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š How to drive unit economics
Forget the theory, this is how it works in real life
This is CFO Secrets. The weekly newsletter that remembers when the Big 4 were the Big 5
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In Todayās Email:
š°Unit Economics - Bringing it all together
šØāšØāš¦āš¦ An Auditor, A 4 Year Old & The Backstreet Boys
šTurnarounds, where to start
THE DEEP DIVE
Unit Economics; How to make sure profits grow faster than volumes
Note - This post assumes knowledge from the following previous posts:
Unit economics.
The science of how your business makes money.
Iām lucky to have worked with a great number of business rockstars in my career. High profile CEOs, billionaire founders, brilliant finance pros.
Each of them had one skill in common.
They were jedis of unit economics.
The back of an envelope math that drives how a business makes money and generates cash.
In this post we will step through unit economics. First in theory, and then into more practical applications.
The Theory
Unit economics = incremental marginal contribution generated for each individual unit sold.
Marginal contribution per unit = revenue per unit less variable costs per unit.
Articulating this in a simple statement for your business is crucial.
Example for a DTC business selling one product; e-Scooters manufactured in house:

Cost Behavior Statement
Note: the analysis ignores cost classification; gross margin vs opex. Instead it focuses on cost behavior (fixed vs variable).
Now you can build a profile of how operating income moves with sales volume:

Breakeven charts; unit of time is fixed (monthly)
This gives clean lines, and solving for different volume points is straight forward.
Once plotted against a range of unit volumes you can quickly see where the Breakeven volume is. Somewhere between 200 & 250 units per month.
This becomes a helpful maxim in the business:
āWe need to sell 8 scooters per day to breakevenā.
Or
āTo hit our target of $50k profit per month, we need to sell 400 scooters per month, or 14 per day.ā
Feels manageable. Understood by anyone.
Calculating the breakeven point precisely is easy, once youāve done the work above.
Breakeven Volume for Period = Fixed Cost per Period / Contribution Per Unit

Straight forward enough.
But thereās a problemā¦
Unit Economics in Practice
The theory assumes that your costs play fair and self identify as either fixed or variable.
As we said in Issue 6 - that is not the case. Nearly all costs are 'mixed'. They have at least some component that is fixed and some component that is variable.
I challenge you to this:
Name any fixed cost that is identical in $ for a business with 1 unit vs another with 1bn units.
I canāt name one example of a fixed or variable cost per unit that doesn't evolve in same way as volumes grow.
Reply to this email with any ideas
This is where the science can run away a bit. Costing models can get extremely complex, and will vary by industry.
Complexity can mean more accurate outputs. But its also can be alienating for those that didnāt build it. I see lots of finance folk fall in this trap.
And these are managerial tools remember.
They are designed to drive behavior and improve profits.
They must be accessible. Actionable > perfect.
Hereās a more practical way to look at it
It's true that all costs have a fixed and variable component at some level. But there is normally a relevant range of units within which a cost can be assumed to be either fixed or variable.
Letās say for our scooters that it is unit increments of 50 per month.
From here you can scale out the cost dynamics at each step of 50 units per month. Rather than theorizing. We can draw out exactly what we expect our cost structure to look like at each volume step.
I call this a Volume Step Cost Analysis:

Volume Step Cost Analysis
Note the units on the horizontal access are units sold not time. The time period is fixed.
The assumptions that sit underneath the above example:
Increased scale will improve the unit cost prices of materials, and conversion efficiences
After 250 units per month we are able to yield some labor productivity efficiences
Up to 150 units we are outsourcing assembly (no rent and utilities, but higher other variable). After 200 units we insource, incurring property costs, and reducing other variable costs
We will need to step in more salaried cost at higher volume levels
500 units per month is a ātipping pointā. To hit and service these levels of volume we need to step in much more fixed cost ($85,000 to $118,000 per month)
For this illustration it is assumed that the net revenue per unit is flat at $500. In practice we might reduce prices to pass on some of our efficiencies and drive higher volumes.
And how do you calculate a Volume Step Cost Analysis?
For each cost step, ask yourself, how would I operate at this level of volume in the cheapest way possible? If you donāt know the answer, find out. Speak to suppliers, examine your capacities, do the math.
Remember what I said:
Every rockstar iāve ever worked with can do this on a napkin. Often in extraordinary detail for their business.
Now lets look at the unit economics for this step analysis:


