Chapter 4 of 12

Chapter 4: The Unit Economics Engine

The physics of profitability: LTV, CAC, and the Payback Period.

Playbook Chapters
What You'll Learn By the end of this chapter, you'll understand how to calculate LTV and CAC properly, why payback period matters more than you think, and industry benchmarks for healthy unit economics.

The Physics of Profitability

Unit economics represent the atomic structure of your business. If the atom is unstable, the matter built from it will decay.

The Unit Economics Engine calculates the relationship between what a customer is worth (LTV) and what it costs to acquire them (CAC). At the feasibility stage, these are projections—but they must be grounded in industry benchmarks to be credible.

The Core Equation

LTV:CAC Ratio = Customer Lifetime Value ÷ Customer Acquisition Cost.
Target: 3:1 or higher.
Below 3:1, your growth engine consumes more fuel than it generates.

1. Calculating LTV (Customer Lifetime Value)

LTV is the total gross profit you expect to make from a single customer over their entire relationship with you. It is NOT revenue. It is profit.

The Formula

LTV = (ARPU × Gross Margin %) ÷ Churn Rate

  • ARPU (Average Revenue Per User): Monthly subscription price or average transaction volume.
  • Gross Margin %: The percentage of revenue left after direct costs (COGS). For SaaS, usually 70-80%. For AI, often lower (50-60%) due to compute costs.
  • Churn Rate: The percentage of customers who cancel each month.

The "Revenue Mistake"

Wrong: "We charge $100/mo and they stay for 20 months, so LTV is $2,000."

Why: You forgot costs! If it costs $60/mo to serve them (support, hosting, AI tokens), your profit is only $40/mo. Your real LTV is $800, not $2,000.

The Correct Calculation

Right: ($100 Revenue - $60 Cost) = $40 Gross Profit.

$40/mo × 20 months = $800 LTV.

2. Calculating CAC (Customer Acquisition Cost)

CAC is the total cost of sales and marketing divided by the number of new customers acquired. It must be "fully loaded."

The Formula

CAC = (Ad Spend + Salaries + Tools + Events) ÷ New Customers

Don't cheat. Include the salaries of your sales team, the founders' time spent selling, and the cost of your HubSpot license.

B2B SaaS

~$700+

Driven by sales salaries

Consumer App

~$5-20

Driven by viral/ads

E-commerce

~$40-80

Driven by FB/Insta ads

3. Payback Period: The Cash Flow Killer

While LTV:CAC tells you if you are profitable eventually, Payback Period tells you if you will run out of cash now. It measures how many months it takes to earn back the CAC.

Payback Period Assessment Implication
< 6 Months Amazing Self-funding growth. You can grow incredibly fast with little outside capital.
6-12 Months Healthy Standard for venture-backed SaaS. Efficient enough.
> 18 Months Deadly You need massive capital to float the float. Risky in tight markets.
The "Cash Trough"

If your Payback Period is 12 months and you grow 20% month-over-month, your cash burn will explode. Growth sucks cash. You need to model this "Cash Trough" specifically so you don't die of success.

The Rule of 40

Investors use the "Rule of 40" to judge software companies. It simply says:

Growth Rate % + Profit Margin % should be ≥ 40

High Growth Example

100% growth rate + (-60%) profit margin = 40

Verdict: Healthy. Burning money is okay because growth is massive.

Profitable Example

20% growth rate + 20% profit margin = 40

Verdict: Healthy. Slower growth is backed by solid profits.

What You Walk Away With

  • LTV Integrity: You calculate LTV using Gross Profit, not Revenue.
  • Fully Loaded CAC: You include salaries and overhead in your acquisition costs.
  • Payback Focus: You optimize for < 12 month payback to manage cash flow.
  • Benchmarks: You know where you stand against industry standards.
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Works Cited & Recommended Reading
Unit Economics & Financial Modeling
SaaS Metrics & Benchmarks
  • 7. SaaS Trends 2025-2026: 25 Definitive Trends Shaping the Industry. Modall
  • 8. The Great SaaS Price Surge of 2025: A Comprehensive Breakdown. SaaStr
  • 9. SaaS gross margin explained: What it is, and why it's important. Stripe
  • 10. SaaS Gross Margin Benchmarks and How To Increase Yours. Lighter Capital
  • 11. 2025 SaaS Churn Rate: Benchmarks, Formulas and Calculator. Vena Solutions
  • 12. How to Compare CAC Benchmarks by Industry. Phoenix Strategy Group
  • 13. How I Calculate the CAC Payback Period. The SaaS CFO
  • 14. The Rule Of 40: How To Calculate And Use It For SaaS. CloudZero
Pricing Strategy & Research
  • 15. What Is A Hybrid Revenue Model? Definition, Types, Benefits. Marketplacer
  • 16. How To Use The Van Westendorp Price Sensitivity Meter. SurveyMonkey
  • 17. How To Price Your Product: Van Westendorp Pricing Model. Forbes
  • 18. Van Westendorp Price Optimization Using LimeSurvey. LimeSurvey
  • 19. Using Conjoint Analysis for Pricing Research. Qualtrics
  • 20. Understanding Conjoint Analysis in Market Research. LimeSurvey
AI Costs & Unit Economics
  • 21. AI Pricing: How Much Does AI Cost in 2025? Monetizely
  • 22. The Best Cheapest AI Inference Services of 2025. SiliconFlow
  • 23. Welcome to LLMflation - LLM inference cost is going down fast. Andreessen Horowitz
  • 24. Avoiding The Looming AI Unit Economics Crisis. Moreland Connect
  • 25. Beyond Benchmarks: The Economics of AI Inference. arXiv
Burn Rate & Cash Management
  • 26. What is burn rate? What startups need to know. Stripe
  • 27. The Bill Gurley Chronicles: VCs, Marketplaces, and Early-Stage Investing. Macro Ops
Feasibility & Risk Assessment
  • 29. AI Project Feasibility Checker. LaSoft
  • 30. Technical Feasibility Study & Risk Assessment Framework. Incurvo
  • 31. Startup feasibility: How to know if my startup idea is good. Business Model Hacking
  • 32. Startup Evaluation Checklist: Essential Investment Criteria. Qubit Capital
  • 33. What Is a Risk Matrix? [+Template]. Atlassian
  • 34. How to Run Pre-Mortem Exercises [Templates Included]. Atlassian
Regulatory & Compliance
  • 35. EU AI Act Compliance Checker. EU AI Act
  • 36. President Trump Signs EO to Stop State Regulation of AI. Ogletree
  • 37. Executive Order Limiting State Power to Regulate AI. K&L Gates
  • 38. How 2025 state legislative sessions grew the AI patchwork. Engine
  • 39. CCPA Requirements 2026: Complete Compliance Guide. Secure Privacy
Templates & Frameworks

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