What is contribution margin?
Contribution margin is the revenue left after subtracting variable costs from sales. It shows how much each sale contributes toward covering fixed costs and generating profit, after the direct costs of delivering that sale are accounted for.
In promotions and loyalty, it answers the practical question: after the discount, reward, or incentive is applied, is this sale still worth it?
Contribution margin formula
The basic formula is:
Contribution margin = sales revenue - variable costs
The contribution margin ratio expresses this as a percentage of revenue:
Contribution margin ratio = Contribution margin / sales revenue
Example:
- A product sells for €100
- Variable costs total €60
- Contribution margin: €100 - €60 = €40
- Contribution margin ratio: €40 / €100 = 40%
That means 40 cents of every euro stays to cover fixed costs and profit.
What counts as a variable cost?
Variable costs are the costs that change directly with each sale. Common examples include:
- Cost of goods sold
- Shipping and fulfillment
- Packaging
- Payment processing fees
- Marketplace or platform fees
- Commissions
- Promotional discounts or rewards
Fixed costs – rent, salaries, software subscriptions – are not included. Contribution margin is about what changes per sale, not what the business costs to run.
Contribution margin vs. gross margin
These two metrics are often confused. The difference matters when evaluating campaign and product-level decisions.
Contribution margin after incentives
Discounts reduce contribution margin because they reduce the revenue left after variable costs.
Example:
- Product price: €100
- Discount: €20
- Net sales after discount: €80
- Variable costs: €60
- Contribution margin after discount: €80 - €60 = €20
Without the discount, the contribution margin was €40. With the discount, it drops to €20.
The campaign needs to create enough incremental value to justify the lost margin. For example, it may still make sense if the discount drives a first purchase, increases order value, activates a dormant customer, or improves repeat purchase behavior.
Why contribution margin matters for promotions
Promotions change contribution margin fast. A 20% discount does not just reduce the selling price. It reduces the amount left after variable costs. Add free shipping, loyalty points, referral rewards, or cashback on top, and the campaign may start looking a little less heroic.
Contribution margin helps brands understand:
- Whether a discount still leaves enough margin
- Which products can safely be promoted
- Which offers drive profitable growth
- Which customer segments are expensive to convert
- Whether a campaign increases revenue but reduces profit
- How much incentive value can be offered without overpaying
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