Months of Runway? Profit Margin? Growth Rates? Revenue Multiples? Bessemer Efficiency Index? Rule of 40? Cash Burn? These are all metrics investors care about through various stages of a startups lifecycle. The common thread…
What is the SaaS Magic Number?
In a SaaS business, it’s critical to understand how your sales and marketing spend is effecting your ARR growth. You may be investing heavily in these areas, but how efficient is your spending? The SaaS…
In a SaaS business, it’s critical to understand how your sales and marketing spend is effecting your ARR growth. You may be investing heavily in these areas, but how efficient is your spending? 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.
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 spend on ARR growth.
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 formula:
Let’s say that you spend $100,000 on sales and marketing to create an 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.
A SaaS magic number of .75 or greater is said to be a sign that you should continue to invest in customer acquisition, while anything less than .75 means that you should reevaluate your spending. Many in the SaaS community view a magic number of 1.0 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.
What Metrics Are Related to the 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.
- 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.
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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