How to improve your eCommerce contribution margin, and why you should
Getting a complete picture of your eCommerce profit
To succeed in a competitive online market, every eCommerce business needs to have a clear understanding of how its products are performing – both individually and as part of the bigger picture. That’s where KPIs like eCommerce contribution margin are essential, providing insight into the more granular details of a retailer’s operations and highlighting areas for improvement.
An eCommerce contribution margin is one of the most valuable of these KPIs, showing how much profit is being made off each individual product. That matters because it can help clarify which products are having the greatest, or least, impact. And from there, it’s considerably easier to decide which items to prioritise, optimise, or discard.
You might also see a contribution margin referred to as a contribution profit margin, and in this article, we’ll look at it in more detail and explore how to get the most out of this vital piece of data.
Calculating contribution margin and contribution margin ratios
The formula for calculating a contribution margin is relatively simple. You just subtract the variable costs from the total revenue, and whatever’s left over is the margin. It can also be expressed as a ratio, which you get by a basic formula of:
(contribution margin) ÷ total revenue = contribution margin ratio
It’s clearer with an example. If a business sells a particular item for £250, but there is £100 in variable costs required to produce, market, and distribute it, then the contribution margin would be £150 and the contribution margin ratio formula would look like this:
(150) ÷ 250 = a contribution margin ratio of 60% (although you might see it expressed as 0.6 as well).
The closer your contribution margin ratio is to 100%, the better. But in practice, many eCommerce ratios are much lower. Depending on the business, anything over 50% might be considered pretty good.
Where to start with improving your contribution margin
There are all sorts of ways that you can improve the contribution margin of a particular product. But in basic terms, they all either aim to increase the amount of revenue (by raising the price) or reduce the variable costs.
Each approach will improve your contribution margin, but while raising prices is an easy change to make, it isn’t always possible in a competitive eCommerce market. Reducing variable costs is therefore usually the best place to start, and there are plenty of different ways to do it.
One change that can work particularly well for contribution margin improvements is focusing your marketing spend much more precisely on the products that generate the most return. However, most eCommerce retailers are unable to specify the cost of marketing at a SKU-level – instead it’s usually generalised across product categories. With Google Shopping, for example, those might match the campaign groups that have been set up.
This can mean that within a product category, some SKUs might have much better contribution margins than others, while some SKUs are making a loss. In that case, retailers are paying Google to advertise a product but ending up out of pocket each time it’s sold.
Without being able to understand advertising costs as SKU-level, and calculate contribution margin accordingly, many online retailers are wasting millions in ad spend each year. Our research indicates that 40% of Google Ad spend is wasted annually in the eCommerce industry.
New technology makes the difference
Processing, understanding, and driving marketing activity based on large and ever-changing data sets like a retailer’s full inventory of SKUs is impossible for humans to do. Even the best PPC managers and agencies can only work with the data they can access – which is often generalised (and therefore inaccurate) or outdated.
Machine learning and artificial intelligence technology like Upp. provides a solution, because its superpower is being able to collate and then analyse every single piece of information that relates to a specific SKU. That unmatched insight makes it possible to automatically adjust marketing spend on a product-by-product basis.
This can benefit a contribution margin in two different ways. On the one hand, cutting unnecessary spend provides a clear boost by reducing those all-important variable costs. And on the other, more efficient advertising can increase overall revenue, with Upp. leading to a 52% increase in revenue in the first year, on average.
In this way, marketing can fuel a company’s success – becoming a lever for growth instead of a budgeted cost, and channelling new technology to unlock better contribution margins across the board.
