What is contribution margin?
Contribution margin is the revenue from a single unit (customer, order, or subscription) minus the variable costs to deliver that unit — payment processing, server costs, customer support, shipping, etc. It excludes fixed costs (rent, salaries, R&D). Contribution margin shows whether each incremental sale meaningfully covers variable costs and contributes toward fixed-cost coverage.
The formula
Contribution Margin = Revenue per Unit − Variable Costs per Unit. As a percentage: CM% = (Revenue − Variable Costs) ÷ Revenue. A SaaS customer paying USD 100/mo with USD 25/mo in variable costs (Stripe fees, AWS, support headcount allocation) has a USD 75 contribution margin or 75% contribution margin.
Gross margin vs. contribution margin
Gross margin and contribution margin are related but distinct. Gross margin excludes only COGS (direct production cost). Contribution margin additionally excludes ALL variable costs — sales commissions, transaction fees, customer support, fulfilment. Contribution margin is therefore lower than gross margin and is the cleaner test of unit economics.
Why VCs care about contribution margin
A company with USD 1M revenue and 80% gross margin but 20% contribution margin has expensive variable-cost structure (sales-led, support-heavy) that doesn’t scale with revenue. Contribution margin is the metric VCs use to evaluate whether the business model has true operating leverage — whether more revenue actually generates more profit at the margin.
Contribution margin and LTV:CAC
The “L” in LTV is more accurately calculated as Average Customer Lifetime × Contribution Margin (not Revenue × Lifetime). A SaaS company with USD 1,000 ARR per customer, 70% contribution margin, and 5-year customer lifetime has LTV of USD 3,500 (not USD 5,000). Against USD 1,000 blended CAC, the LTV:CAC ratio is 3.5:1.
Related: Blended CAC, Paid CAC, Organic CAC, Hockey Stick Growth.