Knowledge · Strategy & Planning

Fixed Costs · Variable Costs · Contribution Margin

Fixed Cost, Variable Cost & Contribution Margin

📂Strategy & Planning⏱2-min read📊Practical🔗10 related

What are fixed costs?

In one line
A concept that separates costs that change with revenue (variable costs) from those that don't (fixed costs), then uses revenue minus variable costs to judge how well fixed costs are recovered and how much profit the business can generate.
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⚡ Summary in 3 lines
  • Reclassify costs by whether they move with revenue
  • Contribution margin = Revenue − Variable costs
  • Rank products by contribution margin, not revenue

Adopting this split changes how a company talks about its numbers. The income statement divides costs into cost of goods sold and SG&A, but that classification cannot answer “how much more cash goes out if we take one more order?” Redrawing the lines as variable and fixed costs lets you judge “do we come out ahead if we take it?” on the spot, one order, one course, or one branch at a time. The biggest change is that, in the monthly performance review, people first ask “how much was left to cover fixed costs?” instead of “how much did we sell?”

In reality, though, costs don't split neatly into two buckets. Some are semi-variable, like a salesperson's base pay plus commission, or an electricity bill that mixes a base charge with usage. Others are semi-fixed: once output crosses a threshold, they jump in steps, one machine or one instructor at a time. In practice, you plot 12–24 months of revenue and costs on a chart and read the slope as the variable cost ratio and the intercept as fixed costs. At a 30% contribution margin ratio, recovering KRW 300 million (≈ US$224,500) in fixed costs takes KRW 1 billion (≈ US$748,200) in revenue; raise the ratio to 40% and that falls to KRW 750 million (≈ US$561,100). And if you have limited resources, such as classrooms or instructor availability, the right order comes from ranking by contribution margin per unit of the scarce resource, not by absolute amounts.

The most common misconception is “if the contribution margin is positive, we can take it.” That logic holds only when there is idle production capacity and the deal is one-off. Once low-price orders become routine, that price hardens into the market reference, existing customers ask to renegotiate, and the moment higher volume forces you to add equipment or staff, fixed costs jump in steps and the whole calculation flips. The opposite misconception is just as risky. If you allocate salaried labor costs to each course and treat them like variable costs, you end up cutting a perfectly good course on the strength of costs that do not disappear when the course is closed. The result is the worst combination: fixed costs stay, and only revenue goes away.

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💡 In plain English
For a shop that pays rent, what is left after materials goes toward the rent. Only once the rent is covered does real profit begin.
Why it matters in practice
Questions like “Should we take this order?” and “Which products should we push?” are answered by contribution margin, not revenue.
🧮 Formula
Contribution margin = Revenue − Variable costs / Contribution margin ratio = Contribution margin ÷ Revenue / Break-even revenue = Fixed costs ÷ Contribution margin ratio
If one training session brings in KRW 5 million (≈ US$3,740) in revenue and variable costs such as instructor fees and materials come to KRW 3 (≈ US$1) million, the contribution margin is KRW 2 million (≈ US$1,500) (a 40% ratio). With monthly fixed costs of KRW 20 (≈ US$1) million, break-even revenue is KRW 20 million (≈ US$15,000) ÷ 0.4 = KRW 50 million (≈ US$37,400). (Hypothetical example)
Origin and sources

It became a standard concept in the early 20th century, when cost-volume-profit (CVP) analysis took shape in management accounting.

Source · Management accounting CVP analysis
An example

Consider a hypothetical case. Company A, an industrial packaging manufacturer with 62 employees and KRW 14 billion (≈ US$10,474,300) in annual revenue, had seen revenue grow for three years while operating profit stayed flat at KRW 100 (≈ US$1)–300 million. The CEO was uneasy about the sales division’s repeated advice to “push the best-selling products harder.” At the first-half workshop, they decided to re-rank all 14 products by contribution margin.

  1. The head of business planning went back through the cost sheets for all 14 products and redrew the lines: raw materials, outsourced processing, and freight as variable costs; production-staff pay, equipment leases, and the like (KRW 2.6 billion (≈ US$1,945,200) a year) as fixed costs.
  2. P-3, the top seller at KRW 3.8 billion (≈ US$2,843,000) a year, had a contribution margin ratio of just 11%, while the specialty coating material, with KRW 900 million (≈ US$673,400) in sales, was at 42%. The head of sales conceded, “We had our priorities backwards.”
  3. Instead of dropping P-3 outright, the CEO ordered a price renegotiation. Over three months, the purchasing team negotiated with the raw-material supplier and cut material cost by KRW 180 (≈ US$1) per kg, while raising the delivery price 4%, lifting the contribution margin ratio to 19%.
  4. They recalculated the break-even point too. Dividing KRW 2.6 billion (≈ US$1,945,200) in fixed costs by an average contribution margin ratio of 21% gave KRW 12.4 (≈ US$1) billion, and the executives were rattled to see a cushion of only KRW 1.6 billion (≈ US$1,197,100) against KRW 14 billion (≈ US$10,474,300) in revenue.
  5. For the sales team, they set a rule: “any deal with a contribution margin ratio below 15% needs division head approval,” with an exception only for one-off orders that fill idle lines in the off-season.
  6. A year later, revenue had fallen from KRW 14 billion (≈ US$10,474,300) to KRW 13.2 (≈ US$1) billion, but operating profit rose from KRW 300 million (≈ US$224,500) to KRW 900 million (≈ US$673,400). The result came from discontinuing two low-margin products and growing specialty coating materials from KRW 900 million (≈ US$673,400) to KRW 2.1 billion (≈ US$1,571,200).
Related terms
Break-Even Point · BEPThe break-even point is the sales amount or sales volume at which revenue exactly equals total costs (fixed plus variable), so there is neither profit nor loss.Cost Structure · Cost ReductionThe mix of costs behind your revenue and their proportions, and the practice of reshaping that mix to improve profitability.Pricing StrategyThe strategy for deciding how to price products and services. Whether you anchor on cost, competition, or value shapes your profit.Reading Financial Statements · Income Statement and Balance SheetThe core skill of reading the income statement (the company’s report card), the balance sheet (its financial position), and the cash flow statement (its actual cash movement) to support business decisions.Sensitivity Analysis · What-ifA validation technique that changes key assumptions one at a time to see how much the result shifts, revealing which variables make or break the outcome.Unit EconomicsAn analysis that calculates revenue and cost per customer or per unit of product to check whether the business makes money as it scales.Profitability Metrics · Operating Margin and ROEA family of metrics showing how much profit is earned relative to revenue and capital, typically gross margin, operating margin, net margin, ROE (Return on Equity), and ROIC.Target CostingAn approach that sets the allowable cost as the price the market will accept minus the target profit, then designs the product to meet that cost from the design stage.Profit PlanA plan that first decides how much profit to make next year, then works backward to set revenue, cost, and SG&A targets that deliver it, tying the sales plan and cost budget into a single income structure.BU P&L ManagementA management approach that treats each business unit (BU) like a small company, aggregating revenue and costs at the BU level so the BU head is accountable for profit and loss (P&L).
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Last updated 13 Sep 2026 · Reviewed by John Kim

FAQ

Salaried staff pay is a fixed cost; per-job outsourcing and freelancer fees are variable costs. Components tied to revenue, such as performance bonuses, behave like variable costs.
Yes. Contribution margin is the amount before fixed costs are deducted; operating profit is what remains after fixed costs are deducted too.
It works for using idle capacity in the short term, but making it routine undermines your pricing standards. Set exception conditions and an approval process before using it.