Contribution MarginvsGross Margin

Contribution margin measures how much revenue from each unit sold contributes to covering fixed costs and generating profit after variable costs are subtracted. If you sell a subscription for $100/month and the variable costs (hosting, support, payment processing) are $20/month, your contribution margin is $80 (80%). This is the TRUE profit engine — every additional dollar of revenue at 80% CM adds $0.80 directly toward covering fixed costs. Once fixed costs are covered, contribution margin becomes pure profit. DoorDash operated at negative contribution margin for years (-$1.50 per order in 2019), meaning they lost money on every single delivery before even counting corporate overhead.

Gross margin is the percentage of revenue left after subtracting the direct costs of delivering your product (Cost of Goods Sold / COGS). For SaaS, COGS includes hosting, customer support, and payment processing — typically leaving 70-85% gross margins. For e-commerce, COGS includes product costs, shipping, and packaging — typically 30-50% margins. Gross margin determines how much money you have to invest in growth (sales, marketing, R&D). A SaaS company with 80% gross margins has $0.80 per revenue dollar for growth; a hardware company with 30% margins has only $0.30.

The trap is confusing contribution margin with gross margin. Gross margin includes ONLY cost of goods sold. Contribution margin includes ALL variable costs — sales commissions, payment processing, variable customer support, transaction costs. A SaaS company might report 85% gross margin but have 55% contribution margin once you include the 15% variable sales commission and 15% variable support cost. Fundraising on 85% gross margin while operating on 55% contribution margin creates dangerous investor misalignment about unit economics health.

The trap is miscategorizing expenses to inflate gross margin. Some companies exclude customer success, onboarding, or infrastructure costs from COGS to make gross margins look SaaS-like (75%+) when they're really services businesses (50-60%). VCs see through this immediately. If your 'SaaS' has 55% gross margins, you're not a SaaS company — you're a services company with a software wrapper. The valuation difference is 3-5x.

List every cost that increases or decreases proportionally with each additional customer or sale. These are your variable costs. Subtract them from revenue per unit. Contribution Margin = Revenue per Unit - ALL Variable Costs per Unit. Then calculate your break-even: Fixed Costs ÷ CM per Unit = Units needed to break even. Track CM by product line and by customer segment — you'll often discover that 20% of your product mix has negative contribution margin, subsidized by the other 80%.

Calculate gross margin honestly: include ALL costs directly related to delivering your product to one more customer. For SaaS: hosting/infrastructure, payment processing, customer support, DevOps. Formula: Gross Margin = (Revenue − COGS) ÷ Revenue × 100. Target: 70%+ for SaaS, 50%+ for marketplace, 30%+ for e-commerce. Track monthly and investigate any decline — it usually means infrastructure costs are scaling faster than revenue.