How to Improve Your Ecommerce Contribution Margin

July 13, 2023

Discover effective techniques to optimize pricing, reduce costs, and boost profitability

How to Improve Your Ecommerce Contribution Margin

Looking to get ahead of your competition on Shopify, Amazon, Walmart, and any of the other sales platforms?

Well, improving your contribution margin is crucial to achieving sustainable growth and profitability for your ecommerce business.

As opposed to profit margin which measures the overall profitability of your business, contribution margin measures the amount of revenue left over after subtracting the variable costs associated with producing your product. 

Contribution margin is a fantastic way to measure how profitable your ecommerce business is, how profitable a particular product line is, and if it makes sense for you to continue selling it at its current price.

Because of the significance that contribution margin holds for your ecommerce business, you need to be careful not to miscalculate your contribution margin. Learn more here 6 Common accounting mistakes that are costing you money

How to calculate your contribution margin

Contribution margin = Revenue - Variable costs

Your ecommerce contribution margin is your revenue minus your variable costs.

While there are some different schools of thought here, this is what we've found is the most meaningful way to break this number down:

Step 1: Gross Revenue - Discounts, Returns, Disputes = Net Revenue

Step 2: Net Revenue - Products COGS - Shipping & Fulfillment - Merchant Fees = Gross Margin

Step 3: Gross Margin - Variable Marketing Costs = Contribution Margin

Working with thousands of different ecommerce brands, this is the method we've seen most widely used to track this crucial KPI across multiple selling platforms - Shopify, Amazon, Walmart, Etsy, Ebay, Multi-channel, wholesale, etc. and across multiple industries - home goods, CPG brands, fashion...the list goes on.

What is a good contribution margin for ecommerce?

The specific contribution margin benchmark to aim for varies across sales platforms, marketplaces, and industries but as a general rule, where ever you are starting out, you'll want to constantly focus on increasing this number. The higher your contribution margin, the more money you have available to cover overhead expenses and fixed costs.

Your minimum contribution margin target should be higher than your fixed costs. If not, you'll be at a net loss and won't be able to cover your expenses.

Take a look at your fixed costs or operating costs (OPEX)- including rent, office supplies, salaries, fixed marketing costs, legal fees, etc. If the total fixed costs come out to $500,000, your contribution margin should be at least $500,000 to break even and higher than that to actually realize a net profit.

Here is an example of what some fixed costs may include:

On average, ecommerce contribution margins we see are between 35% to 65% of net sales. Anything over 50% is pretty good, assuming it covers all your fixed costs (if not, it's time to reduce your fixed costs).

So, if your contribution margin is below 50% or you are just looking to improve your profit even more, how do you increase your contribution margin?

Here are five effective strategies...

How to improve your contribution margin

1) Review Your Pricing Strategy

Review and refine your pricing strategy to maximize revenue and your contribution margin.

  1. Conduct market research to understand your target audience and competitors' pricing.
  2. Consider value-based pricing by emphasizing the unique benefits and value your products offer.
  3. Experiment with dynamic pricing, offering discounts or incentives during slow periods to stimulate sales.
  4. Bundle related products or upsell complementary items to increase average order value (AOV) and maximize revenue.

Learn how to find your ideal selling price here How to calculate the ideal selling price for your product

2) Cost Optimization

Consider these cost-saving measures to optimize your costs:

  1. Evaluate your supply chain and negotiate better terms with suppliers to reduce costs.
  2. Optimize inventory management to avoid overstocking and minimize storage costs.
  3. Leverage technology to streamline processes, reduce manual work, and improve operational efficiency.
  4. Opt for cost-effective marketing strategies, such as targeted online advertising and social media campaigns, to optimize your marketing spend.

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3) Improve Conversion Rate and Average Order Value

Enhancing your conversion rate and average order value can significantly impact your contribution margin:

  1. Optimize your website's user experience to improve conversion rates.
  2. Implement effective upselling and cross-selling techniques during the purchasing process.
  3. Offer personalized product recommendations based on customer browsing and purchase history.
  4. Create a sense of urgency with limited-time offers or exclusive discounts to encourage larger purchases.

4) Customer Retention and Repeat Business

Focusing on customer retention helps increase customer lifetime value (LTV) and improves your contribution margin:

  1. Make sure to always provide exceptional customer service to build trust and loyalty.
  2. Implement customer loyalty programs or referral programs to encourage repeat purchases.
  3. Leverage email marketing to stay engaged with customers and offer personalized promotions or discounts.
  4. Collect and analyze customer feedback to address concerns and continually improve your products and services.

5) Streamline Operations and Reduce Overhead Costs

Efficient operations and reduced overhead costs contribute to a healthier contribution margin:

  1. Automate repetitive tasks and leverage technology to streamline processes and reduce manual labor.
  2. Implement lean inventory management practices to minimize waste and optimize storage costs.
  3. Explore opportunities for outsourcing non-core activities to reduce overhead expenses.
  4. Continuously assess and optimize your operational workflows to improve efficiency and reduce costs.

Conclusion

Remember, every ecommerce business is unique, so it's essential to analyze your specific situation and tailor strategies to your business needs. Continuously monitor your financial performance, analyze data, and adjust your strategies to optimize your contribution margin. 

Using AI, automated accounting and bookkeeping that is tailored for ecommerce to give you easy access to accurate real-time financials is key to keeping your finger on the pulse of your contribution margin.

Use Finaloop and watch the immediate financial impact of your actions and make real-time decisions.

Sign up HERE to get your financials set up today.

About Finaloop

We are a technology company providing automated end-to-end accounting service to ecommerce businesses. Our system connects to your apps, syncs all your data, and reconciles your books in real-time, replacing your bookkeeper. We offer reconciled books available 24/7, tax-saving insights, and a single place for all your financial data.

*The information provided on this website does not, and is not intended to, constitute legal advice. All information, content, and materials available on this site are for general informational purposes only. Readers are advised to consult with their attorney or accountant with any questions or concerns.*

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