Contribution Margin, With Examples: Which Product to Push

Contribution margin is what each sale leaves after the costs that rise with it: price minus variable costs (ingredients, packaging, card fees and labor paid per batch). It's what each unit contributes toward your fixed costs, and then profit. You can measure it three ways: per unit, as a ratio of the price, and per hour of whatever limits your kitchen, usually an oven or a fryer. They rank products differently, and the third is the one that matters when you can't make everything. In the example below, a loaf contributes the most per unit, a cookie the most per dollar and per oven hour, and the cinnamon roll, popular as it is, the least for the oven time it takes. Below are all three worked through, and how to choose a mix.

The short version

• Contribution margin per unit = price − variable cost per unit.
• Contribution margin ratio = contribution ÷ price.
• Contribution per bottleneck hour = contribution per unit × units per hour on the oven, fryer or whatever limits you.
• When demand is the limit, push the highest contribution per unit.
• When the kitchen is full, push the highest contribution per bottleneck hour.
• Contribution isn't profit until fixed costs are covered.
• TaroStack keeps each product's variable cost and its time on each work center. More below.

Three products, per unit and as a ratio

Windward Roots, the made-up taro business I use in these examples, bakes three products in one oven:

Per unit, the loaf wins: $4.15 each. As a ratio, the cookie wins: 64 cents of every dollar is contribution. Which is "best" depends on what's scarce.

Per oven hour

The oven is what limits the kitchen. In an hour it bakes 24 loaves, or 36 rolls, or 96 cookies:

Now the cookie leads and the roll trails. If the oven is full, an hour given to rolls earns $44.40 less than the same hour given to cookies.

Choosing a mix

The month's demand is 900 loaves, 600 rolls and 2,000 cookies, which needs about 75 oven hours: 37.5 for loaves, 16.7 for rolls and 20.8 for cookies. With 100 hours available, everything fits, and the right answer is to make all of it.

Now suppose the oven is only available for 60 hours. Something has to give, and the per-hour ranking says what:

Cutting loaves instead, to keep all 600 rolls, would leave 22.5 hours for loaves, 540 of them, and a total of $6,001: $360 less from the same oven. When the kitchen is full, contribution per hour of the bottleneck decides the mix. How to work out what your bottleneck is, and how many hours it has, is in how to calculate production capacity.

Contribution margin vs gross margin

Contribution margin is the decision tool; gross margin is the reporting one. Both start from an honest variable cost, and that's the number most likely to be stale. How fixed costs and contribution meet in a break-even point is in break-even point for a food business, and why margin beats markup for pricing is in markup vs margin.

Where this stops working

Contribution margins on a spreadsheet are worked out once, from a recipe cost and a guess at batch time. Then butter goes up, the cookies start taking longer because the new baker is still learning, and the rolls' price goes up at one café. The ranking the sheet shows is last season's, and the busy week gets planned on it.

How TaroStack does it

TaroStack keeps both halves of contribution per bottleneck hour current: what each product costs, and how long it takes.

Variable cost from real batches. Ingredients and packaging come in at what you paid, with freight spread across each delivery, and every batch is costed from the lots it used, divided by what came out good. Recipes contain sub-recipes, so dearer butter flows into every product that uses it, and margins are reported per product on what each one actually cost.

Time on the bottleneck, measured. Each recipe can hold the hours a batch takes on its work center, like the oven, and recipe truth, from your own batch history, shows how long a batch really takes once a few have been timed, and whether it yields what it claims. So the cookies taking longer shows up as a number.

And the plan respects the oven. Planning turns orders and your own sales history into what to make and when, and checks it against each work center's hours, so a week's plan doesn't promise more oven time than you have. When it can't fit, it says so in plain words, and every suggestion is a draft you approve, so you choose which product gives way.

Stock value and lots are on every plan, from $49 a month; recipes, batch costs, margins on actual cost, work centers and planning are on Standard at $99. The first 30 days are free, with no credit card. If you'd like a hand setting up, ask, and we'll do it with you.

Questions people also ask

What is the contribution margin formula?

Contribution margin per unit = price − variable cost per unit. The ratio is contribution ÷ price. In the example, a $7.25 loaf with $3.10 of variable cost contributes $4.15, a 57.2% ratio.

What is a good contribution margin ratio?

There's no single number; it depends on your fixed costs and volume. What matters is that total contribution covers fixed costs with room to spare, and how each product compares per hour of your busiest equipment.

How do you decide which product to push?

If demand is the limit, push the highest contribution per unit. If your kitchen is full, push the highest contribution per hour of the bottleneck, such as the oven. In the example, cookies earn $120 an oven hour against $75.60 for rolls.

What is the difference between contribution margin and gross margin?

Contribution margin subtracts only variable costs, for decisions; gross margin subtracts the full cost of goods, including fixed production costs, for financial statements.