“A man who stops advertising to save money is like a man who stops a clock to save time,” – Henry Ford
In 1913, Henry Ford brought the assembly line to the automobile industry, because he knew that prioritizing efficiency in his plants would make him more profitable. And it worked; the Model-T was the most-produced car in the world until 1975.
So, of course when it came to revenue-driving activities, Ford knew that success in marketing—and business—wasn’t about how much your marketing spend is, but how efficiently you spend it.
One hundred-odd years later, the types of businesses driving the global economy may have changed, but the lesson stays the same: It’s about efficiency.
For modern Software as a Service (SaaS) companies, the automobile is replaced by primarily digital and cloud-based solutions and software. And because of the digital nature of SaaS businesses and their subscription-based business models, the ability to collect data on how the company is performing is easier and faster than ever.
Enter the SaaS Magic Number, which measures the return on sales and marketing spend in generating new subscription revenue.
This article sheds light on what the SaaS Magic Number is and how to optimize it.
TL;DR
- The SaaS Magic Number is a metric, somewhat similar to ROI, but designed to assess the efficiency and effectiveness of a company’s sales and marketing strategies.
- By analyzing the SaaS Magic Number, SaaS companies can determine how well their revenue-driving investments (in sales, marketing, and customer retention) are translating into actual revenue growth.
- A high Magic Number suggests that a company is efficiently converting its investments into revenue, while a low Magic Number may indicate the need for adjustments in sales and marketing approaches.
What is the SaaS Magic Number?
The SaaS Magic Number is a metric, related to ROI, but better designed to assess the efficiency and effectiveness of a company’s sales and marketing strategies. It’s an especially useful metric for SaaS startups, early-stage companies, or companies with shorter sales cycles that have a lot of data, but can adapt and change direction quickly.
It’s a ratio that compares the growth in recurring revenue to the sales and marketing expenses incurred during a specific period. By analyzing this ratio, SaaS companies can determine how well their revenue-driving investments (in sales, marketing, and customer retention) are translating into actual revenue growth.
According to Hubspot, 44% of marketers say that being able to better measure return on investment (ROI) of digital marketing is a priority in the coming year. This is where the SaaS Magic Number becomes particularly handy.
Why is the SaaS Magic Number important?
The Magic Number is one of many SaaS metrics, such as customer lifetime value (LTV), churn rate, profit and gross margin, annual recurring revenue (ARR), and monthly recurring revenue (MRR), you should be using to evaluate sales and marketing performance.
However, it stands out for its relationship between spend and growth over time. It’s not just a measure of total return on investment (ROI) or a simple method of monitoring of cash flow, but serves as a sales efficiency metric. It helps businesses understand the effectiveness of their customer acquisition and retention strategies.
For example: a high Magic Number suggests that a company is efficiently converting its investments into revenue, while a low Magic Number may indicate the need for adjustments in sales and marketing, pricing, or other approaches.
How Do You Calculate the SaaS Magic Number?
The SaaS Magic Number is calculated using three numbers:
- Your current quarter’s ARR (annual recurring revenue, or your current quarter’s revenue, multiplied by four)
- Your previous quarter’s ARR (your previous quarter’s revenue, multiplied by four)
- Your previous quarter’s total sales and marketing spend (also known as your Customer Acquisition Cost, or CAC)
The SaaS Magic Number formula is as follows:
SaaS Magic Number = (Current Quarter Revenue ARR – Previous Quarter Revenue ARR) / Previous Quarter Sales and Marketing Spend
Or, if you’re unfamiliar with ARR (again, that’s Annual Recurring Revenue), you can calculate it using the following:
SaaS Magic Number = (Current Quarter Revenue 4) – (Previous Quarter Revenue 4) / Previous Quarter Sales and Marketing Spend
To calculate the SaaS Magic Number, simply gather the necessary data, plug the data into the formula, and analyze the result.
