13d • General
Contribution Margin
Contribution margin is the basis of unit economics and likely to be a focal point of future posts and classroom content.
What is your contribution margin (CM)?
Your CM is the difference between your selling price and all variable costs associated with delivering on the service.
- CM = Selling price - variable costs
The CM is what helps you pay the fixed costs of your business (think rent, software licenses, insurance, etc).
Why should you care?
Your business is delivering a service and requires labor hours (unless its automated) and so you have variable costs associated with delivering that service. The higher the CM, the faster you can pay your fixed costs and ideally, pay yourself.
What if you have more than one service offering?
Let's look at an example:
Service 1
- requires 1 hour of labor
- $100 of CM
Service 2
- requires 2 hours of labor
- $150 of CM
What one should you choose?
We will assume that your business is constrained by the amount of labor hours available. This is likely the case in a service business as you and each of your team members only have 24 hours each day.
With this assumption, we MUST look for the contribution margin PER unit of constrained resource. In your case, labor HOURS.
Service 1
- $100 CM / labor hour (100/1)
Service 2
- $75 CM / labor hour (150/2)
Although the total CM is greater for service 2, given that labor hours are limiting your supply, service 1 should be pursued as it provides more CM per labor hour used.
For a further analysis on how CM relates to your total profits, please read the Operating Leverage post here: https://www.skool.com/poor-sams-almanack-7280/operating-leverage
Stay Under Par,
Samuel
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Contribution Margin
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