Unit Economics 101: Don't Scale a Loss
By Valid8 Editorial Team | 2024-03-22
Master unit economics startup fundamentals including LTV, CAC, and the 3:1 golden ratio that determines whether your business model can survive.
> TL;DR: Unit economics startup survival comes down to three metrics: Customer Acquisition Cost (fully loaded, including salaries), Lifetime Value (using realistic 18 to 24 month retention, not five year fantasies), and the LTV:CAC ratio. Below 3:1 you lose money at scale. Above 5:1 you are underinvesting in growth. Track payback period alongside the ratio because cash flow kills companies faster than bad ratios.
# Unit Economics 101: The Math That Kills Startups
If you lose money on every customer, volume won't save you. As the old joke goes: "We lose money on every sale, but we make it up on volume!": this is a comical recipe for bankruptcy.
In the startup world, concepts like "vision" and "disruption" get the headlines. But unit economics startup math (the direct revenues and costs associated with a business model on a per-unit basis) gets the term sheet.
> "The most common reason startups die is not competition, but running out of money.": Paul Graham, Y Combinator
In this guide, we break down the only three metrics that actually matter for your financial survival.
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Unit Economics Startup Metric #1: Customer Acquisition Cost (CAC)
Definition: The total cost of sales and marketing efforts required to acquire a new customer.How to Calculate It
`CAC = (Total Sales + Marketing Expenses) / # of New Customers Acquired`
The Trap: Most founders cheat here. They include ad spend but exclude the salary of the Marketing Manager. Or they exclude the cost of the sales team's tools. True CAC: Includes everything*. Salaries, tools, commissions, ads, improved branding costs.How to lower it:
- Inbound: Write content (like this blog) that brings users for free.
- Virality: Build referral loops.
- Conversion: Optimize your funnel using Market Validation Basics to ensure you are targeting the Right Person.
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2. Lifetime Value (LTV)
Definition: The total revenue a single customer generates throughout their relationship with your company.How to Calculate It
`LTV = (Average Revenue Per User * Gross Margin %) / Churn Rate`
The "Infinite LTV" Fallacy:Founders love to assume customers will stay for 5 years. In reality, average SaaS retention is closer to 18-24 months, a figure consistent with CB Insights' analysis of SaaS retention benchmarks. If you are pre-revenue, use benchmarks, not hope.
- Read David Skok's SaaS Metrics 2.0 for the industry bible on these calculations.
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3. The Golden Ratio: LTV:CAC
This is the pulse of your unit economics startup health.
- 1:1 Ratio: You are losing money on every sale. Burn the ships.
- 3:1 Ratio: Healthy. You have a scalable business.
- 5:1 Ratio: You are growing too slowly. Spend more on marketing.
> "If you have a 5:1 LTV:CAC ratio, you are under-investing in growth.": Andreessen Horowitz (a16z)
The "Payback Period" Constraint
Even with a 3:1 ratio, you can die.
If it costs $1,000 to acquire a customer, and they pay you $100/month, it takes 10 months to break even.
- Do you have 10 months of cash?
- If not, you have a Cash Flow Problem, not a Unit Economics problem.
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