Unit Economics Chart
Notice, there are scale points at which our profitability falls despite higher unit volume. E.g. 350 to 400, and 450 to 500.
Why is this?
In this example there are three volume phases:
0-200 units (subscale, loss minimization is objective)
200-350 unit (unit economics improve with volume and convert to profit)
350 -500 units (unit economics mature)
The business is sub-scale at 0-200 units. The product contribution is healthy, but itās not enough to offset the higher fixed cost per unit.
There arenāt enough units to divide out the fixed costs by. Even with those much lower assumptions at small volumes.
Then from 200 to 350 units you see the unit economics working their magic:
The product contribution per unit remains flat (ish)
But the fixed costs per unit crash down as the $ value remains relatively fixed, despite volumes growing
the difference between the two passes through to an increased operating income per unit
Then as the business hits 350 units and more, the fixed cost per unit starts to flatten and even increase. Itās clear that 350 units is the capacity of that profitable cost structure.
After that point there is a step in fixed costs to access the capacity needed to support the higher volumes.
You can see the increased fixed cost $ fighting against the volume increases in the grey line.
For a business at 350 units this asks some interesting existential questions:
Do you want to grow?
How do you grow? What is the right level of fixed cost to step in? And when?
How do you avoid the risk of stranded costs? What happens if volume falls
How does the above inform your pricing and sales strategy?
The above assumes a single product business
It gets more nuanced as you overlay many products, revenue streams, operating locations, etc.
Big retailers (tens of thousands of products) look at contribution per square inch of shelf space. And use that as a way determining product range and location within a store.
But it all starts with a robust view of contribution margin and fixed costs at each relevant level.
Key takeaways
Perform a simple breakeven analysis. Using your current cost structure, and current volume level:
Using the contribution grid form last week, convert this into āper unitā analysis
Understand the different breakeven points in your business, for your relevant unit of analysis; (i.e. product, customer, location)
Build out a Volume Step Cost Analysis
Identify the different steps of volume and model the cost structures for those units
Identify the key inflexion points in volumes that will need decisions on the business economics
Consider how you can underwrite the volume levels to protect from stranded cost
Aggressively pursue discounts on variables cost per unit as volumes grow
Think about your pricing strategy, and how that will change with volumes. Does it stack up against the movement in costs?
Put formal flags in to manage those inflexion points
Set parameters that would need to be met to add extra fixed cost. For example:
X consecutive months at XX units or more
Contribution per margin to remain above $XXX throughout that time
A worst case future volume is no lower than XX per month
This brings us to the end of this series on managing the Income Statement.
Weāll revisit the science of Income Statements again, as there is more ground to cover here, but for next time weāll move on.
MEME OF THE WEEK
From one of my favorite Twitter accounts The Big 4 Accountant

BOOK CLUB
I love turnarounds. Itās the best way to learn business fast, especially in finance.
Corporate Turnaround by Slatter & Lovett is the best book on turnarounds Iāve read.
I first read it 15 years ago, and applied the ideas from the book in my day job of the time. This helped me get a shot as the CFO of a struggling business unit. Turning round that business unit gave me the resume for a Group CFO job.
And from there i had a seat at the tableā¦
Hands on turnaround CFOs are some of the best paying jobs in the profession, but its hard to break into. Boards want people who have a track record.
For me it started with this book, I hope it helps you too.
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POACHED GREG
Way to pick the losing team Cousin Greg.

Iām taking a one week break next week, so CFO Secrets will be back on March 17.
I will be more active on twitter over the coming weeks, so come join me.
In the meantime ā¦
Stay Crispy,
The Secret CFO
Disclaimer: I am not your accountant, tax advisor, lawyer, CFO, director or friend. Well, maybe Iām your friend. But I am not any of those other things. Everything I publish represents my opinions only, not advice. Running the finances for a company is serious business, and you should take the proper advice you need to make the right decisions.
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