Unit Economics

intermediate📖 6 min read

Contribution Margin

Also known as: CMUnit ContributionVariable Profit MarginContribution Profit

Contribution Margin = Revenue per Unit − Variable Costs per Unit | CM% = (CM ÷ Revenue) × 100

💡The Concept

Contribution margin measures how much revenue from each unit sold contributes to covering fixed costs and generating profit after variable costs are subtracted. If you sell a subscription for $100/month and the variable costs (hosting, support, payment processing) are $20/month, your contribution margin is $80 (80%). This is the TRUE profit engine — every additional dollar of revenue at 80% CM adds $0.80 directly toward covering fixed costs. Once fixed costs are covered, contribution margin becomes pure profit. DoorDash operated at negative contribution margin for years (-$1.50 per order in 2019), meaning they lost money on every single delivery before even counting corporate overhead.

⚠️The Trap

The trap is confusing contribution margin with gross margin. Gross margin includes ONLY cost of goods sold. Contribution margin includes ALL variable costs — sales commissions, payment processing, variable customer support, transaction costs. A SaaS company might report 85% gross margin but have 55% contribution margin once you include the 15% variable sales commission and 15% variable support cost. Fundraising on 85% gross margin while operating on 55% contribution margin creates dangerous investor misalignment about unit economics health.

🎯The Action

List every cost that increases or decreases proportionally with each additional customer or sale. These are your variable costs. Subtract them from revenue per unit. Contribution Margin = Revenue per Unit - ALL Variable Costs per Unit. Then calculate your break-even: Fixed Costs ÷ CM per Unit = Units needed to break even. Track CM by product line and by customer segment — you'll often discover that 20% of your product mix has negative contribution margin, subsidized by the other 80%.

⚡Pro Tips

Use contribution margin to decide pricing floors. Your price can never go below variable cost per unit or you lose money on every sale. During discounting or promotional pricing, the floor is your variable cost — anything above that contributes positively.

Track contribution margin per channel. If paid acquisition customers cost $50 commission and organic customers cost $5 in support, they have very different contribution margins on the same product.

Weighted Average Contribution Margin (WACM) across your product mix tells you the true blended profitability. If your premium product (60% of revenue, 85% CM) subsidizes your entry product (40% of revenue, 45% CM), your WACM is 69%.

🚫Common Myths

✗Myth: “Higher prices always mean higher contribution margin”

✓Reality: Higher prices often come with higher variable costs: enterprise customers require dedicated support ($8K/month), custom integrations ($15K setup), and 15-20% sales commissions. A $50K/year enterprise deal might have 50% CM while a $500/year self-serve deal has 90% CM.

✗Myth: “Negative contribution margin is always bad”

✓Reality: During the land-and-expand phase, negative CM on the initial sale can be strategic IF the expansion revenue has high CM. Amazon Web Services initially priced below cost to win customers, knowing that usage expansion would generate massive positive CM over time.

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