Contribution Margin

What is Contribution Margin?

Contribution margin is the revenue remaining after subtracting variable costs, the costs that scale directly with each additional customer or unit sold. It shows how much each sale contributes toward covering fixed costs and generating profit.

Unlike gross margin which uses accounting COGS, contribution margin focuses on truly variable costs. This makes it more useful for unit economics and pricing decisions.

Why Contribution Margin Matters

Contribution margin tells you whether each incremental sale is profitable before fixed costs. If contribution margin is negative, you lose money on every sale regardless of volume. If it's positive, more sales eventually lead to profitability.

It's essential for break-even analysis and understanding how pricing changes affect profitability. Small changes in contribution margin have outsized impacts on the bottom line.

Contribution Margin vs Gross Margin

Gross margin uses COGS from accounting. Contribution margin uses truly variable costs from an economic perspective. They're similar but contribution margin is more precise for decision-making.

Per-customer economics:

• Monthly subscription: $200
• Hosting cost per customer: $10
• Support cost per customer: $15
• Payment processing: $6

Variable costs = $31

Contribution Margin = $200 - $31 = $169 per customer

Contribution Margin % = $169 ÷ $200 = 84.5%

Each new customer contributes $169/month toward fixed costs and profit.