Ecommerce Contribution Margin: What It Is and How to Improve It

Ecommerce contribution margin is the metric most founders ignore and it’s quietly killing your profit.

Could you be missing thousands of dollars in profit without knowing it? Ecommerce store owners are so interested in growing sales that they ignore the optimizations that really impact profit growth: contribution margin. Knowing how to evaluate this metric is the key to transforming revenue into profit. If you want to be in business in 2024 and beyond, being able to evaluate and improve your contribution margin is non-negotiable.

Let’s say you’re growing quickly, but your profit isn’t. You’ve increased your advertising campaigns and offered discounts to drive sales, but are you stuck in that traffic and discounts cycle? High sales volume of your products isn’t the be all and end all. Knowing how to impact contribution margin is the true driver of ecommerce business growth. Simply put, contribution margin is how much of your revenue is converted into profit after variable costs. The higher your contribution margin, the more useful and profitable your sales are.

Why Contribution Margin Should Be Your Top Priority?

When consulting with ecommerce owners, one of the first things we’ll analyze is traffic, conversions, and average order value. All of those are important, but they don’t lead directly to profit. If you think of your business as a bucket, traffic is like water. If your conversions and average order value isn’t good, then your bucket probably has a leak. Contribution margin measures how big that leak is. There are a number of reasons that drive costs up: product costs, packaging, shipping, and advertising. Contribution margin shows you where your profit can flow freely and shows you how to fix the leak.

The big mistake is that many brands pursue higher sales, believing that more traffic means guaranteed profits, without considering profitability per order. This often means sacrificing margins for volume. You may have high revenue but may have low profitability since high variable costs are unmanaged or not considered.

Research by McKinsey states that 65% of profit loss within the retail industry can be attributed to costs and pricing that is not managed. Contribution margin helps to pinpoint which overhead costs are unnecessary, pricing optimally, and ensure that you have a healthy, survivable business.

What is Contribution Margin?

Contribution Margin is expressed as:

CM = ( Selling Price – Variable Costs ) ÷ Selling Price

This formula essentially shows us what good of every dollar earned will be actual profit.

For example:

With a good that sells for 50$, and the associated variable costs (ads, shipping, commissions) are 30$.

Contribution Margin = (50 – 30) ÷ 50 = 40%.

This means that 40% is the true profit potential for every sale (before fixed costs) This means that you have more profitability, and will be able to invest more your business.

Why is Contribution Margin More Important than Gross Profit?

Gross profit is a measure of how much a company earns after direct costs. Contribution margin is a more informative measure that only considers sales-related costs. Contribution margin helps better inform future decisions.

Pricing decisions and advertising decisions also more opportunities based on contribution margin. Without this measure optimized profitable operations explode.

A Statista survey shows that companies prioritizing contribution margin optimization see 25% more profit than competitors in the same fiscal year.

What Causes the Margin Devastation?

1. Excessive Variable Costs

Costs associated with commission payouts of sales transactions and fulfillment costs can be so large that they obliterate the contribution margin. A 2023 report from Shopify showed that poor management of fulfillment costs can cause profit margins to drop by 20%

2. Bad Pricing

A significant margin can be diminished by setting your prices too low in the hopes of achieving higher volume of sales. A lack of seasonal price changes or price inflating due to higher costs of purchasing advertisements can also create lower margins and diminish profit.

3. Ineffective Advertising

Poorly designed and directed advertisements can be a waste of money and make advertising costs unprofitable. A McKinsey report states that advertising costs can be 30 to 50% loss of the contribution margin

4. Product line Issues

The overall profit of a company can be decreased by offering low margin products. It is too common of an occurrence that businesses are providing products with poor margins.

5. Pricing Strategy Change

Boosting sales by lowering prices is not the only option. Consider using flexible pricing, upselling, or bundling to increase the average order value. For instance, bundling together customer favorites can increase the margin per sale.

6. Improved Logistics for Cost Reduction

Fulfilment providers can be negotiated at lower prices. Analyze the data to determine which carrier added the lowest cost. Order management can be automated using Twinr and other No-Code applications. This helps eliminate waste and helps consolidate order management.

7. Concentration on High Margin

Identify profitable SKUs through data analytics. Promote and cross-sell strategically. Consider creating exclusive cutout bundles to eliminate the low-margin clutter.

8. Technology for Efficiency

Customized workflow systems for Twinr Apps are created. Labor costs are reduced through order tracking and customer engagement bots. This optimizes investment through resource allocation.

9. Improve Customer Experience

Creating a network effect is driven by customer satisfaction. Customer retention is improved through personalized offers and loyalty messaging, which increases customer lifetime value (CLV) and protects margin.

10. Marketing Spend Optimization

Internal analytics and data are critical for tracking customer acquisition cost (CAC) vs customer lifetime (CLV) to determine the return on investment for each marketing dollar spent.

Contribution Margin Should Be Top Of Mind for All E-Commerce CEOs

With the competition increasing for the year 2024, many e-business leaders place focus on just volume, which greatly diminishes profit. However, the real cash inflow is from contribution margins. The higher the margins, the greater the cash inflow, flexibility, and long-term viability.

According to industry margins, contribution margins increasing by 1% will lead to greater cash inflow by hundreds of thousands.

The best part of this is you can implement strategies today. Reassess your costs, review your pricing, and identify losses due to lack of automation. Use Twinr to create automated processes to help maximize contribution margins.

Take the Reins: Transform Your Website into a Profit Powerhouse

The average e-business is obsessed with traffic and volume. However, the true focus should be on the margins. Being able to understand your contribution margin is what will differentiate you from your competition. The ability to understand your contribution margin will help you make the right investments and help expand your e-business faster than anyone else.

Curious about how automation can help your e-business grow? Twinr can help you differentiate your e-business by giving you the automated processes that will allow you to take the reins and grow your business without the help of developers.

FAQs:

What would e-commerce consider as a healthy contribution margin?

A healthy contribution margin is usually 30%–40% across most industries. Digital goods often have a contribution margin above 50%. Luxury products often have a better contribution margin above 50%. Low-margin goods and products sold in bulk usually have a contribution margin around 20%.

How often should I be reviewing my contribution margin?

You should be reviewing your contribution margin at least at a minimum of 3-month intervals. You should also review after there are major changes in product costs, selling prices, or if a new product is introduced.

Is it possible to increase contribution margin without increasing prices?

Yes. There are many ways to increase contribution margain. You can do this by decreasing the variable costs of a product, improving operational processes within the business, or even increasing the average order sizes through methods of bundling or upselling to your customers.

How can customer engagement apps impact the contribution margin of a business?

Retention apps and apps that increase the size of customer orders, CLV, and thus contribute to improving contribution margin. An example of such apps are loyalty programs and promotional push notifications directed to customers.

What should I do to increase my e-commerce contribution margin?

You should have your costs and prices analyzed in detail, then target and select the most strategic adjustments. You should also focus on areas that have the least contribution margins. Finally, you should consider utilizing automated workflow systems like Twinr.