SaaS magic number – an introduction
The SaaS magic number is a metric used by SaaS businesses to measure the effectiveness of sales and marketing spend. Simply put, it’s a measure of sales efficiency.
What does the magic number in SaaS mean?
The SaaS magic number is a metric that SaaS businesses can use to understand sales efficiency. It looks at the return on revenue for every pound spent on sales and marketing initiatives. Essentially, it highlights the pay-back period on these costs.
In isolation, it has limitations on what it actually tells you. Other metrics like LTV:CAC ratio, churn and gross margin are can be used in conjunction to add more relevance.
Why is the SaaS magic number so important?
The SaaS magic number gives you an easy-to-understand measure of your sales and marketing efficiency and pay-back period. By understanding and tracking your SaaS magic number, you can make better informed decisions on how to invest or pull back on sales and marketing.
Generally, a SaaS magic number below 1 indicates you should focus on retention and customer success. Conversely, a magic number above 1 means you have the potential to increase your sales and marketing spend.
How to improve it
As we’ve highlighted in the MRR expansion metric, there are a number of strategies to expand your existing customers, such as upselling, cross-selling and add-ons. Focusing on MRR expansion, rather than new customer acquisition can often improve your SaaS magic number.
If you can grow MRR without incurring costs, or at least minimising them, your SaaS magic number will increase. Ultimately, anything that reduces your customer acquisition cost (CAC) will improve the magic number.
What’s a good SaaS magic number?
1 is the magic number. Anything below 1 is considered poor whereas above 1 is desirable. A magic number of 1 means it takes a year for the sales and marketing costs to be recouped. However, it's worth highlighting that if you have low churn and a long customer lifetime, you will benefit from the contribution of your customers in future periods beyond one year. In this instance, you can actually afford to have a lower magic number as you will benefit from the longer period of contribution. While this is an overall benefit, a lower SaaS magic number could mean you grow at as lower rate or hit your working capital harder.
Both gross margin and lifetime value are important metrics to contextualise your SaaS magic number. If you have a magic number of 0.5 or below, you should seriously consider the viability of both your product and your sales and marketing approach and consider implementing changes to improve this.
As mentioned, gross margin is important to consider when looking at your SaaS magic number. While you’re essentially assessing pay-back period to cover your sales and marketing costs, you also need to give consideration to other costs.
SaaS businesses can have a very high gross margin. However, even at 75%, it now takes one and a half years for acquired customers to start contributing to operating expenses. This might give you quite a different viewpoint, especially if the customer lifetime is short. A gross margin of 50% would mean the pay-back period is two years.
What does the SaaS magic number look like?
How do you calculate the SaaS magic number?
The formula to the SaaS magic number is:
SaaS magic number = (Current quarter MRR - Prior quarter MRR) x 4 / Sales and marketing spend from prior quarter
The SaaS magic number worked example
If a company has the following, it’s SaaS magic number can be calculated like this:
MRR:
- Q1: £150,000
- Q2: £175,000
- Q3 £220,000
Sales team costs:
- Q1: £45,000
- Q2: £60,000
Marketing costs:
- Q1: £80,000
- Q2: £120,000
SaaS magic number Q2 = (£175,000 - £150,000) x 4 / (£45,000 + £80,000) = £25,000 x 4 / £125,000 = 0.8
SaaS magic number Q3 = (£220,000 - £175,000) x 4 / (£60,000 + £120,000) =£45,000 x 4 / £180,000 = 1.0
In the above example, the Q2 SaaS magic number would initially be considered poor. However, at 0.8, the business should try to understand the drivers behind this, as well as considering gross profit. As previously mentioned, looking at the SaaS magic number in isolation (as with most metrics) never tells the full story.
The SaaS magic number increases in Q3 to 1, which indicates the company has had a better sales/marketing and revenue balance. In this quarter, as £45,000 of incremental revenue has been generated, it tells us it takes 1 year to recover the sales and marketing costs.
Conclusion
The SaaS magic number is a relatively easy and quick metric to calculate, which give you a basic measure of sales efficiency. You can use this to understand how soon you start to get a return on sales and marketing spend.
Don’t use this metric in isolation, always consider gross margin when looking at the SaaS magic number. If you find that you have a magic number of 1 as a starting point, that’s great news as you are on the right track.
