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How to calculate SaaS Magic Number? A Step-by-Step Guide

The SaaS magic number is the lifetime value of a customer. It is the amount that you can earn by converting a customer to your SaaS platform.

If you have a negative ratio, you're spending more money on customer acquisition than the revenue generated by those customers. If it is positive, you're making more money than it costs to get them.

Calculating a SaaS magic number is essential to your marketing strategy, but it is also challenging to do it correctly, as it requires a lot of research and data analysis.

Let's look at the steps in calculating it for your business model and see how the SaaS magic number calculation process works.

SaaS Magic Number: What's That?

The SaaS magic number calculates the lifetime value of a customer. It's used to predict how much revenue you can expect from a customer in the future — and it's one of the most critical metrics for SaaS businesses. You can calculate it by multiplying your average customer lifetime value by your churn rate (the percentage of customers who leave each month).

It gives you an idea of how many customers you need to retain each month to keep your company profitable. And it's important to know this because if you need more customers, even if they pay you every month, you might still end up going out of business!

Related Read: Rule of 40 in SaaS meaning and guide on how to calculate it

How to calculate the SaaS magic number?

Doing SaaS magic number calculation, the current quarter's recurring revenue should be subtracted from the previous quarter's revenue. The difference should then be multiplied by four (to convert to an annual run rate) and divided by sales and marketing efforts costs.

SaaS Magic Number formula

Here's the formula for the magic number SaaS calculation:

Magic Number= [(GAAP Revenue Current Quarter − GAAP Revenue Previous Quarter) × 4] / (Sales & Marketing Spend Previous Quarter)

This metric is a great way to see if your SaaS company's marketing strategy is translating into revenue growth, and it demonstrates the effectiveness of your total marketing investment.

Why is the SaaS number significant?

As a SaaS business owner, you want various metrics to monitor the health of your business. When a metric allows you to see which areas of your business need improvement, it can become invaluable and provide several advantages. Here are the examples:

Customer Retention

The main benefit of the magic number SaaS calculation is customer retention. Looking at the long-term picture, it becomes evident that keeping customers happy and satisfied with your product or service will significantly impact your business's future success.

You cannot afford to lose clients if you want to stay profitable in the long run. You need them to keep paying you every month, so their satisfaction is paramount for your future earnings.

It's Affordable

The cost of SaaS is often less than a traditional software license because you're paying only for what you use. If your business requires more modules or features, you can pay for those upgrades later.

You may also like: An ultimate guide for mapping the SaaS customer journey

Flexibility

The most significant advantage of SaaS is that you can pay as you go, allowing your business to grow at its own pace. You can also scale down quickly when needed. In addition, you don't have to worry about upgrading or buying new equipment.

Make a better team

This magic number indicates when you should stop investing in sales and marketing. Instead, invest in process improvement. This assists you in improving the skills and competency of your sales team or purchasing a higher-end sales tool. It's also essential to improve your sales department's overall performance.

Recalibration

The SaaS magic number concept is to re-calibrate how you think about your business. You must keep in mind that your business is not a product but a service.

The goal of the SaaS magic number is to help you understand that there are no "endpoints" for your services or products. Your customers will always have new needs and requirements, and the best way to serve them is by providing an ongoing stream of valuable services.

What are some other metrics related to the SaaS magic number?

If you're starting with a SaaS company, you might need help calculating your LTV and CAC accurately. But you can still use some SaaS sales efficiency metrics to determine whether your business model is working.

Churn rate

The churn rate is how many customers stop paying for your product during any given period. This metric tells you how many customers you need to acquire each month to stay even in revenue growth. If your churn rate is too high, it's hard for your business to grow because more customers are leaving than joining each month.

Customer acquisition cost (CAC)

This is the money spent acquiring new customers each month (including marketing costs). The lower this number, the better because you're spending less on marketing and getting more return on each customer acquisition dollar spent.

