Contribution Margin in Ecommerce, Explained: CM1, CM2, CM3
Contribution margin measures what each sale keeps after variable costs: CM1 deducts cost of goods sold and inbound freight from net revenue, CM2 also deducts fulfilment costs like shipping, payment fees and returns handling, and CM3 also deducts variable marketing and acquisition cost. ROAS hides this: a 4x ROAS product on a 20% margin can be worth less than a 2x ROAS product on a 55% margin. Set breakeven ROAS from CM2 and judge new customer acquisition against CM3.
What are CM1, CM2 and CM3 in ecommerce?
CM1, CM2 and CM3 are the three tiers of contribution margin: CM1 is net revenue minus cost of goods sold, CM2 also subtracts the variable costs of fulfilling each order, and CM3 also subtracts variable marketing and acquisition cost.
Gross Revenue
The total value of sales before anything is deducted. It is the biggest, friendliest number you own, and on its own it tells you almost nothing about whether you made money. A brand can grow gross revenue every month and go broke doing it.
Net Revenue
Gross revenue minus the things that were never really yours: VAT & returns or refunds.
CM1 - Contribution Margin 1
Net revenue minus the cost of goods sold: the cost of making your product & it's inbound freight cost (getting it to your UK warehouse). CM1 is close to what most people mean by gross profit.
CM2 - Contribution Margin 2
CM1 minus the variable costs of getting the order to the customer: outbound shipping and carriage, pick and pack or 3PL fees, packaging, payment processing fees, and the cost of handling returns. These costs scale with each order, which is exactly why they belong in the margin picture and not buried in overheads.
CM3 - Contribution Margin 3
CM2 minus variable marketing and acquisition cost: the ad spend, agency/freelancer fees, subscription costs, attached to winning that customer.
Brands draw these lines in slightly different places. Some consider storage and freelancer fees as fixed costs (CM4), The labels are less important than the discipline. What matters is that every variable cost is accounted for before you decide a sale was profitable - and that your ad targets are set against your own P&L, not a generic benchmark.
UK D2C Unit Economics Calculator
Model every cost line and get your breakeven targets at CM1, CM2 and CM3.
Why doesn't return on ad spend show which products are profitable?
ROAS treats every pound of revenue as if it carries the same value. The waterfall shows that it does not.
Take two SKUs. The first does a 4x ROAS but sits on a thin 20% margin. The second does a 2x ROAS on a strong 55% margin. The dashboard says the first one is twice as good. The CM3 maths says the opposite is closer to the truth - the high-margin product can sustain far more aggressive bidding before it stops making money, while the thin-margin "winner" is one bad week of returns away from losing on every order.
Run a whole account on blended ROAS and these two products are managed identically. You over-invest in the flattering one and starve the profitable one, all while the in-platform numbers look fine. The margin waterfall is what stops that happening.
How Kiezo Growth uses this to build Google Ads strategy
Kiezo Growth uses contribution margin to decide which products go into Google Ads, to set ROAS targets from breakeven CM2, and to judge new customer acquisition against CM3 rather than revenue.
Account built around margins & commercial objectives
Not every SKU should be used in the ads account. Not every SKU has margin that holds up to ads spend. It's simply not profitable to run them.
Campaigns are segmented based on SKU-roles & margin bands. This means that you allow smart bidding to learn off the same intent & commercially viable products, rather than grouping high & low margin & varied AOV SKUs together.
Even if SKUs share the same margin-band- their purpose creates further segmentation or consolidation.
Profitable SKUs should live separately aged-warehouse stock. New season should live separately from BAU.
Start with the business objectives for the SKU catalogue, then the unit economics and then map this to the ads account. Your tactical expertise in Google Ads should come last.
ROAS targets start at break-even CM2
Your breakeven ROAS is set by your contribution margin. Knowing the exact CM2 on a product tells you the precise point at which an extra pound of ad spend starts costing you money, rather than relying on a round-number target someone picked because it felt safe.
Monitor CM2 in the back-end & then subtract ad spend (CM3) to model variable profitability & new customer acquisition.
From there, you can lower the tROAS (find new customers and colder audiences), or increase it to find warmer audiences (more likely to increase repeat sales).
An arbitrary ROAS increase or decrease means nothing without the margins & customer volume and acquisition cost to support the finding.
New customer acquisition is judged against margin, not revenue
For prospecting, the relevant question is whether the cost of acquiring a new customer (NCAC) is justified by the contribution margin that customer delivers - on the first order, and over a sensible payback window. CM3 is what makes that judgement possible. Without it, "we're acquiring loads of new customers" is just a spend report with a positive spin.
Should you optimise Google Ads for revenue or contribution margin?
Google Ads should be optimised for contribution margin rather than revenue, because left alone the platform optimises for the revenue it can see.
Every decision above comes back to the same idea: revenue is what a campaign generates, but contribution margin is what your business keeps. The platform optimises for the first because that is what it can see and what keeps you spending. Building the account around CM optimises for the second.
If you are not sure what your true CM is on the products you advertise most, that is usually the first thing worth fixing. A profit-first audit starts there.
For the full picture - breakeven ROAS, NCAC and the rest of the KPIs that sit alongside contribution margin - see the Profit-First Measurement & KPIs Hub.