Tips for Calculating the SaaS Magic Number
It’s important to note that while the SaaS Magic Number is commonly calculated quarterly, as in the example above, it can be calculated over any time period, so long as you’re consistent with your data and you properly annualize the result.
You could, for example, calculate the SaaS Magic Number monthly. You would follow a similar template, but you would just need to make sure that you pull all of your data (the current revenue, the previous revenue, and the previous sales and marketing spend) monthly. It’s also important to note here that to annualize your recurring revenue from monthly data, you should multiply by twelve instead of four.
In other words, to calculate the SaaS Magic Number with monthly data, you’d use the following formula:
SaaS Magic Number = (Current Month’s Revenue 12) – (Previous Month’s Revenue 12) / Previous Month Sales and Marketing Spend
SaaS Magic Number example calculation with hypothetical data
*Let’s try a hypothetical scenario to illustrate how to calculate the SaaS Magic Number:
- New Revenue from the Current Quarter Revenue: $1,450,000
- Last Quarter Revenue: $1,200,000
- Previous Quarter Sales and Marketing Spend (or CAC): $800,000
Remember, our formula using quarterly numbers is:
SaaS Magic Number = (Current Quarter Revenue 4) – (Previous Quarter Revenue 4) / Previous Quarter Sales and Marketing Spend
So, plugging in our numbers, we see:
SaaS Magic Number = (1,450,000 4) – (1,200,000 4) / 800,000
Following through on our math, that becomes:
SaaS Magic Number = (5,800,000) – (4,800,000) / 800,000
That simplifies down to:
SaaS Magic Number = 1,000,000 / 800,000
SaaS Magic Number = 1.25
In this example, the SaaS Magic Number is 1.25.
What Different Values of the Magic Number Indicate
| Magic Number | What it Means |
| < 0 | The business is not efficiently converting its investments into revenue, indicating potential issues in the sales and marketing strategies. Focus on lowering marketing costs and optimization before investing more. |
| 0 | The revenue growth is in line with the expenditures incurred, but there is no positive leverage. Sales and marketing spend is sustaining revenue, but not driving profit. |
| 0-1 | The business is achieving positive leverage, with revenue growth outpacing sales and marketing expenses. Consider investing more money in existing strategies or optimizing to improve marketing efficiency. |
| > 1 | The business is generating significant revenue growth for every dollar invested in sales and marketing, indicating a high level of efficiency. |
Now that we have our example SaaS Magic Number calculation, we need to know what that number means. Here’s a breakdown of different SaaS Magic Number benchmarks and what they may indicate:
- Magic Number < 0: A negative Magic Number suggests that the business is not efficiently converting its investments into revenue, indicating potential issues in the sales and marketing strategies. You’ll want to focus on lowering your marketing costs and instead focusing on optimization here before investing any more sales and marketing dollars into these current strategies.
- Magic Number = 0: A Magic Number of 0 signifies that the revenue growth is in line with the expenditures incurred, but there is no positive leverage. In this case, sales and marketing spend is sustaining revenue, but not driving profit.
- Magic Number = 0-1: A Magic Number between 0 and 1 suggests that the business is achieving positive leverage, with revenue growth outpacing sales and marketing expenses. It is possible you would want to invest more money in existing strategies here, or optimize existing strategies to improve marketing efficiency.
- Magic Number > 1: A Magic Number greater than 1 indicates a high level of efficiency, where the business is generating significant revenue growth for every dollar invested in sales and marketing.
In our example, where we have a SaaS Magic Number of 1.25, the metric indicates that our sales and marketing investment is very efficient. That should tell us that we’re on the right track with our strategies. And that we may want to invest more money to scale our current sales and marketing strategies.
Common Mistakes to Avoid for Accurate Calculation
While calculating the SaaS Magic Number, it’s crucial to avoid a few common mistakes that can skew the results:
- Inconsistent time periods: Ensure that all the time periods for revenue and expenses align. They should all be quarterly if you’re calculating quarterly, monthly if you’re calculating monthly, etc. Mixing and matching time periods will lead to a very skewed result.
