Blog · Board and management reporting · Distributors
Customer profitability is reported at three levels that are often confused. Gross margin is revenue less the cost of the goods. Contribution margin takes off the costs the customer's own behaviour causes: deliveries, order handling, sales time, returns, rebates and credit. Net margin takes off a share of fixed overhead as well. This page sets out the three definitions, computes all of them for three customers, shows why the ranking changes at the contribution line and why it should not be taken further, and says which decisions each level is for.
Three lines on the same customer's account. Each removes a different kind of cost, and only one of them is useful for deciding what to do about the customer.
| Level | Starts from | Subtracts | Answers |
|---|---|---|---|
| Gross margin | Revenue | Cost of goods sold | Is the pricing right for the product mix? |
| Contribution margin | Gross margin | Rebates, delivery, order handling, sales time, returns, credit cost: the cost to serve | Is this customer worth serving the way we serve them? |
| Net margin | Contribution | Allocated fixed overhead: rent, systems, management, finance | Does the business as a whole cover its costs at this level of pricing? |
| A | B | C | |
|---|---|---|---|
| Revenue | $400,000 | $90,000 | $12,000 |
| Cost of goods | $328,000 | $67,500 | $8,400 |
| Gross margin | $72,000, 18% | $22,500, 25% | $3,600, 30% |
| Rebate | $8,000 | $0 | $0 |
| Delivery: drops × $38 | 52: $1,976 | 250: $9,500 | 104: $3,952 |
| Order handling: keyed lines × $1.90 | 600: $1,140 | 2,400: $4,560 | 300: $570 |
| Sales visits × $85 | 6: $510 | 12: $1,020 | 4: $340 |
| Credit: days beyond terms | $1,200 | $300 | $0 |
| Contribution | $59,174, 14.8% | $7,120, 7.9% | −$1,262, −10.5% |
| Overhead at 9% of revenue | $36,000 | $8,100 | $1,080 |
| Net margin | $23,174, 5.8% | −$980, −1.1% | −$2,342, −19.5% |
By gross margin percentage the ranking is C, B, A. By contribution it is A, B, C. The order reverses completely, and nothing about the products or prices changed; only the cost of how each customer buys was counted.
Gross margin percentage is highest on small accounts, because small accounts buy at list. They also take small, frequent deliveries, key their orders by phone, and cost the same sales visit as a large account. Customer C's 30 percent is $3,600, and delivering to them twice a week costs more than that. The cost to serve benchmark and the Excel guide cover the allocation.
The net margin row allocates overhead by revenue. Look at what it did to B: positive contribution of $7,120 became a loss of $980. If B were dropped on that evidence, the business would lose $7,120 of contribution and save none of the $8,100, because the rent and the finance team do not shrink when one customer leaves. Profit falls.
Overhead allocated by revenue is the same percentage for every customer, so it cannot change a ranking; it only moves the zero line, and in doing so it invites exactly the wrong decision. Net margin has one good use: checking that a whole segment's pricing, at scale, covers a fair share of fixed cost.
| Decision | Level |
|---|---|
| Is this product priced correctly for this customer? | Gross margin, by line |
| Should this customer have a minimum order value, fewer delivery days, a portal? | Contribution, with the driver counts |
| Which accounts deserve a field rep? | Contribution, in currency, not percent |
| Should we stop serving this customer? | Contribution; only if negative and not fixable |
| Is this segment's pricing sustainable? | Net margin, for the segment as a whole |
| What should the rebate be at renewal? | Contribution before and after the proposed rebate |
Revenue = cost of goods + cost to serve + contribution, per customer Sum of customer contributions − fixed overhead = operating profit
The second line is the check that the per-customer figures tie back to the accounts. If the contributions do not sum to operating profit plus overhead, a cost pool has been left out or allocated twice.
Gross margin percentage as the ranking. The sales team protects C and neglects A.
Rebates left out. A's reported 18 percent is 16 after the retrospective rebate nobody deducted.
Overhead allocated, then acted on. B is dropped, and profit falls by B's contribution.
Percent instead of currency. A's 14.8 percent is $59,000; a small account at 25 percent is $2,000. Field time follows the currency.
Gross margin is the product's profit; contribution is the customer's; net margin is the business's. Manage customers on contribution, in currency, with the driver counts beside it so the behaviour to change is visible. For how the costs differ by desk, see the cost to serve by industry hub. Covirage computes all three levels per customer from the ledger and the operational exports, with both identities checked.
Contribution. It includes everything that would change if the customer changed their behaviour or left, and nothing that would not. Gross margin alone rewards high-percentage, high-effort small accounts. Net margin after overhead allocation punishes large accounts for costs they do not cause.
Treat them as a deduction from revenue if your ledger already nets them; otherwise take them at the contribution line. What matters is that they are in one place, stated, and not forgotten: retrospective rebates paid a quarter later are the commonest reason a customer's reported margin is higher than its real one.
Not on that evidence. If their contribution is positive, they are paying toward fixed costs that will not go away when they do, and dropping them lowers profit. Drop or re-serve customers with negative contribution; use net margin only for pricing a whole segment, never for a decision about one account.