The SaaS Magic Number Calculation Guide

The SaaS Magic Number

 The Saas magic number is a popular metric that software-subscription businesses use to measure their sales efficiency. The most basic question a magic number asks is: How much revenue (dollar worth) do we generate for the company for every dollar spent on sales and marketing to acquire new customers?

 

How is the SaaS Magic Number Calculated?

 As a Saas business owner, you can calculate the magic number for your business by following these simple calculation steps: 

  • First, deduct your prior quarter-Annual Recurring Revenue (ARR) from your current quarter-ARR
  • Then divide the result by your total Customer Acquisition Cost (CAC) from the previous quarter

 

Your Customer Acquisition Cost (CAC) means your total sales and marketing expenses.

 

The formula above uses quarterly revenue figures to calculate the primary SaaS magic number. However, depending on your usual sales cycle, you can use Monthly Recurring Revenue (MRR) to arrive at a monthly magic number. 

You can also calculate your magic number on an annual basis. But whichever strategy you choose, magic number calculation gives you a high-level understanding of your sales efficiency. 

The magic number calculation combines new ARR/MRR and renewal revenue to offer a better and thorough knowledge of the business growth rate. However, you can add your magic number calculation with other financial metrics such as the Net Revenue Retention (NRR) or Net Dollar Retention (NDR). And this is if you need to be more specific about renewal and upgrade performance.

Why is the Magic Number Important?

 Your magic number is vital because it can help you understand the effectiveness of your sales and marketing engines over a given period. In addition, it can help you decide when to increase or decrease your investment in those sales and marketing engines.

A magic number of 1 is a simple illustration. If your magic number is 1, it indicates you will pay back your quarter-worth of sales and marketing expenses (the denominator in the SaaS magic number equation) from the incremental revenue you generate over the following year (the numerator in the SaaS magic number equation).

Furthermore, to determine whether or not to increase Sales and Marketing (S&M) spending, you can examine that efficiency metric in the company context. However, the image below illustrates three thresholds to consider if you are looking for typical benchmarks for SaaS magic numbers.

Benchmarks for SaaS Magic Numbers

 

SaaS magic number benchmarks

 

The SaaS magic number benchmarks tell SaaS business owners about the efficiency of their sales process. Thus, when analyzing magic numbers, it is essential to consider what the following SaaS magic number benchmarks say about the effectiveness of your sales process:

 

1. Magic Number Less Than 0.5

A magic number that is below 0.5 usually indicates that there is a problem with your business model. It means you have to evaluate your business model and figure out what is not working. It could be because your total cost of service may be unreasonably high. 

Also, there may be a possibility that your SaaS product might not appeal to your potential customer. A magic number at this level also indicates an unusually high churn rate or attrition rate (this is the rate at which clients stop doing business with an organization). And a lack of product maturity may be the reason for your unusually high churn rate, causing a decline in Annual Recurring Revenue.

Furthermore, another possibility for having a magic number below 0.5 is spending a lot of money on attracting new customers without having a pricing strategy that can cover the costs. Therefore, you probably need to keep improving your product-market fit if your magic number is less than 0.5.

 

2. Magic Number Less Than 0.75

 A magic number below 0.75 is the primary SaaS magic number benchmark you should consider when analyzing a magic number. A magic number close to 0.75 is a good sign that you are doing well in terms of your sales efficiency.

Nevertheless, your business context will determine whether or not you should increase marketing spending or expand your sales team at this level. If you want to know whether making additional growth investments is good, then examine your free cash flow and gross margins.

 

3. Magic Number Greater Than 0.75

If the magic number is above 0.75, it indicates a good time for you to expand the sales and marketing operations. You attain this level after establishing your product-market fit and acceptable-CAC payback times.

Furthermore, you most likely have an efficient monthly payback number at this point. In other words, you can handle higher costs for marketing initiatives such as Search Engine Optimization (SEO), content marketing, and digital advertising. Even though a 1.0 magic number might be the ideal value, you should be at ease once you surpass the 0.75 threshold.

