Unit Economics In Advertising: Why You Can’t Buy Your Way Out of Bad Numbers

5 min read

Most businesses are fixated on ads and the thrill of gaining new customers.

It’s exhilarating to dive into advertising, but let’s not lose sight of what really drives a business: unit economics.

It might not be the most exciting topic, but it’s the backbone of your profitability.

Why is this so vital? Simply put, acquisition costs are climbing across all media channels. To make a profit, your numbers need to be in order.

This means understanding the pricing of your initial product, the upsells and cross-sells in your funnel, and their conversion rates.

Before you launch any marketing campaign, these are the metrics you need to focus on.

You can’t out-advertise bad numbers, no matter how skilled you are at customer acquisition.

Some business owners mistakenly believe that a top-notch marketing campaign will solve all their problems. It won’t, unless your unit economics are solid.

So, in this post, we’re zeroing in on unit economics.

What Is Unit Economics?

At its core, unit economics is all about understanding your numbers to gauge if you’re on the path to profitability.

But it doesn’t stop there. If you’ve got a good handle on your numbers, you can take it up a notch by comparing them to industry average acquisition costs.

This gives you a sense of whether your costs are in line and helps you identify the best media channels for scaling your business.

So, let’s start simple. Use the following guidelines to crunch your basic numbers on a per-product basis. In the next section, we’ll dive deeper.

Then, in a future blog post, we’ll explore more advanced strategies and tactics.

How To Calculate Basic Unit Economics

Let’s say you’re in the T-shirt business for this example. You can apply the same principles to any product. Here’s how to break it down:

  1. Selling Price (Revenue): You’re selling those T-shirts for £30 a pop. That’s your revenue, plain and simple.
  2. Cost Per Unit (Expenses): This is the sum of all costs for creating and delivering a single T-shirt to a customer. We’re talking Cost of Goods Sold (COGS) plus shipping. For argument’s sake, let’s say it’s £10 per unit.
  3. Profit Margin: Subtract your expenses from the selling price, and you’ve got your profit margin. In our example, that’s £20 (£30 – £10).

These are your bread-and-butter numbers. But keep in mind, they’re not set in stone.

Maybe shipping fees go through the roof, or your supplier decides to up their prices.

Whenever that happens, you’ll need to revisit and tweak these numbers.

Can You Be Profitable On First Purchase?

So you’ve got your basic numbers down, as we discussed. What’s next?

You need to figure out if you can turn a profit or at least break even on that first purchase. Or, let’s face it, if you’re going to be in the red.

Given the uptick in acquisition costs these days, turning a profit right off the bat is getting trickier. It’s doable, but not the best spot to be in.

To get a clearer picture, you’ll want to stack your numbers against industry average customer acquisition costs.

In our T-shirt example, your profit margin is £20. That gives you £20 to play with for paid advertising and still breakeven, ignoring other overhead like staff salaries for now.

Let’s say you’re eyeing Facebook ads. You dig into the industry averages for the fashion sector to find out the typical cost to acquire a customer.

For the sake of this example, let’s pretend it’s £20.

That means you’d break even on the first sale. But is this a long-term game plan? Only if you’ve got a solid strategy to get repeat purchases or can bump up your Average Order Value (AOV).

How To Increase Average Order Value (AOV)

So, you’re looking to boost that AOV as a route to profitability on the first purchase?

Here are five strategies to help you get there:

  1. Bundling: Got attribution software like Triple Whale? Perfect, it’ll show you what products to bundle based on demand. If not, no worries. Just identify products that customers often buy together and offer them as a discounted bundle.
  2. Volume Discounts: The classic ‘Buy 2, Get 10% Off’ works wonders. It’s like bundling, but without the pre-packaged deal. This is especially effective for items like T-shirts, which people often buy in multiples.
  3. Upsells and Cross-Sells: If you’re using Shopify, you’ve got a treasure trove of upselling and cross-selling apps at your disposal. Use them to nudge customers to add more to their cart, either while they’re shopping or at the order confirmation stage.
  4. Free Shipping Thresholds: Set an order value that unlocks free shipping. It’s a simple yet effective way to get customers to add more to their cart. Make sure this offer is visible across your website.
  5. Offer Financing Options: Payment plans like Klarna and ClearPay can make larger orders more palatable, encouraging customers to go big.

