Why unit economics matters and how businesses can improve it

Unit economics is directly linked to the profitability of a business. Here’s what to focus on to improve it

It took ride-hailing company Uber 15 long years to turn profitable. When it finally turned green in February 2024, chief executive officer Dara Khosrowshahi attributed it to shifting the company’s focus to unit economics.

“If I could go back in time, I would start focusing on unit economics earlier. That saves you from a lot of distractions,” he was quoted as saying in the media.

Unit economics involves achieving profitability at the level of the smallest unit of a business.

A common unit that most businesses consider for measuring unit economics is the customer acquisition cost or customer lifetime value. For profitable unit economics, businesses must ensure that their customer lifetime value is greater than their customer acquisition cost.

Edtech company Physics Wallah, which offers offline courses as well as pen drive courses and study materials, focuses on increasing every customer’s lifetime value for profitability.

“We try to make every user/customer profitable by keeping them with us through marketing campaigns and offers that increase their lifetime value,” said Shakeb Tawhed, Senior Manager – SCM, Physics Wallah.

The company’s sharp focus on unit economics is one of the key factors that helped it attain unicorn status within two years of starting operations, shared Tawhed.

Unit economics is directly linked to the profitability of a business. Here’s what to focus on to improve it…

Operations

In the era of omnichannel retail, the complexity of operations has increased manifold. It has also become one of the biggest expenses.

“If one can manage operations properly and bring down cost at the unit level, it optimises the entire value chain,” Radheshyam Saraf, Head of Business at Primarc Pecan Retail, an end-to-end e-commerce & digital enablement company that has worked with more than 500 brands across geographies.

Key elements within operations that add to the expenses are logistics, manpower, and inventory among others.

“Every business has many moving parts, just like an engine. Keeping it running smoothly requires OIL (operations, inventory, and logistics). There should be minimal wastage in these areas. Performance marketing is the fuel that keeps the engine running,” Gaurav Ahuja, General Manager—marketing & business development at Brandeyes Distributors, the official partners of Skullcandy in India. Skullcandy sells headphones and earphones.

Logistics

Although it comes under operations, logistics needs a special mention as it is extremely cost-intensive, especially for e-commerce and delivery-heavy businesses.

Ahuja recommends optimizing the cost of shipping per order to customers as otherwise, it will eat into the margins. One of the reasons that retailers bundle orders or offer discounts on second purchases is to bring down the cost of the shipment, he said. The more products in an order, the lower its cost.

A company’s warehousing strategy plays an important role in bringing down costs as well. In the case of large and bulky items, return to origin or returns hurt the balance sheet. Being closer to the consumer ensures lesser costs while reducing the chances of damage to products. Damaged goods are bad news as the retailer loses money on the product and must even bear the cost of returns.

“Just by being closer to the consumer, one large appliance brand slashed its returns rate from 5% to 2%,” said Saraf, who works with several brands to optimise their e-commerce operations.

According to him, increasing the basket value per customer also helps in bringing down the cost per customer.

Manpower costs

Manpower costs form a sizeable chunk of a company’s budgets and operating costs. And getting good talent is not cheap. Therefore, optimising manpower and increasing productivity can directly impact operational costs and thus unit economics.

“You need to focus on reducing the manpower cost by 90% and it is going to happen by deploying the right people for the right job,” said Mohd. Mubashshir, Associate Director – SMB Sales & Partnerships, Unicommerce, an integrated e-commerce enablement (software as a service) SaaS platform.

Technology

Technology is both an expense and an enabler. While technology can improve customer experience, it can also help reduce manpower costs by increasing productivity and automating tasks, although initially, it appears as an expense, impacting the bottom line.

“However, as a business grows, even one year down the line, the same technology will reduce your per unit cost drastically,” Mubashshir said.

The strategy should be therefore to prioritise technology investment as per growth stages.

“Technology is important. One way to reduce technology costs is to collaborate with the right tech partner who has all the tools and experience to handle tasks like smooth payments, and hassle-free returns, which not only take your stress out of the equation but also optimise costs, thereby improving unit economics,” said Ahuja.

According to Saraf of Primac Pecan, the right technology or tech partner can help manage warehouses, optimise deliveries, and create bundling to bring down costs.

“This optimises the overall working capital investment from a brand’s side and that optimises the overall unit economics,” said Saraf.

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