Sales Efficiency Metrics: How to Calculate the SaaS Magic Number

Description
As a CFO, it's critical to monitor and measure the balance between new ARR/MRR creation and S&M spend. Relatively to your new SaaS bookings, if you over invest in sales and marketing, you'll not see the cash creation or expected margin expansion that you would like. On the other hand, if you under invest in sales and marketing when you've already achieved the right product/market fit, you will not be able to take advantage of opportunities for growth. In this way, a good way to determine your sales health is to calculate the SaaS Magic Number and other sales efficiency metrics.

What Metrics to Measure?

There are many metrics in SaaS, but coming up is 3 sales efficiency metrics that you may find are relevant to your SaaS business. You can also adjust them so that they match better with your business model

This description will explain how to calculate:
1) SaaS Magic Number
2) Bessemer CAC Ratio
3) CAC Payback Period

How to Calculate the SaaS Magic Number
The SaaS Magic Number is a formula that is commonly used to measure sales efficiency. Fir every dollar spent on sales and marketing, it measures the output of revenue growth over a year. In other words, for every dollar spent on sales and marketing, it measures how many dollars of ARR are created.

If you spent $1 on sales and marketing in 1Q16, and your revenue went up by 25 cents in 2Q16, your magic number would be 1.0.

A magic number that is 1.0 also would imply that in a one year time frame, you paid back the customer acquisition costs. After year 1, assuming that you have a positive figure for ARR-ACS, you should be generating margin on that client.This doesn't mean that the metric discriminates between new and existing businesses. It can measure growth from every area.

Bessemer CAC Ratio

This is alike the magic number, however the formula is more specific to new acquisition. This ratio says something more along the lines of: how quickly does our gross margin pay off our new customer acquisition costs.

Bessemer CAC Ratio

If you attain a ratio of 1.0, it means that inside one year you have completely broken even on a customer. Here, break even refers to covering customer acquisition costs and gross expenses. A SaaS magic number means you have only covered sales and marketing expenses within your first year, and you have not yet covered your gross expenses in month 12.

You should note that the Bessemer has stopped publishing this ratio.

CAC Payback Period

This is not unlike the Bessemer CAC Ratio. This ratio flips the denominator and numerator and utilises MRR for conversion to monthly payback number. The ratio has been interpreted slightly differently in the formula given below:

Ben's formula: Previous Quarter's CACs/(New MRR in Current Quarter x Gross Margin)

Bessemer's formula: Previous Quarter S&M Expense/(New CMRR in Previous Quarter x Gross Margin)

The previous quarter has been used in Bessemer's formula as the time period in the denominator and the numerator. However it is common to experience a lag between investing in sales and marketing and when you actually see the results. (New ARR/MRR)

You should ensure that this timing is applicable to your business as each business' sales cycle differs.

I interpret Bessemer’s original payback formula above as an all-in formula that includes growth from new and existing customers. Why? Because they use CMRR which typically includes churn from existing customers. And sales the marketing spend is not defined specifically to just new customer acquisition costs.

Bessemer's original payback formula can be interpreted as an all-in formula that incorporates growth from both existing and new customers. This is because they use CMRR which usually includes the churn from existing customers. As well as this, S&M spend is not specifically defined to solely new customer acquisition costs.

Conclusion
You will draw interesting insights out of all of these sales efficiency metrics, but the CAC Payback Period Formula is really useful. It takes gross margin into consideration whereas the SaaS Magic Number doesn't. It also does so using months which makes it easy to understand. It can also giive you a clearer picture of bookings growth against cost of sales and marketing.