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Contribution margin allows us to calculate
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the profitability of our product even at the unit level.
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It is based on the number of units that are being sold.
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Remember, not the number of orders.
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To calculate the contribution margin,
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we take the difference between the revenue and the variable costs.
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So let's go ahead and do that.
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So this is just the difference between the revenue and the variable costs.
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If you want the contribution margin at the unit level,
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you just divide that difference by the number of goods sold.
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So, let's go ahead and do that.
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So that would be total revenue minus variable cost over number of goods sold.
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So this tells you per unit sold how much is the contribution margin.
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In this example, we can see that the contribution margin is less than three dollars.
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To pay for overhead costs,
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we need to get as close as possible to this to $2.94 magic number to break even.
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This can even help in making decisions about allocating limited resources,
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directing the funds to more profitable product lines.
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For example, a grocery store like Target would typically have
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a low contribution margin because it works with large quantity of types of products.
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So they can make up their profits for
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the share quantity of their sales across a wide range of products.
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In other words, if one product has low contribution margin,
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another has a higher contribution margin,
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and that way they can make up for any loss on the item with the low contribution margin.
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On the other hand, imagine an online store that
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only sells very high-end fashion products.
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They, on the other hand, will have a high contribution margin per item
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as they have fewer sales in comparison to the products being sold at Target.
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So this online fashion store needs to make sure each sale counts.
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So that is the broad idea of contribution margin.
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