The contribution margin of a product is calculated by subtracting the total variable costs, including labour expenses and material expenses, from the product price.
For example, the price of product A is $150. The business has to pay $10 for the materials and $15 for the labour to manufacture each unit of product A. The business also incurs an additional $25 in variable costs to sell this product. The contribution margin of product A is $150 – $10 – $15 – $25 = $100.
The contribution margin allows businesses to calculate how much each individual product contributes to the profit of the business. Businesses can use this information to distinguish their best sellers from their laggers, and adjust their pricing strategies accordingly.