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Purpose
Calculate the economic viability of a business model at the individual customer level—determining whether each customer acquired generates more lifetime value than it costs to acquire and serve, thereby validating that the business can scale profitably before committing to expensive A4.4 expansion.
Unit economics answers A4's fundamental question: Can we make money on each customer? Revenue projections and market size (TAM/SAM/SOM) mean nothing if the cost of acquiring and serving each customer exceeds the revenue they generate.
When to Use
Use unit economics modelling when:
- Designing the Cost Structure block of the Business Model Canvas (A4.1).
- Validating whether target pricing supports profitability (A4.2).
- Measuring actual customer economics during pilot (A4.3).
- Making the scale/pivot/iterate decision (A4.3 → A4.4 gate).
- Monitoring economics during scaling for deterioration (A4.4–A4.5).
Do NOT use when:
- No pricing or cost data exists—design the business model first (A4.1).
- Evaluating product desirability—use NPS (the referenced method) and usability testing (the referenced method).
- Comparing strategic options at portfolio level—use ROI modelling (the referenced method) and weighted scoring (the referenced method).
Sample Size and Duration
- A4.1 (assumption-based): 4–8 hours with Finance lead.
- A4.2 (partially validated): 2–4 hours to update with test data.
- A4.3 (pilot actuals): Continuous monitoring, weekly review.
- A4.4–A4.5: Automated dashboarding with monthly deep-dive.
Prerequisites
- Revenue model from A4.1 (pricing, revenue streams).
- Cost estimates: CAC (from A4.2 test campaigns or benchmarks), COGS (from supplier quotes), support costs (from A3.3 pilot data).
- Retention data: churn rate (from A3.3 or A4.3 pilot cohorts).
- Spreadsheet or financial modelling tool.
- Finance lead support for model construction and validation.
Complete Procedure
Step~1: Calculate Customer Acquisition Cost (CAC)
Calculate by channel (e.g. Google Ads CAC 150, referrals CAC 20, organic CAC $0). Blended CAC is a weighted average.
Step~2: Calculate Customer Lifetime Value (LTV)
For subscription models:
Example: 99/month ARPU, 5% monthly churn LTV = 99 / 0.05 = 1,980$.
For transaction models:
Step~3: Calculate LTV/CAC Ratio
| p3cmp7cm LTV/CAC | Signal | Action |
|---|---|---|
| <1:1 | Losing money per customer | Halt or pivot—fundamental BM problem |
| 1:1–2:1 | Marginal | Iterate pricing, reduce CAC, or improve retention |
| 2:1–3:1 | Approaching healthy | Optimise before scaling |
| 3:1–5:1 | Healthy | Green light for A4.4 scaling |
| >5:1 | Under-investing in growth | Increase acquisition spend—leaving growth on table |
Step~4: Calculate CAC Payback Period
Target: <12 months (B2B SaaS 5–7 months, B2C 3–6 months).
Step~5: Calculate Gross and Contribution Margins
Targets: Gross margin ≥60% (software), ≥40% (hardware), ≥30% (marketplace).
Step~6: Sensitivity Analysis
Model best/expected/worst cases by varying churn (2%), CAC (30%), and pricing (20%). Identify the variable with highest impact on profitability—this becomes A4.2's validation priority.
Quality Criteria
- Data-tagged: Every input labelled as “validated” or “assumed”.
- Channel-segmented: CAC calculated per acquisition channel.
- Scenario-modelled: Best/expected/worst cases presented.
- Cohort-grounded: LTV based on actual retention data where available.
- Decision-oriented: Model produces clear go/no-go signal via LTV/CAC.
Theoretical Foundation
Seminal references
- Established unit economics as the core analytical framework for lean startups, demonstrating that LTV/CAC ratio is the single most important metric for business model viability. Recommended LTV/CAC ≥3:1 as the threshold for healthy economics.
- Positioned unit economics within the build-measure-learn cycle: assumptions about CAC, LTV, and margins are hypotheses requiring A4.2–A4.3 validation.
Contemporary references
- Applied unit economics to growth hacking, showing how channel-specific CAC analysis drives efficient customer acquisition—directly applicable to A4.3 pilot channel optimisation.
- Introduced the AARRR framework (Acquisition, Activation, Retention, Revenue, Referral) which provides the customer lifecycle stages that unit economics must model.
Challenges and Solutions
Challenge~1: Premature Precision
Symptoms: A4.1 model shows LTV of $1,847.23—false precision from assumptions.
Solutions: Use ranges, not point estimates. Present as “LTV $1,500–2,200 depending on churn assumption.” Tag every input as validated (A3/A4.3 data) or assumed (to be tested in A4.2).
Challenge~2: Ignoring Channel-Specific CAC
Symptoms: Blended CAC looks healthy, but one channel (paid ads at 300) subsidised by another (referrals at 20).
Solutions: Always calculate and present per-channel CAC. Scale decisions should be per-channel, not blended.
Challenge~3: Short-Horizon LTV
Symptoms: LTV calculated from 3-month pilot data extrapolated to 24-month lifetime.
Solutions: Be explicit about data horizon. Use cohort retention curves (the referenced method) and present LTV at observed horizon (e.g. “6-month LTV = 594, projected 24-month LTV = 1,980 assuming constant churn”).
Relationship to Other Methods
Unit Economics Modelling receives input from:
- Cohort Analysis (the referenced method)—retention data for LTV.
- A/B Testing (the referenced method)—conversion rates for CAC.
- Van Westendorp PSM (the referenced method)—validated pricing.
Unit Economics Modelling provides input to:
- Business Model Canvas (the referenced method)—Cost Structure and Revenue Streams quantification.
- ROI Modelling (the referenced method)—per-customer economics feed aggregate financial projections.
- Sensitivity Analysis (the referenced method)—identifies which economic levers have highest impact.
Example: C001 Smart Checkout — A4.3 Pilot Unit Economics
| p3cmp5.5cm Metric | Value | Source |
|---|---|---|
| ARPU | $99/month | A4.2 validated pricing |
| Monthly churn | 5% | A4.3 pilot (6-month cohort) |
| LTV | $1,980 | $99 / 0.05 |
| Blended CAC | $180 | A4.3 pilot (3 channels) |
| LTV/CAC | 11:1 | Healthy—green light |
| CAC Payback | 2.3 months | 180 / (99 - $20 COGS) |
| Gross Margin | 80% | (99 - 20) / $99 |
Decision: Strong go to A4.4—LTV/CAC well above 3:1, payback under 3 months, gross margin exceeds 60% target.
Tools and Templates
- Excel / Google Sheets: Standard for financial modelling.
- Causal: Visual financial modelling with scenario analysis.
- Baremetrics / ChartMogul: SaaS-specific unit economics dashboards.
- Mixpanel / Amplitude: Usage data feeding retention calculations.
- A. Croll & B. Yoskovitz (2013). Lean Analytics: Use Data to Build a Better Startup Faster. O'Reilly Media.
- D. McClure (2007). Startup Metrics for Pirates: AARRR!. Presentation / blog post.
- E. Ries (2011). The Lean Startup: How Today's Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses. Crown Business.
- S. Ellis & M. Brown (2017). Hacking Growth: How Today's Fastest-Growing Companies Drive Breakout Success. Crown Business.
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