Understanding Unit Economics Beyond SaaS
CAC, LTV, and contribution margin calculations for service businesses, product companies, and hybrid models
Key Takeaways
- •Unit economics apply to every business—not just software companies with subscriptions
- •Define your 'unit' correctly: customers, projects, products, or transactions depending on your model
- •Contribution margin is the foundation—know exactly what each unit contributes to fixed costs
- •Customer lifetime value works for non-subscription businesses; it just requires different calculations
- •Segment analysis reveals which customers, products, and channels create value versus destroy it
Unit economics has become a buzzword in the technology world, where software companies obsess over customer acquisition cost, lifetime value, and payback periods. But unit economics is not a SaaS invention—it's a fundamental business concept that applies to every company.
Whether you run a professional services firm, a distribution company, a manufacturing business, or a retail operation, understanding your unit economics is essential for profitable growth. This guide translates the concepts beyond SaaS jargon to show how established businesses can use unit economics to identify profitable segments, improve pricing, and make better strategic decisions.
The Core Principle
If you lose money on every unit (customer, project, product), you cannot make it up on volume. Scaling an unprofitable unit accelerates losses. Unit economics tells you whether your business model works at the most fundamental level.
Step 1: Define Your Unit
The first step in unit economics is defining what your "unit" actually is. This depends on your business model and what drives value creation.
| Business Type | Primary Unit | Secondary Unit | Example |
|---|---|---|---|
| Professional Services | Project / Engagement | Client relationship | Consulting, accounting, legal |
| Manufacturing | Product / SKU | Order / Customer | Custom machinery, components |
| Distribution | Order / Transaction | Customer account | Wholesale, logistics |
| Construction | Job / Project | Customer type | General contractors, trades |
| Retail / E-commerce | Transaction | Customer | Specialty retail, D2C brands |
| Recurring Services | Customer / Contract | Service tier | Managed services, maintenance |
| Healthcare | Visit / Procedure | Patient | Medical practices, clinics |
Choosing the Right Unit
When choosing your primary unit, consider:
- Decision relevance: Which unit drives your key decisions? If you price by project, analyze by project. If you compete for customer accounts, analyze by customer.
- Cost attribution: Can you accurately assign costs to this unit? If you cannot allocate costs meaningfully, choose a different unit.
- Actionability: Can you act on the insights? Analysis should inform decisions about pricing, customer selection, product focus, or resource allocation.
- Data availability: Do you have the data to track this unit over time? The best unit is one you can actually measure.
Common Mistake
Many businesses analyze only at the revenue level without connecting to profitability. Knowing that Customer A generates $500K in annual revenue is less useful than knowing Customer A contributes $75K in profit after all direct costs. A smaller customer contributing $60K profit on $200K revenue may be more valuable.
Contribution Margin: The Foundation of Unit Economics
Contribution margin measures how much each unit contributes to covering fixed costs and generating profit. It separates variable costs (which change with volume) from fixed costs (which remain constant regardless of volume).
Contribution Margin Formula
Contribution Margin = Revenue - Variable Costs
Contribution Margin % = (Revenue - Variable Costs) / Revenue
Variable costs = costs that increase/decrease directly with unit volume
Identifying Variable Costs by Business Type
Service Businesses
Variable costs include:
- • Direct labor (billable staff time)
- • Subcontractor costs
- • Project-specific materials
- • Travel for specific engagements
- • Sales commissions
- • Project-related software licenses
Product Businesses
Variable costs include:
- • Raw materials and components
- • Direct production labor
- • Packaging and shipping
- • Sales commissions
- • Transaction fees (credit cards, payment processing)
- • Warranty and returns costs
Contribution Margin Examples
Example: Professional Services Engagement
Project Revenue: $150,000
- Senior Consultant (400 hrs x $85/hr fully loaded): $34,000
- Associate (600 hrs x $50/hr fully loaded): $30,000
- Subcontractor: $12,000
- Travel: $8,000
- Sales Commission (8%): $12,000
Total Variable Costs: $96,000
Contribution Margin: $54,000 (36%)
This $54,000 contributes to paying for office rent, admin staff, partners, software, marketing, and generating profit.
