Contribution Margin: Proving Marketing’s Return

Contribution margin with marketing strategies helps understand how effective the strategy was. Digital marketing has made its way into the marketing business, but measuring success and cost analysis is not easy. However, doing so is necessary to prove marketing’s return on investment (ROI).

The marketing channels have increased over the past years, which made proving return on marketing investments an even difficult task. However, you can effectively do this with the right tools and make proving ROI an easy task.

What Does Contribution Margin Mean?

A contribution margin is a way of looking at profits differently. While calculating profits, consider the variable costs to get to the contribution margin. 

Contribution margins give a picture of the aggregate sum of revenue left after variable costs that will help cover fixed expenses and provide profit to the firm. Contribution margins usually help in balancing out fixed costs.

Contribution cost is calculated by deducting revenue from variable costs. Whatever amount is left is used to cover fixed costs. Once paid, whatever amount is then left is taken as earnings.

The contribution cost can be taken as a total amount, or ratio or percentage of net sales, or amount per unit product.

How Is Contribution Margin Calculated?

There are different approaches to calculate Contribution margins:

When Computing the Amount

  1. Contribution margin = net sales revenue – variable costs
  2. Contribution margin = fixed cost + net income 

When Computing the Contribution Margin Ratio

Contribution margin ratio = (net sales revenue – variable cost) / (sales revenue)

What Are Variable Costs?

The direct and indirect expenses that a business incurs from the production and sale of products are treated under variable cost.

  1. Raw materials
  2. Product supplies
  3. Wages
  4. Per unit labor
  5. Freight in and freight out

What Are Fixed Costs?

Costs that do not change regardless of the changes in production and sale are fixed costs.

  1. Depreciation
  2. Insurance
  3. Rent
  4. Salaries
  5. Property tax

Importance Of Contribution Margin

When an organization is settling on the cost of selling, contribution margin is frequently utilized as a source for examination. Fixed costs are typically huge; hence, to cover the expenses of a business, the contribution margin should necessarily be high.

If you get a negative contribution margin, it means that your product offering or business is not that profitable. Hence do not keep making the product at the current prices; if it is a high-end product, make some changes and continue the sale. 

Survey the commitment edge for breakeven examination. If you need a figure of the objective number of units to sell in order to achieve breakeven, divide the fixed costs by contribution margin (per unit).

To make achieving the break-even easier, contribution margins can help determine which business products induce higher profits and, likewise, are more essential to produce within given resources.

Products with a high contribution margin are given more preference.

Roadmap To Proving Marketing’s Return on Investment

Marketing ROI: What Is It?

Marketing ROI helps measure the return on investment from whatever you have spent on marketing activities. This works by calculating the return of a single marketing activity or marketing as a whole helps in generating during a given time period. As a result, it helps:

  1. To back up and justify whatever you have spent on your marketing
  2. In deciding the budget placement
  3. To compare marketing effectiveness with competitors

Marketing ROI: Proving Marketing Return on Investment

There are many different approaches to calculate marketing ROI; however, here is what the core formula used at a high level is:

  1. Marketing ROI= (Sales Growth – Marketing Cost) / Marketing Cost
  2. Marketing ROI= (Sales Growth – Organic Sales Growth – Marketing Cost) / Marketing Cost

Critical Elements For Contribution Margin Calculation

Gross Profit

Factoring in the gross profit helps understand the overall revenue generated by marketing efforts and the cost of production of goods and services. Here is what needs to be added to the ROI formula:

= (Total revenue – the cost of goods to deliver a product)

Overall Revenue

Total generated revenue can help marketers gain a better and clearer image of a holistic overview of the efforts of marketers. Factoring in total revenue helps in budget allocation, media planning and also impacts marketing.

Net Profit

If the marketers which to calculate the impact of the marketing efforts, they can add the following to their formula:

= (Gross profit – additional expenses)

Marketing ROI: How To Know If What You Achieved Is A Good Marketing ROI

The ideal and realistic marketing ROI is generally a 5:1 ratio, whereas, in exceptional cases where you outdo your marketing efforts, you can easily score a 10:1 ratio. If you have a 2:1 or above ratio, it is considerable; however, any value below the 2:1 ratio does not indicate any room for profits. 

If your costs and ongoing business expenses are lower than 50% than the sales, you can witness profits on your efforts at lower ratios. 

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