Decoding the SaaS Magic Number & What It Means For Your Business
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As a growing SaaS company, finding the right balance between your marketing and sales spend and your ARR is essential to understand your actual growth (or lack thereof).
Spend too much on marketing and sales without having achieved product-market fit, and you’ll end up with a cash flow scarcity.
Spend too little on marketing and sales after having achieved product-market fit, and you’ll miss out on a ton of growth opportunities.
But striking the perfect balance can be quite tricky, especially if you don’t have an efficient way to measure it.
That’s the idea behind the SaaS Magic Number. It’s a metric that can help you measure how much your SaaS is growing by contrasting your quarterly ARR (annual recurring revenue) with your quarterly CAC (customer acquisition cost).
The magic of the SaaS Magic Number lies in helping you see how much revenue you’re creating for the cost of acquiring new customers with your sales and marketing investments.
Basically, it’ll help you determine whether you need to invest more in marketing or take a step back and figure out how to achieve product-market fit.
Let’s dive into what the SaaS Magic Number is and how to calculate it.
The SaaS Magic Number Formula
Quite simply, the SaaS Magic Number can be defined as the number that tells SaaS companies how well they're doing.
It helps them figure out if they're growing efficiently and if they're on track to achieve their revenue goals - or if they're overspending their resources and not getting enough of a return.
Despite the mysterious name, the Magic Number is actually pretty easy to calculate. It contrasts the two metrics that SaaS companies already track frequently - their quarterly ARR and CAC.
Your quarterly ARR shows how much money you made from existing and new customers in a specific quarter. It helps you see if your customers are returning and if your customer base is growing.
Your quarterly CAC is the money you spend to acquire new customers in a specific quarter. It includes all your marketing, sales, and advertising expenses. It shows you how well your business is doing at getting customers through its marketing and sales efforts.
To calculate your SaaS Magic Number, just subtract the previous quarter's ARR from the current quarter's ARR, multiply that by 4, and then divide that number by the total amount you spent on customer acquisition (CAC) in the previous quarter.
Here’s the formula:
Looks pretty simple, doesn’t it?
The result of this equation will show you how efficient your sales and marketing efforts are and if your revenue growth is sustainable.
Why Is the SaaS Magic Number Important?
Your Magic Number measures the health of your SaaS business. More specifically, it helps you:
Make decisions based on data to determine where to put your resources.
Optimize your customer acquisition costs when necessary.
Realize you need to go back to basics and reevaluate your product-market fit.
Guide your attention where it should go - whether it’s to increase your marketing spend or focus on other things that drive growth, like conversion rate optimization or customer retention strategies.
Aside from that, the Magic Number is a good indicator of the company’s growth for investors and stakeholders.
The better your Magic Number, the easier it’ll be for you to get that funding you’ve been after.
But most of all, this rather mysteriously-sounding metric helps you align your overall growth strategy to increase ROI in a more efficient, sustainable, and long-term way.
What Is a Good SaaS Magic Number Target?
Now you may be thinking, “That’s all great. But how do you make sense of your Magic Number?” Well, typically your Magic Number will be somewhere between 0 and 1.5 (or more, but that’s less frequent).
So, if your Magic Number is 0.5, it means that you needed $1 of sales and marketing spend to achieve $0.50 of revenue. This means you’re not growing at a rate that can compensate for the amount of money you’re investing in sales and marketing.
Here’s how to further interpret your Magic Number:
< 0.5 - You aren’t growing sustainably. Stop spending on customer acquisition and reevaluate your product-market fit. It may be time to make changes to your product, pricing, or anything else that might be discouraging customers from subscribing.
< 0.75 - You’re on the right track, but think twice before investing more in sales and marketing. Make sure your existing customer acquisition strategies are bringing results and are aligned with your growth goals.
> 0.75 - You’re doing great. It’s time to put more money into sales and marketing, as it will likely help you grow even faster.
> 1 - Your growth is sustainable, and your marketing strategy is paying off. You can confidently pour more money into your growth.
> 1.5 - Your growth and marketing strategies are super efficient. You’re generating substantial revenue compared to the amount of money you’re spending on customer acquisition. At the same time, you may be limiting your potential by underinvesting in sales and marketing.
What to Consider When Calculating The Saas Magic Number
After reading this article, you’re surely eager to calculate your SaaS Magic Number.
But before you start crunching the numbers, there are some things you need to know about this metric so you get a full picture of what it can tell you.
It implies a payback period
If your magic number is 1, it means you’ll pay back the previous quarter’s sales and marketing spend from the revenue generated over the next year.
If your magic number is 2, it means you’ll pay back the previous quarter’s sales and marketing spend from the revenue generated over the next 6 months. And so on.
It doesn’t consider gross margins.
You can have a Magic Number of 1 and still be struggling to maintain your head above water.
To know your real payback periods, you’ll still need to calculate your CAC Payback Period.
It only takes into account recognized revenue…
…but it doesn’t take into account booked or invoiced revenue. Recognized revenue is the real money a company earns and records.
The SaaS Magic Number only considers the recorded revenue, rather than the promised one.
It doesn’t differentiate between acquisition and retention
The SaaS Magic Number takes into account all revenue - both from new customers and existing customers.
So your Magic Number could still be great if you have a great number of new customers, even if your retention rate is low.
Don’t Rely Too Much on Your SaaS Magic Number
As you can see, the SaaS Magic Number isn’t a perfect metric. Well, no metric is perfect.
Sure, the Magic Number can serve as a compass, pointing you in the right direction and signaling where to focus your efforts - whether it’s on investing more in sales and marketing or going back to basics and reevaluating your product-market fit.
It's a powerful indicator of how well your business is doing, so by all means, do calculate it and take it into account when evaluating your business’s performance.
But remember that your SaaS Magic Number isn’t a metric you can entirely rely on. It has its limitations and won't paint the full picture of your SaaS business's intricacies. It's like peering through a keyhole when you really need to open the door.
So, while the Magic Number is a handy tool, it's just one piece of the puzzle. Rather than relying on it blindly (which you might be tempted to do since it’s so easy to track), complement it with other metrics.
Delve into deeper analysis, and take a holistic view of your SaaS business’s performance. Only this way can you truly see what’s going on in your business and make informed decisions that drive sustainable growth.
I'm the CEO & founder of ScaleCrush. You can often find me ranting way too much about BS marketing advice, fluffy and regurgitated content, and calling out gurus. I also happen to have my very own unoriginal thoughts about the stuff we're going through.
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