Example: Product Business (Per Unit)
Selling Price: $85.00
- Raw Materials: $22.00
- Direct Labor: $12.00
- Packaging: $3.50
- Shipping: $8.00
- Credit Card Fees (3%): $2.55
- Sales Commission (10%): $8.50
Total Variable Costs: $56.55
Contribution Margin: $28.45 (33.5%)
Each unit sold contributes $28.45 toward fixed costs (manufacturing overhead, rent, salaries, marketing) and profit.
Break-Even Analysis
Once you know your contribution margin per unit, you can calculate break-even: Break-Even Units = Fixed Costs / Contribution Margin per Unit. If fixed costs are $500,000 annually and contribution margin is $28.45 per unit, you need to sell 17,575 units to break even.
Customer Lifetime Value for Non-Subscription Businesses
Customer lifetime value (LTV or CLV) measures the total profit a customer generates over their entire relationship with your company. While SaaS companies calculate this using monthly recurring revenue, non-subscription businesses need different approaches.
Non-Subscription LTV Formula
LTV = Average Purchase Value x Purchase Frequency x Customer Lifespan
For profit-based LTV:
LTV = Average Contribution Margin x Purchase Frequency x Customer Lifespan
Calculating LTV by Business Type
Service Business: Client LTV
Average engagement value: $75,000
Contribution margin %: 40%
Engagements per year: 1.5
Average client relationship: 4 years
Revenue LTV = $75,000 x 1.5 x 4 = $450,000
Profit LTV = $450,000 x 40% = $180,000
Distribution Business: Account LTV
Average order value: $2,500
Contribution margin %: 22%
Orders per year: 24
Average account lifespan: 6 years
Revenue LTV = $2,500 x 24 x 6 = $360,000
Profit LTV = $360,000 x 22% = $79,200
Retail/E-commerce: Customer LTV
Average order value: $125
Contribution margin %: 45%
Orders per year: 3.2
Average customer lifespan: 2.5 years
Revenue LTV = $125 x 3.2 x 2.5 = $1,000
Profit LTV = $1,000 x 45% = $450
Getting Accurate LTV Inputs
The quality of your LTV calculation depends on the accuracy of your inputs. Here is how to measure each component:
- Average purchase value: Calculate from your actual transaction history. Use a trailing 12-month average to smooth seasonality.
- Purchase frequency: Count transactions per customer per year. For businesses with long sales cycles, use a multi-year window.
- Customer lifespan: Analyze your customer retention data. When did customers acquired 5-7 years ago make their last purchase? Calculate the average active relationship period.
- Contribution margin: Use actual margin data, not pricing assumptions. If margins vary by product or customer, segment your analysis.
Avoid Optimistic LTV Calculations
Many businesses overestimate LTV by using hoped-for rather than actual metrics. If your best customers buy 6 times per year but your average is 2, use 2. If customers say they will stay for 10 years but data shows 4 years, use 4. Optimistic LTV calculations lead to overspending on customer acquisition.
Customer Acquisition Cost for Non-SaaS Businesses
Customer acquisition cost (CAC) measures what you spend to win a new customer. For non-SaaS businesses, this requires careful accounting of all sales and marketing expenses.
CAC Formula
CAC = Total Sales & Marketing Costs / Number of New Customers Acquired
Period: Use a consistent time period (quarterly or annually) that captures your full sales cycle.
