How To Calculate and Interpret Your SaaS Magic Number
In a SaaS business, it’s critical to understand how your sales and marketing spend is affecting your annual recurring revenue (ARR) growth. In order to better help you understand how efficiently you are growing you need to understand your SaaS magic number.
So what is your SaaS magic number? The SaaS magic number is a way to evaluate whether or not you should continue to invest in customer acquisition, or take your foot off the gas.
Related resource: How to Start and Operate a Successful SaaS Company
Why Use the SaaS Magic Number?
Lars Leckie popularized the ‘Magic Number’ as a SaaS metric in the mid-2000s, citing it as a way to help companies decide ‘how much gas to pour on the fire’ of your startup. Subscription businesses are fortunate to have clearly definable payback periods, but it’s critical to understand the influence of today’s spending on future performance. The magic number helps SaaS companies determine the impact of sales and marketing spending on ARR growth.
So why track the SaaS magic number for startups?
Understand Your Sales & Marketing Efficiency
Ultimately your SaaS magic number is a metric intended to uncover just how efficient your go-to-market efforts are. By measuring your magic number, you’ll be able to better forecast future ARR growth and make sure your team is scaling in an efficient manner.
Evaluate Where to Spend
Because your magic number helps you understand your efficiency, you can easily translate this data to find the specific channels and go-to-market methods to put your focus, and dollars, behind.
How to Calculate Your SaaS Magic Number
There are many great resources that explain how the magic number is calculated. The SaaS CFO has an excellent in depth breakdown on the topic. Here is the SaaS magic number formula:
(Current Quarter Revenue – Previous Quarter Revenue) *4 / Previous Quarter Sales & Marketing Spend
Let’s say that you spend $100,000 on sales and marketing last quarter to create a monthly recurring revenue (MRR) increase of $25,000 for the quarter. This $25,000 will become $100,000 in ARR, provided that churn is minimal. In this case, your $100,000 in sales and marketing spend has earned you $100,000 in new ARR, resulting in a SaaS magic number of 1.0 for the quarter. This implies that you’ll pay back your sales and marketing expenses within a year.
SaaS Magic Number Benchmarks
A SaaS magic number of 0.75 or greater is said to be a sign that you should continue to invest in customer acquisition, while anything less than 0.75 means that you should reevaluate your spending. Many in the SaaS community view a magic number of 1.0 or greater to be ideal. However, you need to be careful not to view this in isolation. While the magic number is great at helping you determine how efficiently you can create new revenue, it won’t show the whole picture. Check out the SaaS magic number benchmarks below:
Less Than 1
Between 0.75 and 1.0 is a relatively green zone and represents that you can continue to invest in your sales & marketing efforts. However, if you’re magic number is much lower than that there might be something noticeably wrong in your process. For example, churn could be abnormally high or your customer acquisition costs (CAC) might (learn more about CAC ratio here) not warrant your current pricing model. The goal here is to improve period over period to get closer to a magic number of 1 or greater.
Equal to 1
As we mentioned above anything around 1.0, warrants further investment. Your current go-to-market process is likely working and it is time to start putting fuel on the fire. As Lars Leckie puts it, “if you are above 0.75 then start pouring on the gas for growth because your business is primed to leverage spend into growth.”
Greater Than 1
If your magic number is greater than 1 you likely are building a well-run machine. Revenue growth should almost feel easy at this point. You should pour on more investment and can test new channels and customer acquisition models along the way.
Other Metrics You Need To Use With the SaaS Magic Number
Your magic number may be great, but it doesn’t tell the whole story – be sure to factor these metrics in when evaluating your sales & marketing spend.
Is your churn rate low? If your sales and marketing expenses are helping you generate new ARR, it doesn’t matter how effective you are at acquiring new customers if you can’t keep them for long. Customer retention is key to a solid SaaS magic number.
What are your gross margins? If you have high COGS (and thus, lower gross margins), then you should keep in mind that the sales and marketing expenditure payback period will be longer. Just because your magic number may be greater than 1, doesn’t mean you should ramp up spending on customer acquisition until you know how long it will take to truly pay back the cost of those new clients.
How much cash do you have to spend? This may seem self explanatory, but you should be careful not to break the bank just because you’re efficient at acquiring new customers. Downturns and unexpected events happen – be sure you have your cash flow modeled and keep it in check. You won’t be able to service your new customers if you run out of cash.
How to Track Your Key SaaS Metrics
The SaaS magic number is only one of many metrics that you should be tracking – be sure to check out our Ultimate Guide to SaaS Metrics to make sure you’re keeping an eye on every area of your business.
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