Contribution Margin
Gross profit minus marketing, payment processing, and variable shipping costs. Contribution Margin = Net Revenue - COGS - Variable Costs. Reflects the real profit each order 'contributes' toward covering fixed costs.
In practice
Contribution margin is more 'financially honest' than gross margin. Gross margin excludes marketing fees, shipping, and payment processing fees. Contribution margin includes everything. If contribution margin is negative, every additional sale means a bigger loss.
Common misconception
'40% gross margin means we're making 40% profit.' No. 40% gross margin, after a 20% ad fee, 8% shipping, 3% processing, and 5% returns, becomes a 4% contribution margin. Many stores grow into losses because they never calculate this.
How to fix it
Negative contribution margin? (1) Identify the biggest driver: CAC? shipping? COGS? (2) raise prices by 5-10% — usually doesn't hurt volume significantly, (3) reduce ad spend — improve CR before spending more, (4) increase AOV via a free-shipping threshold.
Example
A pet supply store: gross margin 42%, felt 'profitable.' Contribution analysis: CAC $27, shipping $5, processing $1, COGS $13, average price $42 = contribution -$4. Every order lost $4. Fix: raise the price $6 plus set free shipping at $55+.
Priority
Calculate contribution margin at least quarterly — by product and by channel. This calculation reveals whether your business is truly profitable or hiding a loss. A store growing gross revenue without growing contribution margin is heading toward bankruptcy.
Related terms
Keep learning. Metrics that touch the same area:
- Gross MarginFinance(Sale price - COGS) / sale price × 100. The basis for every pricing and advertising decision.
- ROI – Return on InvestmentFinanceA general profitability metric: (net profit / investment cost) × 100. Different from ROAS — it includes all expenses.
- AOV – Average Order ValueFinanceTotal revenue divided by number of orders. The biggest lever for increasing revenue without more advertising.
- LTV / CLV – Customer Lifetime ValueFinanceTotal expected profit from a customer over the entire relationship. A healthy LTV:CAC ratio is 3:1.
- COGS – Cost of Goods SoldFinanceThe direct cost of producing or acquiring products sold. Includes: product + import shipping + customs + packaging.
- Cash FlowFinanceThe movement of cash in the business. 'Profitable on paper, broke in the bank' — a common problem in growing stores.
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