The Ultimate Guide to Contribution Margin for eCommerce Brands

In the eCommerce world, profitability isn't just about driving revenue. For most brands, the crucial thing is to ensure that you keep as much as possible after you account for all the costs. And that's where the need for knowing the contribution margin comes into play. 

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A lot of eCommerce brands rely on gross profit exclusively when they measure the financial health of their brand. Knowing how to calculate contribution margin and what it means can make a huge difference. Additionally, you also want a tool like Conjura to help you measure this metric appropriately, even down to the SKU level. 

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What is the contribution margin?

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The contribution margin definition is very important because it helps differentiate it from other metrics, such as gross profit. The contribution margin shows how much money your company earns per sale once you cover all costs related to selling that product. Simply put, you learn how much money is spent on the product and selling it and how much profit you're making.  

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On top of that, you get to learn how much each product contributes to the bottom line. Gross profit normally subtracts the cost of goods sold. However, the contribution margin covers way more than that, especially variable costs that the gross profit ignores. That's why the contribution margin is one of the most important eCommerce metrics out there. 

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The difference between your contribution margin and gross profit

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In order to highlight the differences between gross profit and contribution margin, we made a simple table, which you can see below.

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While knowing the gross profit is a great idea, truthfully, you need more accurate insights than that. And that’s where all the contribution margin data comes into play. It helps you focus more on manufacturing costs, scalability, but also narrow down costs specific to that product. Not only that, but the contribution margin is great for knowing the true net value creation per product and channel as well.

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How can you calculate the contribution margin?

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When it comes to calculating the contribution margin formula, it's very easy to understand. You need to use the following formula:

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"Contribution Margin = Net Revenue - COGS - Refunds - Shipping - Ad Spend - Platform Fees - Additional Costs"

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But what does each metric mean? Let's find out:

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• Net revenue is the total revenue you get after discounts, cancellations, and returns
• COGS is the amount it costs you to either purchase or create the product you're selling
• Refunds cover all costs related to refunded products and expenses such as restocking, return shipping, etc
• Shipping entails fulfillment, handling, and postage
• Platform fees: depending on the platform you use, be it Stripe, Amazon, or Shopify, usually they have a fee per sale/month
• There can be other variable/additional costs, everything from transaction costs to packing fees, inserts, or packaging, among many others.

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By adding all these metrics into the mix, you will have a more accurate insight when it comes to the contribution margin. And with more accuracy, you can make better decisions that will have a meaningful, amazing impact when it comes to growing and expanding your business. 

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Why is the SKU-level contribution margin very powerful?

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One of the things that few eCommerce companies do is calculate the contribution margin at the SKU level. It's a missed opportunity if you're not doing this because it can offer a lot of insight when it comes to strategic business decisions. Here’s why you should be doing it:

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• Knowing the contribution margin at the SKU level allows you to price your products smarter. Basically, you can raise prices on the high-performing SKU products. 
• It also allows you to trim the fat. When you calculate the contribution margin at the SKU level, you will find items that look good on paper but drag down your profits.
• Additionally, you can optimize promotions by focusing on higher margins and not just volume. That can prove to be a game-changing approach for any business. 
• Lastly, it gives you the opportunity to avoid ad waste. Those low-margin SKUs that are unable to carry their ad costs should be the first you avoid. And once you do that, it leads to a much better ROI.

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The SKU-level contribution margin gives you info that will make it easier to take ad spend, promotion, and pricing-related decisions. Even within a single product category, individual SKUs can have different performance. For example, one of the shirt colors might have very high return rates, or a product will cost more to ship due to its size/weight. And yes, some products will respond better to ads when compared to others. Discover how Conjura's Product Deepdive insights help brands leverage SKU-level contribution margin data.

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Why most brands don't measure the contribution margin properly?

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As you can see from this article, the contribution margin is extremely important to know, but a lot of the time, eCommerce companies let it slip through the net. It's one of the most valuable eCommerce metrics if you use it right. However, there are certain reasons why companies tend not to calculate this metric.

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For starters, data tends to be fragmented. It takes time and effort to acquire and collate all the data. On top of that, manual reporting can be very difficult to do since you have to manually handle CSV reports, spreadsheets, as well as pivot tables. It can help make that process much easier. Additionally, there's a lack of SKU visibility. Few tools actually offer you subcategory data, and that can be very problematic. 

