Contribution margin
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Revenue minus the variable costs of serving that revenue. What each dollar of revenue contributes toward covering fixed costs and profit.
Contribution margin is what is left after you subtract the variable costs of delivering your product. Revenue minus COGS (cost of goods sold) minus variable sales and marketing costs. It tells you how much each dollar of revenue contributes toward covering your fixed costs (rent, salaries, R&D).
For SaaS companies, contribution margin typically ranges from 60-85%. Your variable costs are hosting, payment processing, and customer support scaled to usage. Your fixed costs are engineering salaries, office space, and overhead. The higher your contribution margin, the more revenue drops to the bottom line as you scale. It is a key input when calculating unit economics.
Contribution margin matters because it shows whether growth is economically viable. A company with 20% contribution margin needs $5 of revenue to cover $1 of fixed costs. A company with 80% contribution margin needs only $1.25. Higher contribution margins mean you reach profitability faster as revenue grows. It differs from gross margin, which only subtracts COGS and ignores variable sales costs.
Examples
A SaaS company calculates contribution margin.
Revenue: $100k/month. Hosting costs: $8k. Payment processing: $3k. Customer support (variable portion): $5k. Variable costs total: $16k. Contribution margin: $84k, or 84%. Each dollar of revenue contributes $0.84 toward fixed costs and profit.
Comparing contribution margins across business models.
A pure SaaS product has 85% contribution margin. A managed services product has 40% contribution margin because every customer requires dedicated engineering hours. The SaaS product reaches profitability at $2M ARR. The managed services product needs $8M ARR. Same fixed cost base, different contribution margins.
Contribution margin guides pricing decisions.
A company's free tier costs $2/user/month to serve. Their paid tier is $10/user/month with $3 in variable costs. Free tier contribution: -$2. Paid tier contribution: +$7. If only 5% of free users convert, each paid user must cover the cost of 19 free users. $7 - (19 x $2) = -$31. The free tier is too expensive.
In practice
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Frequently asked questions
What is the difference between contribution margin and gross margin?
Gross margin subtracts only COGS (hosting, infrastructure, support). Contribution margin subtracts all variable costs, including variable sales and marketing expenses. Contribution margin is always lower than or equal to gross margin. Both are useful, but contribution margin gives a more complete picture of per-unit profitability.
What is a good contribution margin for SaaS?
60-85% for software products. Below 50% suggests your variable costs are too high, often because of heavy customer support or professional services requirements. Above 85% is excellent and typical of self-serve products with minimal support costs.
Related terms
Revenue minus cost of goods sold, expressed as a percentage. For SaaS, this is revenue minus hosting, support, and delivery costs.
Revenue minus all operating expenses, expressed as a percentage. Shows how much profit your core business generates before interest and taxes.
The revenue and cost associated with a single customer. Profitable unit economics mean each customer generates more revenue than they cost to acquire and serve.
How fast a startup spends cash each month. Gross burn is total spending. Net burn subtracts revenue. The clock on your runway.
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