SaaS Magic Number

What is the SaaS Magic Number

In a nutshell, the SaaS magic number is a Key Performance Indicator that measures sales efficiency by tracking how much new revenue is generated per dollar spent on acquiring new customers through sales and marketing initiatives. 

Why use the SaaS Magic Number?

The Magic Number was popularized by Lars Leckie in the mid 2000s, as a way for startups to understand "how much gas to pour on the fire" and deliver on their growth objectives. The magic number helps SaaS companies determine the impact of sales and marketing spend on new ARR growth.

Over invest in marketing or sales relative to new bookings and you will not see the expected margin expansion. On the other hand, under investing in sales and marketing can mean missing out on opportunities for efficient growth. 

At the core, your SaaS magic number is a metric that signals how efficient your go-to-market efforts are. 

How to calculate your SaaS Magic Number?

The SaaS magic number formula measures the output of a year's worth of revenue (ARR) for every dollar spent on sales and marketing. Or in a nutshell, for every dollar of Sales and Marketing spend, how many dollars of new ARR is your business able to generate.

Here is the SaaS magic number calculation:

(Current Quarter Revenue – Previous Quarter Revenue) *4 / Previous Quarter Sales & Marketing Spend

Let's say that you spent $100,000 on sales and marketing expenses during the previous quarter to generate a monthly recurring revenue (MRR) increase of $20,000. This $25,000 will become $100,000 in ARR, as long as your churn rates are minimal. In this example, your $100,000 in sales and marketing spend has earned you $100,000 in new ARR, resulting in a SaaS magic number of 1 for the quarter. This means that you will pay back your sales and marketing expenses within a year.

Magic Number benchmarks

When Lars Leckie popularized the magic number he said:

“Fundamentally, the key insight is that if you are below 0.75 then step back and look at your business, if you are above 0.75 then start pouring on the gas for growth because your business is primed to leverage spend into growth. If you are anywhere above 1.5 call me immediately.”

It is important to understand that no SaaS financial metric is perfect, but benchmarks give us a good understanding of the operating parameters. 

 Magic number lower than 1:

Having a magic number between 0.75 and 1 signals that you can continue to invest in your sales and marketing efforts. However, if your magic number is much lower it is a good opportunity to dive deeper in your sales or marketing strategy. For example, your churn rate could be unusually high due to product maturity. Or, you are over-investing in acquiring new customers and other sales efficiency metrics such as your customer acquisition costs (CAC) need to be considered. 

Use this result in tandem with your Free Cash Flow, Runway, and Gross Margin to determine whether or not more marketings investments make sense.

Magic number of 1:

A magic number of 1 is considered highly efficient, and signals that you are ready to scale your sales and marketing functions. As Lars Leckie puts it, “your business is primed to leverage spend into growth.” At this stage, you likely also have an efficient monthly payback number, which means you can withstand increased marketing expenses in things like SEO, content marketing, growing your marketing team and scaling marketing processes. 

Magic Number above 1:

If your magic number is greater than 1 you likely are growing sustainably. Revenue growth should be predictable and you can test new marketing channel and customer acquisition models to drive incremental revenue. 

How to improve your Magic Number

When your magic number is less than 1

If your magic number is less than 1, this signals it will take more than a year for the business to recover the marketing costs for that quarter. The best thing to do in this situation is to reduce your marketing investments in activities that are generating the lowest Return on Investment (ROI), and concentrate your marketing spend on high ROI channels. 

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Some strategies that can be used: 

1. Adjusting your business model

2. Finding more cost effective acquisition channels

3. Experimenting in your sales and marketing initiatives

4. Reducing your sales or marketing expenditures in low ROI initiatives

 Alternatively, you can leverage your Customer Success team and focus on generating more revenue from your existing active customers. Or, reducing revenue churn by focusing on customer satisfaction. 

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When your magic number is equal to 1

If you have a magic number above 1, you have an opportunity to optimize your business for sustainable growth rather than focusing on short-term sales efficiency metrics. While SaaS metrics like a high magic number may make it seem like everything is as it should be, you should never hesitate to scale up your teams and campaigns. Fast ROIs on your investments means that you have money to spare to generate even more revenue instead of letting capital lay dormant.

To continue the positive growth trend, double down on the sales and marketing activities that generate the highest returns. You can also experiment by expanding your customer base and target new demographics.  

As you can see, the SaaS magic number is a simple metric to measure sales and marketing efficiencies. This combined with other SaaS metrics (CAC, Payback Period, Lifetime Value, Rule of 40, Gross Margins), can help you create a capital-efficient business model.

A better way to measure your Magic Number

Looking at the work sales and marketing teams do can sometimes seem like pure magic. The way your sales team achieves its quarterly quotas, or marketing is able to drive demand with the perfect ad. 

Fortunately, the finance team doesn't have to understand how to run marketing campaigns, but they do need to measure how efficiently sales and marketing are helping it grow – and to do this you need to know you magic number. 

Finance teams can use Abacum, connect all of their financial and operation data, and automatically calculate all KPIs. Giving you insight into operating metrics like CAC, Payback Period, SaaS rule of 40, or cost of goods sold (COGS). Abacum is saving finance teams 75% of their time with reporting templates, meaning no more manual copy-paste, no error-prone calculations, or confusing dashboards. Just a simple view of your overall company performance and forecast in a single place. That's magic!