be right, you’re refining your customer success team, hosting costs are settling, the churn - you’ve figured out what it is that’s going to help you retain customers.
So, the LTV stuff is stabilising and your CAC is also stabilising, so things will start looking better. And then as you scale up and then you develop things and improve processes, then your unit economics will look really, really good. And that’s the point when you raise quite a lot of money and then you scale rapidly.
But, as is always the case, competitors will enter the market and then that will mean that your CAC goes up again. So there’s always a ramp up and then an improvement and then another ramp up to the previous high, but it’s sort of like an M-shaped curve.
Realistically, you need to be using unit economics throughout your business lifecycle. They can work as a litmus test, revealing whether it’s a good time to scale or expand, or if you should hold back a little longer. Utilising that can help to prevent you from making big mistakes.
So, here Andre has shed some light on using unit economics in the long term. We tried for a case study in order to contextualise some of this stuff a little better, but unfortunately this is all we got….
Maybe something to brush up on for our next series hey, Andre?
We hope you enjoyed this post! If you have any questions about any of this, or have ideas for content you’d like to see, then let us know.
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