The SaaS Magic Number - Definition, Calculation, Benchmark

Yesterday, I was doing my regular research on SaaS business health.

I came upon articles and books concerning many financial metrics and key performance indicators (KPIs), but one caught my attention big time: the magic number method.

Having heard about it once or twice before, I left no stone unturned to check how it affected business, potential investors, and future performance.

For subscription businesses, this key metric means the world to measure sales efficiency.

SO, I had to write an article to let you all know about it—because it's every business owner's right to use this simple metric in quarterly meetings.

This article focuses on each detail regarding the SaaS magic number, from its significance to its formula.

What Is the Magic Number in SaaS?

For SaaS businesses, the magic number is a measure of sales efficiency as it provides you with an outlook of sales and marketing efforts. The magic number represents revenue growth in regard to both sales expenses and marketing expenses. By using this number, you can evaluate how profitable a business is based on generating recurring revenue at the cost of sales and marketing spending.

Directly connected to business health, the magic number tells a lot about the cash balance between monthly recurring revenue (MRR) and sales and marketing spending, enabling you to take action concerning growth sustainability.

Why does the SaaS magic number matter?

The magic number in SaaS matters because keeping track of SaaS metrics is always a good idea, especially when it comes to the growth rate. As this metric measures sales & marketing costs against revenue growth, you'll be able to see the overall effectiveness of the business in generating and retaining revenue—which will allow you to identify which areas of the business need improvements.

For example, you contemplate making a big sales and marketing investment just when you've acquired a few customers. You should consult the magic number because you might not experience expansion revenue or boosted cash flow right away. The same goes for the other version, where you lack investment in sales and marketing activities when you've already reached a decent product-market fit. As a result, you'll pass up on growth opportunities this time.

Moreover, there are various functions the magic number has. For example, it helps you:

👉advance your sales and marketing process by pinpointing the exact areas that need improvements.

👉decide on a better Customer Acquisition Cost (CAC) by calculating Return on Investment (ROI).

👉push your team to the next level by showing what steps could be taken to boost the overall performance.

👉promote efficient sales by revealing where discrepancies appear.

👉 work toward better sales and marketing solutions by running the magic number process on a regular basis with other SaaS metrics and KPIs that complement each other.

In short, you should make use of this measure of sales efficiency to optimize sales and marketing expenditure and lower customer acquisition costs in the long term.

How to Calculate the SaaS Magic Number

As one of the sales efficiency metrics, the SaaS magic number measures the outcome of yearly revenue growth for each dollar spent on sales & marketing. To calculate the  SaaS magic number, you need to subtract the previous quarter's revenue from the current quarter's recurring revenue. Then, multiply the result by four so that it gives the annual run rate. For the last step, all you need to do is divide the result by the previous quarter's marketing and sales expenses.

Here is the magic number formula:

(current quarter's revenue - previous quarter's revenue) * 4 / previous quarter's sales and marketing expenses

Voila!

Now, let's check how you can find your revenue to apply this formula in the future successfully.

Revenue

When it comes to the SaaS magic number, Monthly Recurring Revenue (MRR) is one of the metrics you can use. To find your MRR, you need to multiply the number of monthly users by the average revenue per user (ARPU).

Monthly Recurring Revenue (MRR) Formula = The Number of Monthly Users * Average Billed Amount

OR

You might calculate your Annual Recurring Revenue (ARR) and save yourself from multiplying the result by four. To find your ARR, you need to multiply your MRR by twelve.

Annual Recurring Revenue (ARR) Formula = Monthly Recurring Revenue * 12

Now that's out of the way, let's turn back to the magic number process.

Assume that your business spent $100,000 on sales and marketing last quarter to generate a monthly recurring revenue (MRR) of $25,000 for the quarter. This amount will become $100,000 in annual recurring revenue (ARR) on the condition that churn is at the minimum. In this situation, the $100,000 you spent on sales and marketing has brought in $100,000 in new ARR. As a consequence, you find 1.0 as your SaaS magic number for the quarter—which means that you get to pay your sales and marketing expenses and Customer Acquisition Costs (CAC) in a one-year timeframe.

It's time to check what these numbers mean for your business.

What is a good magic number in SaaS?

