Understanding contribution margin and operating leverage is essential for diagnosing profitability in case interviews. These concepts help you evaluate how costs behave and how much room a business has to grow profitably.
This article will break down both concepts with examples, shortcuts, and common consulting-style prompts.
1. What Is Contribution Margin?
Contribution margin is the amount left after subtracting variable costs from revenue. It shows how much money is available to “contribute” to fixed costs and profit.
Contribution Margin = Revenue – Variable Costs
You may also see it expressed as a percentage:
Contribution Margin % = (Revenue – Variable Costs) / Revenue
Typical prompt:
“Our product sells for $100. Variable costs are $60. What’s the contribution margin?”
Answer: $40 or 40%
2. Why It Matters
Contribution margin helps assess:
- Which products are more profitable
- If adding volume helps cover fixed costs
- Break-even analysis
Products with higher contribution margins are more attractive when trying to scale profitably.
3. Fixed vs. Variable Costs
Quick recap:
- Fixed costs stay the same regardless of volume (e.g., rent, salaries)
- Variable costs increase with each unit sold (e.g., materials, shipping)
“If we double our volume, fixed costs stay flat—but variable costs double.”
4. What Is Operating Leverage?
Operating leverage measures how sensitive profits are to changes in revenue. A company with high fixed costs and low variable costs has high operating leverage—profits grow faster as revenue increases.
“With high operating leverage, a 10% increase in sales might lead to a 30% increase in profit.”
But it also means more risk: if revenue falls, profits drop fast.
5. Break-Even Point
This is where total revenue equals total costs. Beyond this point, the firm starts making a profit.
Break-even volume = Fixed Costs / Contribution Margin per unit
Example: Fixed costs = $100K, contribution margin per unit = $20 → Need 5,000 units to break even.
6. Real Case Example
“Our client operates gyms with high fixed costs (rent, salaries) and low variable costs (towels, utilities). They're at 70% capacity. Should they pursue a membership push?”
Use operating leverage to answer: if most costs are fixed, adding members can be highly profitable—if marginal cost per user is low.
Final Thoughts
Contribution margin shows how much profit each unit brings in. Operating leverage shows how those units translate into overall profit growth. Together, they help you judge scale potential and risk in case interviews.
Always ask: Are we making enough per unit? And do profits scale with volume?