The Economics of

One Unit

The Economics of one unit is a method ofanalysis used to determine financial feasibilityin the profits obtained from the sale of oneunit of product. If you have a business idea,but you haven’t yet vetted it, and aren’t sureif it is viable, this is what you would use to

determine if the idea will actually make youmoney.

You’re looking specifically at what is called “variablecosts” -which are costs that vary with production. Asyou produce and sell more of something, you incur

more of those costs.

In this example we’ll use a coffee shop. Coffee shopshave quite a few variable costs. The more coffee you

sell, the more coffee beans you need to buy, themore cups, and lids, and sleeves and sugar you needto buy. If you sell no coffee, you incur no costs, but ifyou sell lots of coffee, you incur more of those costs.

This is opposed to fixed costs, which do not vary withproduction, i.e. rent, which does not vary with coffee

production at all. And keep in mind that one unit doesnot equal one item. One unit could be a gross of 144

items. One unit could be a case of 12, or in theexample of our coffee shop, it could be one single cup

of coffee.

First thing you have to figure out is selling price perunit. This is important because you have to know howmuch is left over after you subtract all of the costs of

the item.

Next you will be determining the figure in the three categoriesof variable costs. 1 - Direct materials: all of the

items/ingredients that go into creation/producing/making theitem or service.

The best way to look at this to determine if it is a directmaterial? If you did not have this item, you would not be ableto 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 youwill 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 oroffer the service, per unit. Obviously some division will be

needed because your barista will not be making one cup ofcoffee 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, butare not specific with one item cost. These can be things likeshipping, 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 outwhat your gross profit margin per unit is, and what your

contribution margin per unit is. Contribution margin representsthe final product of the economics of one unit. This is the

amount of money that contributes towards covering a firm’sfixed costs (i.e. utilities, salaries, advertising, insurance, interest,

rent, and depreciation).