Gross margin or contribution margin: which to price on?

1. Two customers, the same margin, very different profit

Most price lists are built on gross margin. It is the number the accounts produce without asking, and it looks like a safe guide. The trouble is that it stops before the costs of serving the order: the extra delivery, the rework, the chasing, the small batch that interrupts a run.

Here is an illustration (illustrative figures, not real data). Two customers each buy £100,000 a year. Direct costs are £70,000 for each, so both show a 30% gross margin. Customer A costs £6,000 a year to serve. Customer B costs £22,000: split deliveries, rush changes and frequent small orders. After serving costs, A leaves £24,000 (24%) and B leaves £8,000 (8%). The average hides the story.

2. Why it matters more when costs are rising

The ONS reports that UK producer input prices rose 8.3% in the year to September 2026, up from a revised 6.7% in August. Output (factory gate) prices rose 4.6%, up from a revised 3.8%. On a monthly basis, input prices rose 1.5% in September and output prices 0.8%.

When costs rise faster than prices, an old gross margin quietly overstates what each order earns. The thinner the margin, the more a customer like B matters: a 5% discount on B's £100,000 is £5,000, which takes B's £8,000 down to £3,000. The same discount on A leaves £19,000. The next ONS release is due on 18 November 2026, so there is a natural date to repeat the check.

3. The method: a three-column table, about an hour

For each of your ten largest customers (or products), fill in three columns from invoices and your order records:

1. Sales.
2. Direct costs: materials, direct labour, anything that moves with the order.
3. Serving costs: delivery, rework, extra handling, small-batch set-ups.

Contribution is sales minus the second and third columns. Rank by contribution percentage, then set a minimum you will accept below which a price, discount or term needs a second look. This is direction, not measurement: serving costs are estimates, and a rough number beats none. Fixed overheads stay out of this table on purpose, because they do not change with the order you are pricing.

Decide the rule before the negotiation, not during it. A minimum written down in advance is far easier to hold than one argued on the phone.

4. Why the principle holds

The idea is not new. A Wiss worked example shows two products, each selling at $100 with a 15% gross margin, whose contribution margins are 60% and 30%. The article's point is that gross-margin-only analysis leads to poorer production and pricing decisions. Management accounting teaching says the same about choices: ACCA's relevant-costing material asks only which future cash flows change between the options, and includes opportunity costs even when the accounts do not record them.

Tips and tricks for this week

• Start with the ten largest customers, not the whole ledger.
• Add the serving cost you already know: carriage, credit notes, re-runs.
• Mark every customer whose contribution falls below your minimum.
• Change terms or price for those customers first, not across the board.
• Repeat the table after each ONS release.

One change, one date. If you want a wider view of where margin goes, the Business Health Check is a place to start.