Metric
Contribution Margin
The money left over from sales after deducting the variable costs of producing and selling them.
Formula
Contribution margin=Net revenue − Variable costs
Contribution margin ratio=Contribution marginNet revenue
What is Contribution Margin?
Learn about Contribution Margin and how it impacts your business’s profitability. Discover what defines a good or bad Contribution Margin and explore effective strategies to improve it. Enhance your financial insights and optimize your business’s bottom line with this guide.
Contribution Margin represents the amount of money left over from sales after deducting variable costs associated with producing and selling those products. Net revenue is gross revenue minus discounts and refunds. Variable costs are the costs that rise with every order: cost of goods, shipping, fulfilment, payment processing and advertising.
How to calculate Contribution Margin
First, we’ll calculate the Net Revenue (gross revenue minus discounts & refunds). Since there are no discounts or refunds, the Net Revenue equals the gross revenue. Next, we’ll calculate the total Variable Costs:
| Net revenue | €50 |
|---|---|
| COGS | €10 |
| Shipping costs | €5 |
| Fulfillment costs | €5 |
| Payment processing fees | €2 |
| Advertising spend | €10 |
| Our variable costs amount | €32 |
Now, we can plug the values into the Contribution Margin formula:
Contribution margin=€50 − €32 = €18
In this example, the Contribution Margin is €18, or 36% of net revenue. This means that for each product sold, the brand has €18 left over after covering all variable costs associated with that product. This remaining amount can be used to cover fixed costs and contribute to the brand’s overall profitability.
Why it matters
This metric is crucial for understanding the profitability of individual products, as well as the overall health of the business. Failing to monitor the contribution margin can lead to offering products that eat into profits, rather than boosting them.
Benchmarks
What is a good Contribution Margin?
Is your Contribution Margin closer to 100%?
A strong contribution margin is one that approaches 100%. The closer the contribution margin is to this ideal, the better. A high contribution margin indicates that a company is effectively covering its overhead costs with the revenue generated from each unit sold, and demonstrates the company’s ability to generate profits and fund its ongoing operations without relying heavily on external funding sources.
What is a bad Contribution Margin?
Is your Contribution Margin far from 100%?
A poor contribution margin is one that falls significantly below 100%. When the contribution margin is low, it indicates that the revenue from each unit sold is insufficient to cover the associated variable costs and contribute meaningfully to covering fixed costs and generating profits. It could be a sign of inefficient cost management, pricing strategies that are not aligned with costs, or an imbalance between sales volume and costs.
How to improve Contribution Margin
- Review pricing strategyEvaluate your pricing to ensure it adequately covers variable costs while remaining competitive in the market. Consider price adjustments that enhance profitability without compromising customer value.
- Optimize cost structureIdentify areas where you can reduce variable costs without sacrificing product quality or customer satisfaction. Streamline operations, negotiate better supplier agreements, and explore cost-saving measures.
- Increase sales volumeFocus on strategies to boost sales volume, such as targeted marketing campaigns, product diversification, and expanding your customer base. Higher sales can help spread fixed costs over a larger revenue base.
- Enhance operational efficiencyImprove production processes, minimize waste, and optimize resource allocation to maximize productivity and reduce variable costs. Implement lean methodologies and invest in technologies that streamline operations.
- Monitor and manage inventoryAvoid excessive inventory that ties up capital and incurs holding costs. Optimize inventory levels to ensure a smooth flow of goods while minimizing carrying costs and obsolescence.
Frequently asked questions
What is Contribution Margin?
Contribution Margin is the money left over from sales after deducting the variable costs of producing and selling those products. It pays for fixed costs and then profit.
How do you calculate Contribution Margin?
Contribution margin = net revenue − variable costs. An order with €50 of net revenue and €32 of variable costs (COGS, shipping, fulfilment, payment fees and advertising) has a contribution margin of €18, or 36%.
What is a good Contribution Margin?
A strong contribution margin is one that approaches 100%: the closer, the better.
What is a bad Contribution Margin?
One that falls significantly below 100%, so each unit sold barely covers its variable costs and contributes little to fixed costs and profit.
Is advertising a variable cost?
In StoreHero’s example it is: the €10 of advertising spend on the order is counted with the other variable costs.
Calculators and further reading
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