I am often asked, "What is the most important thing to know when starting a small business?" After 33 years of working with thousands of students and startups—mostly young and poor—I can answer without hesitation that it is the economics of one unit (EOU). A timeless tool of thought, the EOU is the most powerful tool ever invented in business, and understanding it can make the difference between business failure and business success. Yet, it is often buried deep in business school textbooks or never read at all.
I clearly remember when I first had the insight of its importance. It was 1982 and I was standing in front of a classroom in East New York. I was trying to explain to a disinterested class how we thought about pricing cars at Ford Motor Company. No one cared about this passion of mine until I looked out of the window and said, “So what does that Taurus cost to buy?" At least half of this class knew the price. Then I asked the magical question, “And what does it cost to make that Taurus?"
"That is the mystery of business," I said. "You can usually find out how much something costs to buy but finding the secret of what it costs to make is the magic."
And there, from somewhere deep in my subconscious, came an explanation of the magic of the economics of one unit. From that moment I talked about it often and used it the way a quantum physicist talks about atoms—as the building block of business.
This is how important I think EOU is: a misunderstanding of the economics of one unit is the major cause of business failure and hence, perhaps of world poverty because business failure in one form or another is the root cause of poverty. If every business ever started had been successful we would have hundreds of millions of more businesses, more jobs and trillions of dollars of additional capital – time, money, reputation, land – and world poverty would ultimately be eradicated.
So as a business owner, you must ask yourself: what is the smallest unit of one that you are selling? Close your eyes and picture it: how does it looks and feel? And most importantly, how does the customer think of it and why will they buy it? What need does it fulfill?
A classic example is my friend Cory Henderson who does portraits of people. One time I tried to negotiate him down from his price but he knew exactly his costs of material and how many hours it would take him to draw me (10 to be exact). He rightfully argued that to go below $300.00 would make it unprofitable for him, even though his cost of materials was almost zero. He had to make at least $30.00 per hour.
Once you have the Zen of it, then bring in the numbers—what will it sell for in a market and what is the magic secret number that it costs to make an additional unit? This is the most fascinating exercise in business—cost analysts. Tens of thousands of people struggle with this in any industry and the questions are never fully answered as costs often are invisible and immeasurable; it is what you give up for something. "Cost is choice" as my friend and mentor the Noble Prize winner, James Buchanan, once wrote.
Every year business techniques change and improve, as the world becomes a global market. But one thing always remains the same -- the core of any business, and all entrepreneurial success, is understanding the economics of one unit.
About Steve Mariotti
Steve founded the Network For Teaching Entrepreneurship (NFTE) 25 years ago. Today, NFTE is a global organization that inspires young people to stay in school, to recognize business opportunities and to plan for successful futures.
Follow Steve @NFTESteve.