← Business Metric: Financial (all topics)
Gross margin & contribution margin
What it is
Gross margin is revenue less direct cost of goods, as a percentage of revenue. Contribution margin goes further, deducting only genuinely variable costs, so it shows what each incremental unit adds toward fixed costs
The gap between the two is the fixed cost embedded in production
Impact on industries
- Contribution margin is the correct basis for pricing, discounting and capacity decisions, because it isolates what changes with volume
- Gross margin trends reveal input cost pass-through and mix shift earlier than operating margin, which is muddied by overheads
- Classification of costs between fixed and variable is a judgement, so contribution margin is easy to define favourably
- A high gross margin with a low operating margin points to an overhead or distribution problem rather than a pricing one