How to Calculate the SaaS Magic Number

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Sales Efficiency Metrics – SaaS Magic Number and More

As a CFO, the balance between sales and marketing spend and new ARR or MRR creation is critically important to measure and monitor.  Over invest in sales and marketing relative to your new SaaS bookings and will you not the see the expected margin expansion or cash creation.  Conversely, under investing in sales and marketing when you have achieved the correct product/market fit and you will miss out on opportunities for growth.  Therefore, it’s important to calculate the SaaS Magic Number and other sales efficiency metrics to determine your sales health.

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What Metrics to Measure?

Of course, in SaaS, there are metrics as far as the eye can see, but in this post I will explain three sales efficiency metrics that may be relevant to your SaaS business.  Or you can tweak them so that they are more applicable to your business model.

I’ll explain how to calculate the Saas Magic number, Bessemer CAC Ratio, and the CAC Payback period and what these numbers mean to your SaaS business.

How to Calculate the SaaS Magic Number

The SaaS Magic Number is a widely used formula to measure sales efficiency.   It measures the output of a year’s worth of revenue growth for every dollar spent on sales and marketing. To think of it another way, for every dollar in S&M spend, how many dollars of ARR do you create.

SaaS Magic Number Formula

 

Let’s say you spent $1 on S&M in 1Q16.  If your revenue then increased by 25 cents in 2Q16 (which annualizes to a $1), you would have a Magic Number of 1.0.

A magic number of 1.0 also implies that you paid back your customer acquisition costs in a one year timeframe.  After year one, you should be generating margin on that customer (assuming ARR – ACS is positive).  This metric does not discriminate between new business and existing.  It measures growth from all areas.

See the table below for what SaaS Magic Number targets.

SaaS Magic Number Targets

Bessemer CAC Ratio

The Bessemer CAC Ratio is similar to the Magic Number, but the formula is more defined to new acquisition.  To me this ratio says, how fast does my gross margin pay for my new customer acquisition costs.

Bessemer CAC Ratio

A ratio of means 1.0 indicates that within one year you are completely break even on a customer.  In this case, I define break even as covering your gross expenses AND customer acquisition costs.  Whereas a SaaS Magic Number of 1.0 means that you have only covered your S&M expenses within the first year, and you are still out-of-the money at month 12 with the customer because you have not covered your gross expenses yet.

Bessemer CAC Targets

Please note that it appears that Bessemer does not publish this ratio anymore (at least that I can find.).  They may have transitioned to the CAC payback period below.

CAC Payback Period

This is similar to the Bessemer CAC Ratio, but it flips the numerator and denominator and uses MRR to convert this to monthly payback number.  Please note that I’ve interpreted their ratio a bit differently in my formula below.

Bens CAC Payback Period Formula

Bessemers CAC Payback Period Formula

In Bessemer’s formula, they use the previous quarter as the time period in both the numerator and denominator.  In my experience, there is typically a lag between the investment in S&M and when you see results (new MRR or ARR).

You will want to make sure this timing is relevant to your business as everyone’s sales cycle is different. As such, I take MRR in the current quarter versus the previous quarter’s customer acquisition spend (I measure against S&M from a year ago for longer sales cycles).  I also drop the Committed from the CMRR and take only the portion of S&M expenses dedicated to new customer acquisition.

I interpret Bessemer’s original payback formula above as an all-in formula that includes growth from new and existing customers.  Why?  Because they use CMRR which typically includes churn from existing customers.  And sales the marketing spend is not defined specifically to just new customer acquisition costs.

The table below outlines ideal payback months per Bessemer.

Bessemer Payback Period Targets

Conclusion

It is interesting to calculate all of these sales efficiency metrics for your business, but I find that the CAC Payback Period formula is powerful.  It incorporates gross margin (the SaaS Magic Number does not) and quantifies it in months which is easy to understand.  It can also cut through the noise of what appears to be great bookings growth but at the cost of over investing in sales and marketing that will take years to payback if at all.

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2 Comment

  1. Muhammad says: Reply

    Awesome Formula “SaaS Magic Number”

  2. […] determines your efficiency in generating incremental recurring revenue.  In the SaaS community, a SaaS Magic Number of 1 or greater is considered ideal, but should you really pour more money into sales and marketing […]

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