What Is Contribution Margin?

Textbook Definition

Contribution margin is a product's or job's selling price minus its variable costs. It represents the amount available to cover fixed costs and generate profit, and can be expressed per unit, in total, or as a ratio of sales.

In Plain English

Contribution margin is what a job leaves after the costs that only exist because you took it, like materials, fuel, and the crew's hours. That leftover helps pay your rent, insurance, and other overhead. If it is negative, the job costs you money.

Why Does Winning on Price Leave Owners Broke?

Because most owners who compete on price know the customer's number to the dollar and guess at their own. They find out what the competitor charged and go under it. They never ask the real question: what does this job cost me to do?

Every job has two kinds of cost. Variable costs happen only because you took the job. Overhead happens either way. When a discount eats more than the job's contribution, you work for free, or worse, to keep someone else's price honest.

Signs you have this problem:

  • You win jobs by finding out the competitor's price and going under it.
  • You have never worked out what a typical job costs you to do.
  • You are busier than ever and have less in the bank.
  • You take jobs at any price because "some money is better than none."
  • You do not have a price you will not go below.
  • Your biggest job of the year made you nervous instead of excited.
A floor price turns "can I win this?" into "should I want this?" Work out yours before the next quote.

What It Looks Like to Win Every Job and Lose Every Coin

From the Fabled Forest · Chapter 15

Dumpster Dani was busier than ever, two trucks every day, and had less in the bank than in the spring. She had just won the library's big moving job by bidding a hundred coins against the coast movers' two hundred and Talon and Beak Freight's hundred and ten. She won jobs the same way every time. She went under.

Doctor Owl asked what the library job would cost her to do. Drivers, fuel, and wear came to twelve coins a day, for ten days: a hundred and twenty. Her ledger showed eight days last month where she had gone under and lost a coin a day. Twenty days of driving had made her four coins.

Dani refused the Talon trick of making it back on extras. She went to the library and told the truth. The librarian found thirty more coins. Dani set a floor of fifteen a day, turned down jobs below it, and made twenty-four coins the next month while driving four fewer days.

Dani's story is Chapter 15 of Accounting and Finance for Small Businesses, Book 2 of Dr. Paul's Fabled Forest Business School Series.

How to Find Your Contribution Margin and Floor Price in 5 Steps

Do this for one typical job first. Then use it on every quote.

  1. List the costs that exist only because you took the job.

    Materials, fuel, crew wages for the job, equipment rental, wear. If you would not pay it without the job, it is a variable cost.

  2. Subtract them from the price.

    That is the job's contribution margin. Positive means it helps pay the overhead. Negative means it takes from it.

  3. Find each job's share of overhead.

    Add up a month of overhead and divide by your usual number of jobs, or working days if job lengths vary. That is the roof each job needs to carry.

  4. Set your floor: variable cost plus overhead share.

    That is your minimum price. Below it, as a rule, say no. Above it, discount if you choose to.

  5. Use the one exception on purpose.

    If a day would otherwise sit empty, a job between variable cost and the floor still puts a little toward overhead. Take it now and then, deliberately. Never just because a competitor went lower.

Dr. Paul's Insight

When you discover you bid a job too low, you have three choices: eat the loss, quietly make it back with surprise charges, or go back and tell the customer the truth. The second one wins the job and loses the customer, and everyone they talk to. The third one feels terrible for ten minutes and often works. Customers remember the business that told them the truth before the bill arrived.

Worked Example: The Same Month, With and Without a Floor Full-price days: 12 at $1,800, variable cost $1,200: contribution $600 a day = $7,200. Under-the-competitor days: 8 at $1,100, variable cost $1,200: −$100 a day = −$800. Total contribution $6,400 − overhead $6,000 = $400 profit for 20 days of work. With a $1,500 floor: 12 full-price days ($7,200) + 4 floor days at $300 ($1,200) − $6,000 = $2,400 profit, working 4 fewer days. Figures are an illustration to show the math, not a projection for your business.

Sample: A Floor Price Worksheet

Work out the floor once. Check every quote against it.

Business: Moving and haulingUnit: One full working day
LineAmount
Crew wages for the day$800
Fuel$300
Tires, oil, and wear$100
Variable cost per day$1,200
Overhead share ($6,000 a month ÷ 20 days)$300
Floor price per day$1,500
Regular price per day$1,800

Sample for illustration. Below the floor, say no. Between $1,200 and $1,500, only to fill a day that would sit empty.

Win It Cheap, Make It Back on Extras?

In the book, a company called Talon and Beak keeps offering owners shortcuts. Every one sounds reasonable. Every one works for a while. Every one costs more than it saves. Here is the one in Chapter 15.

The Shortcut

Win the job with a low bid, then make it back with stairs fees, heavy-item fees, and gate fees written into the contract's small print.

Why It Works for a While

You win every bid, and the real bill arrives after the work is done.

What It Costs

Customers feel tricked and say so to everyone. The next time you bid, nobody believes your number.

A low bid that only works because of hidden extras is not a price. It is a trap. Set an honest floor, quote above it, and put every charge on the front page.

Video: Contribution Margin and Your Price Floor

Video Coming Soon

What Is Contribution Margin? When to Discount Your Price

Dr. Paul calculates contribution margin and a floor price for a service business on screen.

What Does the Job Cost You to Do?

Chapter 15 · Discounting and Contribution Margin

Winning Every Job, Losing Every Coin: A Raccoon's Bid

"Dani," said Doctor Owl. "What does the library job cost you to do?"

"Cost me?" Dani looked up for the first time. "I don't know. I didn't work that out. I worked out what the coast movers charged."

"Then work it out now. You have the ledger."

What did the biggest job in the forest really cost Dani, and what did she do about it? Find out in Chapter 15. Book 2 of Dr. Paul's Fabled Forest Business School Series.

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Contribution Margin Questions

How do you calculate contribution margin?
Subtract the variable costs of a sale or job from its price. If a job sells for $1,800 and its materials, fuel, and job labor cost $1,200, its contribution margin is $600. Divide by the price to get the contribution margin ratio, here about 33 percent.
What is the difference between contribution margin and gross margin?
Gross margin subtracts cost of goods sold, which can include some fixed production costs depending on how your accountant classifies them. Contribution margin subtracts only variable costs, the ones that rise and fall with each sale or job. Contribution margin is the better tool for pricing and discount decisions.
When is it safe to give a discount?
When the discounted price still stays above your floor, meaning the job's variable costs plus its fair share of overhead. Occasionally, filling a day that would otherwise sit empty can justify going between variable cost and the floor. Never go below variable cost, or you are paying to work.
What is a minimum price?
A minimum price, or floor, is the lowest price you will accept for a job. It should cover at least the job's variable costs plus its share of your monthly overhead. Setting it in advance lets you say no quickly to jobs that would cost you money.

Written by Dr. Paul Borosky, DBA, MBA, business consultant, author, and educator with an MBA focused in finance. Want help setting floor prices for your services? See fractional CFO services.

This page is for general educational purposes only. It is not legal, financial, tax, accounting, or lending advice. Tax rules change by place and by year. Dollar figures are illustrations. The Fabled Forest and its characters are fictional. For decisions about your own business, consult a qualified professional.