Marketing expenditures are a big line item in the budget for SaaS companies, particularly in early-stage growth years. According to data from studies in 2013 and again in 2021, SaaS businesses spend 80% to 120% of their revenue on marketing and sales in the first 3 years.
That figure drops to 50% by the time the SaaS company is 5 years old, but that's still hefty compared to the 10 to 14% average across other industries. With such big spending in these areas, it's no wonder that the metric named the SaaS magic number is a marketing and sales efficiency calculation.
Below, we'll dig deeper into the SaaS magic number, providing details on how to calculate it, what other metrics you should pay attention to, and how CFOs can use the SaaS magic number to drive stronger sales, marketing, and business decisions.
What is the SaaS Magic Number?
Unfortunately, the magic number is merely an accounting tool; not a magic fix for your SaaS business (and certainly not the promise of 100% profit margins after you work with a "coach" with questionable credentials).
Like customer acquisition cost (CAC), the SaaS magic number is a calculation that helps you understand the performance of critical business efforts. Specifically, it tells you how many dollars of revenue each dollar of sales and marketing spend creates.
Key Objectives for CFOs Utilizing This Metric
CFOs can use this figure to understand the real return on sales and marketing dollars spent. With large percentages of the revenue being reinvested in marketing efforts, this is obviously an important consideration at any time. But it's especially critical during times of potential growth — the SaaS magic number can indicate with high accuracy whether a business is ready to scale marketing and sales efforts.
Components That Make Up the Magic Number
The SaaS magic number formula is as follows:
SaaS magic number = [(Current quarter revenue - previous quarter revenue) x 4] / previous quarter's sales and marketing expenses
For accuracy with the magic number calculation, it's important to get each component correct, so let's dig a bit deeper into each figure that makes up the SaaS magic number.
- Current quarter revenue: This is the total income related to sales for the quarter you just ended. For example, if you're calculating the SaaS magic number in July, you would use Q2 (April through June) as your current quarter.
- Previous quarter revenue: This is the total income related to sales for the quarter before the one you just ended. If you're calculating the figure in July, you would use Q1 (January through March) as your previous quarter.
- Previous quarter sales and marketing expense: This is the total amount spent on sales and marketing efforts for the previous quarter. This includes but isn't limited to paid ad spend, content marketing expenses, travel costs, and costs for sales automation tools.
Why Do We Multiply by 4?
The first step in calculating the SaaS magic number is subtracting the previous quarter's revenue from the current quarter's revenue. This gives you a quarterly figure that helps you understand your revenue growth, quarter over quarter. Multiplying this figure by four annualizes it.
Example of Saas Magic Number Calculation
To understand what this calculation looks like, consider the hypothetical example below:
- Current quarter revenue: $200,000
- Previous quarter revenue: $150,000
- Previous quarter sales and marketing expenses: $250,000
In this case, the SaaS magic number is calculated by:
- [($200,000 - $150,000) x 4]/$250,000
- ($50,000 x 4) / $250,000
- $200,000 / $250,000
- Saas magic number equals 0.8
Why Is It Important for CFOs to Understand the Magic Number?
The SaaS magic number can help CFOs of Saas businesses get a more comprehensive picture of profitability, revenue growth, and whether marketing investments are a good idea. Here are a few ways you can use this figure, usually alongside other accounting metrics, to make financial and management decisions for a start-up or growing SaaS company:
- Is it time to up the ante on your marketing strategy? When the SaaS magic number exceeds certain benchmarks, CFOs know it might be time to increase investments in marketing and sales. High magic numbers indicate that product-market fit is strong or that you've stumbled upon especially effective marketing strategies, and acting quickly to capitalize on those favorable conditions can help drive growth in the near future and set the business up for stability in the long term.
- Is the business model healthy? The magic number can be an indicator of whether the overall business model, including marketing strategies, pricing structures, and customer service efforts, is healthy. This figure won't point out the issues, but it can clue CFOs into the need to dig deeper into operations and other data to figure out why sales and marketing efforts aren't driving a higher return.
- Are issues causing lagging revenues? Excellent sales and marketing efforts can still result in a low SaaS magic number if you’re losing customers or taking too long to convert them; for example, your magic number won’t accurately reflect your new revenue sources if your churn rate is high, as you’ll be losing your old revenue sources. Paying attention to the SaaS magic number in addition to other popular marketing metrics such as cost of acquisition can help CFOs understand the long-term effects of sales and marketing efforts. After all, if a sales campaign drives thousands of free trial signups but only small percentages stick around to become long-term customers, that's a poor conversion funnel and you should focus on other mediums.
- Are marketing and sales efficiency almost, but not quite, there? Sometimes, the SaaS magic number isn't bad as much as it's lackluster and unexciting. For CFOs, this can indicate a cooling-off period on highly successful viral marketing campaigns; such waxing and waning is normal for a healthy SaaS business. Allow this to play its course while your team experiments with new mediums!
