Contribution margin

What the contribution margin says

The contribution margin is what remains of revenue after variable cost. Variable cost only occurs when something is sold: cost of goods, packaging, shipping, payment fees and a share for returns. The contribution margin therefore first carries fixed cost, meaning rent, salaries, software and advertising budget, and turns into profit beyond that.

The formula is revenue minus variable cost. Calculated per unit the value is called unit contribution margin. A product at 60 euros with 36 euros of variable cost has a unit contribution margin of 24 euros and a margin of 40 percent.

Why it steers better than revenue

Revenue says nothing about the result. An item with high revenue and a thin margin contributes less than one with low revenue and a wide margin. Anyone steering by revenue therefore often promotes the wrong assortment and is surprised by a weak result.

The contribution margin also makes advertising comparable. It determines how much a click may cost for a campaign to pay for itself. A shop with 24 euros of contribution margin per order and a conversion rate of two percent may spend 4.80 euros per click. That figure replaces any general rule of thumb and can be recalculated per channel.

Which costs belong in it

• Cost of goods: the purchase price, not the supplier's list price. Rebates and bonuses belong deducted.
• Shipping and packaging: even when the customer pays, part of the cost usually stays with the retailer.
• Payment fee: it is variable because it only occurs with a sale, and it differs by payment method.
• Returns: they belong in as a share, not as a special case. In fashion that share is the largest item.
• Advertising cost: kept separate, because it differs per channel and should drive the decision.

Where the calculation stays too coarse

The split into variable and fixed is a model assumption. Staff cost in the warehouse is partly variable, because more orders mean more packing. A newsletter tool is fixed although it costs per recipient. Anyone treating too much as variable makes products look worse than they are; anyone treating too much as fixed overestimates the margin.

A second point is the reference unit. A contribution margin per order, per line item and per customer produces different figures. For advertising decisions the order is right, for assortment decisions the line item, for customer care the customer.

Frequent questions

• Is the contribution margin the profit? No, fixed cost has not been deducted yet.
• Which margin is normal? It depends on the assortment. In many shops it sits between 20 and 50 percent.
• Can it be negative? Yes, when variable cost exceeds the price. Then every sale carries a loss.