The SaaS magic number tells you how efficiently your recurring revenue business is growing. It takes into account recurring revenue growth and spend on sales and marketing to quantify how efficiently money is spent to grow your business. The result is a number. If it's greater than one, you should invest more in marketing. If it's less than one, you should focus on making your sales marketing strategy more effective.
The Magic Number was coined by Lars Leckie. To calculate it, you'll need to know three things:
Your monthly recurring revenue for the quarter just passed.
Your monthly recurring revenue for the preceding quarter.
The complete budget for sales and marketing activities for the preceding quarter. Be sure to include everything; salaries, subscription costs, etc.
To get your Magic Number, plug your numbers into this formula:
Magic Number = ((LR – PR) * 4) / MS
The formula calculates the difference between revenue for the preceding quarter, then multiplies it by four. This number is divided by the sales and marketing spend for the preceding quarter. By offsetting the sales and marketing costs to the previous quarter, the Magic Number formula takes into account the payback period before these initiatives bear fruit.
Let's look at an example. Say we had Q2 revenue of $1MM. In Q1, we had $500K revenue, and $1MM sales and marketing spend. Plugging those figures into the formula gives us a Magic Number value of 2:
((1,000,000 - 500,000) * 4) / 1,000,000 = 2
The Magic Number is greater than one, so there's room to grow. You should invest more in your sales efficiency and marketing processes.
Conversely, say we had Q2 revenue of $1MM, but our Q1 revenue was $900K. Sales and marketing expense is unchanged at $1MM. Plugging those figures into our formula gives us a Magic Number value of 0.4:
((1,000,000 - 900,000) * 4) / 1,000,000 = 0.4
Because our Magic Number is less than one, we need to do a better job of acquiring new customers. The difference is clear; in the first example, we added $500K of revenue with $1MM spent on sales and marketing, while we only managed to add $100K in example two. In terms of gross margins, the first business is growing five times more efficiently.
A Magic Number less than one indicates your customer acquisition process is inefficient. There are two ways to tackle this; improve the return on investment of your sales and marketing processes, or cut costs. You may need to review your whole business model. Improving sales and marketing ROI is a profession unto itself. SaaS businesses using paid acquisition might examine which channels are most effective and cut out the less inefficient channels.
A low Magic Number is an opportunity to explore new, more cost-efficient customer acquisition strategies. Content marketing can often be an efficient strategy for online subscription businesses as your initial investment will continue to offer returns over time.
You've likely found product-market fit. Double down on whatever you're doing, and invest more in your sales and marketing channels. If you can reliably add revenue by doing what you're doing, now's the time to lock those processes in.
The simplicity of the Magic Number in a sea of bewildering SaaS metrics is appealing. However, no one metric can give you a complete picture of the health of your business, and the Magic Number is no exception.
You'll also want to consider the type of saas company you're trying to build. The Magic Number focusses on customer acquisition costs and growth. These are critical goals for many, but if like many software entrepreneurs you're building a lifestyle business, these aren't the be the be-all and end-all. If you can only increase your Magic Number by increasing your workload, this may not be a trade-off you're willing to make.