What is unit economics?

Why unit economics matter

A business can grow revenue rapidly while destroying value if the cost of acquiring each customer exceeds the profit that customer generates. Unit economics answers the fundamental question: is each customer worth more than it costs to acquire and serve?

Core metrics

Customer Lifetime Value (LTV).

LTV = ARPA x Gross margin % x Customer lifespan (in months or years)

Where ARPA is average revenue per account. Customer lifespan can be estimated as 1 / monthly churn rate.

Example: £500 ARPA per month x 80% gross margin x 30 months average lifespan = £12,000 LTV.

Customer Acquisition Cost (CAC).

CAC = (Sales costs + Marketing costs) / New customers acquired

Include salaries, commissions, advertising, events, tools, and any other cost directly related to customer acquisition. Typically calculated on a quarterly basis.

Example: £300,000 total S&M spend / 50 new customers = £6,000 CAC.

LTV:CAC ratio.

Using the examples above: £12,000 / £6,000 = 2:1. This is below the 3:1 benchmark, suggesting the business needs to either improve retention, increase ARPA, reduce acquisition cost, or improve gross margin.

CAC payback period.

CAC payback = CAC / (ARPA x Gross margin %)

Example: £6,000 / (£500 x 80%) = 15 months. This is within the 12-18 month target.

Using unit economics in FP&A

Business model validation. Before scaling customer acquisition spend, confirm that unit economics are positive. Negative unit economics at scale lead to faster cash burn, not profitability.

Budget allocation. Use unit economics to determine the right level of sales and marketing investment. If LTV:CAC is above 3:1, there may be room to invest more aggressively in growth. If below 2:1, focus on improving margins or retention before increasing spend.

Forecasting. Build revenue forecasts bottom-up from unit economics: planned S&M spend / target CAC = expected new customers x ARPA = expected new revenue. This is more robust than top-down growth rate assumptions.

Investor communication. UK investors and VCs expect to see unit economics in board packs and fundraising materials. Strong unit economics significantly increase confidence in the business model.

Segment-level analysis

Unit economics vary by customer segment. Enterprise customers may have higher CAC but much higher LTV. SMB customers may be cheaper to acquire but churn faster. Analysing unit economics by segment reveals where to focus growth investment.

Common pitfalls

Blending too much. Average unit economics across all segments can mask problems. A blended 3:1 ratio might hide an enterprise segment at 5:1 and an SMB segment at 1:1.

Ignoring expansion revenue. LTV should include revenue expansion from upselling and cross-selling, not just initial contract value. SaaS businesses with net revenue retention above 110% have significantly higher LTV than the initial contract suggests.

Using fully-loaded vs marginal CAC. Fully-loaded CAC includes the entire S&M team cost. Marginal CAC considers only the incremental cost of acquiring one more customer. Both perspectives are useful; be clear about which you are presenting.