Gross margin is one of the most familiar numbers in ecommerce. It helps you understand how much revenue remains after accounting for the cost of the products you sell. But gross margin and contribution margin are not the same thing.
The difference may seem small on paper, but it can change how you understand the economics of your products, orders and overall ecommerce business.
What Is Gross Margin?
Gross margin shows how much revenue remains after deducting the cost of goods sold (COGS).
The formula is:
Gross Margin = (Revenue − COGS) ÷ Revenue × 100
For example, if you sell a product for $100 and it costs $40 to purchase or produce, your gross profit is $60 and your gross margin is 60%.
This gives you a useful view of the relationship between your selling price and product cost. It can help you assess product pricing, supplier costs and the overall margin of your product range. But it doesn’t account for every variable cost associated with making a sale.
That’s where contribution margin comes in.
What Is Contribution Margin?
Contribution margin looks at what remains after deducting the variable costs associated with a sale.
A simplified formula is:
Contribution Margin = Revenue − Variable Costs
The exact costs included can vary depending on how a business defines contribution margin. For an ecommerce brand, these may include costs that change as order volume changes, such as fulfilment, shipping, payment processing, discounts and returns.
The key difference is simple:
Gross margin looks at revenue after COGS. Contribution margin looks further into the economics of the sale.
Neither metric is wrong. They are simply measuring different things.
A Simple Ecommerce Example
Imagine an ecommerce brand sells two products for $100 each.
Product A costs $40, while Product B also costs $40. Both therefore have a 60% gross margin.
At first, the two products look identical from a gross margin perspective. But Product A might have $10 in variable costs associated with each order, while Product B might have $25.
That means the amount each product contributes after those variable costs is different, even though their gross margins are exactly the same. This is where looking at contribution margin at SKU level becomes useful. It helps you see the economics of individual products rather than assuming that products with the same gross margin contribute equally.
The point isn’t that one margin is better than the other. It’s that they give you different information about the same product.
How to Get a Clearer Picture of Your Ecommerce Margins
Once you understand the difference between gross margin and contribution margin, the next step is making sure you’re actually using the right numbers in your ecommerce business.
Map Every Variable Cost Per Order
COGS, fulfilment, shipping, payment processing, platform fees, packaging, returns provision. If it varies with each order, it belongs in the calculation.
Calculate Contribution Margin at SKU Level
Don’t rely only on an overall business-wide margin.
Calculate contribution margin at the SKU level so you can see how individual products perform. Two products with the same gross margin can have very different contribution margins once their variable costs are considered.
This gives you a more accurate view of your product-level profitability and ecommerce unit economics.
Feed Contribution Margin Into Your Bidding Model
If you’re using paid search or other automated bidding systems, contribution margin can be incorporated into your bidding and performance models. This helps align your marketing decisions with the actual economics of the products you’re selling rather than treating every dollar of revenue as having the same value.
Update Quarterly
Your numbers aren’t fixed.
Shipping rates, fulfilment costs, payment fees, supplier pricing, return rates and other variable costs can change over time. Review your contribution margin calculations at least quarterly to make sure you’re working with current numbers.
A margin calculation is only useful when it reflects the economics of your business today.
Final Takeaway
Gross margin and contribution margin both play an important role in understanding ecommerce performance, but they are not interchangeable. Gross margin helps you understand the relationship between revenue and COGS, while contribution margin takes additional variable costs into account. Looking at both gives you a more complete understanding of your product economics and what each sale contributes to your business.
If you’re unsure how your current margins are being calculated or want to understand your contribution margin at a deeper level, get in touch with BuffYellow. We can help you look at the numbers behind your ecommerce business and understand what they mean for your growth.