What is Contribution Margin?
The contribution margin refers to additional revenue that a company generates after deducting all the variable expenses that go into producing a specific product. It allows e-commerce businesses to calculate their overall profit and provides insights into pricing and product’s success.
Significance of Contribution Margin in E-commerce
The contribution margin is a ratio that shows how much profit a business makes from a product; the higher its value, the better. Here is why contribution margin is important to a business:
- A business can also understand which product lines are more popular and successful amongst customers and which are not. It can help them shift their focus onto products that bring more revenue to the company.
- If the business wants to cut back costs, it can close the lines of products with a minimal contribution margin.
- Based on the contribution margin of certain products, a business can choose to reduce or increase its price to bring forth more revenue to the company.
Prerequisites of Contribution Margin
To calculate the contribution margin, companies require details about the total revenue generated by the product and the revenue cost. It is computed using this formula:
Contribution Margin = Product Revenue Generated – Variable Costs
Use Case with Contribution Margin
Contribution margin helps businesses understand whether a product is worth its production costs. Suppose a company sells a product for AUD20, its variable costs are AUD10 for each product, and its contribution margin is AUD 10.
