Looking for a metric to add some magic to your SaaS sales game?
Meet the magic number!
The magic number is a sales efficiency metric commonly used by subscription-based businesses.
The metric not only helps SaaS companies optimize their sales and marketing strategies but also enables them to make informed decisions about growth and investment opportunities.
In this article, we’ll explore the ins and outs of the magic number SaaS, why you should be tracking it, its formula, and benchmarks. We’ll also give you some tips to improve the metric and discuss a few of its limitations and related metrics.
This Article Contains
- What is the SaaS Magic Number?
- The Benefits of Tracking Your SaaS Magic Number
- How to Calculate the Magic Number
- SaaS Magic Number Benchmarks
- How to Optimize Your SaaS Magic Number
- Limitations of the Magic Number
- Related SaaS Metrics
Ready to discover the magic behind this metric?
What Is the SaaS Magic Number?
The magic number refers to the ratio between a SaaS company’s new quarterly recurring revenue and its previous quarter’s sales and marketing expense.
By calculating this value, SaaS companies can get an idea of how much incremental revenue they can generate for every sales and marketing dollar spent.
But that’s not all.
SaaS companies can also use this metric to determine how effective their sales and marketing efforts are and whether or not they should spend more on such strategies.
The Benefits of Tracking Your SaaS Magic Number
Here are four ways how subscription-based companies can benefit from tracking this sales efficiency metric:
1. Gain Insight into the Success of Your Sales and Marketing Efforts
The magic number can help SaaS companies gauge how successful their sales and marketing efforts are over a specific timeframe.
A high magic number indicates you’re getting a decent return on your sales and marketing investment. Additionally, it could mean that it’s time for your company to invest more heavily in marketing spending.
On the other hand, a low magic number may indicate that there’s something wrong with your current marketing strategy. In this case, you could be overspending on marketing, targeting the wrong customer base, or lacking product market fit.
2. Boost Your Appeal to Investors
Investors are often interested in how a startup’s sales and marketing efforts translate into revenue growth.
So, a startup that has a high magic number can leverage this metric to showcase its sales and marketing efficiency. This can be a persuasive factor for potential investors evaluating funding opportunities.
But there’s more.
The magic number can also be used as a benchmark to compare a startup’s performance to industry standards and publicly traded companies based on GAAP revenue (generally accepted accounting principles). This gives investors a clearer picture of how the company is performing.
3. Make Informed Budgeting Decisions
A SaaS CFO can use the magic number to determine if the company should adjust its marketing spend.
Here’s an example:
If a company’s main marketing strategy is centered on customer acquisition, but the magic number is high, it could signal an opportunity to explore new customer segments and expansion opportunities.
Additionally, since the magic number tracks the performance of your sales and marketing efforts per quarter, you can use it to determine what marketing channels and tactics are working and allocate your marketing spending budget accordingly.
4. Align Sales Efficiency Goals
The magic number SaaS can promote alignment within a company’s board and leadership team by providing a common metric for evaluating the effectiveness of sales and marketing strategies.
By tracking this sales efficiency metric, leaders can make data-driven decisions about resource allocation and ensure everyone is working towards the same sales efficiency goals.
How to Calculate the Saas Magic Number
You can calculate your magic number with the following formula:
SaaS magic number = [(Current quarter’s recurring revenue – previous quarter’s recurring revenue) * 4] / (Previous quarter’s sales and marketing spend)
The above formula calculates the difference in recurring revenue between the current quarter and the previous quarter.
That value is multiplied by four to annualize the quarterly difference. This way, companies can estimate the amount of recurring revenue they are likely to generate from customers over a year.
The result is then divided by the previous quarter’s sales and marketing expense.
Here’s an example:
Suppose your SaaS company’s recurring revenue in Q1 was 100k and in Q2, the current quarter, it’s 150K. Your Q1 sales and marketing spend was 110K.
Using the above formula:[(150,000-100,000) x 4] / 110,000 = 1.80
In this case, your company is generating $1.80 in incremental revenue for every sales and marketing dollar spent.
Now, you may be wondering:
What’s the ideal magic number?
Let’s find out!
SaaS Magic Number Benchmarks
The general magic number benchmark for SaaS companies is 1.
Here’s a closer look at what different magic numbers may mean for your business:
- < 0.5: A magic number this low means you may need to rework your business model. You should re-evaluate your pricing strategy, target market, customer acquisition costs, churn rate, and product-market fit.
- < 0.75: If you’re approaching the 0.75 mark, you’re on the right track. At this stage, you can look at where your sales and marketing budget would be best spent, depending on your gross margins and free cash flow.
- > 0.75: A magic number greater than 0.75 means you can start investing more in your sales and marketing functions. You should have achieved product-market fit and decent customer acquisition cost payback periods at this stage.
- 1: This is the ideal magic number benchmark and means that the incremental recurring revenue generated from customers within 12 months after the quarter covers your sales and marketing costs. In other words, you’ll likely break even on your costs within a year.
- > 1: While a magic number above 1 is great, it may also indicate that the company is under-investing in sales and marketing. So, consider adding new marketing channels and expanding your marketing and sales team.
Is your SaaS magic number not where you want it to be?
Not to worry — below are a few tips to help you improve it.
How to Optimize Your SaaS Magic Number
Here are a few ways to get a better return on your sales and marketing investment:
1. Upsell and Cross-Sell
The metric doesn’t differentiate between expansion revenue and new recurring revenue.
So your marketing and sales team can also focus on upselling and cross-selling your existing customer base to boost your average revenue per user.
