- Considering increasing your ad budget and want to know if you can afford it
- Don't know exactly what a new customer is allowed to cost
- Have a ROAS that looks good, but a bottom line that isn't keeping up
- Sell products with different margins
Unit economics is a staircase where something is subtracted at each step:
- Revenue including VAT. The most misleading figure, because a portion of it isn't yours. Therefore, always calculate excluding VAT. In Denmark, VAT is 25% on top, which is 20% of the amount including VAT.
- Subtract cost of goods. This is your first contribution margin (CM1).
- Subtract shipping and payment fees. This is your contribution margin per order (CM2). These three costs are variable: if you sell twice as much, you pay twice as much.
- Subtract advertising spend. This is CM3: what remains of revenue after goods, shipping, fees, and advertising spend have been paid. A positive number means you are making money right now.
- Subtract fixed costs. Then you have EBITDA, your actual operating profit.
A good marketing return and a red bottom line can easily coexist. Break-even is a volume threshold, not an efficiency threshold: it is about how many contribution margin dollars you bring in, not just how good your ROAS is.
Two hypothetical products, all figures excluding VAT:
Product A
- Price 400 DKK, cost of goods 120 DKK, shipping 40 DKK, payment fee 10 DKK.
- Contribution margin per order: 230 DKK (57.5%)
Product B
- Price 250 DKK, cost of goods 125 DKK, shipping 40 DKK, payment fee 6 DKK.
- Contribution margin per order: 79 DKK (31.6%)
Assume that a new customer costs 120 DKK to acquire:
- A: 230 − 120 = plus 110 DKK on the first order.
- B: 79 − 120 = minus 41 DKK on the first order.
- Average of the two (half of each): 154.5 − 120 = plus 34.5 DKK.
The average looks fine. But it hides the fact that product B loses money on every new customer you acquire at that price.
The ceiling for the first order is the contribution margin of the first order for the product the customer purchases. In the example, a new customer should cost no more than 230 DKK for product A and 79 DKK for product B. Calculate based on the order value and margin of new customers, not on a blended average: returning orders are larger and make the numbers look better.
If you can wait for repeat purchases, the ceiling can be higher. But that requires two things:
- The repeat purchase rate must be calculated for all customers, not just those who return. Most people buy once. If you only calculate based on those who come back, you are overestimating.
- You must always specify a time horizon, for example, over two to three years and not within the quarter. A repeat purchase figure without a time horizon cannot be used for decision-making.
Two lines, not one
- Break-even ROAS = 1 ÷ (1 − cost of goods sold percentage). That is the floor: is the business staying afloat? See What is a good ROAS.
- Scaling limit = 1 ÷ contribution margin after shipping and fees. That is the lowest return the next krone must deliver before it costs you contribution margin for the period.
In the example:
- Product A: break-even ROAS 1.43x, scaling limit 1.74x. The first order provides a ROAS of 400 ÷ 120 = 3.3x. That is well above both lines.
- Product B: break-even ROAS 2.0x, scaling limit 3.2x. The first order provides 250 ÷ 120 = 2.1x. It appears to be staying afloat, but it is below the scaling limit, which is why B loses 41 DKK per customer.
Use both figures, and always state which one you are using.
Averages hide the purchases you get for free. Ask instead: what did the next dollar deliver? And focus on dollars in contribution margin, not the ratio. An ad with a lower ROAS but a higher contribution margin in dollars is better, because it is dollars that pay the fixed costs.
Compare the change in budget with the change in contribution margin after ads (CM3) over the same length of time, preferably the same period last year. Zero is break-even.
- Budget up, CM3 up: The extra budget paid off. Scale.
- Budget up, CM3 down: Diminishing returns. No more budget on the same thing. Add new units, for example new ads, campaigns, or products.
- Budget down, CM3 up: The cut worked. Scale what works, don't just put the whole budget back.
- Budget down, CM3 down: This is a conversion problem, not a budget problem. Find the cause, and don't spend new budget.
- Confusing profitable marketing with a profitable business. A red bottom line does not necessarily mean bad marketing. It could be volume or cost structure.
- Cutting the budget to protect ROAS, when the marginal dollar is still profitable. Then you are cutting the only dollars that can cover the fixed costs.
- Managing based on what the platform says about itself. The numbers overlap and tell you nothing about the bottom line. Manage based on your own P&L. See MER vs. ROAS.
- Hiding fixed costs. You cannot hit a target you cannot see.
- Estimating cost of goods sold based on industry standards. Use your own numbers.
DVISIONMEDIA's approach
We start with a P&L sheet where all figures are broken down into main categories and subcategories. Next, we calculate your minimum requirements: necessary ad budget, required revenue, and break-even point. We review your costs and follow up with EBITDA every week, along with a more in-depth P&L and advisory session every month. We optimize for contribution margin in currency, not for a ratio. This is part of the approach we integrate into our work with strategy and consultingand throughE-COM OS.
1. What are unit economics for an online store?
Profit per order, calculated as revenue excluding VAT minus cost of goods sold, shipping, and payment fees. What remains is the contribution margin. After ad spend, this is CM3.
2. What should a new customer cost?
On the first order, no more than the contribution margin of the product the customer purchases. Repeat purchases can raise the ceiling, but only if you calculate the repurchase rate for all customers and define a time horizon.
3. What is the difference between break-even ROAS and the scaling limit?
Break-even ROAS is 1 ÷ (1 − cost of goods percentage) and shows whether the business is profitable. The scaling limit is 1 ÷ your contribution margin ratio after shipping and fees, and it shows the lowest return the next dollar must generate.
4. When should I increase my ad budget?
When a higher budget results in a higher contribution margin after ad spend—meaning budget up and CM3 up. If it results in a lower CM3, you are seeing diminishing returns.
5. Why shouldn't I manage based on the platform's ROAS?
Because platform data overlaps and tells you nothing about your bottom line. Manage based on your own P&L.
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