Anything above 1.0 makes a good magic number for SaaS businesses. It shows that you are able to neutralize what you spend and earn, making it apparent that you have no problem with revenue growth. Anyhow, if your magic number is between 0.75 and 1.0, you need to focus on growth a bit more to enter the safe zone. Any number below 0.75 means that you have a lot to work on as your magic number isn't optimized yet.

Here is what the SaaS magic number benchmarks tell about your sales efficiency in detail:🟥If it's lower than 0.75 

Having a magic number lower than 0.75 means that some problems are present within your business model for you to fix. These problems might derive from a high churn rate or a high Customer Acquisition Cost (CAC)—causing the ARR to descend. For this reason, you should focus on optimizing your expenditures and improving your score by keeping an eye on metrics and KPIs to interpret the situation better.🟨If it's between 0.75 and 1.0

Having a magic number greater than 0.75 is every business' objective since it symbolizes a green zone for future growth. Til then, it means that you can mostly cover what you spend on sales and marketing in a year. Besides, it indicates that, even though your marketing efficiency is just fine as it is, you might start spending more on growth.

🟩If it's greater than 1.0

At this point, you should feel at ease since revenue growth is no problem for you. You have enough money to invest and spend on testing new strategies and models to assure more growth for the future.

4 Quick Tips to Improve Magic Number in the Next Quarter

If your SaaS magic number isn't high enough, don't worry! I'll give you a few tips that will surely change that in the next quarter:

1. Promote upsell and cross-sell so that your customers derive even more value from using your products. That aside, expansions will increase your MRR.
2. Shorten your sales cycle so that your business can grow further quicker than before.
3. Find different marketing channels which cost less but affect more to attract highly qualified leads. For example, content marketing is a place where you could easily reap what you sow should you invest.
4. Try downsizing—and no, I don't mean your co-workers. Find out the tools, channels, or any kind of expense that doesn't bring that much value and break it off.

In the end, all you need to do is earn more revenue and optimize your sales and marketing. Whether you achieve this goal by finding new strategies to acquire and retain customers or lessening the amount of money you reserve for sales and marketing doesn't matter as long as it proves to be fruitful.

Metrics That Complement The Magic Number

While the magic number is a really useful metric, it's even more effective when other metrics and KPIs support it. Up next are the four metrics that complement the magic number in any and every way:

#1 Rule of 40

The rule of 40 states that for a business to be healthy and profitable, that business's growth rate and profit margin should be greater than 40% when combined. Besides, it doesn't require much to do: All you need to do is add your percentage of growth rate to your percentage of gross margin and check whether it reaches 40 or not.

#2 Net Dollar Retention (NDR)

Net Dollar Retention (NDR) focuses on how you achieve growth without acquiring any new customers. Also, it shows how happy your customer base is to keep spending more on your products. Of course, the higher the NDR, the more beneficial it's for the business.

#3 Gross Revenue Retention (GRR)

Gross Revenue Retention (GRR) measures to what extent a business is able to retain its existing customers. In simple words, it represents the percentage of customers that a business is able to keep at the current price point. There is one catch, though; it includes downgrades and churns while excluding any kind of expansion.

To calculate GRR, you need to subtract the amount of revenue lost due to churn and the amount of revenue lost due to downgrading from the recurring revenue at the beginning of a specific time period. Then, divide the result by the recurring revenue at the beginning.

Gross Revenue Retention (GRR) Formula = (MRR Start - Churn - Contraction) / MRR

#4 Net Revenue Retention (NRR)

Net Revenue Retention (NRR) gives us the percentage of revenue earned from existing customers, including upsells and cross-sells. To calculate NRR, you need to follow these steps:

First, add your revenue churn to expansions. Then, subtract the result from downgrades, and again subtract that result from the recurring revenue at the beginning. Lastly, divide the result by the recurring revenue at the beginning.

Net Revenue Retention (NRR) Formula = (Starting MRR - Contraction - Churn + Expansion) / Starting MRR

Conclusion

I don't know much about the magic tricks; the ONLY magic I know is the SaaS magic number.

The SaaS magic number is all about measuring sales efficiency.

In this article, I present you with the magic number calculation, definition, and benchmarks so that you can boost your growth by putting importance on it—and don't go anywhere else to look for it.

Have fun reading!