The Economics of one unit is a method of analysis used to determine financial feasibility in the profits obtained from the sale of one unit of product. If you have a business idea, but you haven’t yet vetted it, and aren’t sure if it is viable, this is what you would use to determine if the idea will actually make you money.
You’re looking specifically at what is called “variable costs” -which are costs that vary with production. As you produce and sell more of something, you incur more of those costs. In this example we’ll use a coffee shop. Coffee shops have quite a few variable costs. The more coffee you sell, the more coffee beans you need to buy, the more cups, and lids, and milk and sugar you need to buy. If you sell no coffee, you incur no costs, but if you sell lots of coffee, you incur more of those costs.
This is opposed to fixed costs, which do not vary with production, i.e. rent, which does not vary with coffee production at all. Also keep in mind that one unit does not equal one item. One unit could be a gross of 144 items. One unit could be a case of 12, or in the example of our coffee shop, it could be one single cup of coffee.
First thing you have to figure out is selling price per unit. This is important because you have to know how much is left over after you subtract all of the costs of the item.
Next you will be determining the figure in the three categories of variable costs:
1 – Direct materials: All of the items/ingredients that go into creation/producing/making the item or service. The best way to look at this to determine if it is a direct material? If you did not have this item, you would not be able to produce the good or service. You want to determine the cost of the direct material per unit. For example, you will be buying coffee beans in bulk, so you will need to determine the amount of bean that will go into one cup and how much those beans will cost. (1lb of coffee is $10 and makes ten cups of coffee, so the direct materials cost for one cup of coffee’s worth of beans is $1)
2 – Direct labor: Manpower needed to produce the good or offer the service, per unit. Obviously some division will be needed because your barista will not be making one cup of coffee per hour. How many cups of coffee can they make per hour, what is the salary of the barista?
3 – Other variable costs: These do vary with production, but are not specific with one item cost. These can be things like shipping, packaging for shipment, or sales commission, and don’t fit into either of the other two categories.
Once you figure out all of those things, you can figure out what your gross profit margin per unit is, and what your contribution margin per unit is. Contribution margin represents the final product of the economics of one unit. This is the amount of money that contributes towards covering a firm’s fixed costs (i.e. utilities, salaries, advertising, insurance, interest, rent, and depreciation).