Understanding and correctly forecasting the unit economics of your business is extremely important. It is a large part of a successful business plan, and the business itself. The term might sound complicated, but it is surprisingly simple. At least we will try to make it so with an example.
In an effort to make this material easy and fun to understand, we will actually go over the unit economics of a real business. Our example business: A single-location exercise gym. We will call it Bob's Fitness.
This kind of a business is going to have some heavy costs before you start. Here are some:
a) Leasing the facility
b) Remodeling the place
c) Buying exercise equipment
d) Buying liability and other types of insurance
e) Hiring and training staff
f) Getting various city and state permits and licences to open the business
g) Legal costs that come with opening such a business
h) Optionally creating a website
i) Software for gym membership management and on-site computers and card scanners
This list goes on and on and depending on your state and geographic location can cost far over $100,000 and take 3-9 months to complete.
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If the fixed costs to start the business were not high enough, the ongoing costs can be just as high. Here are some examples:
a) Ongoing staff salary
b) Equipment replacement
c) Building maintenance
d) Possibly being sued and the costs for legal fees
e) Electric bills
f) Ongoing insurance payments
g) Ongoing facility rent payments
h) Marketing costs
i) Add a little extra because every month some extra cost is bound to come out of the blue
j) Here is the sad news for many people: after all those costs, you will have to pay taxes from your revenues
This list also goes on and on. The point of it is not to get depressed or discouraged, but to understand the difficulties and plan for them. If you plan for them, you will be more ready to meet the challenge. Now we will get to some of the more encouraging parts of the business.
This is the moment we have been waiting for. Let's count how many customers we need to break even, then turn a profit. It is precisely here that you get to understand whether all the risk we outlined above will be worth the reward. Sometimes this is also useful to tell whether this business can never be profitable, but sometimes the financial opportunity really becomes clear right here. Let's get right into the calculations:
Let's say, just as an example, that you charge each user $50/month. You also have a $50 activation fee. On average, a user remains a member for 12 months.
Let's say your costs to open were $100,000 which you need to eventually recoup, and your ongoing costs are $50,000.
To break even on a month-to-month basis, you will need 1000 members paying $50/month. If you keep signing up new members, you will need fewer registered members, but the number of $50 transactions has to be 1000 to get to the break-even point of $50,000 per month.
Note: You will be taxed on your revenue, so remember to adjust for taxes and tax write-offs.
Now think about how long it will take to get to a point where you are having that many regular and new customers. Think about the first month. Maybe you will have 200 customers. The next month you might have 300 customers. Different businesses grow at very different rates. In the summer, people might want to exercise outside so you might actually have a decrease in customers. The important thing here is to understand that for the first year or so, this business will very possibly lose more and more money as you improve your marketing initiatives and start to grow your customer base.
If the entrepreneur keeps working and, the business will become mature and get to the 1000 customers per month and grow from there. Note that this is the good-case consideration. Many gyms never get to that many members.
Unfortunately, there will be some space constraints so the single gym cannot be home to some number of members just because it is a physical facility. If it gets too crowded, and the gym will feel less like the small community place that it once was, that will turn off some members and they will switch gyms to a competitor gym a few blocks away. So there is a maximum number of members a gym can have. All this means that after a pretty long time, a gym can become profitable. But you would have to put about $300,000 or more into it before it becomes profitable. And it can never become infinitely profitable because it has a space capacity so membership growth will eventually level off. To make more money, you would have to open another gym and go through a number of the pains you went through with the first gym before it can become profitable.
Note: Some costs to start a business can be the
legal costs that come with opening such a business such as the cost to
incorporate in California or Nevada or
wherever your business will be physically located.
Now you should see the value of thoroughly going through such unit-economics forecasting. We just went through how much money it would cost to open and run this kind of a business. We also went over an estimate of how long it would take to break even, and what the maximum opportunity might be.
What if you wanted to open a gym, but did not go through this section thoroughly? You might be kicking yourself two years later and asking yourself why you did not thoroughly go through the early cost, revenue and profit estimates.
So as part of your planning, we really encourage you to consider the unit economics. This is something that you should be thinking about as you first get your business idea and begin the initial planning since the unit economics of your business are such a key metric. It is something that will never go away, regardless of your business stage. In fact, it will only get more and more important as your business grows so it is vital to plan ahead for it.
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Having a website or even a blog can help you begin to discuss your idea with others and be able to point people towards the resources on your site.
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If you are at the idea stage, check out this article on business ideas which will help you understand what to do at the business idea stages, and how to begin planning your business. You can also check out some popular articles on business ideas that cover how to protect business ideas, and how to know which business ideas are bad or are mistakes.
And here is a video with a collection of the top 40 business idea tips:
And this basic business planning tutorial in which you can get a sense of the importance of your company's unit economics.
And this full business planning tutorial in which you can get an even bigger sense of the importance of your company's unit economics and how to understand the single transactions and the profits and losses that go into them, and how that effects your entire business model.
Before starting a business, you must have a solid business plan that outlines a strong strategy for how you will create a competitive product,
promote that product effectively, and do it all in a way that is profitable.
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