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And that's where the main problem lies. Most brands don't have the right tools to calculate their contribution margin. Because of that, they rely on inaccurate data that can lead to bad decisions. That's the reason why you want to use a tool like Conjura. Its focus is on unifying all your data, down to every single detail. Not only that, but Conjura also helps calculate the contribution margin automatically across all channels, campaigns, and SKUs. 

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Additionally, you can access other benefits, including:

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• Conjura helps you link the eCommerce platform, fulfillment partners, payment processors, and ad accounts in a single place.
• It gives you SKU-level analysis, and you can break down performance for every channel, variant, SKU, and so on.
• You'll also get proactive alerts. That means in case any SKU falls behind the profitability threshold, you will be the first to know.
• You get cohort insights, which means you can see how customers and products actively contribute to the contribution margin.
• There's a great dashboard system to ensure that you can easily assess the contribution margin without having to calculate it manually.

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Does it help if you calculate the contribution margin?

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The short answer is yes, and there are plenty of companies that already do it, with help from Conjura's detailed tools. A fashion retailer used Conjura and discovered that around 40% of their ad budget was spent on SKUs with a negative contribution margin. Reallocating the budget helped boost their net profit by around 22% in just 3 months. 

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Another great example is a DTC furniture brand that used Conjura to help test its discount levels. What they realized is that 10% discounts were maximizing the contribution margin, even if 20% discounts were increasing the revenue. It's simple info like this which can help refine your strategy. That's why you want to know the contribution profit eCommerce strategy is ideal, and of course, you need to have access to all the info.

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What does the contribution margin reveal?

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When you check the profit margin, you might have products that have the same revenue. And in that case, you go ahead and keep selling both of them because they contribute to the total revenue. But that's where the problem drains a lot of time. When you use a tool like Conjura, it becomes much easier to see just how good of a contribution margin a product has…not bad eh?!

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For example, we have 2 products that are sold for $100 each. However, product B requires more ad spend, shipping costs more, same with refunds. Even if that product seems to deliver great profits, the truth is that it just drags down your profits. The best approach here is to focus more on product A because it has a higher contribution margin and not focus as much on product B since it's not as profitable as you might expect. 

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It's simple info like this that can help you better decide which one of the products offers great results. Without accurate info, it's very easy to think that everything is going fine. But truthfully, when you know how to calculate contribution margin or use a dedicated tool for that, things are much easier to understand. You can avoid expensive mistakes while streamlining your profits and focusing on the best possible outcome.

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Why is it important to know the contribution margin of each product?

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Knowing the contribution margin is crucial for any ecommerce business. In fact, it's one of the most important ecommerce metrics thanks to its accuracy and detail. And you can expect many benefits and info from it, such as:

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• The contribution margin offers a great insight into profitability. Even if the gross profit shows that a product might be successful, that doesn't always tell the whole story. With help from the contribution margin, you have all the information there, ready to go and accessible at any given time. 
• Once you identify the highest margin channels and SKUs, you will be able to focus your budget and energy on the stuff that works very well. And that's possible thanks to knowing the contribution margin.
• Additionally, the contribution margin helps with campaign optimization. You know what campaigns will drive profits, not just sales. And that's because a product might seem profitable, but it's not always the case. In this situation, you know what drives profits, and in doing so, you can obtain a much better ROI.
• With the contribution margin, you have a good idea of how you can drive smarter decisions about promotions, bundling, inventory, and pricing. The focus here is to make choices based on what brings the most profits. You have all the accurate data you need, and that can prove to be extremely useful.

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The thing we have to realize is that knowing the contribution margin becomes mandatory if you want to have a profitable business. And it's especially true when you have a lot of products that you're selling. You clearly want to differentiate between great sellers and those items that don't contribute that much to the bottom line. Taking into account all costs related to producing and selling a product is mandatory, and that's exactly why the contribution margin has so much value!

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Not all companies decide to calculate the contribution margin because it's difficult to do and it requires manual work. Unless, of course, you rely on a tool like Conjura, which can help do that manually. Once you have access to all your unified data in one platform, everything becomes clearer to understand and take action on.

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Wrapping Things Up

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In order to reach great results with your eCommerce business, it's very important to understand what contribution margin is and how it affects your company. Having a data-driven company is the way to go because all those insights can help you make better decisions while avoiding costly business mistakes. Conjura can help you identify the contribution margin for each product while also delivering exceptional, highly accurate eCommerce insights such as LTV, CAC, Refund Rates etc. The list is endless! If you're looking to grow your business, understand your contribution margin and leverage other important eCommerce insights, then book a Conjura demo today!

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