What Is Contribution Margin?
Contribution margin tells you how much each product or order contributes to covering your fixed costs. Essential for pricing decisions.
Key Takeaways
- Contribution margin = Revenue minus Variable Costs.
- It shows how much each unit sold contributes toward covering fixed costs.
- Products with negative contribution margin cost you money with every sale.
The formula
Contribution margin is revenue minus variable costs. Variable costs are costs that change directly with the volume you sell: product cost, packaging, payment processing fees, direct shipping. Fixed costs — rent, salaries, software — are excluded. The result tells you how much each sale contributes toward those fixed costs.
Why it differs from gross margin
Gross margin typically includes all COGS, some of which may be semi-fixed (production labour, for example). Contribution margin is stricter: it only subtracts costs that are truly variable — that is, costs you would not incur if you made zero sales of that product. The purer the variable cost definition, the more useful contribution margin becomes for pricing decisions.
How to use it
If your contribution margin per unit is £15 and your monthly fixed costs are £30,000, you need to sell 2,000 units per month to break even. This tells you exactly how sales volume translates into fixed cost coverage — and therefore profit. It also reveals which products carry more weight in funding your overheads.
The danger of negative contribution margin
If a product has a negative contribution margin — it costs more in variable costs to sell than the price you charge — you lose money on every unit regardless of volume. No amount of sales growth fixes a negative-contribution-margin product. Identify and fix or eliminate these products immediately.