Unit Economics are the calculations you make before starting ANY e-commerce advertising campaign. They help you know when you are breaking even, profiting, and ready to scale your business. Once you begin to understand the numbers you need to achieve before scaling, you have a target to aim for and have complete clarity on the objective you need.
The number 1 reason you need to understand your unit economics is to clarify and help you achieve your goals. If you don’t know your costs, how can you properly judge whether or not you are in profit? This is the issue you will have a solution for by the end of this article.
How do I calculate my Unit Economics?
Calculating your Unit Economics begins with understanding your Unit Costs or COGS (Cost Of Goods). Unit Costs are all costs involved in sourcing and shipping your product. The main ones to consider are:
- Product cost from your supplier
- Shipping from your supplier to your warehouse
- Cost of packaging
- Cost of shipping to your customer
- Cost of fulfillment (if applicable)
- Transaction fees
Once you know all of the above costs, you will now understand what you pay in total per product. If this total cost is too close to your sale price, you may want to consider raising your price to ensure profitability in the long term if you plan to scale your business.
By calculating your COGS, you will be able to know what your Break-Even Cost Per Acquisition is. This is done by the following formula: Sale Price – COGS. For example, if we pay a total of £7 for 1 unit or product and sell it for £20, we can spend up to £13 to acquire a customer to break even. This £13 is available to market your product and find customers. From here, you can also calculate your desired profit per product.
I buy my products in bulk from my supplier. How do I take that into account?
If you buy your products in bulk, you will need to divide your bulk cost+shipping cost by the number of units you ordered. For example, if we buy 1000 units for £1000. Your product cost is £1.
How can I incorporate fixed costs into my unit economics?
When you are starting or have a fixed number of units to sell, it makes sense to incorporate your fixed costs when calculating your Unit Economics. Some of the fixed expenses that e-commerce businesses have are warehouse space, employees, website hosting, plugin subscriptions. Let’s take the example of warehouse space in this instance. You’re paying £1000 per month to store up to 2000 products. Divide the price of the warehouse by the number of units. This means the warehouse costs you 50p per product. Or in the scenario where you are paying an employee £1500 per month for packing and shipping your 2000 products, that would add 75p to your product cost. However, once you start scaling, your fixed costs will not necessarily go up at this time, so it’s not necessary to include them when calculating.
Formula: fixed costs – number of units to sell
My supplier/shipping company charges me a different price depending on the amount I buy/sell. How do I incorporate that?
Suppose your supplier/shipping provider charges a different rate depending on the number of units you sell or ship out. In that case, you will need to calculate your costs every time you order and sell a new batch of products using the same formula. Sale price – COGS. On the other hand, these variable prices should be communicated to your marketing team or the agency doing your marketing.
So I know my Unit Costs. What’s next? (Target Setting)
Since you now know your Unit Costs and Break-Even CPA, you can begin to set your targets. For example, if you want a profit margin of 30% for each product you sell, you need to complete the following formula: Break-Even CPA * 0.7.
For example, £13 * 0.7 gives you a profit margin of 30% which means your target CPA should be £9.10. Achieving this number or below means you are making at least 30% for every sale you get.
You will also need to calculate your Break Even ROAS to ensure you don’t lose money from each purchase via paid advertising. The formula for this is Sale Price / Break Even CPA. For example: 20/13 = 1.54 ROAS to break even. Now that you know the Break-Even ROAS, you can set a goal above the Break-Even ROAS to make your Target. We usually give a 20-30% margin above the Break-Even ROAS to ensure profitability for our client. In this example, given a 30% margin, it would be a Target ROAS of 2.00.
You also want a Scale Point ROAS to set a target of when you will scale your ads and increase ad spend. Again, use a 20-30% margin to lock in profitability. In this case, using a 20% margin, it gives a Scale Point ROAS of 2.4. You will not scale your advertising below this margin and above your Target CPA. This ensures you stay profitable and have a number to qualify before you scale your advertising spend.
Now you know that Target CPA is £9.10 and the Scale Point ROAS is 2.40, every consecutive day that you reach these numbers within your ad account, you can begin scaling and increase your daily spend by 20%. We increase spend by 20% to ensure that the adset/campaign doesn’t go back into its learning phase by increasing the budget too steeply.