The probability of selling to an existing customer is around 60-70%. While the likelihood of selling to a new prospect is only 5–20%!
Here are a few ways to do this:
- Product analytics: Identify usage and behavioral patterns to recommend additional products or services to your customers.
- Free trials: Offer existing customers a free trial of a higher-tiered plan to increase the likelihood of them upgrading.
- Create urgency: Use emails and in-app messages to communicate limited-time discounts or special offers on an upgrade or additional product.
- Social proof: Highlight customer success stories or testimonials to showcase the value of additional products or services.
- Referral programs: Incentivize customers to refer others to your product for a discount on their subscription or other rewards.
2. Focus on Customer Retention
A high customer churn rate means the SaaS company is losing revenue and customers, resulting in a lower magic number.
So, SaaS companies need to have customer retention strategies in place.
Some tactics to consider include:
- Encouraging users to downgrade their plan instead of canceling the subscription
- Creating better onboarding experiences by including checklists, product demos, knowledge bases, and self-service options like chatbots
- Using exit surveys to find out why a customer decided to cancel their subscription
- Using a SaaS KPI (key performance indicator) like the net promoter score (NPS) to identify and prevent unhappy customers from churning.
- Re-conducting market research to better understand your target customer’s pain points and needs. This way, you can create marketing strategies that better resonate with your target market.
3. Test New Marketing Channels
Experimenting with new marketing channels can help a SaaS business broaden its reach and determine what strategies generate the best results.
SaaS companies can explore social media advertising, video marketing, content marketing, SEO, and more.
Did you know that leading SaaS companies like Canva use an SEO approach to skyrocket their search growth?
In fact, search growth for Canva was over 282% between 2020-2022!
Additionally, SaaS companies with a robust content strategy see around 30% higher growth rates than those without.
4. Adjust Your Pricing Strategy
SaaS companies can re-evaluate their pricing strategy to create plans and packages that their target market is willing to pay for.
Here are a few different pricing models you could try out:
- Per-user pricing: Charging customers based on the number of users accessing the software
- Tiered pricing: Offering different feature sets or usage limits at various price points
- Usage-based pricing: Charging customers based on how much they use the software
- Value-based pricing: Charging customers based on the value they receive from using the software or the results they achieve
- Freemium pricing: Offering a free forever, limited version of the product, so customers can derive value at their own pace and upgrade when ready.
Limitations of the Magic Number
While the magic number can give SaaS companies crucial insights into sales and marketing efficiency, it doesn’t fully describe a company’s health.
Here are a few of its limitations:
- Inaccurate payback periods: A SaaS CFO should only interpret the magic number’s payback period as a guideline. This is because the magic number doesn’t consider other metrics like gross margin and cost of goods sold (COGS), which can lengthen or shorten the payback period.
- Doesn’t differentiate between new and expansion revenue: The metric doesn’t distinguish between new customer revenue and revenue generated from upselling and cross-selling existing users. As a result, SaaS companies need to track additional metrics to better understand where their revenue is coming from and if they can grow sustainably.
- Can be an unreliable indicator for startups: In the early stage, founders may be more involved in the sales process, distorting sales and marketing costs. As a result, startups should only look at this sales efficiency metric when it has achieved product-market fit and a scalable sales process.
Next, we’ll take a look at some additional metrics you should track alongside the magic number.
Related SaaS Metrics
If you want to get a complete picture of your company’s health, you can’t focus on just one SaaS metric. Below are a few additional metrics and KPIs you should track.
1. Customer Acquisition Cost
Customer acquisition cost is a SaaS KPI that measures how much money a company spends to get one new customer.
CAC= Total costs of sales and marketing / Number of customers acquired
2. CAC Payback Period
The CAC payback period measures how long a company takes to recoup their customer acquisition costs
CAC payback period = CAC / MRR
3. Customer Lifetime Value
Customer lifetime value measures the total amount of money a customer is expected to spend on your product throughout the business relationship.
CLV = Average value of a purchase * Annual purchase frequency * Average customer lifespan (years)
4. CLV to CAC Ratio
This SaaS metric compares the value you expect to receive from a new customer with the cost of acquiring them.
CLV to CAC ratio = CLV over a specific period / CAC over the same period
5. Expansion MRR Rate
The expansion MRR rate tracks the rate at which a company’s expansion revenue is growing monthly.
Expansion MRR rate = [(Expansion MRR of current month – Expansion MRR of previous month) / Expansion MRR of previous month] * 100
6. Net Revenue Churn Rate
Net revenue churn rate tracks the percentage of revenue lost from downgrades and cancellations while taking expansion revenue into account.
Net Revenue churn rate = [(Churned MRR- Expansion MRR) / Beginning MRR ]* 100
7. Net Revenue Retention (NRR)
Net revenue retention is the percentage of recurring revenue from existing customers that a company retains over a specific period.
NRR = (MRR at the start of the month + Expansion MRR – Churned MRR) / MRR at the start of the month
8. Gross Margin
Gross margin tracks a company’s revenue after subtracting the cost of goods and services (COGS). For a SaaS business, COGS usually refers to the cost of maintaining and delivering the software product.
Gross margin = [Revenue – COGS / Revenue] * 100
So, Can This Metric Work Magic for Your SaaS Company?
The magic number is an excellent sales efficiency metric SaaS companies can use to determine sales health, guide budgeting, and support funding efforts.
But it has its limitations and blind spots. So, you’ll need to track additional metrics to get a complete picture of your company’s health.
Use the tips and strategies above to get the most out of the magic number.
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We can help you create a powerful, conversion-based SEO and content strategy that‘ll skyrocket your revenue growth.