Contribution margin and gross margin are both profitability ratios, but they serve different analytical purposes.
Gross margin
Gross Margin = (Revenue − COGS) / Revenue
COGS includes all costs directly attributed to delivering the product — materials, direct labour, hosting, customer success (if costed to COGS). Gross margin is a standard accounting metric reported on the income statement.
Contribution margin
Contribution Margin = (Revenue − Variable Costs) / Revenue
Variable costs are costs that change with each unit sold: sales commissions, payment processing, usage-based hosting, variable support costs. Fixed costs (salaries, rent, software subscriptions) are excluded.
When they differ
The difference is in how fixed vs. variable costs are classified.
Example: a SaaS company with $1M revenue, $100k hosting (COGS), $50k support (COGS), and $200k fixed salaries: - Gross margin = ($1M − $150k) / $1M = 85% - Contribution margin = ($1M − $100k variable hosting) / $1M = 90% (salaries excluded)
Why contribution margin matters more for decisions
Use contribution margin to: - Calculate operating leverage (DOL = CM / Operating Income) - Decide whether to take an incremental order (accept if contribution margin > 0) - Evaluate pricing decisions at the margin
Use gross margin for: investor comparisons, benchmarking, and financial reporting.
Use the operating leverage calculator to compute both CM ratio and operating leverage.