#16 Why Unit Economics matters

In this edition, I’m going to talk about unit economics.

Let’s straight away dive into an example.

Imagine you have a chai stand, (haven’t we all thought about this after hearing about Dolly Chaiwala?).

Now, a cup of chai includes milk, water, tea, and sugar.

To keep it simple, let’s assume one cup costs you around 20 INR. You sell the cup for 50 INR, which leads to a very good 60% profit margin per cup.

For your reference, margin = (selling price - cost price / selling price) * 100

So, you make 30 INR on every one cup sold. This is your unit economics.

So, as the name suggests, unit economics helps the business owner calculate how much profit they make on a per unit basis.

To calculate your total revenue, you would also need to factor in the cost of putting up the stand, as well as the cost of your own time.

Now, let’s understand the unit economics of Zomato. For Zomato, the cost of delivering one single order needs to be calculated.

Let’s say the average order value (AOV) is 500 INR.

Commission from restaurant is 20% of AOC, so, in this case, 100 INR.

Delivery fees = 50 INR

Total revenue per order = 500 + 100 + 50 = 650 INR

Total direct costs = 100 (delivery cost etc.)

So, profit = revenue - cost = 650 - 100 = 550/order.

In a nutshell, Zomato on average makes around 550 per order.

But why is unit economics important?

Well, firstly, profitability. Profits are the driving force behind any business. All businessess want to do is “maximise revenue and cut costs”. By understanding your business’s unit economics, you can focus on forecasting profits.

It also helps you to optimize your product. The number one rule for building a great product is to build it quick and launch it. Then keep on iterating till it works. Unit economics works wonderfully in product pricing. You can assess whether your product is overpriced or undervalued.

Like in the example above, if you are able to sell only 10 cups of chai a day @ 50, then you might want to bring the price down and sell at 20 INR per cup. Making a cup of chai for 20 and then selling at the same price will help you to break - even. You can then gradually increase the price as customers flow in.

Using unit economics, you can also try to ascertain the product’s own future. Assessing market sustainability for your product early on is very important. Most start up founders do this to ensure that their product has a long future, or at least enough to make them rich.

For your chai stand, calculating the cost and profit per cup helps you set the right price and understand how to maximize your profits. Similarly, for a company like Zomato, analysing the unit economics per order helps optimize operations and ensure long-term sustainability.

Understanding unit economics is vital for any business, be it an established company or a small stand. By breaking down the costs and revenues associated with each unit sold, business owners can gain insights into their profitability, master unit economics and make informed decisions to ultimately drive profitability higher.

So, the next time you think about profits, remember to dive into the details of your business' unit economics.

 If you have any feedback, let me know in the comments, or reply back to this email!

Edit: I got feedback from numerous people who pointed out some inaccuracies in the Zomato example. I request you all to stick only to the other example.

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