What to Include in CAC
| Category | Include | Common Omissions |
|---|---|---|
| Sales Staff | Salaries, benefits, bonuses, commissions | Benefits, payroll taxes, training |
| Marketing | Advertising, content, SEO, PR, events | Staff time on marketing, agency fees |
| Sales Enablement | CRM, sales tools, proposal software | Training, sales collateral development |
| Business Development | Trade shows, entertainment, travel | Sponsorships, networking memberships |
| Proposal/Bid Costs | Time and materials for proposals | Technical staff time, prototypes, samples |
CAC Example: Service Business
Annual Sales & Marketing Costs:
Business Development Manager (fully loaded): $180,000
Sales Support (50% of role): $40,000
Marketing (agency + spend): $95,000
Trade shows and events: $45,000
CRM and sales tools: $12,000
Proposal development (estimated time): $35,000
Total S&M Costs: $407,000
New clients acquired: 18
CAC = $407,000 / 18 = $22,611 per client
The LTV:CAC Ratio
The ratio of customer lifetime value to acquisition cost tells you whether your growth model works economically.
| LTV:CAC Ratio | Interpretation | Implication |
|---|---|---|
| Less than 1:1 | Losing money on every customer | Unsustainable; fix immediately |
| 1:1 to 3:1 | Marginally profitable acquisition | Room for improvement; review efficiency |
| 3:1 to 5:1 | Healthy, efficient acquisition | Target range for most businesses |
| Greater than 5:1 | Very efficient or under-investing | Consider spending more on growth |
Using the Service Example Above
With a Profit LTV of $180,000 and CAC of $22,611, the LTV:CAC ratio is 8:1. This suggests the company could invest more aggressively in customer acquisition—or that they have a highly efficient sales model worth protecting and replicating.
Unit Economics for Service Businesses
Service businesses have unique unit economics challenges: labor is the primary cost, utilization drives profitability, and scope creep erodes margins. Here is how to analyze per-project and per-client economics.
Per-Project Economics
Project Profitability Analysis
Contract Value: $200,000
Direct Costs:
- Senior Staff (520 hrs x $95 cost): $49,400
- Mid-level Staff (780 hrs x $65 cost): $50,700
- Junior Staff (400 hrs x $40 cost): $16,000
- Subcontractors: $18,000
- Travel and Expenses: $12,500
Total Direct Costs: $146,600
Gross Profit: $53,400 (26.7% margin)
Key Metrics for Service Businesses
| Metric | Formula | Target |
|---|---|---|
| Realization Rate | Billed Revenue / (Hours x Bill Rate) | 85-95% |
| Utilization | Billable Hours / Available Hours | 70-80% |
| Effective Rate | Total Revenue / Total Hours Worked | Industry-specific |
| Project Margin | (Revenue - Direct Costs) / Revenue | 35-50% |
| Revenue per Employee | Annual Revenue / FTE Count | $150K-$400K+ |
Common Service Business Profit Killers
- Scope creep: Projects expand beyond original estimates without additional billing. Track actual vs. estimated hours and implement change order processes.
- Write-offs: Unbillable hours due to client disputes, rework, or internal decisions to "eat" overages. Monitor write-offs by project and client.
- Low utilization: Staff time between projects or on non-billable activities. Track utilization by person and identify patterns.
- Misstaff projects: Using expensive resources on work that could be done by junior staff. Match resource cost to task requirements.
Unit Economics for Product Businesses
Product businesses must track unit economics at multiple levels: per-SKU, per-order, per-customer, and per-channel. Each provides different insights for decision-making.
Per-SKU Economics
SKU Profitability Analysis
| Item | SKU A | SKU B | SKU C |
|---|---|---|---|
| Selling Price | $150 | $85 | $42 |
| COGS | $65 | $52 | $28 |
| Variable Costs | $22 | $15 | $9 |
| Contribution Margin | $63 (42%) | $18 (21%) | $5 (12%) |
| Annual Units Sold | 2,400 | 8,500 | 15,000 |
| Total Contribution | $151,200 | $153,000 | $75,000 |
SKU C has the lowest margin and lowest total contribution despite highest volume. Consider: Can pricing be increased? Can COGS be reduced? Is SKU C necessary for the product line, or should resources shift to higher-margin products?
Per-Order Economics
Order-level analysis reveals whether your order fulfillment and logistics operations create or destroy value.
