To increase your Contribution Margin in e-commerce, you can try to spend less money on things like shipping by negotiating with shipping companies about better rates, or finding cheaper raw materials for your products. Another way is to sell more – you can do this by advertising to more people, reaching out to new groups of customers, or adding extra products that go well with what you already sell.
Let’s continue our discussion to best utilize the Contribution Margin calculation.
The Contribution Margin Ratio
The Contribution Margin Ratio is closely associated with the Contribution Margin Formula introduced in Part 1, which indicates the percentage of a company’s revenue allocated to cover fixed expenses.
Read More:
Why E-Commerce Contribution Margin Is Important?
The formula is as follows:
Contribution Margin ratio = (Sales Revenue – Variable Costs) / Sales Revenue |
Let’s look at an example with comparisons:
Product A
- Selling Price: $15
- Variable Costs: $5
- Contribution Margin for Product A: $15 (Selling Price) – $5 (Variable Costs) = $10
- Contribution Margin ratio = 66%
Product B
- Selling Price: $25
- Variable Costs: $22
- Contribution Margin for Product B: $25 (Selling Price) – $22 (Variable Costs) = $3
- Contribution Margin ratio = 12%
Pricing Strategies for Product A vs Product B
In this case, you might decide to offer a discount on Product A without going below its $10 Contribution Margin. This ensures you’re still making a profit even with a lower price. Whereas Product B highlights an area for concern with its slim margin, meaning there’s limited flexibility in pricing, and it contributes less to covering fixed costs. A closer look is needed to determine if adjustments are necessary, such as cost reduction or pricing strategy changes.
What Is a Good Contribution Margin?
A higher ratio, closer to 100%, indicates efficient cost management, leaving more revenue to cover fixed costs and generate profit. Realistically, this ratio often falls well below 100% and even below 50% due to various variable costs.
It’s a common belief that a good Contribution Margin hovers around 25%. Factors including business size, industry sector, and the nature of its products or services can influence your company’s ability to achieve a higher or lower margin.
It’s essential for you, as a business owner, to conduct a thorough analysis of your unique circumstances. This analysis will help you pinpoint the Contribution Margin that best aligns with your company’s specific needs and objectives.
How Can We Improve Our Contribution Margin?
Two avenues for enhancing Contribution Margins: either seeking ways to boost revenues or implementing measures to decrease variable costs:
Increase Business Revenue
- Price Optimisation: Consider increasing prices for products or services with solid demand, but be cautious not to overprice and decrease sales volume.
- Bundle and Upsell: Implement upselling and cross-selling techniques to encourage customers to purchase higher-margin items.
- Strategic Marketing: Focus your marketing efforts on high-margin products or services while avoiding excessive marketing expenses that could erode margins.
- Customer Segmentation: Offer personalised pricing or incentives to high-value customers without compromising overall margins.
- Long-Term Strategic Planning: Consider diversifying product or service offerings to tap into higher-margin segments but assess the associated costs and risks.
Reduce Variable Costs
- Operational Cost Control: Identify and reduce unnecessary variable costs across your operations while maintaining product or service quality.
- Negotiate with Suppliers: Negotiate lower variable costs with suppliers, such as materials or shipping fees, while meeting quality standards.
- Automate Processes: Invest in technology and automation to reduce labour and operational costs without sacrificing quality.
- Regular Financial Analysis: Continuously analyse your financial statements to track and measure the impact of cost-reduction efforts on Contribution Margins.
Contribution Margin analysis allows you to assess the financial implications of cost fluctuations and pricing changes. This proactive approach equips you to mitigate financial risks and respond effectively to the ever-evolving market dynamics.
This article is originally published by Aspire:
Aspire is the all-in-one finance platform for modern businesses, helping over 15,000 companies save time and money with international payments, expense management, payable management, and receivable management solutions — accessible via a single, user-friendly account.
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