Definition
Contribution margin is the portion of revenue left after variable costs. It tells you how much each incremental dollar of revenue contributes to covering fixed costs (and eventually profit).
Formula
Contribution margin ($) = revenue - variable costs. Contribution margin (%) = (revenue - variable costs) / revenue.
What to include as variable costs
- COGS (hosting, fulfillment, support directly tied to usage).
- Payment processing fees.
- Shipping and returns (for ecommerce).
- Platform fees (marketplaces, app stores) when they scale with revenue.
How it relates to break-even
Break-even models use contribution (or gross) margin because fixed costs are covered by the margin dollars left after variable costs. If you use net margin, you double-count fixed costs and the model becomes misleading.
How it relates to ROAS
ROAS targets are really contribution margin targets. A campaign can have a high ROAS but still be unprofitable if variable costs and overhead allocations are large.
How to use it in pricing and growth
- Set break-even ROAS or CPA from contribution margin, not revenue.
- Use contribution margin by segment to decide which plans to scale.
- Monitor contribution margin after discounts or channel mix shifts.
Common mistakes
- Mixing fixed and variable costs across periods.
- Using blended averages when margins differ by segment.
- Ignoring refunds or chargebacks that erode contribution.