Unit Economics – A Modern Value Approach

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During his recent interview with Tobias, the man behind the pseudonymous Twitter account, Bluegrass Capital discusses how unit economics provide an alternative method for valuing companies today. Here’s an excerpt from the interview:

Tobias Carlisle: Well, that’s very kind. I heard your podcast with Ryan Reeves and he had this little quote of yours right at the start which blew my mind a little bit. And you said at the start, “If something like”, and I’m going to misquote you slightly but, “If I can find a company that invests $1 in acquiring a customer and they can get back $3 to $5 in gross profits, it doesn’t matter to me if the EBITDA margin is negative or positive.” And honestly I was blown away by that and I thought about it a lot since and I now I think I understand what you’re driving at. But can you just describe how you’re valuing these companies when you when you first start out?

Bluegrass: Absolutely. Yeah, we’ll give a shout out to Ryan. He’s a learning machine. I’m really glad to have met him. So what we were talking about there, and the quote you reference is, we’re talking about unit economics of a transaction. So to back up and start broader, what’s the example of unit economics? This used to be a lot simpler for investors to figure out when you had businesses that employed a lot of physical capital, tangible capital. So if Walmart is going to build a new store, and let’s say Walmart has 50 stores now or 10 stores or whatever and they’re about to build one new store. Well you can look at their existing business and you can say, okay, this income statement is a reflection of their 10 existing stores.

Bluegrass: They just told us, they’re going to spend cap X of whatever $10 million to build this store and the returns they expect to get are X, the store will pay back itself in two or three years, there’s going to be a drag of cash going out the door while they build the store. They’re going to have to hire employees and buy inventory before that new store opens. So, if that store wasn’t open, their existing 10 stores would look better on the consolidated income statement, but that new store is going to be a drag for a little while.

Bluegrass: So that’s the unit economics. That’s just saying, okay, maybe the income statement is going to look bad next year or not as good as it would have because this new store is making the other 10 stores not look as profitable as they are. And that’s easy to understand.

When you transition that capital model to today’s framework or I should say, what’s more common today, where a lot of currently successful and growing businesses don’t need tangible assets, to invest reinvest in their business they’re not building a Dollar general store, or a Costco store, or a Walmart store, they’re acquiring a customer, they’re acquiring a digital customer. And so you just have to think about differently the unit economics of their business.

They’re not going and building a Walmart store, they’re spending money advertising on Google to acquire the customer, but it’s the same exact idea. It’s just, how much money do you spend today? And then what cash flow are you going to get on that outflow in a year, three years, five years, 10 years?

You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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