Contribution Margin

• financial metric
• how much revenue remains after deducting variable costs (materials, labour, other costs directly associated with production or service delivery
• the amount of revenue available to cover fixed costs (rent, salaries, marketing expenses) and to contribute to generating profit
• assess profitability at a product, service or business unit levels
• relevant when evaluating the ROMI= how much each sale contributes to covering fixed costs = how much to invest in marketing and where to allocate resources for the best possible return

Example

• company sells a product for $100
• variable costs (e.g. materials, labour) are $40, the contribution margin is $60 (contributes towards covering fixed costs and generating profit).
• with fixed costs of $30 per unit (e.g. marketing and other overheads),
• the profit per unit would be $30 ($60 contribution margin minus $30 fixed costs).

Marketing budget allocation

• determine how much of the revenue from each sale can be reinvested in marketing without cutting into fixed costs or profits
• product generates a high contribution margin = justification of greater marketing spend to maximise sales
• lower contribution margin = tighter control over marketing budgets

Product and campaign profitability

• which products to market more aggressively
• higher contribution margins contribute more towards covering fixed costs and generating profit = prime candidates for increased marketing focus
• Marketing campaigns driving sales of high-margin products = deliver better overall profitability.

Pricing and discount strategies

• decide on pricing or discounts to boost sales of lower-priced items only if the contribution margin remains high enough to cover additional costs
• variable costs are too close to the product’s sale price, increasing marketing spending = a negative return on investment (ROI).

Assessing break-even point

• break-even point=the level of sales needed to cover all costs
• direct marketing efforts towards reaching or surpassing the break-even point
• investment of $10,000 in a marketing campaign for a product that has a contribution margin of $60 per unit = sell at least 167 units to cover the marketing costs ($10,000 / $60 contribution margin per unit = 167 units). Any additional sales beyond this point would generate profit.

Improve ROMI

• improve ROMI by focusing marketing budgets on products or services with a higher contribution margin
• boosts with marketing campaign the sales of a product with a high contribution margin = > the revenue will more effectively cover the campaign costs and contribute to profitability

Target high-margin products

• which products or services to promote?
• High-margin products = More aggressive marketing spend (each additional sale contributes more to fixed costs and profit.)
• use the contribution margin to track the effectiveness of marketing campaigns in real-time
• marketing campaigns for certain products fail to cover their associated costs? reduce marketing spend or focus on different products with higher contribution margins.

Evaluate cost structures

• products with high variable costs and lower contribution margins = require more precise, targeted marketing campaigns to maintain profitability
• products with low variable costs allow for broader, more scalable marketing efforts