Legal Definitions - contribution margin

The contribution margin is a financial metric that represents the revenue remaining from the sale of a product or service after covering its direct, variable costs of production. These variable costs are expenses that change in direct proportion to the volume of goods or services produced, such as raw materials or direct labor for a specific item.

Essentially, the contribution margin is the portion of sales revenue that "contributes" to covering a business's fixed costs (expenses that do not change with production volume, like rent or administrative salaries) and ultimately generating profit. It helps businesses understand the profitability of individual products or services and how much money is available to cover their overhead expenses.

• Example 1: A Custom T-Shirt Printing Business

  Imagine a small business that prints custom designs on t-shirts. They sell a custom-designed t-shirt for $25. The direct costs associated with producing one t-shirt include the blank t-shirt itself ($7), the ink used for printing ($2), and the packaging ($1). These are the variable costs, totaling $10 per t-shirt.

  The contribution margin for each custom t-shirt is $25 (selling price) - $10 (variable costs) = $15. This $15 is the amount that each t-shirt sale contributes towards paying for the business's fixed costs, such as the monthly rent for their workshop, the salary of their graphic designer, and utility bills, before any overall profit can be realized.

• Example 2: A Digital Marketing Agency

  Consider a digital marketing agency offering a social media management package to clients for $1,000 per month. For each client on this package, the agency incurs variable costs such as specific software licenses used only for that client's campaigns ($50), and a portion of a freelance content creator's fee directly attributable to that client's posts ($150).

  The contribution margin for each social media management package is $1,000 (package price) - $200 (variable costs) = $800. This $800 per client per month is what the agency has available to cover its fixed costs, like office rent, full-time employee salaries (account managers, administrative staff), and general marketing efforts, ultimately leading to the agency's overall profit. A higher contribution margin per client indicates greater efficiency in covering overhead and generating profit.