CAC can be challenging to calculate accurately, but if you're using tools like Google Analytics or Mixpanel, they should be able to provide rough estimates based on web traffic sources and campaign costs.

Worth checking: SaaS revenue model - how does it work? Explanation with examples

Customer retention rate  

This shows how many customers are still using your product after some time has passed. It also indicates how satisfied customers are with your service and whether they believe it's worth paying for over time.

A high customer retention rate in SaaS means you're doing something right, while a low customer retention rate might indicate issues with your product or customer service.

According to Business News, a 5 percent boost in customer retention rate can give business profits up to 95 percent. On top of that, companies enjoy 65 percent of sales just from their repeat clients.

The ARPU

The average revenue per user is an essential metric for measuring customer value. It is calculated as total revenue divided by the total number of customers at a given time. As you might expect, this metric should increase over time as you add more customers and increase your average revenue per user (ARPU).

Monthly recurring revenue (MRR)

The money you make from your customers every month is a good indicator of how many customers you have and how much money you can make in the future.

Net expansion rate

It's how many new customers you get each month compared to how many existing customers you churn out in the same month. The higher the percentage, the better.

Identifying the correct SaaS Magic Number Benchmarks

SaaS magic number benchmarks should be interpreted cautiously because business models and COGS can differ significantly between SaaS companies. So, here are three scenarios and how you should react to them.

Magic Number = 1

Magic number 1 is efficient. Your sales and marketing investment can generate enough revenue to pay for itself in a year. In other words, you'll reach breakeven in a year.

Magic Number < 1

A magic number of less than one is deemed inefficient. It implies that your sales and marketing investments could be more efficient in generating additional revenue. And, if the remaining factors remain constant for the next three quarters, you may only be able to recoup your quarter-worth of investment after a year.

Different test sales and marketing strategies are needed to maximize your returns in this scenario, with a focus on ROI on each channel. Find the most cost-effective client acquisition strategies as well. Finally, reduce your sales and marketing expenditures as well.

Magic Number > 1

A SaaS magic number greater than one effectively generates additional revenue. You can recoup your sales and marketing expenses in less than a year. However, because you have the opportunity to scale your sales and marketing teams, it also means that your sales and marketing require more investment. As investments begin to recover, you can increase your sales and profitability.

Also read: SaaS gross margin and net profit business metrics explained

What should you do if the magic number falls between 0 and 1?

The SaaS magic number indicates your company's health and alerts you to take action. The following are the various phenomena that may occur due to your business's magic number.

If your SaaS magic number is below 0.5:

You need more time to be ready to scale your sales process. You may need to refocus on product/market fit, fine-tune your business model, reconsider your pricing strategy, and address inefficiencies in your sales and marketing efforts.

If your SaaS magic number is between 0.5 and 0.75:

It's time to determine whether you're ready for rapid growth. Look at your cash flow, runway, and gross margins to see if you're prepared for a significant sales and marketing investment.

If your SaaS magic number is above 0.75:

You're prepared to put money into sales and marketing. You'll want to aim for a SaaS magic number in this range, which indicates a healthy CAC payback while also indicating efficiency and momentum. The closer your SaaS magic number can be to 1, the better.

Final Verdict  

The SaaS magic number is a quick metric that can help you monitor the pulse rate of your SaaS subscription business. Furthermore, metrics work best in tandem with each other. So if your SaaS magic number is higher than one, that is great, but make sure you calculate the churn rate, gross margin, and LTV/CAC before it's too late.

If you focus on more than one metric, you will quickly run into metric debt. For the best results, calculate and evaluate this metric quarterly and yearly to see progress and track big-picture trends beyond the short term.

Get in touch to see how we can help your SaaS company keep and grow its loyal customer base.

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Marketing Specialist
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How to calculate SaaS Magic Number? A Step-by-Step Guide

January 20, 2023
11
minutes read
audio description available
TL;DR

Today, we will discuss the SaaS magic number, a metric used to evaluate the effectiveness of every dollar spent on sales and marketing for your SaaS business. It provides insight into the growth of your company in relation to the marketing expenses incurred. By monitoring the magic number, you can determine the appropriate focus for your efforts, whether it be expanding existing customer base or acquiring new customers.

