On this publish you’ll be taught:
- Why gross margin is a deceptive metric for decision-making
- The best way to calculate contribution margin and why it issues extra
- The actual math behind why reductions damage far more than you assume
This can be a publish in our collection on Monetary Mastery for eCom Homeowners, particularly Commandment #2: Grasp Your Monetary Statements.
Two merchandise. Identical value. One has 65% gross margin, the opposite has 50%.
Which one do you push more durable?
If you happen to mentioned the 65% margin product, you could be leaving severe cash on the desk. I’ve watched retailer homeowners make this error again and again – prioritizing merchandise, killing campaigns, and allocating sources primarily based on a quantity that doesn’t inform the total story.
Gross margin is among the most looked-at metrics in eCommerce. It’s additionally some of the deceptive.
What Gross Margin Really Tells You
Gross margin tells you what it prices to fabricate your product and get it to your warehouse.
That’s it.
It doesn’t account for buyer acquisition prices. It ignores delivery and packaging. It skips over bank card charges, returns, and all the opposite variable prices of truly promoting and delivering that product to a buyer.
So once you take a look at your P&L and see a wholesome gross margin, you’re seeing an incomplete image. Your earnings assertion is providing you with one huge common throughout all merchandise and all channels – and that common is hiding the reality about what’s truly making you cash.
The Metric That Really Issues
Contribution margin tells you what’s left after ALL variable prices are paid. It solutions the query: “After I promote this product, how a lot truly goes towards masking my overhead and producing revenue?”
That is the quantity that ought to drive your choices.
Let me present you why with an actual instance.
The Bells of Metal Instance
Kavon Khoozani runs Bells of Metal, a incredible residence health club gear firm. Let’s faux we’re wanting over his shoulder deciding which merchandise to push more durable. (These numbers are hypothetical for illustration.)
He sells two merchandise for $400 every:
Product A: Exercise Bench
- Gross margin: 65%
- Appears to be like nice on paper
Product B: Excessive-Finish Barbell
- Gross margin: 50%
- Appears to be like worse
Straightforward name, proper? Push the bench.
Not so quick.
Once we calculate contribution margin – accounting for delivery prices, promoting complexity, and conversion charges – the image flips:
Exercise Bench:
- Increased delivery prices (cumbersome merchandise)
- Extra advanced promoting required
- More durable to transform clients
- Contribution margin: 30%
- Kavon retains: $120
Barbell:
- Ships cheaper
- Easier sale
- Simpler buyer acquisition
- Contribution margin: 40%
- Kavon retains: $160
The “worse margin” product places $40 extra in his pocket on each single sale.
Multiply that throughout 1000’s of orders and also you begin to see how optimizing for gross margin can quietly price you a fortune.
Why This Destroys Your Low cost Math
This identical blind spot makes retailer homeowners wildly underestimate what reductions truly price.
Let’s say you promote podcast gloves for $100. (Sure, podcast gloves. Each severe podcaster wants correct hand apparel.)
You’ve received 80% gross margins. Fats and wholesome. So you work working a 20% off sale isn’t any huge deal – you’re solely giving up 1 / 4 of your revenue, proper?
Unsuitable. Very mistaken.
Right here’s the actual math:
Your gross margin is 80%, however after accounting for buyer acquisition, delivery, packaging, and bank card charges, your contribution margin is 40%. Meaning $40 per sale goes towards overhead and revenue.
Now you run a 20% off promotion.
You simply lower your actual revenue in half with a ‘small’ 20% low cost.
That $20 low cost doesn’t come off your gross margin. It comes straight off your contribution margin.
$40 turns into $20.
You simply lower your actual revenue in half with a “small” 20% low cost.
And that’s assuming your different variable prices stayed flat. If you happen to spent extra on adverts to advertise the sale? Even worse.
Why Black Friday Feels Like a Treadmill
Because of this so many retailer homeowners really feel exhausted after huge promotional intervals.
File income. File orders. File hours labored. And someway… not that rather more revenue to point out for it.
The maths is brutal once you don’t perceive contribution margin. You’re working more durable to promote extra items at dramatically lowered actual margins.
The best way to Calculate Your Contribution Margin
Contribution margin isn’t listed in your P&L. You’ll must calculate it your self, often in a spreadsheet.
Right here’s the essential formulation:
Contribution Margin = Sale Value – Variable Prices
Variable prices embody:
- Value of products bought
- Buyer acquisition price (for that product/channel – estimates if you need to)
- Transport and packaging
- Bank card processing charges
- Estimate returns and refunds (some merchandise get returned rather more than others)
- Some other prices that scale with every sale
Your Task This Week
Calculate contribution margin for:
- Your high 10-20% of merchandise (those driving most of your income)
- Your high 2-3 gross sales channels
You’ll most likely be shocked by what you discover. Merchandise you thought had been winners could be lagging. Channels you’ve been neglecting could be your most worthwhile.
And subsequent time you’re planning a promotion, you’ll know the actual price earlier than you commit.
Wish to Go Deeper?
Excited about common insights on monetary mastery from the archives of our 7- and 8-figure proprietor neighborhood?
Or need detailed sources, templates and tutorials on how precisely to calculate contribution margin in your small business? If that’s the case,let’s keep in contact