According to Investor Lars Leckie, when he popularized the magic number as a metric for sales efficiency in 2008:

“Fundamentally, the key insight is that if you are below 0.75, then step back and look at your business. Then if you are above 0.75, start pouring on the gas for growth because your business is Primed to leverage spending into growth. If you are anywhere above 1.5, call me immediately.”

Every SaaS financial metric is imperfect, and a magic number is no different from other SaaS financial metrics. However, these benchmarks for SaaS magic numbers continue to be effective benchmarks to monitor.

The magic number is a formula used by SaaS companies at every different stage. But it is useful especially for illustrating how efficient sales and marketing contribute to the robust revenue growth of early-stage startups. You can win or lose your pitch for a new round of Venture Capital (VC) if you have this kind of context.

 

How to Improve Your SaaS Magic Number

 For SaaS companies worried about not attaining their desired magic number, there are numerous approaches they can use to improve this metric. Businesses can enhance their metrics through the following ways:

  • Try optimizing your advertising spend or improving your buyer or customer persona to ensure you are targeting the right customers.
  • Try buying sales automation tools that expand your reach and automate follow-ups and also help cut costs associated with sales and marketing (S&M)

 

How to Track Your Magic Number Better

 

In the past, keeping track of your magic number required manual effort. In addition, by the time your financial data was retrieved, entered into excel, and calculated, it had already become stale. 

But with Mosaic, you can monitor your magic number in real time using its SaaS magic number calculator. In turn, this allows you to know precisely when to increase your marketing spending to reach more customers or when to reduce it for safety.

No doubt, seeing your magic number can be helpful. However, being able to quickly change different components of the calculation to obtain a different view of the financial health of your business is more effective.

For instance, you might consider using your Bessemer CAC ratio as a benchmark instead of a magic number. This efficiency metric only considers new customer acquisition and gross margins relative to CAC. 

Closely related to the magic number, the Bessemer CAC ratio also offers another benchmark for assessing your capacity to bear higher marketing expenses. Similarly, you could incorporate a CAC payback period chart into Mosaic to view that metric next to a magic number. Gaining as much context as you can is ideal.

 

Why You Need More Than a Magic Number for Your SaaS Business

 Many tasks carried out by the sales and marketing teams can appear to be pure magic. It can seem like a sort of sorcery how your sales team meets its quarterly quotas in time to reach your bookings target. Additionally, the remarkable ability of marketing operations to present the ideal advertisement at the perfect moment is pure ESP. 

Fortunately, the finance team does not have to understand the magic the marketing and sales team are doing. That is, how the marketing team is constantly providing customers with an ideal timed, personalized solution. Or how the sales team comes up with new ways to close deals every time. 

Nevertheless, you need to perform your little magic. It may include the ability to measure how efficient sales and marketing fosters business growth. To measure this, you will need to know your magic number. But, there is not much magic in the magic number itself. 

Although it is a helpful SaaS metric, looking at individual SaaS KPIs will never provide the complete picture of your company. Your company performance must be fully-visible to you at all times, in one place, and in real-time. And to do that, you should continuously monitor every SaaS metric essential to your company.

You can integrate all your financial data-generating tools, normalize that data, and automatically calculate different useful metrics. With metrics, you can gain an understanding of various metrics such as: 

  • The SaaS rule of 40
  • CAC
  • Lifetime value (LTV)
  • Average Revenue Per Customer (ARPU)
  • Cost of revenue or Cost of goods sold (COGS)  

 

You can quickly experiment with various inputs and modify your calculations to align better with your business KPIs. In addition, it allows you to share your findings with other departments using neat, unambiguous representations. 

Thus, providing a comprehensive view of your financial efficiency and financial outlook without any manual data pulls or error calculations, or confusing financial dashboards. Indeed, that is magic.

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