- Missing relevant expenses: Be sure to account for all sales and marketing expenses to provide a comprehensive view of the investments made.
- Inaccurate revenue figures: Double-check revenue data to avoid miscalculations that could impact the Magic Number.
- Failure to consider adjustments: In certain cases, adjustments may be necessary to account for anomalies or exceptional circumstances.
How to Use This Metric for Decision-Making
The SaaS Magic Number serves as a valuable tool for decision-making across various business units. Here are some ways companies can leverage this metric.
Optimizing resource allocation
Businesses can use the Magic Number to identify areas where additional investments may yield higher returns or where adjustments are needed to enhance efficiency. For example, you could discover that money spent in paid advertisements driving new customers is not as efficient as money spent on content marketing or upselling your existing customer base. In that case, you’ll want to pull money from the former and invest it in the latter.
Adding efficient revenue streams
This metric can also prod you to expand or diversify your revenue sources.
Let’s say your SaaS Magic Number is hovering just above zero, and you want to optimize your revenue streams. One thing to consider is integrated payments. SaaS companies that offer payment processing services as part of their platforms open up sources of revenue through processing fees or additional subscription tiers.
Integrated payments also improves user retention in SaaS. When a platform offers seamless payment processing, it reduces friction for the user, making transactions easier and more efficient. The result? Users continue using the platform and companies benefit from a steady revenue stream.
Pro tip: if you’re looking to offer integrated payments within your software, Stax Connect can help fuel your growth.
By partnering with Stax Connect, you can combine the monetization power of payments with the control and security of your own infrastructure. Level up your SaaS platform by enabling payments for your users.
And with custom revenue-share opportunities, you can maximize your profit margins while adding significant value to your customers.
Forecasting and budgeting
The Magic Number aids in creating more accurate revenue forecasts and budget plans by providing insights into the relationship between investments and growth. You’ll be able to use this efficiency metric to help determine where and when to expand your sales team or your marketing team
Strategic planning
Companies can align their strategic decisions with the Magic Number, ensuring that growth plans are sustainable and in sync with sales and marketing efforts.
How Often Should You Calculate the Magic Number?
The frequency of calculating the Magic Number depends on the specific needs and dynamics of each business. A quarterly assessment is a common practice, and generally allows for timely adjustments and insights into short-term performance trends. That said, some businesses may choose to calculate it monthly or annually, depending on the pace of their operations and the granularity of data required.
Conclusion
In conclusion, the SaaS Magic Number can be a powerful tool for SaaS businesses seeking to optimize sales efficiency and make informed strategic decisions. By implementing the SaaS Magic Number, businesses can drive sustainable growth and navigate the competitive SaaS landscape with confidence. It’s an efficiency metric that even an efficiency legend like Henry Ford would use to assess success.
FAQs about the SaaS Magic Number
Q: What is the SaaS Magic Number?
The SaaS Magic Number is a metric similar to ROI, designed specifically to evaluate the efficiency and effectiveness of a company’s sales and marketing strategies in the SaaS industry. It compares the growth in recurring revenue to the sales and marketing expenses incurred during a specific period, so companies understand how well their investments are translating into actual revenue growth.
Q: Who is it for?
The SaaS Magic Number is a metric that’s particularly useful for SaaS startups, early-stage companies, or companies with shorter sales cycles that have a lot of data and can adapt and change direction quickly.
Q: How do you calculate the SaaS Magic Number?
You calculate the SaaS Magic Number by taking the growth in annual recurring revenue (ARR) from one period to the next, divided by the sales and marketing expenses of the previous period.
So, if you’re calculating your magic number over the last 12 months, the formula would be:
SaaS Magic Number = (Current Month’s Revenue 12) – (Previous Month’s Revenue 12)/ Previous Month Sales and Marketing Spend
Q: How often should you measure the SaaS Magic Number?
A quarterly assessment is common practice, but some businesses may choose to calculate it monthly or annually, depending on their operational pace and the granularity of data required.
