What Is the Contribution Margin, and How Is It Calculated?
Contribution margin accounting was developed in the 1930s based on the understanding that the production quantity as a variable has a significant influence on the period profit of a company. This variable must be put in relation to the fixed costs, as it loses weight in relative comparison the higher the production quantity is. It is, therefore, a matter of calculating the amount needed to cover the fixed costs. This is what makes the contribution margin so crucial in price and margin calculation.
Fixed costs are divided into product fixed costs (for example, certificates), fixed costs of a product group (for example, storage costs) and enterprise fixed costs (for example, employee costs). Variable costs describe all costs that increase or decrease with the production quantity (for example, transport costs, raw materials, labor costs).
The various options for calculating the contribution margin (DB1, DB2, DB3, DB4) are ideal for determining the operating result. Also, the calculations provide a breakdown of the cost structure for the respective product and, in combination with suitable measures, enable more efficient production.
Contribution Margin CM 1
For CM 1, there are two different variants to be able to make a statement about the operating success.
- Variant 1 (primarily used)
- Revenue – variable costs = CM1
- Variant 2
- Also known as “relative contribution margin”. If the production force is different (e.g. due to different machines all performing the same process), the so-called “production force” is included as a time unit
Unit contribution margin / time unit = relative CM1
Contribution margin CM 2
CM2 is used to break down the contribution margins a bit further and obtain a result that is easier to analyze. If, for example, different designs have to be produced for product manufacture or special machines have to be used, these are included as fixed product costs.
CM1 – Product fixed costs = CM2
Contribution margin CM 3
There are two different variants for the CM1 to be able to make a statement about the operating success. This also takes into account the group fixed costs that can be assigned to individual product groups.
- CM2 – Group fixed costs = CM3
Contribution Margin CM 4
The DB4 (irrelevant for most small & medium-sized companies) also includes the area fixed costs. Area fixed charges are incurred when individual fixed costs are incurred for different product groups.
- DB3 – Area fixed costs = DB4
Contribution margin calculation – 1,2 & 3 as an example
|Preis in €||Examples|
|Sale Price per Unit||+ 50,00|
|– Variable Unit Cost||– 20,00|
|= Unit contributions margin||= 30,00|
|x Sales quantity (number of pieces)||5.000|
|= Contribution Margin 1||+ 150.000,00|
|– Fixed product costs||– 30.000,00||e.g. Storage Costs|
|= Contributions margin2||+ 120.000,00|
|– Gruppenfixkosten||– 10.000,00||e.g. special machinery|
|= Contributions Margin 3||+ 110.000,00|
|– Area fixed costs||-20.000,00||e.g. administrative costs|
|= Contribution Margin 4||+ 90.000,00|
|– Company fixed costs||– 45.000,00||e.g. personnel costs|
|= Operating profit||+ 45.000,00|
Note: The table is only intended to show in a very reduced form which components are included in the contribution margin calculation. In practice, a large number of other factors are often taken into account. Also, the division between variable and fixed costs is often more difficult than shown here. What is important is the accuracy of the data collection – which on the one hand is decisive for the accuracy of the calculation of important key figures and on the other hand provides clarity when differentiating boundaries.
Contribution Margin and PPC – Importance for the ACoS in Amazon Advertising
The ACoS (Advertising Cost of Sale) quantifies the percentage of costs as a function of the revenue generated by an advertising campaign. To keep product sales profitable in advertising campaigns, it is crucial to either set the target ACoS below the profit margin or at least equal the profit margin. The different variants of contribution margin calculations are ideally suited for this task. Depending on how extensively one wants to include the fixed costs in the contribution margin calculation, DB1, DB2 and DB5 are particularly suitable for Amazon sellers & vendors. These invoices contain the most important fixed cost items and also include the global company fixed costs. The “operating profit” calculated in this way describes the profit margin at the product level, which in turn determines the break-even ACoS in relation to sales.
Contribution Margin ACoS Amazon PPC Example
- VK price per piece = 20€
- Total costs = 14€
- Proportionate fixed costs = 6€
- Variable costs = 8€
- Profit margin = 6€
- Break-even ACoS = 6€ / 20€ = 3 (30%)
The strategies of advertising campaigns on Amazon should, in the best case, not only aim at the break-even ACoS but should also enable the achievement of an ambitious target ACoS. For profitable advertising campaigns, the experts at intomarkets are constantly developing profitable strategies so that customers achieve the best possible results in every product niche.