On this put up you’ll study:
- Why gross margin is a deceptive metric for decision-making
- Methods to calculate contribution margin and why it issues extra
- The actual math behind why reductions harm far more than you assume
This can be a put up in our collection on Monetary Mastery for eCom Homeowners, particularly Commandment #2: Grasp Your Monetary Statements.
Two merchandise. Similar worth. One has 65% gross margin, the opposite has 50%.
Which one do you push more durable?
Should you stated the 65% margin product, you is perhaps leaving critical cash on the desk. I’ve watched retailer house owners make this error time and again – prioritizing merchandise, killing campaigns, and allocating sources primarily based on a quantity that doesn’t inform the complete story.
Gross margin is likely one of the most looked-at metrics in eCommerce. It’s additionally one of the deceptive.
What Gross Margin Truly 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 have a look at your P&L and see a wholesome gross margin, you’re seeing an incomplete image. Your earnings assertion is supplying you with one massive common throughout all merchandise and all channels – and that common is hiding the reality about what’s really making you cash.
The Metric That Truly Issues
Contribution margin tells you what’s left after ALL variable prices are paid. It solutions the query: “Once I promote this product, how a lot really 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 implausible dwelling fitness center 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.
After we calculate contribution margin – accounting for delivery prices, promoting complexity, and conversion charges – the image flips:
Exercise Bench:
- Larger 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 hundreds 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 house owners wildly underestimate what reductions really price.
Let’s say you promote podcast gloves for $100. (Sure, podcast gloves. Each critical podcaster wants correct hand apparel.)
You’ve obtained 80% gross margins. Fats and wholesome. So you work operating a 20% off sale is not any massive deal – you’re solely giving up 1 / 4 of your revenue, proper?
Fallacious. Very fallacious.
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. Should you spent extra on advertisements to advertise the sale? Even worse.
Why Black Friday Feels Like a Treadmill
Because of this so many retailer house owners really feel exhausted after massive promotional durations.
File income. File orders. File hours labored. And one way or the other… not that rather more revenue to point out for it.
The mathematics is brutal once you don’t perceive contribution margin. You’re working more durable to promote extra models at dramatically decreased actual margins.
Methods to Calculate Your Contribution Margin
Contribution margin isn’t listed in your P&L. You’ll have to calculate it your self, normally in a spreadsheet.
Right here’s the fundamental formulation:
Contribution Margin = Sale Worth – Variable Prices
Variable prices embody:
- Value of products bought
- Buyer acquisition price (for that product/channel – estimates if you need to)
- Delivery and packaging
- Bank card processing charges
- Estimate returns and refunds (some merchandise get returned way more than others)
- Every 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 have been winners is perhaps lagging. Channels you’ve been neglecting is perhaps 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?
Eager 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
