Framework library · Finance and valuation

Unit economics

Unit economics asks whether one customer, on average, returns more margin over their life than it cost to acquire them. Monthly margin divided by monthly churn gives lifetime value. Set against acquisition cost, it shows whether growth creates value or destroys it, and the months needed to earn back the acquisition cost show how much cash growth will absorb.

LevelFoundational
TimeAn hour once revenue, margin, churn and acquisition cost are known
Who to involveThe product or segment owner with finance and whoever runs acquisition.
Also calledcustomer lifetime value, LTV to CAC, CLV, customer acquisition cost, CAC payback

Use it when

  • You sell a subscription, such as broadband, mobile or a managed service, and need to know whether each new customer is worth winning.
  • Acquisition includes subsidised equipment, such as a satellite terminal or a router, and you need to know how long it takes to earn back.
  • You are setting a budget for marketing or channel commission per new customer.
  • Customer numbers are growing but cash is falling, and you need to see why.

Avoid it when

  • Customers differ widely in price, margin or churn. Averages hide the segments that lose money. Work it out by segment.
  • The service is new and churn is not yet known. A lifetime from a few months of data is a guess. Use a range and sensitivity analysis.
  • The decision is about fixed costs, such as a new network or platform. Use break-even analysis or investment appraisal.

How to run it

  1. Use realised revenue per customer

    Average revenue per customer per month, after discounts and promotions.

  2. Apply the gross margin

    Revenue less the costs that rise with each customer: capacity, wholesale, support, payment fees. Leave fixed overheads out.

  3. Turn churn into lifetime

    Average lifetime in months is one divided by monthly churn: 2% a month is 50 months.

  4. Compare lifetime value with acquisition cost

    Acquisition cost is marketing, commission and any equipment subsidy, divided by customers won. A ratio of about 3 is a common rule of thumb in subscription businesses. Below 1, each new customer destroys value.

  5. Check the payback in months

    Acquisition cost divided by monthly margin. A long payback means growth absorbs cash even when lifetime value looks healthy.

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Mistakes to avoid

  • Using revenue rather than margin. Lifetime revenue against acquisition cost nearly always looks good.
  • Taking churn from the whole base. New customers usually leave faster in their first year. Use the churn of recent cohorts.
  • Leaving the equipment subsidy out of acquisition cost. In satellite and fixed wireless it is often the largest part.
  • Ignoring the time value of money over long lifetimes. Beyond three or four years, discount the margin or treat the figure as an upper bound.

Where it comes from

No single originator. Customer lifetime value comes from direct marketing: F. Robert Dwyer, "Customer lifetime valuation to support marketing decision making", Journal of Direct Marketing 3(4), 1989, and Paul D. Berger and Nada I. Nasr, "Customer lifetime value: Marketing models and applications", Journal of Interactive Marketing 12(1), 1998. Sunil Gupta, Donald R. Lehmann and Jennifer Ames Stuart used it to value whole companies in "Valuing Customers", Journal of Marketing Research 41(1), 2004. Source.

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