Contribution margin

What it means

Contribution margin is price less variable costs. It is what each sale leaves behind to cover fixed costs and produce profit.

It differs from a percentage margin in working with an absolute amount per unit. That is why it decides what to produce when capacity is the constraint.

The result depends on what the company labels variable. Wages of permanent production staff behave as fixed in the short run, piecework or agency staff as variable. The same product can therefore show a different contribution depending on where the line is drawn, which is why the line has to be set in advance and kept.

How it works in practice

Total contribution across all sales must exceed fixed costs or the month is a loss. From that relationship comes the break-even point in units and in euros.

On an order below the usual price what matters is whether contribution stays positive. A positive contribution always helps cover fixed costs, even if full costing says the job "loses money".

In an online shop we calculate contribution per order, not just per product: the purchase price, shipping, the payment gateway fee and packaging all come off the price. With cheap items it often turns out that a small order brings in almost nothing, and only a minimum order value or a shipping charge helps.

What to watch out for

The "at least it covers overheads" argument dies once the exception becomes the rule. Sell below full costing for long and nobody pays the fixed costs, so losses accumulate.

When machine time or staff capacity is the bottleneck, what decides is contribution per hour of that resource, not per unit. The product with the highest contribution per unit may tie up the bottleneck longest, and a company that favours it without capacity planning earns less overall.