The simplest way to understand economics is to express it in terms of units. That’s where the term unit economics comes from: all the things that affect business revenue, reduced to their smallest and simplest expression.
Understanding the term “unit” in business:
A unit is the absolute smallest single thing that will make a business money. For our purposes, a unit is a restaurant location. The physical size of the unit doesn’t matter, only that it produces revenue for the business. Multi-unit franchisees express each one of their restaurant locations as a unit.
A simple way to understand economics:
Economics is the study of production and consumption. For our purposes, think of economics simply as: A restaurant makes food and people buy it.
It’s important to note that economics is not about money. Economics, like every part of life, is actually all about making choices. What do you do when a choice is too big to manage? You break it down into smaller and smaller pieces until you can handle each one on its own. This simplification of complex elements is designed to help restaurant owners discover two things:
1) What drives business?
2) What keeps customers coming back?
Balancing unit economics is the key to running a business.
When first starting out with only a single location, it’s not a big deal to spend all day overseeing inventory and staff directly. But with every location you open, that responsibility doubles, on and on, until an owner has 50 locations with 50 managers and 50 daily reports on hundreds of employees and thousands of inventory items. Keeping track of it all at a glance is Herculean, so don’t!
Separating restaurant locations into units can make it much easier to track their effect on business models and their impact on a budget. This makes it easy to track two very important factors:
- The cost to acquire a new unit (site, customer, or user).
- The amount of revenue each unit generates for the company — in your case likely a restaurant location.
An easy way to express unit value is:
CAC or “Cost to Acquire new Customer” and LTR or “Lifetime Revenue.” Get used to using these terms, they pop up a lot in discussions about unit economics.
Unit economics easily demonstrates profit potential.
Simplifying data makes it easier to track, which makes it easier to chart, which makes it easy to answer the most vital question to any business: when will it become profitable?
Opening one restaurant is a major milestone but it isn’t going to make anyone a millionaire. True success comes from the second, third, tenth, hundredth location. It’s at this point when an owner/operator needs to start thinking about how to simplify their business model, and unit economics is the most popular way to do that.
A key factor: Average Unit Volume
Another important metric in unit economics is Average Unit Volume (AUV). A restaurant opened in the bottom floor of a downtown office tower would produce a very high Average Unit Volume due to the large number of customers. Opening the same franchise location in a suburban retail park may provide a much lower AUV due to the smaller market and less convinient location.
However, AUV can be misleading in terms of reflecting how much actual profit a unit is producing. Using the above example, that office tower location may provide a very high AUV due to the lunch rush, but not actually turn a profit because of shorter hours, coupled with the high cost of downtown rent. The suburban location’s AUV may be low, but the lower overhead can lead to high profits. It’s important to keep the individual needs of each location in mind, rather than relying on general rules.
Understand your business by understanding unit economics.
There are a lot of dead companies who never found a balance between these numbers. Either the cost of acquisition is too high, or the lifetime value is too low, or both. If nothing else, finding a healthy balance between these factors is the most important thing one can learn from unit economics, and is arguably the most important single element to running a successful business.
There is no magic wand for running a business, but the popularity of unit economics isn’t a fluke. In this increasingly complex world, being able to manage a large system quickly and efficiently is key to staying afloat and gaining profit. Having a healthy smart business ecosystem will go a long way toward achieving the goals of unit economics, which is where Solink comes in and why we were named in Deloitte’s “Fast 50 Awards.”