Contribution margin: meaning and how it differs from gross margin
Contribution margin answers whether each extra sale in a channel makes money.
Definition
Contribution marginContribution margin is the amount each unit sold contributes to fixed costs and profit after all variable costs are deducted. For a product brand, variable costs typically include landed cost, channel commissions, payment fees, fulfilment, returns and advertising that scales with sales. It is calculated per unit or as a percentage of revenue.
How brand owners use contribution margin
Contribution margin is the figure that shows whether a channel works. Take a product with a 60 percent gross margin. On a marketplace, a referral fee, fulfilment fee, advertising per sale and a share of returns can take most of that, leaving a small contribution. In a wholesale channel, the retailer’s margin is larger but advertising and fulfilment costs are lower. The same product can be profitable in one channel and a loss in another.
Decide which costs are variable. Anything that rises with each unit sold belongs here: commissions, payment fees, pick and pack, shipping to customers, packaging inserts, return handling, and advertising if you spend in proportion to sales. Rent, salaries and design work usually do not. Brands that leave advertising out of contribution often overestimate how much they can grow profitably.
Use contribution margin for decisions about price, channel and SKU. A SKU with low contribution may still be worth keeping if it brings first-time buyers, but that should be a deliberate choice. Recalculate when fees change, and calculate it per channel rather than as a company average. Include the realistic return rate for the category too, since returned goods often cannot be resold at full price.
The guide own brand unit economics compares channels, and the launch stage sets contribution targets for the first twelve months.
Gross margin compared with contribution margin
| Gross margin | Contribution margin | |
|---|---|---|
| What is deducted | Cost of goods sold | All variable costs |
| Typical deductions | Product, packaging, freight, duties | Plus commissions, fulfilment, payment fees, returns, scaling ads |
| Changes by channel | Little | A lot |
| Answers the question | Is the product priced well against its cost? | Does each extra sale in this channel make money? |
Related terms
Gross margin
Revenue minus the cost of goods sold, shown as a percentage of revenue.
Landed cost
The full cost of a product once it reaches your warehouse, including freight, duties and fees.
Sell-in
The quantity a brand sells into retailers or distributors, before shoppers buy it.
Go-to-market strategy
The plan for who you sell to first, through which channels, at what price and budget.
Frequently asked questions
How do I calculate contribution margin?
Subtract all variable costs per unit from the net selling price per unit. Divide by the net selling price to get it as a percentage.
Should advertising be included in contribution margin?
Include advertising that scales with sales, such as marketplace ads or performance campaigns. Brand campaigns with a fixed budget are usually treated as fixed costs.
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