Intro
How often have you heard that the golden era for VC startups is drawing to a close? More and more voices, from Steve Blank to VC investors and accelerator representatives, are emphasizing that startup founders need to demonstrate financial performance rather than simply relying on groundbreaking ideas and technological innovations. Consequently, founders are faced with a crucial question: do they possess the skills in modeling and utilizing unit economics?
To gain a deeper understanding of this framework, I had a conversation with Daniil Khanin, a Barcelona (Spain) - based entrepreneur known as the guru of Unit Economics and the Data-Driven Decisions approach. Daniil is the founder and CEO of the startup ueCalc and the author of the book "Unit Economics: Data-Driven Decisions for Business and Startups" featuring a foreword by Ash Maurya, bestselling author of "Running Lean" and "Scaling Lean".
Over the years, we've collaborated with startups through The Internet Initiatives Development Fund accelerator, and as part of my special project, "Behind the Startup: Conversations with Founders & VC Visionaries", I extended an invitation to Daniil to participate in an interview.
Unit economics offers a rapid and accessible means to answer critical questions about the effectiveness of a chosen business model, the required investment for a startup and its duration, the projected depletion of funds, and the prioritization of business processes.
Q&A
Victor Markov: "Let's begin with the most common question: what is unit economics, and why is it so crucial?"
Daniil Khanin: "Unit economics serves as a universal framework that integrates the financial aspects of a business with the product competencies of the team driving that business. In the early stages of its journey, an innovative startup operates in a realm of complete uncertainty. It's unclear who the customer is, what their true needs are, how much time it will take to develop a sought-after product, and the associated costs for the team. Nonetheless, decisions regarding product creation must be made. While various frameworks exist for this purpose, such as Lean Canvas developed by Ash Maurya, unit economics stands out as a tool for evaluating finances at the outset. Additionally, this tool aids in identifying growth opportunities within an already expanding startup."
Victor Markov: "What makes unit economics so indispensable?"
Daniil Khanin: "The significance of unit economics lies in its ability to conserve the scarce resources of a startup. It guides startups in correctly allocating resources over time, directing them toward the most crucial processes. Furthermore, it can lead to the unpopular decision of not launching a startup at all if it lacks economic viability. While this may seem counterintuitive - who can predict the future? - unit economics is not solely about forecasting; it's about assessing the team's readiness to shape that future."
Victor Markov: "I recall numerous instances where teams opted to abandon their business models and shut down their startups after analyzing their financial models and unit economics. Can you share your experiences working with such teams?"
Daniil Khanin: "While I can't disclose specific details due to confidentiality, I can provide a general overview. It began when a team set out to develop IT solutions for large public facilities like stadiums and major shopping centers. The team harbored expectations regarding the project's profitability. However, upon assembling their financial model, they were dismayed by the dismal financial outlook. It became evident that the projected returns were insufficient to justify pursuing the venture.
At this juncture, conventional wisdom might dictate tweaking the model parameters to yield favorable outcomes. However, with a unit economics-based model, altering several key parameters implies adjusting corresponding aspects of the business model, each overseen by a team member. This realization prompted the team to acknowledge their lack of requisite competencies to enter the market and navigate subsequent business development."
Victor Markov: "Why were the teams unable to recognize this themselves?"
Daniil Khanin: "Often, our unwavering belief in an idea blinds us to rational and critical evaluation. No set criteria can circumvent this tendency. I've made similar mistakes countless times. The beauty of unit economics lies in its transparency. By constructing a financial model based on unit economics, you control a limited set of parameters, each directly linked to your team and its expertise. You can deceive yourself all you want, but the numbers lay bare any underlying issues, illuminating the true cost involved."
Victor Markov: "To what extent does this approach align with traditional methods? Financial modeling has been a staple of business schools and online courses for quite some time."
Daniil Khanin: "This is a pivotal question. Formally, a financial model crafted using my templates mirrors one crafted by seasoned financiers. However, the challenge lies in finding someone within a startup capable of creating such a document and adeptly managing all the parameters therein. My approach represents a fundamental shift - a new philosophy of document creation. I encapsulate it as 'being accountable only for what you can control.'"
Victor Markov: "Intriguing. Can you delve deeper into this philosophy?"
Daniil Khanin: "It all circles back to unit economics. As unit economics intertwines business processes with financial metrics, it facilitates the construction of financial documents like profit and loss statements, cash flows, and balance sheets. However, the model's author only manages a select set of metrics comprising the unit economics model. Thus, to achieve specified targets - say, EBITDA or Revenue - the model's author adjusts unit economics metrics, which, in turn, directly influence business processes.
Whether the team possesses the means to impact these processes becomes readily apparent. Most importantly, this approach is easily verifiable. If a team claims a 15% conversion rate significantly higher than the market average, they must elucidate their strategy for achieving this feat. Do they possess relevant experience or a concrete plan? If not, surpassing the market average seems improbable."
Victor Markov: "It appears to be a win-win scenario - benefiting both startup founders and potential investors. You recently published a book on this topic. Can you elaborate?"
Daniil Khanin: "Certainly. While advocating for unit economics, I fielded inquiries about further reading on the subject. Surprisingly, I couldn't identify any books despite accumulating a wealth of material. Consequently, I compiled a book elucidating the approach, philosophy, and underscoring how competencies influence business's financial performance. Essentially, I distilled my decade-long experience with unit economics, examining myriad examples of its application in addressing various business inquiries - from identifying growth opportunities to crafting financial models."
Victor Markov: "Okay, while startups leverage unit economics for modeling, those at later funding stages with impressive revenue figures also employ this framework for decision-making. How is this approach utilized in such scenarios?"
Daniil Khanin: "Indeed, unit economics alone proves insufficient. While it offers insight into the current state of a business, informed decision-making requires identifying processes ripe for improvement, thereby enhancing business performance while minimizing resource expenditure. This task isn't straightforward, but it represents the essence of business focus. By pinpointing the process that currently offers the most potential for growth, you can achieve substantial growth with minimal resource outlay - a critical consideration for resource-constrained startups."
Victor Markov: "That sounds intriguing. Can you shed light on how startups can identify these growth opportunities? What tools or solutions are required?"
Daniil Khanin: "You can start with just a napkin and pen, but effective tools are indispensable. While you can construct a model using any spreadsheet editor or even pen and paper, pinpointing growth opportunities and crafting financial models is no easy feat. It all boils down to cohorts - the bedrock of unit economics data. Managing and analyzing cohorts isn't straightforward, even with Excel.
Hence, I developed ueCalc. It streamlines the creation of unit economics models for most business models and facilitates the rapid construction of corresponding financial models. The service handles the heavy lifting, requiring the team merely to delineate their fundamental capabilities in influencing their model's unit economics metrics. Even though creating a high-quality model necessitates some adjustments and a serious commitment, the process remains far more streamlined and expedited than Excel-based modeling."
Outro
Cohort analysis in unit economics presents a multifaceted challenge deserving of a dedicated article. In this interview, Daniil Khanin touched upon critical issues in today's world and the state of the venture capital market, such as profitability, resource conservation, and decision-making based on data-driven decisions.
While implementing the framework requires time, the return on investment is swift. Crucially, all the necessary elements are present: market demand, accessible solutions, and a plethora of articles, books, and resources. Such models yield benefits not only for startups and investors but also for the market at large.