Unit economics explained for e-commerce founders

Unit economics determines your future

Unit economics is the financial math at the individual transaction level. How much does it cost to acquire a customer? How much profit does each order generate? How much is a customer worth over their lifetime?

If your unit economics don’t work, growth makes things worse, not better. Understanding these numbers is essential for building a sustainable business.

The core unit economics equation

At its simplest, e-commerce unit economics comes down to one question: Does a customer generate more profit than they cost to acquire?

The equation:

Customer lifetime value (LTV) must exceed customer acquisition cost (CAC). If LTV is $150 and CAC is $50, you make $100 per customer. If LTV is $50 and CAC is $80, you lose $30 per customer.

Every customer you acquire at negative unit economics makes your business weaker, not stronger.

Customer acquisition cost (CAC)

CAC measures what you spend to acquire each new customer.

The calculation:

Total acquisition spending divided by number of new customers acquired. If you spend $10,000 on marketing and acquire 200 new customers, CAC is $50.

What to include:

Paid advertising spend. Marketing team costs. Agency fees. Referral program costs. Any spending specifically aimed at acquiring new customers.

Blended versus channel CAC:

Blended CAC averages all acquisition spending. Channel-specific CAC breaks down by source. Facebook might have $40 CAC while Google has $60 CAC. Both views are useful.

First-order economics

What happens on a customer’s first order reveals a lot about your unit economics.

First-order contribution margin:

How much profit does the average first order generate? This is contribution margin (revenue minus variable costs) for new customer orders.

First-order payback:

Does the first order cover CAC? If CAC is $50 and first-order contribution margin is $30, you’re negative $20 after the first order. You need repeat purchases to reach profitability.

First-order negative isn’t always bad:

Many successful e-commerce businesses lose money on first orders and profit from repeat purchases. But you must know your numbers and have confidence in repeat behavior.

Customer lifetime value (LTV)

LTV measures total profit generated by a customer over their entire relationship with you.

Simple LTV calculation:

Average order value multiplied by average orders per customer multiplied by contribution margin percentage. If AOV is $75, customers order 3.5 times on average, and contribution margin is 35%, LTV is approximately $92.

More accurate LTV:

Cohort-based LTV tracks actual cumulative profit per customer over time. This is more accurate than theoretical calculations but requires historical data.

LTV timeframe:

Over what period do you calculate LTV? Twelve-month LTV differs from 24-month LTV. Longer timeframes capture more value but introduce more uncertainty.

The LTV to CAC ratio

The ratio of lifetime value to acquisition cost indicates business health.

Benchmark ratios:

LTV:CAC of 3:1 or higher is generally considered healthy. You make $3 for every $1 spent on acquisition. Below 3:1 suggests either acquisition is too expensive or lifetime value is too low.

What the ratio tells you:

High ratio (5:1+): You might be under-investing in acquisition. Growth opportunities exist. Healthy ratio (3:1-5:1): Business is sustainable. Balance of growth and profitability. Low ratio (1:1-3:1): Efficiency concerns. Need to either reduce CAC or increase LTV. Negative ratio (below 1:1): Losing money on customers. Unsustainable without change.

CAC payback period

Payback period measures how long until a customer becomes profitable.

The calculation:

CAC divided by monthly contribution margin per customer. If CAC is $60 and customers generate $10 monthly contribution, payback is 6 months.

Why payback matters:

Shorter payback means faster cash recovery. You can reinvest in more acquisition sooner. Longer payback ties up cash and increases risk if customers churn before payback.

Payback benchmarks:

Under 6 months is strong. 6-12 months is acceptable for most businesses. Over 12 months creates cash flow challenges and retention pressure.

Contribution margin per order

Understanding contribution at the order level is fundamental.

The calculation:

Order revenue minus COGS minus shipping minus payment processing minus fulfillment. What’s left is contribution margin.

Example breakdown:

$80 order revenue. $32 product cost (40%). $8 shipping. $2.50 payment processing. $4 fulfillment. Contribution margin: $33.50 (42%).

Track contribution margin over time:

Rising costs (shipping, materials, processing) can erode contribution margin without price increases. Monitor this metric monthly.

Break-even analysis

Understanding your break-even point reveals financial stability.

Order break-even:

How many orders do you need to cover fixed costs? Fixed costs divided by contribution margin per order. If fixed costs are $25,000 monthly and contribution margin is $25 per order, break-even is 1,000 orders.

Revenue break-even:

What revenue level covers all costs? This combines fixed cost coverage with understanding of variable cost ratios.

Improving unit economics

If unit economics are weak, you have several levers.

Reduce CAC:

Improve marketing efficiency. Find better channels. Optimize conversion rates. Increase organic traffic share.

Increase contribution margin:

Raise prices. Reduce costs. Negotiate better supplier terms. Optimize shipping. Reduce returns.

Increase lifetime value:

Improve retention. Increase purchase frequency. Increase AOV. Better customer experience drives repeat purchases.

Unit economics by segment

Aggregate unit economics can hide important variation.

By acquisition channel:

Different channels might have very different unit economics. Facebook-acquired customers might have different LTV than Google-acquired customers.

By product:

Customers who first buy different products might have different lifetime value. First-purchase product affects future behavior.

By customer type:

Different customer segments might have different unit economics. B2B versus consumer, geographic segments, or demographic segments.

Metrics to track for unit economics

Focus on these unit economics metrics:

Customer acquisition cost (blended and by channel). First-order contribution margin. Customer lifetime value (12-month and longer). LTV to CAC ratio. CAC payback period. Contribution margin per order. Break-even order volume. Unit economics by segment.

Unit economics is the foundation of sustainable growth. Know your numbers at this level before scaling acquisition spending.