The first time I came across this metric was as a Product Manager at Infinity Learn. I would hear from the business team about achieving profitability on specific CM levels - the CM1, CM2, and CM3. At that time I was not directly tracking such a metric and hence my knowledge of it remained limited.
However I believe its a good time now to explore this metric in detail and its use case - so I can apply it more widely to teardown B2C businesses.
Why is it called Contribution Margin?
The metric is core for Unit Economics where we aim to understand or visualise how an individual unit product contributes to the profitability of the business. And since we are looking at an individual product or SKU - we measure in terms of a percentage margin instead of absolute figure.
So every SKU that a company offers can have contribution margins to the companies profitability. However, SKUs can also be consolidated to get a CM figures for the company as a whole. How we consolidate would have to be justifiable math which might differ with every company.
What are the Levels of CM?
Since profitability can be expressed at different levels - hence for each profitability level we have a separate CM figures.
Every industry would have a different definition for profitability levels - and hence the context of CM1, CM2, and CM3 will change. For instance, we cannot compare CMs of a SaaS company to a D2C as the meanings of each levels are completely different.
The levels are set to make business context clear and to solve bottlenecks in a stepwise manner. For a D2C brand selling cosmetics, the core industry levels would be: Manufacturing Profitability (CM1), Distribution Profitability (CM2), and Marketing or Growth Profitability (CM3). For a SaaS product, the core levels would be: Product and Infra Profitability (CM1), Operational Profitability (CM2), and Sales Profitability (CM3).
For a D2C business
| Levels | Meaning |
|---|---|
| CM1 - Manufacturing Profitability | Net Revenue - COGS (raw materials, labor, etc) |
| CM2 - Distribution Profitability | CM1 - Delivery and Fulfillment (packaging, returns, etc) |
| CM3 - Marketing or Growth Profitability | CM2 - Performance Marketing (advertisements, etc) |
For a SaaS business
| Levels | Meaning |
|---|---|
| CM1 - Product and Infra Profitability | Net Revenue - Hosting, Infra, and Token Costs, etc |
| CM2 - Operational Profitability | CM1 - Human Capital, Subscription, Gateway Costs, etc |
| CM3 - Sales Profitability | CM2 - Sales Capitals and Commissions, Discounts, etc |
| For Infinity Learn an EdTech software business which makes it a SaaS - the salaries for teachers, engineers, business and operations team might have been considered in CM2 level. While the Sales salaries might have been subtracted in CM3 levels. |
For a business like Amazon, Swiggy, BluSmart - the Net Revenue will be the commission. CM1 will include the physical infrastructure like packaging facilities, dark stores, or vehicle costs.
For an IT services company - any AI Token usage to deliver services will count under CM1 costs. If IT companies start using AI more effectively, they will switch their costs from CM2 (salaries) into CM1 (tokens) - tokens are more easy to buy wholesale over people, and given an individual employee can employ multiple agents simultaneously, the CM2 can further drop. Hence improving margins.
Other businesses
For Oyo Hotels or Indigo Airlines - the cost of a seat or a room will be under the CM1. Any vacancies would bring pressure on CM1 itself.
Similarly Hospitals would be high CM1 industry. Most public transport like High Speed Rail would similarly have high CM1 strain. And CM3 will likely have the least stress given the necessity of these products and services.