What is the SaaS Magic Number?
The SaaS Magic Number is a metric used to measure a company's efficiency in acquiring new customers and its ability to generate recurring revenue from them. It’s a ratio of the company's sales and marketing expenses to its recurring revenue, which indicates how much money the company is spending to acquire new customers and how long it takes to break even on that investment.
Why the SaaS Magic Number Is Important
The SaaS Magic Number is important for several reasons. First, it helps SaaS companies understand their customer acquisition costs and how effective their marketing and sales efforts are at bringing in new customers. Second, it can help companies identify areas where they can improve their efficiency and optimize their spending. Finally, it can help companies forecast their future growth and profitability, allowing them to make informed decisions about investment and expansion.
How to Calculate the SaaS Magic Number
The SaaS Magic Number is calculated by looking at the change of ARR from the prior period to the current period and dividing that result by the operating spend on acquiring new business for the prior period. This is generally calculated on a quarterly basis. The formula for calculating the SaaS Magic Number is:
SaaS Magic Number = (Current ARR - Prior ARR) / Prior New Business Operating Expense
To illustrate this calculation, let's say that a company had $200,000 in recurring revenue in Q1 and $350,000 in Q2, and it spent $100,000 on sales and marketing expenses to obtain new business during Q1. Using the formula above, the SaaS Magic Number would be:
SaaS Magic Number = ($350,000 - $200,000) / $100,000 = 1.5
Generally a value less than 0.5 means that a company is not ready to invest in S&M, a value between 0.5 and 0.75 means that the company should evaluate S&M spend, and a value greater than 0.75 means the company is ready to invest in S&M. In the example, a value of 1.5 is high and means the company has curated a successful model and can invest additional resources.