Contribution Margin Explained: How to Calculate and Utilize It

What is the Contribution Margin?

• Contribution margin is a financial metric that shows how much revenue is available after variable costs to cover fixed expenses and provide profit to the company.

• It is a measure of the amount of money generated per product unit when variable costs involved in its production are subtracted.

• In other words, it represents the incremental money generated for each product/unit sold after deducting the variable costs per unit.

How to Calculate Contribution Margin?

The contribution margin is calculated by subtracting the variable costs from the selling price per unit

The formula for calculating the contribution margin is:

Contribution margin = revenue - variable costs

For example, if the price of a product is $25 and the unit variable cost is $4, then the unit contribution margin is $21

Why Do We Need to Know about Contribution Margin as a Product Manager?

• Analyzing the contribution margin helps managers make several types of decisions, from whether to add or subtract a product line to how to price a product or service to how to structure sales commissions

• The most common use is to compare products and determine which to keep and which to get rid of.

• If a product’s contribution margin is negative, the company is losing money with each unit it produces, and it should either drop the product or increase prices

Conclusion

As a product manager, understanding the contribution margin of each product can help you make informed decisions about pricing, product lines, and sales commissions.

It can also help you optimize variable costs and determine which products are profitable and which should be discontinued

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