Gross margin and contribution margin

Gross margin is the part of revenue a company keeps after paying the direct cost of what it sold. It is written as a percentage. If a company sells goods worth ₹100 and the goods cost it ₹60 to buy or make, the gross profit is ₹40 and the gross margin is 40 per cent.

The word direct matters. Direct costs are the ones that exist only because a sale happened: raw material, the factory labour that makes the product, the price a retailer pays a supplier, or the cloud server cost of running a software product for a customer. Rent for the head office and salaries of the marketing team are not direct costs, because they would be paid even if one fewer sale happened.

Gross margin is the first test of a business model. A company with a low gross margin has little left to pay for staff, marketing and technology. A company with a high gross margin has room to spend on growth and still end up profitable.

Contribution margin is the money left from one sale after subtracting all the variable costs, meaning every cost that grows with each order. It answers a simple question: when we take one more order, do we end up with more money or less?

Variable costs go beyond the direct cost of the product. For a food delivery or quick commerce company they include the delivery rider's payout, packaging, payment gateway fees, refunds and the discounts given to the customer. For a software company they include customer support time and sales commissions that scale with each deal.

The money that remains is called the contribution because it contributes towards the fixed costs, such as salaries, rent and technology teams. Once the total contribution from all orders is bigger than the fixed costs, the company makes a profit.

• Gross margin = (revenue minus direct cost of goods or service) divided by revenue.
• Contribution margin = (revenue minus all variable costs) divided by revenue.
• Contribution margin is almost always lower than gross margin, because it removes more costs.

The difference is where the line is drawn. Gross margin follows accounting habits and is usually what appears in published financial statements. Contribution margin is a management measure. A company chooses which costs count as variable, so two startups can report different contribution margins for similar businesses.

Take a consumer brand that sells skincare online. Its gross margin may look healthy at 65 per cent because the product is cheap to make. But after paying for shipping, cash on delivery handling, returns, and paid advertising on every order, the contribution margin may fall to 10 per cent or even go negative. The gross margin hides the cost of reaching and serving the customer.

This is why investors in India often ask for contribution margin when they study delivery, e-commerce, mobility and consumer brands. In these businesses the cost of getting the product to the customer is a large share of the order.

There is no single good number. It depends on the type of business, and the useful comparison is with companies that sell the same kind of thing. As a rough guide, software companies often have gross margins well above 70 per cent because copying software costs little. Retail and trading businesses usually have far lower gross margins, since they buy goods and resell them.

Marketplaces are a special case. A marketplace may record only its commission as revenue, so its gross margin can look very high, while a business that buys and resells stock records the full sale value as revenue and shows a thin margin. Comparing the two directly misleads, which is why the idea of take rate and the difference between GMV and revenue matter. See the related guides on both.

Direction matters as much as level. A contribution margin that moves from minus 15 per cent to minus 5 per cent over a year suggests the model is improving with scale. A margin that stays flat despite growth suggests that the company is not getting more efficient.

Some startups lose money on every order in the early days, on purpose. They give discounts to attract customers, run small delivery fleets that are not yet full, and pay suppliers before they have the volume to negotiate a lower price. Investors may accept this if there is a believable path to turning the number positive.

That path usually comes from a few levers: higher order value, fewer discounts, more orders per delivery trip, better supplier terms, and fewer refunds. A company that can name the lever and show its progress on it is more credible than one that says margins will improve later.

First, check which costs the company counts as variable. Ask whether delivery, payment fees, packaging and customer support are included. Second, look at whether the margin is measured before or after discounts and incentives. Third, check whether the margin is shown per order, per customer or for the whole business, because the three can tell different stories.

Finally, remember that a positive contribution margin does not mean the company is profitable. It only means each sale helps pay the fixed costs. A company with a 12 per cent contribution margin and heavy fixed costs can still lose money until its volume grows enough. For a fuller picture, read it alongside unit economics, burn rate and EBITDA. Nothing here is investment advice.