Contribution margin

Before you compute lifetime value, know what one customer contributes in a month or a year after the cost of serving them. That leftover is what pays back CAC. It is not profit. R&D, G&A, and remaining S&M still sit below.

Contribution margin is revenue minus the variable costs of serving that revenue — typically COGS plus any variable support that scales with customers. Gross margin is the usual proxy when support is small. Use contribution margin when support or usage costs are material.

The big idea

A food cart keeps the price minus ingredients and the hourly person taking orders. Rent for the commissary is not in that number. Contribution is the cart. Profit is after the commissary.

The analogy breaks when "support" is really a standing CS org that does not move with the next customer. Do not stuff fixed opex into contribution just to make payback look worse — or omit variable inference cost to make it look better.

Walking through it

Monthly contribution = ARPA × gross margin %

If ARPA is $1,000/month and gross margin is 80%:

Monthly contribution = 1,000 × 0.80 = $800
Annual contribution  = 800 × 12     = $9,600

That $800 is the monthly fuel for payback and LTV. On 80% margin, a revenue-based "contribution" of $1,000 would overstate the truth by 25%. Always margin-adjust when you compare to CAC.

A free tier that converts at 2% with high support COGS can destroy contribution even when "top of funnel looks great." An enterprise SKU that needs six months of professional services before the subscription starts pushes payback out unless services are priced to margin.

Pick the unit that matches how money moves:

Common mistakes

• Using revenue instead of margin when comparing to CAC. That inflates LTV by 1 / GM.
• Leaving inference or support out of COGS on AI or high-touch products.
• Calling contribution "profit." Fixed opex is still unpaid.
• One ARPA across mixed segments. $400 SMB and $4,000 enterprise are not $2,200 of useful contribution.

Check yourself

ARPA $1,000 / month, gross margin 80%. Monthly contribution?

$800.

Why not compare $1,000 of ARPA directly to a $15,000 CAC?

Only $800 is left after COGS. Payback uses contribution, not list price.

Key takeaways

• Contribution is revenue minus variable cost to serve. It pays back CAC.
• Monthly contribution = ARPA × gross margin. The $1,000 / 80% case is $800.
• Gross margin is a proxy. Use true contribution when support or usage is material.
• Always margin-adjust before you talk LTV or payback.

Further learning

Next: lifetime value.