Step-by-Step Guide to Understanding the SaaS Magic Number
Last Updated June 19, 2023
What is the SaaS Magic Number?
TheSaaS Magic Number metric measures a company’s sales efficiency, i.e. how efficiently its sales and marketing (S&M) spend can generate incremental recurring revenue.
Table of Contents
- How to Calculate SaaS Sales Efficiency (Step-by-Step)
- SaaS Magic Number Formula
- Magic Number – SaaS Industry Benchmark
- SaaS Magic Number Calculator – Excel Template
- SaaS Magic Number Example Calculation
How to Calculate SaaS Sales Efficiency (Step-by-Step)
There are various sales efficiency metrics that compare a SaaS company’s new recurring revenue generated in a specified period to the amount spent on sales & marketing.
Practically all sales efficiency metrics are answering the question, “For each dollar spent on sales and marketing (S&M), how much in new revenue was earned?”
One sales efficiency metric is gross sales efficiency, which divides the new gross annual recurring revenue by the S&M spend.
- Gross Sales Efficiency = Current Quarter Gross New ARR / Prior Quarter Sales & Marketing Expense
The main shortcoming to this metric is that churn is NOT accounted for.
An adjacent metric is called the net sales efficiency, which does indeed account for new sales, as well as churned customers.
In order to calculate the net sales efficiency, the “Net New ARR” metric must first be calculated.
The net new ARR calculation begins with the net ARR from new customers.
From there, the expansion ARR from existing customers is added and then the churned ARR from lost customers (or downgrades) is deducted.
- Net New ARR = Net ARR + Expansion ARR − Churned ARR
In the final step, the net ARR of the current quarter is divided by the S&M spend of the prior quarter to arrive at the net sales efficiency figure.
- Net Sales Efficiency = Current Quarter Net ARR / Prior Quarter Sales & Marketing Spend
SaaS Magic Number Formula
The problem with the net sales efficiency metric is that public companies are under no obligation to disclose the necessary figures required in the formula.
In response,Scale Venture Partners (SVP) developed its own “Magic Number” metric to bypass this hurdle and enable practical comparisons among public SaaS companies.
The solution here is to replace “Net New ARR” with the difference between the two most recent quarterly GAAP revenue figures, annualized.
The SaaS magic number formula is shown below:
- SaaS Magic Number= [(GAAP Revenue Current Quarter − GAAP Revenue Previous Quarter) × 4] / (Sales & Marketing Spend Previous Quarter)
Magic Number – SaaS Industry Benchmark
So how should the Magic Number be interpreted?
- <0.75 → Inefficient
- 0.75 to 1 → Moderately Efficient
- >1.0 → Very Efficient
If the magic number is 1.0, that means that the company can pay back the quarter in question’s sales and marketing spend using the incremental revenue generated across the next four quarters.
As a generalization, it is widely accepted that a magic number >1.0 is deemed a positive sign that the company is efficient, while a number <1.0 indicates the current S&M spend may need some adjustments.
However, no metric by itself can establish whether a company is “healthy” or not, so other metrics like the gross profit margin and churn rate must also be closely evaluated.
SaaS Magic Number Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
SaaS Magic Number Example Calculation
Suppose we’re tasked with determining the sales efficiency of a company under three different scenarios.
In all three scenarios, the SaaS company’s quarterly revenue grew by $25,000 from Q-1 to Q-2.
- Q-1 Revenue = $200,000
- Q-2 Revenue = $225,000
Therefore, the difference between the current and prior quarter revenue is $25,000, which we’ll multiply by 4 to annualize the figure.
As for the denominator, we’ll calculate the sales and marketing (S&M) spend, for which we’ll assume the following values.
- Downside Case * S&M Spend = $200,000
- Base Case * S&M Spend = $125,000
- Upside Case * S&M Spend = $100,000
Using those inputs, we can calculate the SaaS magic number for each scenario.
- Downside Case = 0.5 ← Inefficient
- Base Case = 0.8 ← Efficient
- Upside Case = 1.0 ← On Track to Very Efficient
To further break down what is occurring, the $25,000 in incremental MRR is $100,000 in annual recurring revenue (ARR).
For our Upside Case, the total capital allocated towards sales and marketing spend was $100,000, so the company’s sales appear to be efficient.
In fact, the company should consider spending more on sales and marketing, as the current strategy seems to be working.
The S&M spend can be reduced, but the recurring revenue should continue to be generated for some time, so not only did the company break even within one year – but sources of recurring future revenue were obtained.
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