Contribution Margin
Revenue minus variable costs, representing the amount each unit sold contributes toward covering fixed costs and generating profit.
What is Contribution Margin?
Contribution margin is the revenue remaining after all variable costs are subtracted, representing the portion of each sales dollar available to cover fixed costs and ultimately generate profit. It can be expressed in total dollars, per unit, or as a percentage of sales (contribution margin ratio). The formula is: Contribution Margin = Revenue − Variable Costs. A higher contribution margin ratio means a greater proportion of each revenue dollar flows toward covering fixed costs. Contribution margin is a core concept in break-even analysis — the break-even point (in units) equals fixed costs divided by the contribution margin per unit. It is also essential in make-or-buy decisions, pricing strategy, and product mix optimization.
Example
A software company charges $100 per month for a subscription. Variable costs per subscription include $5 in hosting, $3 in customer support, and $2 in payment processing — totaling $10 in variable costs. The contribution margin per unit is $90 ($100 − $10), and the contribution margin ratio is 90%. If fixed costs (development, offices, management) total $900,000 per month, the break-even point is $900,000 ÷ $90 = 10,000 subscriptions. Each subscription above 10,000 generates $90 of pre-tax profit.