Friday, September 23, 2016

Unit Economics Explained - Part 4: Advanced Unit Economics

The Unit Econonics in some businesses can be quite complicated. Airlines and schools are good examples. Airlines must understand how many tickets they must sell to Break Even, but each plane has limited numbers of seats. Therefore, the airlines must also understand how to Break Even on each individual flight. However, each route – with Austin to Denver being one route and Austin to Des Moines being another route – has limited flights that can be taken each day, so they must understand the Unit Economics of each route.

The airlines are also constrained by how many flights from each airport and each terminal within each airport. A single plane can only fly one flight at a time but also has a limited lifespan, during which the investment in that plane must be recouped, so the airlines must understand the Unit Economics of the lifetime a single plane. Further, the company as a whole must Break Even and earn a profit, even while each ticket, flight, plane, terminal, route, and airport all must be profitable too. Meanwhile, the airlines have intense competition, driving down prices and gross margins, as well as fluctuating fuel prices, wreaking havoc on cost projections.  

Note that with airlines, each level of the Unit Economics is dependent upon the previous level being profitable. Each flight must be full for the plane, terminal, route, and airport levels to be profitable; and the plane, terminal, and routes must be profitable for the airline to be profitable at any given airport. And all those levels must be profitable for the airline itself to be profitable. A breakdown at any of those levels means the airline won’t Break Even or recoup its investment in planes, equipment, airports, marketing campaigns, etc. No wonder so many airlines have gone out of business! 

The Unit Economics of schools are similarly nested and complex. Each classroom must more than break even. Each course must more than break even. Each teacher must break even. Each school must break even. And, similar to airplanes, each classroom and teacher is limited to somewhere between 15-30 students at a time.  

This is partly why online educational models have been so prolific. The Unit Economics work way better than in traditional brick-and-mortar schools that employ live teachers. There are virtually no Variable Costs, the fixed costs are low and limited, and the whole enterprise scales more easily. Even if the online school doesn’t teach quite as effectively as traditional schools (which isn’t necessarily true), there’s no limit to the number of students that can be taught online, no limit to the geography of the students, and the Unit Economics allow for a much lower tuition price will still maintaining large profit margins.

The topic of Advanced Unit Economics is, in fact, much more complicated than described here. Perhaps I'll do a deep dive into it someday, if enough people request it. Please let me know in the comments below if you'd like to see that in the future.


Click here to read the next post in the series:
Unit Economics Explained - Part 5: Common Mistakes

Click here to read the previous post in the series:
Unit Economics Explained - Part 3: The Formulas

Click here to go to the first post in the series:
Unit Economics Explained - Part 1: Why Unit Economics Matter

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