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How to calculate SaaS Magic Number? A Step-by-Step Guide
How to calculate SaaS Magic Number? A Step-by-Step Guide

The SaaS magic number is the lifetime value of a customer. It is the amount that you can earn by converting a customer to your SaaS platform.

If you have a negative ratio, you're spending more money on customer acquisition than the revenue generated by those customers. If it is positive, you're making more money than it costs to get them.

Calculating a SaaS magic number is essential to your marketing strategy, but it is also challenging to do it correctly, as it requires a lot of research and data analysis.

Let's look at the steps in calculating it for your business model and see how the SaaS magic number calculation process works.

SaaS Magic Number: What's That?

The SaaS magic number calculates the lifetime value of a customer. It's used to predict how much revenue you can expect from a customer in the future — and it's one of the most critical metrics for SaaS businesses. You can calculate it by multiplying your average customer lifetime value by your churn rate (the percentage of customers who leave each month).

It gives you an idea of how many customers you need to retain each month to keep your company profitable. And it's important to know this because if you need more customers, even if they pay you every month, you might still end up going out of business!

Related Read: Rule of 40 in SaaS meaning and guide on how to calculate it

How to calculate the SaaS magic number?

Doing SaaS magic number calculation, the current quarter's recurring revenue should be subtracted from the previous quarter's revenue. The difference should then be multiplied by four (to convert to an annual run rate) and divided by sales and marketing efforts costs.

SaaS Magic Number formula

Here's the formula for the magic number SaaS calculation:

Magic Number= [(GAAP Revenue Current Quarter − GAAP Revenue Previous Quarter) × 4] / (Sales & Marketing Spend Previous Quarter)

This metric is a great way to see if your SaaS company's marketing strategy is translating into revenue growth, and it demonstrates the effectiveness of your total marketing investment.

Why is the SaaS number significant?

As a SaaS business owner, you want various metrics to monitor the health of your business. When a metric allows you to see which areas of your business need improvement, it can become invaluable and provide several advantages. Here are the examples:

Customer Retention

The main benefit of the magic number SaaS calculation is customer retention. Looking at the long-term picture, it becomes evident that keeping customers happy and satisfied with your product or service will significantly impact your business's future success.

You cannot afford to lose clients if you want to stay profitable in the long run. You need them to keep paying you every month, so their satisfaction is paramount for your future earnings.

It's Affordable

The cost of SaaS is often less than a traditional software license because you're paying only for what you use. If your business requires more modules or features, you can pay for those upgrades later.

You may also like: An ultimate guide for mapping the SaaS customer journey

Flexibility

The most significant advantage of SaaS is that you can pay as you go, allowing your business to grow at its own pace. You can also scale down quickly when needed. In addition, you don't have to worry about upgrading or buying new equipment.

Make a better team

This magic number indicates when you should stop investing in sales and marketing. Instead, invest in process improvement. This assists you in improving the skills and competency of your sales team or purchasing a higher-end sales tool. It's also essential to improve your sales department's overall performance.

Recalibration

The SaaS magic number concept is to re-calibrate how you think about your business. You must keep in mind that your business is not a product but a service.

The goal of the SaaS magic number is to help you understand that there are no "endpoints" for your services or products. Your customers will always have new needs and requirements, and the best way to serve them is by providing an ongoing stream of valuable services.

What are some other metrics related to the SaaS magic number?

If you're starting with a SaaS company, you might need help calculating your LTV and CAC accurately. But you can still use some SaaS sales efficiency metrics to determine whether your business model is working.

Churn rate

The churn rate is how many customers stop paying for your product during any given period. This metric tells you how many customers you need to acquire each month to stay even in revenue growth. If your churn rate is too high, it's hard for your business to grow because more customers are leaving than joining each month.