How to Interpret Your Magic Number
Understanding SaaS magic number benchmarks is key to converting this figure into a metric that can be used to drive business decisions.
Magic Number Less Than 0.5
When the magic number is lower than 0.5, you're in the red zone. Though it doesn’t identify what the problem is, it's an indicator that something is wrong. CFOs and marketing teams must work together to dig into current processes and performance to find the root cause of lackluster sales and marketing performance.
It's important to remember that the issue certainly could be with sales and marketing processes. For example, if a campaign is poorly targeted, it's unlikely to generate the revenue needed for a high SaaS magic number. However, the problem can also be with the product itself or another process, such as support or customer service.
Magic Number Less Than 0.75
When the magic number falls between 0.5 and 0.75, it's an indicator that sales and marketing efforts are fairly efficient. A magic number in this range isn't an automatic green flag for more sales and marketing spend, but it's not an automatic no either. CFOs should take figures in these ranges as a sign to do a bit of digging to see if processes can be shorn up or if additional spend might be possible based on current budgets and overall business financial health.
Magic Number Greater Than 0.75
When the Magic number begins to approach — or exceed — 1, it's a good indicator that CFOs can safely approve more aggressive sales and marketing budgets. Typically, this is a sign that product-market fit has been achieved and that the business may be positioned for a strong or even viral growth period with the right investment in marketing and sales teams.
Understanding the Impact of Pricing Changes
Pricing plays a key role in the SaaS magic number. After all, if you charge $5 per month for a SaaS product and have 1,000 customers, that's $60,000 in revenue per year. Increase the price by $3 per month, and suddenly the revenue jumps to $96,000. That can mean a huge difference for your SaaS magic number.
Obviously, pricing is only one component of the whole, but it's important for SaaS and tech subscription businesses to pay attention to the impact of pricing and reconsider pricing regularly. According to Price Intelligently, the average company only ever puts 6 hours of work into its pricing strategy. That's 6 hours over the entire lifetime of the company, which isn't much for such an important factor.
Instead, CFOs should consider pricing impacts and changes every 6 months or so. Anytime you change pricing, note it as a consideration for upcoming SaaS magic number calculations, as you might see significant changes to such figures without any real impact from sales and marketing efficiency.
A Better Way to Track Your Magic Number
Using a SaaS magic number calculator to automatically calculate the magic number is one of the best options for CFOs. Consider building figures such as marketing costs and previous quarter revenue into automatic dashboards. By capturing these figures on a regular basis, you always have the information you need to arrive at an accurate SaaS magic number calculation.
If you automatically have this data available to you for a year or more, you can start to see trends over time and understand the operational cycles of your business in a much more actionable way.
How Can CFOs Utilize the SaaS Magic Number?
This sales efficiency metric helps you understand the overall success of the sales cycle and avoid issues such as under-investing in marketing.
Monitoring Key Performance Indicators
CFOs should never track and consider the magic number in isolation. As with all accounting metrics, the magic number doesn't give a holistic picture on its own. As already demonstrated, for example, the magic number can be inaccurately inflated by a change in price. In such a case, your marketing efficiency may not have changed or might even have slid backward, and without a holistic picture, you wouldn't know.
Ensure you're paying attention to other KPIs, such as monthly recurring revenue (MRR), annual recurring revenue (ARR), acquisition costs, cash flow, number of new customers, lifetime customer value, customer retention, and revenue retention rates.
Tracking the Impact of Growth
The magic number is another lens you can use to understand revenue growth, especially when considering how much new revenue sales and marketing campaigns can drive. However, it doesn't offer full insight into growth metrics, and CFOs should continue to work with others across the organization to understand qualitative factors such as customer success.
What Else to Pay Attention To
Using the magic number alone creates financial blindspots for CFOs that can lead to poor decision-making. Ensure you're paying attention to all important account metrics, including cost of goods sold (COGS), gross and net profit margins, current ratio, budget variance, and sales growth rate.
The magic number isn't a mystical spell that does away with the need for balance sheets and other financial reporting. As a CFO, you must still lead the charge on strong accounting practices for your SaaS organization.
Strengthen Your SaaS Financial Management Today
Regardless of what Douglas Adams may have you believe, the magic number isn’t 42. However, it does answer some universal questions, such as how much to spend, where to reign in expenses, and how prepared you are for continued revenue growth.
Whether you're evaluating marketing channels for optimal ROI or you have questions about what current ratio is best for SaaS companies, I can help. Subscribe to the CFO Club newsletter to get industry insights delivered to your inbox, or ask questions in the comments to hear from other CFOs and accounting professionals.