Average Order Value: $285
- Product COGS: $142 (50%)
- Picking/Packing Labor: $8
- Packaging Materials: $4
- Shipping Cost: $12
- Payment Processing: $8.55 (3%)
Order Contribution: $110.45 (38.8%)
Key insight: Orders under $75 may be unprofitable after fulfillment costs. Consider minimum order requirements, shipping thresholds, or small order fees.
Channel Economics
Different sales channels have different cost structures. What looks profitable at the product level may not be profitable in every channel.
| Metric | Direct | Distributor | Marketplace |
|---|---|---|---|
| Retail Price | $100 | $100 | $95 |
| Your Price (net of margins) | $100 | $60 | $80 |
| COGS | $35 | $35 | $35 |
| Channel Fees | $3 (3%) | $0 | $12 (15%) |
| Fulfillment | $8 | $4 | $10 |
| Contribution Margin | $54 (54%) | $21 (35%) | $23 (29%) |
Unit Economics for Hybrid Models
Many businesses combine service and product revenue, or mix project work with recurring relationships. These hybrid models require analyzing unit economics at multiple levels.
Common Hybrid Models
Product + Service
- • Equipment sales + installation/training
- • Software + implementation services
- • Products + ongoing maintenance
Analyze product and service margins separately, then combine for total customer economics.
Project + Recurring
- • Initial build + monthly retainer
- • One-time setup + ongoing support
- • Custom development + SLA contracts
Value the initial project and recurring stream separately to understand true customer lifetime value.
Hybrid Model Example: IT Services Company
Customer Economics - Mid-Market Client:
Initial Project Phase:
Infrastructure assessment and setup: $45,000
Direct costs: $28,000
Contribution: $17,000 (38%)
Recurring Phase (Monthly):
Managed services contract: $4,500/month
Direct costs: $2,800/month
Monthly contribution: $1,700 (38%)
Customer Economics:
Average contract length: 36 months
Initial contribution: $17,000
Recurring contribution: $1,700 x 36 = $61,200
Total Customer LTV (Profit): $78,200
The initial project is important, but 78% of customer value comes from the recurring relationship. This insight should inform sales strategy and resource allocation.
Identifying Profitable vs. Unprofitable Segments
Unit economics analysis becomes most powerful when you segment your business to identify where you make money and where you lose it. Most businesses have both profitable and unprofitable segments—but they do not know which is which.
Segmentation Dimensions
| Dimension | Segments to Analyze | What You Learn |
|---|---|---|
| Customer Size | Enterprise, Mid-market, SMB | Where to focus sales effort |
| Customer Industry | By vertical market | Which verticals to target/avoid |
| Product Line | By product/service category | Portfolio investment priorities |
| Geography | By region or territory | Where to expand or contract |
| Channel | Direct, distributor, online, etc. | Channel investment strategy |
| Customer Tenure | New vs. established customers | Acquisition vs. retention value |
Customer Profitability Analysis
Customer Tier Analysis (Distribution Business)
| Tier | Customers | Revenue | Gross Margin | Contribution |
|---|---|---|---|---|
| A (Top 10%) | 45 | $12.5M | 24% | $2.4M |
| B (Next 20%) | 90 | $8.2M | 28% | $1.8M |
| C (Next 30%) | 135 | $4.8M | 22% | $0.6M |
| D (Bottom 40%) | 180 | $2.5M | 15% | -$0.3M |
The bottom 40% of customers (180 accounts) actually lose $300K after accounting for cost-to-serve. These customers demand attention, place small orders, negotiate prices, and pay slowly. Exiting or repricing these accounts would improve overall profitability.
Taking Action on Unprofitable Segments
Once you identify unprofitable segments, you have several options:
- Reprice: Raise prices to cover the true cost-to-serve. Some customers will accept the increase; those who leave were unprofitable anyway.
- Reduce cost-to-serve: Move customers to lower-touch service models, self-service options, or more efficient fulfillment channels.
- Set minimum requirements: Minimum order sizes, order frequencies, or account values that make small customers economic.