Customer acquisition cost (CAC)

This is the money spent acquiring new customers each month (including marketing costs). The lower this number, the better because you're spending less on marketing and getting more return on each customer acquisition dollar spent.

CAC can be challenging to calculate accurately, but if you're using tools like Google Analytics or Mixpanel, they should be able to provide rough estimates based on web traffic sources and campaign costs.

Worth checking: SaaS revenue model - how does it work? Explanation with examples

Customer retention rate  

This shows how many customers are still using your product after some time has passed. It also indicates how satisfied customers are with your service and whether they believe it's worth paying for over time.

A high customer retention rate in SaaS means you're doing something right, while a low customer retention rate might indicate issues with your product or customer service.

According to Business News, a 5 percent boost in customer retention rate can give business profits up to 95 percent. On top of that, companies enjoy 65 percent of sales just from their repeat clients.

The ARPU

The average revenue per user is an essential metric for measuring customer value. It is calculated as total revenue divided by the total number of customers at a given time. As you might expect, this metric should increase over time as you add more customers and increase your average revenue per user (ARPU).

Monthly recurring revenue (MRR)

The money you make from your customers every month is a good indicator of how many customers you have and how much money you can make in the future.

Net expansion rate

It's how many new customers you get each month compared to how many existing customers you churn out in the same month. The higher the percentage, the better.

Identifying the correct SaaS Magic Number Benchmarks

SaaS magic number benchmarks should be interpreted cautiously because business models and COGS can differ significantly between SaaS companies. So, here are three scenarios and how you should react to them.

Magic Number = 1

Magic number 1 is efficient. Your sales and marketing investment can generate enough revenue to pay for itself in a year. In other words, you'll reach breakeven in a year.

Magic Number < 1

A magic number of less than one is deemed inefficient. It implies that your sales and marketing investments could be more efficient in generating additional revenue. And, if the remaining factors remain constant for the next three quarters, you may only be able to recoup your quarter-worth of investment after a year.

Different test sales and marketing strategies are needed to maximize your returns in this scenario, with a focus on ROI on each channel. Find the most cost-effective client acquisition strategies as well. Finally, reduce your sales and marketing expenditures as well.

Magic Number > 1

A SaaS magic number greater than one effectively generates additional revenue. You can recoup your sales and marketing expenses in less than a year. However, because you have the opportunity to scale your sales and marketing teams, it also means that your sales and marketing require more investment. As investments begin to recover, you can increase your sales and profitability.

Also read: SaaS gross margin and net profit business metrics explained

What should you do if the magic number falls between 0 and 1?

The SaaS magic number indicates your company's health and alerts you to take action. The following are the various phenomena that may occur due to your business's magic number.

If your SaaS magic number is below 0.5:

You need more time to be ready to scale your sales process. You may need to refocus on product/market fit, fine-tune your business model, reconsider your pricing strategy, and address inefficiencies in your sales and marketing efforts.

If your SaaS magic number is between 0.5 and 0.75:

It's time to determine whether you're ready for rapid growth. Look at your cash flow, runway, and gross margins to see if you're prepared for a significant sales and marketing investment.

If your SaaS magic number is above 0.75:

You're prepared to put money into sales and marketing. You'll want to aim for a SaaS magic number in this range, which indicates a healthy CAC payback while also indicating efficiency and momentum. The closer your SaaS magic number can be to 1, the better.

Final Verdict  

The SaaS magic number is a quick metric that can help you monitor the pulse rate of your SaaS subscription business. Furthermore, metrics work best in tandem with each other. So if your SaaS magic number is higher than one, that is great, but make sure you calculate the churn rate, gross margin, and LTV/CAC before it's too late.

If you focus on more than one metric, you will quickly run into metric debt. For the best results, calculate and evaluate this metric quarterly and yearly to see progress and track big-picture trends beyond the short term.

Get in touch to see how we can help your SaaS company keep and grow its loyal customer base.

Nathalie Kim
Nathalie Kim
Marketing Specialist
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