What Are Unit Economics?
Unit economics is the revenue and costs associated with a single "unit" of your business - typically one customer or one order. Understanding these numbers is essential for making profitable advertising decisions.
The core question: How much money do you make (or lose) every time you acquire a new customer?
If you don't know this number with confidence, you're essentially flying blind with your advertising. You might be scaling a money-losing acquisition machine.
Contribution Margin Explained
Contribution margin is what's left after subtracting all variable costs from your revenue. This is the money available to cover fixed costs and generate profit.
Contribution Margin Formula
In this example, for every $80 order, you have $44 to spend on marketing and still break even. This is your maximum allowable CAC for break-even on first order.
Customer Acquisition Cost (CAC)
CAC is the total cost to acquire one new customer, including all marketing expenses.
Blended CAC
Total marketing spend ÷ Total new customers
Includes all channels (paid, organic, referral). Best for overall business health.
Paid CAC
Paid ad spend ÷ Customers from paid ads
Channel-specific. Best for optimizing individual channels.
Important: Your CAC should always be lower than your contribution margin if you want to be profitable on first order. If CAC > CM, you're relying on repeat purchases for profitability.
Lifetime Value (LTV)
LTV is the total revenue (or profit) you expect to earn from a customer over their entire relationship with your brand.
Simple LTV Calculation
AOV: Average Order Value ($80)
Purchase Frequency: Orders per year (2.5)
Customer Lifespan: Years as customer (2 years)
LTV = $80 × 2.5 × 2 = $400
For a more accurate view, calculate LTV based on contribution margin, not revenue:
The LTV:CAC Ratio
The LTV:CAC ratio tells you how profitable your customer acquisition is over time.
| LTV:CAC Ratio | What It Means | Action |
|---|---|---|
| <1:1 | Losing money on each customer | Fix immediately - reduce CAC or increase LTV |
| 1:1 - 2:1 | Breaking even or thin margins | Optimize - not sustainable long-term |
| 3:1 | Healthy - industry benchmark | Good position - scale carefully |
| 4:1+ | Excellent - strong unit economics | Scale aggressively |
| 5:1+ | May be under-investing in growth | Consider increasing ad spend |
How This Affects Your Ad Strategy
Your unit economics determine how aggressively you can advertise:
High Margins (> 60%)
You can be aggressive with acquisition. Even at 2x ROAS, you're likely profitable. Focus on volume and market share.
Medium Margins (40-60%)
Need 2.5-3x ROAS for profitability. Focus on efficiency and creative testing. Balance growth with profitability.
Low Margins (< 40%)
Need 3-4x+ ROAS. Must focus on LTV - email, subscriptions, bundles. Hard to scale profitably on paid alone.
Key Takeaways
- Know your contribution margin - this is your maximum break-even CAC
- Calculate LTV based on profit, not revenue, for accurate planning
- Aim for at least 3:1 LTV:CAC ratio for sustainable growth
- Your margins determine how aggressive you can be with ads
- Low-margin businesses must focus on increasing LTV through retention