What Contribution Margin reveals about your business
Contribution Margin is the foundation of any profitability analysis - it shows which products truly carry your business.
Contribution Margin is one of the most important business metrics. It shows how much each sold product contributes to covering your fixed costs and generating profit. Without this metric, you're making pricing and assortment decisions blindly.
Variable vs. Fixed Costs
The key to understanding Contribution Margin lies in distinguishing between variable and fixed costs:
- 1 Variable Costs: Costs directly tied to sales - cost of goods sold, shipping, packaging, payment fees, commissions.
- 2 Fixed Costs: Costs incurred regardless of revenue - rent, salaries, software licenses, insurance.
Contribution Margin Levels
In practice, different levels of Contribution Margin are distinguished:
CM I = Revenue - COGS (direct product costs only)
CM II = CM I - other variable costs (shipping, payment, returns)
CM II is the more relevant metric for e-commerce businesses.
Practical application in e-commerce
An example: You sell a t-shirt for $40. The purchase price is $12, shipping costs $3, packaging $1 and payment fees $1.20. The Contribution Margin is: $40 - $12 - $3 - $1 - $1.20 = $22.80 or 57% of the selling price.
These $22.80 per sold t-shirt contribute to covering your fixed costs. Only when all fixed costs are covered does the profit zone begin - the so-called Break-Even Point.
Product mix optimization with Contribution Margin
Regularly analyze the Contribution Margin across your entire product range. Products with low or negative Contribution Margin should either be repriced, sourced more cheaply, or removed from your assortment. Combine this analysis with Net Revenue for a complete picture.