Small or large business, it makes no difference. The business principles are the same. No matter what your company is offering, products or services, at the end of the day, you are relying on the contribution margin. It’s not the only important metric that you need to keep an eye on while running a business but it’s the starting point. To find out the contribution margin you need to subtract the variable costs from the selling price of your product or service.
A high contribution margin is not easy to obtain. You often hear business owners complaining about the contribution margin being too low. No matter the industry, each business has variable costs such as raw materials, workforce, supplies, packages or utilities. The lower the costs, the higher the contribution margin becomes. That said, what can a business do to maximize the contribution margin? You don’t need a business school to understand that lowering your expenses will make the margin increase. Businesses try to negotiate better raw material prices, to reduce the overall expenses and save as much as possible in labor costs.
Another option would be to increase prices. Although it may seem an appealing strategy due to the profit boost, the high shrinkage in sold units may be harmful in the long run and positioning the brand out of the blue in a higher-class market (from a price perspective) may not be sustainable. To know what to expect when increasing prices, check my previous article regarding price increase.
A low contribution margin is the first sign that a business is not profitable. However, each business is different and improvements can be made from case to case. Sometimes, strategies such as increasing the product’s quality can work because the brand can pretend a higher selling price. On the other side, some businesses might opt for decreasing the product’s quality with the consequence of positioning the product as a budget one. In any case, the numbers and market trends need to be always analyzed before making such drastic decisions for the business.