The ladder / Level 4 · New products and services/ Business math
Unit economics and pricing
Contribution per unit, customer acquisition cost (CAC), CAC payback and lifetime value; cost-plus versus value-based pricing with economic value to the customer.
How numbers are rounded on these pages. Calculations are done at full precision and rounded only at the end, half up. Rupee amounts are rounded to the nearest rupee unless shown with paise, in which case to the nearest paisa. Percentages are shown to two decimal places, months to one decimal place, years and ratios (such as LTV : CAC) to two, and discount factors to four. Discounting assumes cash flows at the end of each year, compounded yearly. IRR has no exact formula: it is found by repeated trial and shown to two decimal places as a check value. Break-even quantities are rounded up to the next whole unit. All examples and quiz questions are Hypothetical: they show the method, not real prices or rates.
Unit economics: contribution per unit, CAC and payback
Unit economics asks whether each sale, and each customer, makes money before fixed costs. Start with contribution per unit: price (excluding GST) minus every cost that comes with that unit: the product, packaging, shipping, payment fees, returns, any royalty.
Then count what it costs to win a customer: customer acquisition cost (CAC) is sales and marketing spend divided by new customers won. CAC payback is how many months of a customer's contribution it takes to earn that back. Over a customer's whole life, contribution per month × expected months gives a simple lifetime value (LTV), here without discounting. If lifetime contribution is not comfortably above CAC, growth loses money.
The standard formulas
Terms used
- Unit economics
- Revenue and costs per unit or per customer, before fixed costs.
- Contribution per unit
- Price minus variable costs per unit.
- Customer acquisition cost (CAC)
- Sales and marketing spend per new customer won.
- Blended CAC
- Total acquisition spend across all channels ÷ all new customers.
- CAC payback
- Months of contribution from a customer needed to recover CAC.
- Lifetime value (LTV)
- Total contribution expected from a customer over the relationship (simple version: not discounted).
Worked examples
HypotheticalBasicContribution on a kitchen gadget
An online kitchen gadget sells for ₹1,499 excluding GST. Per-unit costs:
- Product (landed): ₹620.00
- Packaging: ₹40.00
- Shipping: ₹90.00
- Payment fee (2% of price): ₹29.98
- Returns allowance: ₹45.00
- Contribution = ₹1,499 − ₹824.98 = ₹674.02; margin = 44.96%
HypotheticalIntermediateCustomer acquisition cost
In a month the company spends ₹3,00,000 on ads, samples and influencer fees and wins 400 new customers.
- CAC = ₹3,00,000 ÷ 400 = ₹750
- The first order earns ₹674.02, so it does not cover CAC on its own: ₹75.98 is still to recover from repeat orders.
HypotheticalAdvancedPayback and lifetime value with refills
Customers buy a refill each month with contribution ₹180; on average they stay 10 months. CAC is ₹750.
- CAC payback = ₹750 ÷ ₹180 = 4.2 months
- Lifetime value = ₹180 × 10 = ₹1,800; LTV : CAC = 2.40
All numbers are assumptions; test retention with real customers before spending more on acquisition.
Pricing a new product: cost-plus and value-based
Cost-plus pricing starts from your cost and adds a markup. It is simple and makes sure each unit covers its cost, but ignores what the customer would pay.
Value-based pricing starts from the customer. Take the price of their best alternative (the reference value), add the money your product saves or earns them over that alternative (the differentiation value). The total is the standard economic value to the customer (EVC). Price below EVC, so the customer has a reason to switch, and well above cost.
A higher price usually sells fewer units, so compare total contribution at each price, not price alone. The volumes in these examples are assumptions.
The standard formulas
Terms used
- Cost-plus pricing
- Price = cost plus a markup percentage.
- Value-based pricing
- Price set from the value to the customer rather than from cost.
- Reference value
- The price of the customer's best alternative.
- Differentiation value
- The extra value (savings, earnings) your product gives over that alternative.
- Economic value to the customer (EVC)
- Reference value + differentiation value: the most a fully informed customer should pay.
Worked examples
HypotheticalBasicA cost-plus price
Unit cost ₹400; markup 50%.
- Price = ₹400 × 1.5 = ₹600; margin = ₹200 ÷ ₹600 = 33.33%
HypotheticalIntermediateEconomic value of an energy-saving controller
A new motor controller for small workshops. The standard controller costs ₹3,000. The new one saves 600 kWh a year at ₹8 a kWh, and we count 2 years of savings (simple, undiscounted).
- Saving = 600 × ₹8 = ₹4,800 a year; over 2 years ₹9,600
- EVC = ₹3,000 + ₹9,600 = ₹12,600
- Cost-plus: the ₹2,500 variable cost plus a 40% markup = ₹3,500, far below EVC
- A value price of ₹7,000 still leaves the customer ₹5,600 better off than the standard controller over two years
HypotheticalAdvancedWhich price earns more?
Assume 4,000 units sell at the cost-plus ₹3,500 and 2,500 at the value price ₹7,000. Variable cost ₹2,500; fixed costs ₹20,00,000 a year.
- Profit at ₹3,500: 4,000 × ₹1,000 − ₹20,00,000 = ₹20,00,000
- Profit at ₹7,000: 2,500 × ₹4,500 − ₹20,00,000 = ₹92,50,000
- Customer's payback on the extra ₹4,000 paid over the standard controller = ₹4,000 ÷ ₹4,800 = 0.83 years
Quiz: unit economics and pricing
Pick an answer to see at once whether it is right, with a short explanation. Each question takes one try; your score appears at the end. No answers are sent anywhere. (Without JavaScript, open “Show answer” under each question.)