By implementing these strategies, you’re not just increasing your AOV; you’re also creating more opportunities for profitability.

By the way, the above list is not exhaustive. There are other strategies as well, but to avoid making this post too long we’ll leave that for a future post.

Increase Profitability Using Repeat Purchases

Here’s the golden rule: repeat purchases are your ticket to higher profits.

You pay for customer acquisition once, but the relationship can pay dividends over time.

There are plenty of cost-effective ways to keep the conversation going and encourage additional purchases.

Think email and SMS. This is on top of the upsell and cross-sell strategies we touched on earlier.

The beauty of these methods? They’re mostly pure profit. The costs are minimal, making them a must-have in your marketing toolkit.

Let’s talk Customer Lifetime Value (LTV). It’s the average amount a customer will spend with you over their lifetime.

And guess what? You can boost this metric using the strategies we’ve discussed.

Here are some practical ways to do it:

  • 1-Click Upsells: Shopify has apps that let you offer in-cart, 1-click upsells. It’s a quick and easy way for customers to add more to their cart before checking out.
  • Email/SMS: With platforms like Klaviyo, you can send targeted emails and SMS messages to entice customers back to your store.

But you need to plan this out in advance. Or at the very least, have a test plan ready to implement.

Map Out Your Numbers And Conversion Rates

This isn’t a game of throwing spaghetti at the wall to see what sticks.

You need a well-thought-out plan for your funnel, and that starts with mapping it out.

Create a spreadsheet and map out the following:

  1. Basic Unit Economics: Yep, the stuff we covered in the first section.
  2. Upsell Strategy: What upsells are you planning, and when will they come into play?
  3. Pricing: At what price points will these upsells be offered?
  4. Expected Conversion Rates: What are your conversion rate expectations for these offers?
  5. Worst-Case Scenario: Using the least favourable numbers and conversion rates, what does your funnel look like? Will it be profitable? If not, what needs to change for it to be, and is that realistic?
  6. Other Scenarios: Sketch out two more scenarios using average and best-case numbers for a side-by-side comparison.

If the numbers show you can still turn a profit even in the worst-case scenario, you’re good to go. Time to put that funnel to the test.

Subscriptions: Recurring Revenue For DTC Businesses

Want to give your Customer Lifetime Value (LTV) a real boost?

Consider a subscription model.

The magic here is predictable, recurring revenue, making you less dependent on constantly acquiring new customers.

Now, this isn’t a one-size-fits-all strategy. It’s a hit for products that need regular restocking. Think supplements. But there’s room for creativity as well.

Some brands offer ‘mystery’ subscriptions, sending out unique products each month that aren’t available to regular customers.

But let’s talk stickiness—your average stick/churn rate. How long do customers typically stay subscribed, and how much do they spend during that time?

I once stumbled upon a McKinsey & Company report stating that the average subscription lasts 3-4 months.

So, your subscription model needs to be profitable within that window, unless you’ve got data showing customers stick around longer.

How to make them stay? Incentives.

Say your average stick rate is 3-4 months. Offer a special gift for those who stay on for 6 months, making it clear that this exclusive perk isn’t available to just any customer.

This is a topic long enough for its own post, which I might tackle down the line.

You Can’t Advertise Your Way Out Of Bad Unit Economics

Let’s hammer this home because it’s crucial: if your numbers are off and you’re not turning a profit, no amount of advertising wizardry will save you.

In fact, a killer ad campaign will just speed up your trip to bankruptcy.

It might not be the exciting part of running a business, but getting your unit economics right is non-negotiable. Nail this, and everything else falls into place.