Contribution margin
What one extra sale contributes toward fixed costs and profit: its price minus the variable cost of serving it.
Contribution margin is what one more sale contributes toward your fixed costs, and after those are covered, toward profit. It is the price minus every cost that only exists because that sale happened: payment fees, hosting for that account, the freelancer hours, the shipping.
It answers a question gross margin does not: is this sale worth taking at all? Fixed costs are already paid whether or not you take it, so any sale with a positive contribution margin makes the month better, and any sale with a negative one makes it worse no matter how good the revenue looks. That is why discounting is dangerous in a way that feels like it should not be — a 30% discount does not cut profit by 30%, it cuts contribution, which can be the whole of the profit.
The second use is deciding what to stop doing. A service line with a thin contribution margin is consuming capacity that a thicker one would use better, even while its revenue line looks healthy.
Worked: a $200 product with $40 of variable cost contributes $160. Fixed costs of $8,000 a month need 50 sales to cover. Discount to $150 and contribution falls to $110 — now you need 73 sales for the same month, a 46% increase in volume for a 25% cut in price.
Also known as
- unit contribution
- CM
Relevant for
- Founders
- Before you discount to close a deal, work out how many extra sales the discount just cost you — it is almost never the number the discount looks like.
- Business owners
- Rank your service lines by contribution per delivery hour, not by revenue; the biggest invoice on the list is often the one eating the capacity.