- Exit: Fire unprofitable customers or stop serving unprofitable segments. This is often the best option but the hardest to execute emotionally.
The 20/80 Reality
Most businesses find that 20% of customers generate 80% or more of profit. Some find that the bottom 20-40% of customers actually destroy value. Knowing this distribution allows you to reallocate resources toward profitable segments and away from unprofitable ones.
Implementing Unit Economics in Your Business
Understanding unit economics conceptually is straightforward. Implementing it requires changes to how you collect data, analyze performance, and make decisions.
Implementation Steps
1Define Your Units and Metrics
Decide what units to track (customers, projects, products, orders) and what metrics matter most for your business. Start simple—you can add complexity later.
2Fix Your Cost Accounting
Ensure costs are captured at the right level. Can you attribute direct costs to individual projects, products, or customers? If not, implement time tracking, job costing, or allocation methods.
3Build the Analysis
Create reports that show unit economics at the level that drives decisions. This might be a customer profitability report, project margin analysis, or product contribution dashboard.
4Integrate into Decision-Making
Use unit economics in pricing decisions, customer selection, product portfolio choices, and resource allocation. Make it part of regular business reviews and sales team metrics.
5Refine Over Time
As you gain experience, refine your analysis. Add more granular cost allocation, segment in new ways, and connect unit economics to strategic planning.
Frequently Asked Questions
What are unit economics?
Unit economics measure the profitability of a single unit of your business—whether that's a customer, transaction, project, or product. They help you understand whether your business model creates value at the most fundamental level. If each unit is unprofitable, scaling the business only accelerates losses.
How do I calculate contribution margin?
Contribution margin equals revenue minus all variable costs directly associated with generating that revenue. The formula is: (Revenue - Variable Costs) / Revenue. Variable costs include materials, direct labor, sales commissions, shipping, and any other costs that scale with volume. This tells you how much each dollar of revenue contributes to covering fixed costs and generating profit.
What's a good contribution margin percentage?
Contribution margins vary significantly by industry. Service businesses often see 40-70% contribution margins, while product businesses might run 25-45%. Distribution businesses may operate at 15-30%. The key is that your contribution margin must be high enough to cover fixed costs and generate profit at your current or planned scale.
How do I calculate customer lifetime value for non-subscription businesses?
For non-subscription businesses, calculate LTV by multiplying average purchase value by purchase frequency by average customer lifespan. For example: $500 average order x 4 orders per year x 3 years = $6,000 LTV. Track actual customer behavior over time to refine these estimates rather than relying on assumptions.
What's a good LTV to CAC ratio?
A healthy LTV:CAC ratio is typically 3:1 or higher—meaning the lifetime value of a customer should be at least three times what you spent to acquire them. Below 3:1 often indicates unprofitable customer acquisition. Above 5:1 might suggest you're under-investing in growth and could acquire customers more aggressively.
How do I calculate customer acquisition cost for a service business?
Add all sales and marketing expenses over a period, then divide by the number of new customers acquired. Include salaries and commissions for sales staff, marketing spend, advertising, trade shows, proposal preparation costs, and any other expenses related to winning new business. Be comprehensive—understating CAC leads to overly optimistic projections.
What if some of my customers are unprofitable?
First, understand why they're unprofitable—is it pricing, cost-to-serve, or low volume? Then decide: Can you reprice? Can you reduce cost-to-serve? Should you fire the customer? Some unprofitable customers may have strategic value or growth potential, but most businesses carry too many unprofitable accounts. Pruning them often improves overall profitability significantly.
How do I identify my most profitable customer segments?
Analyze profitability by customer size, industry, geography, product mix, and sales channel. Look for patterns: Which customers have the highest margins? Which require the least support and customization? Which pay on time and reorder frequently? These characteristics define your ideal customer profile for targeting future acquisition efforts.
Need Help Understanding Your Unit Economics?
Eagle Rock CFO helps growing businesses build the financial infrastructure to understand unit economics, customer profitability, and segment performance. We bring CFO-level analysis to identify where you make money—and where you do not.
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