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Financial Metrics

Contribution Margin Analysis: Why High ROAS Doesn't Mean You're Actually Profitable

Understanding the difference between revenue and profit, and why your ad platforms are lying to you about profitability.

• Navigator Team
contribution margin profitability ROAS unit economics variable costs

Your ad platform just told you something that made you very happy.

“Your ROAS is 4.5x. For every dollar you spend, you make $4.50.”

You poured yourself a celebratory coffee. Maybe you texted your co-founder. Maybe you even updated the pitch deck.

Then, you looked at your bank account. And there was no celebration.

What happened?

Your ROAS was calculated on revenue. Your bank account cares about profit.

This is the most expensive mistake I see founders make. They optimize for the wrong metric, scale the wrong channels, and wake up one day realizing they’re making less money than when they started.

The ROAS Illusion

Let me walk you through a real scenario.

You sell a product for $100. Your cost to make that product is $40. You spent $20 on Facebook ads to sell it.

ROAS calculation: $100 (revenue) / $20 (ad spend) = 5.0x ROAS

You feel great. That’s a healthy ROAS. Most people would kill for that.

But here’s what actually happened to your bank account:

  • Revenue: $100
  • Product cost: -$40
  • Ad spend: -$20
  • Other costs (shipping, payment processing, customer service): -$15
  • Actual profit: $25

Your profit margin on that sale was 25%. Not bad. But what if your product cost was $60 instead of $40?

  • Revenue: $100
  • Product cost: -$60
  • Ad spend: -$20
  • Other costs: -$15
  • Actual profit: $5

Your ROAS is still 5.0x. But your actual margin just collapsed from 25% to 5%.

And here’s the kicker: Your ad platform will celebrate both scenarios equally. They don’t care about your product costs. They only care that you’re spending money with them.

Enter: Contribution Margin

This is where Contribution Margin enters the building.

Contribution Margin is the amount of revenue left after you pay for the cost of goods sold (COGS). It’s the money available to cover your other expenses and hopefully become profit.

The formula is simple: Contribution Margin = Revenue - Variable Costs (COGS)

In our first example: $100 - $40 = $60 contribution margin

In our second example: $100 - $60 = $40 contribution margin

Now, here’s where it gets useful. You can calculate your Contribution Margin Ratio: Contribution Margin Ratio = Contribution Margin / Revenue

First example: $60 / $100 = 60% Second example: $40 / $100 = 40%

This is the percentage of every dollar that’s available to cover fixed costs and turn into profit.

The Decision-Making Shift

Now, let’s bring ad spend into this picture.

If your contribution margin is 60%, and you spend $20 on ads, you’re really spending $20 out of your $60 available dollars. That’s 33% of your contribution margin going to acquisition.

If your contribution margin is 40%, and you spend $20 on ads, you’re spending 50% of your available profit just to acquire the customer.

Same ROAS (5.0x), but the second scenario is significantly riskier.

Here’s what I see happen: A founder looks at ROAS, sees it’s good, and scales ad spend. They go from $20 ads per customer to $40 ads per customer. The ROAS drops to 2.5x, but they don’t care—they assume the increase in volume makes up for it.

Then, three months later, they realize they’ve doubled ad spend and their actual profit margin is now negative. They’ve scaled themselves into insolvency.

The Right Way to Think About It

We build your analytics automation to track three numbers, not one:

1. Contribution Margin Per Customer This is how much profit is “available” per sale. It’s not true profit (because you have fixed costs like rent, salaries), but it’s the pool of money from which profit comes.

2. Customer Acquisition Cost (CAC) This is your ad spend per customer. It should never exceed your contribution margin. If it does, you’re losing money on every sale.

3. The Ratio (CAC / Contribution Margin) If CAC is $25 and Contribution Margin is $60, your ratio is 41%. That’s healthy. You’re spending less than half your available margin to acquire customers.

If CAC is $25 and Contribution Margin is $30, your ratio is 83%. That’s dangerous. You’re eating up almost all of your available profit just to acquire customers.

Where This Gets Complicated

The challenge is that “variable costs” aren’t always obvious.

  • Product cost is clear.
  • Shipping cost is clear.
  • But what about payment processing fees? Customer service time? Returns and refunds?

Some of these are fixed (you pay a salesperson the same salary regardless of sales volume). Some are variable (credit card processing scales with revenue).

We typically define Variable Costs as anything that scales with unit volume:

  • Cost of goods sold
  • Shipping
  • Payment processing fees (2-3% of revenue)
  • Returns/refund costs
  • Direct customer support (if you’re hiring support staff per volume increase)

Fixed Costs stay the same:

  • Rent
  • Salaries
  • Subscription software
  • Insurance

Your contribution margin should cover your fixed costs and leave something for profit.

The Real Problem

Here’s where most founders go wrong: They treat all customers the same.

But not all sales are created equal.

A customer acquired through organic search might have a $0 CAC. They should have the best contribution margin.

A customer acquired through paid search might have a $15 CAC. Still good.

A customer acquired through a bottom-of-funnel retargeting ad might have a $5 CAC. Excellent.

But your average customer, across all channels? Might have a $25 CAC.

If you’re optimizing purely for ROAS, you’re treating all these equally. If you’re optimizing for Contribution Margin, you realize that organic search is your real profit driver.

The Takeaway

Stop looking at ROAS as your north star. It’s a vanity metric.

We build your system to show you Contribution Margin per channel, per campaign, per customer segment.

When you see that your Facebook channel has a 60% CAC-to-Contribution-Margin ratio, but your email channel has a 20% ratio, you know where to focus.

One more thing: Don’t confuse Contribution Margin with profit. Contribution Margin covers your variable costs. Profit covers everything, including the $50k/year you’re paying for this analytics system.

You need a healthy Contribution Margin just to stay in business. But your real goal is profit.

And if you’re only looking at ROAS, you’ll never see it coming.