I always wanted to incorporate magic with SaaS. Well, dreams do come true…

I gotta confession to make. I love numbers. Always have been obsessed with numbers and when I started working in SaaS, it exacerbated because of metrics. Doesn’t matter what type, bottom of the funnel, or top, I always liked tracking wild range of metrics to see how my team(s) were performing and of-course the business.

What I personally like about numbers is that they leave the need (for the most part) to explain things in detail. They list in black and white, where things stand, whether is all good, bad or somewhere in the middle.

In short, let the numbers do the talking.

So, while on the subject, let’s talk about a metric that does not get talked about often enough. A metric that didn’t really make it to “main stream” but it’s a critical one nonetheless.

And that’s SaaS’s Magic Number.

What is SaaS’s magic number?

It’s a metric that is used (more often than you might think) to measure the efficiency of a SaaS company’s sales and marketing efforts in generating new recurring revenue.

It helps companies determine how effectively the company is using it’s sales and marketing investments to drive growth. It gives you a high-level understanding of sales efficiency.

Alright, it’s all great but lets talk about how do you calculate the darn thing.

How do you calculate the SaaS magic number?

You can calculate the magic number by subtracting the last quarter’s annual recurring revenue (ARR) from the current quarter’s ARR and dividing by your total customer acquisition cost (CAC), essentially your total sales and marketing spend from the previous quarter.

Calculation

(Current Quarter ARR – Prior Quarter ARR) / Prior Quarter Acquisition Spend

The primary magic number equation uses quarterly revenue numbers for the calculation. But you can also use monthly recurring revenue (MRR) to come up with your magic number on a monthly basis or calculate it on an annual basis, depending on your average sales cycle.

The calculation combines new ARR/MRR and renewal revenue to provide a more holistic understanding of your company’s growth rate. If you need more granular overview of things, couple this with net revenue retention and it will get you that much closer to getting a better understanding of the health of your business.

Why does the magic number matter?

We got the calculation out of the way. Why does it all matter?

The magic number is one of the most important financial ratios to analyze a SaaS business. Investors use it all the time. Finance’s job can’t just stop short of just reporting on what happened in the past. You have to give the rest of the business a clear, concise picture of the company’s financial health and unlock strategic, forward-looking insights in the process.

This is one of those ratios that are foundational and important to track. Your magic number in a nutshell helps you determine the efficiency of your sales and marketing engines over a period of time and can tell you when to invest more or less in these growth engines.

The best example of magic number is of 1. If your company’s magic number is 1, that means you’ll pay back the previous quarter’s sales and marketing spend (the denominator of the magic number equation) from the incremental revenue generated over the next year (the numerator).

You can also look at the efficiency metric in the context of your business and decide whether or not to increase the S&M Spend. If you’re looking for a typical benchmark, there are 3 thresholds to consider.

Magic Number Breakdown

<0.5 = Not ready to invest in S&M

<0.75 = Evaluate

>0.75 = Invest in S&M

If your magic number is less than 0.5

Not ready to invest in Sales and Marketing. This number indicates inefficient growth. If this is where you’re at, your company is spending a significant amount on sales and marketing relative to the revenue it is generating. This suggests that the return on investment (ROI) for sales and marketing is low.

Action to take here would be to optimize the sales and marketing strategies. Perhaps you need to target the right customer segment, or make the sales process more effective. Or maybe the product-market fit is not strong enough.

If your magic number is less than 0.75

This is the main threshold to consider for magic number. If you’re approaching the 0.75 mark, you as a company are on the right track.

However, it does not mean you should go ahead and start investing heavily in your sales and marketing. That will depend very much in the context of your business and the level at which you’re at.

Look at your cash runway, free cashflow, and gross margins to determine whether or not more growth investments make sense.

If your magic number is greater than 0.75

This is the place at which you can green light investing in sales and marketing. If you as a business have reached this level, that means you’ve proven product-market fit and have acceptable CAC payback periods. At this stage, you’ve likely trimmed your monthly payback number to a reasonable level and can handle increasing marketing spend in areas such as content marketing, digital advertising, and SEO.

While a magic number of 1 is ideal, you should be comfortable after exceeding the 0.75 mark.

Of-course there are companies out there that are doing 1-1.5 or even above. That is what you should be striving for. If this is where you’re at, first off kudos! That is not an easy thing to do.

Next up consider scaling sales and marketing efforts more aggressively. Essentially, the higher the number, the more aggressive the approach you need to take. But at the same time make sure that the growth is sustainable and is not going to negatively affect other aspects of your business. Think customer support, and product development, by making sure that they can keep up with the increased demand.

Practical Example

Assume a SaaS company has the following figures:

•   Q1 QRR: $500,000
•   Q2 QRR: $600,000
•   Sales and Marketing Expenses in Q1: $200,000

1. Calculate QRR Growth:

QRR Growth = $600,000 – $500,000 = $100,000
Sales and Marketing Expenses from Q1: $200,000
SaaS Magic Number: $100,000/$200,000 times 4 = 2

In this example, the SaaS Magic Number is 2, indicating highly efficient growth. The company is effectively using its sales and marketing investments to generate significant new revenue.

As always context matters. No financial metric in SaaS is the silver bullet and perfect on its own, magic number being no exception. Having said that, this is still a very effective benchmark to keep track of.

The magic number is a widely used formula for SaaS companies at all different stages. However, it’s especially valuable for telling the story of sales and marketing efficiency behind the strong revenue growth in early-stage startups. Having this kind of context can make or break your pitch for a new round of venture capital.

If your magic number is not where you want it to be, not to worry. There are plenty of ways to improve this metric. Try optimizing your ad spend or refining your Ideal Customer Profile (ICP), so you’re targeting the right buyer. You can purchase sales automation tools that increase your outreach and automate follow-ups to help reduce the sales and marketing costs as well.

While, the SaaS magic number is useful, it should be considered alongside other metics such as Customer Acquisition Cost (CAC), Customer Lifetime Value (CLTV), churn rate, and overall profitability to get a comprehensive view of the company’s health.

Also, don’t look at any data in isolation. That’s a sure shot way of making bad decisions. Monitoring the magic number over multiple periods will give you insights into the effectiveness of changes in sales and marketing strategies.

Much of the work of sales and marketing can seem like pure magic. It is, remember magician!

Ha. The way your sales team hits their quarterly goal just in time to meet the quota seems like sorcery. And the uncanny ability of marketing functions to serve up the perfect ad at the perfect time – that’s straight-up ESP.

Luckily, you dont have to understand how marketing is always able to offer customers a perfectly timed, personalized solution or how sales always finds new ways to close deals. But you do need to do a little magic of your own: You need to be able to measure how efficiently sales and marketing are helping the business grow – and to do it, you need to know your magic number.

The number in reality is not magical at all, surprise surprise! It’s a useful snippet, but looking at individual SaaS KPIs will never tell you the full story of your business. You need to be able to see a complete picture of the company’s performance, in one place, in real-time, at any time. And that means keeping a finger on the pulse of every SaaS metric that matters to your business.