Friday, September 23, 2016

Unit Economics Explained - Part 6: Summary

Unit Economics are the most important quantitative tool for opportunity analysis. Having even read this chapter, you’re in the company of an elite group of savvy entrepreneurs and investors who actually understand the basics of Unit Economics. Reading about it, however, is not enough.

Now go build a spreadsheet that calculates those formulas, or just email me for a copy of a Unit Economics spreadsheet template (if I get enough requests, I'll make a separate page for download, which isn't as easy as you'd think in Blogger). Even if you use my template, it’s still worth building your own, much as Luke Skywalker from Star Wars could not be considered a Jedi Knight until he’d constructed his own lightsaber. Going through the process of building your own spreadsheet will help you to understand the principles as a much deeper level.  

Then, once you have your Unit Economics spreadsheet for your business or business idea, play with the various assumptions and watch what happens to your Break Even, Pre-Tax Cash Flow, and Payout. How do they change, and how does that affect the attractiveness and riskiness of the opportunity? Playing with the assumptions to answer these new questions is called a sensitivity analysis.

For example, what happens if you doubled the prices and assume sales will drop by 50% as a result? What if you cut prices by 50% and assume sales will quadruple? What if you lease your company truck instead of paying cash for it, turning a Primary Sunk Investment expense into a Fixed Period Cost, as described above? What if you only rent a truck on delivery days instead of leasing it, or similarly, paid a delivery company to handle that task for you, thus turning that same expense into a Variable Cost? What if you only sell your products online, could you eliminate rent, utilizes, salaries, and other overhead, and what happens to your Variable Costs if you’re able to cut out the retailers and distributors as middlemen*? What if you outsourced manufacturing at the beginning, eliminating the need to buy production equipment? How will your unit economics change as you grow? 

You don’t truly understand your business model, pricing, or market positioning until you’ve played around with Unit Economics in every scenario you can think of, and for each separate product, service, and market you’re considering, and with different units as your base. Trying out different assumptions will help you make more informed decisions with regard to this new opportunity. You’ll be able to increase sales, reduce costs, budget appropriately, avoid bad opportunities, identify hot opportunities, and provide new insight that could give you an edge over the competition. 

*Middlepeople? We need a better, gender-neutral word for middlemen.


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

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

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