The Ins & Outs of SaaS Metrics: Mastering the SaaS Magic Number

We started our SaaS metrics blog series with finance leader Christina Ross (CFO turned CEO/co-founder of Cube) on the topic of measuring customer retention and growth. This month, we turn to a central key performance indicator that every enterprise software company should look at: the so-called “SaaS magic number.” While it might take some magic to nail this target, you don’t have to be Harry Potter to learn how to analyze and optimize for it.

Below, Christina shares her plain-speak explanation and some handy tips for calculating and interpreting what is considered by many investors to be the most predictive measure of SaaS success.

At a high level, what is the SaaS magic number and why does it matter?

CHRISTINA: The SaaS magic number is a starting point for determining when an enterprise software company is ready for explosive growth. The TL;DR is that it signals your preparedness to go full-steam-ahead and spend more on sales and marketing. 

This metric uses monthly recurring revenue (MRR) to analyze your company’s health by asking, “for every dollar we spend acquiring new customers, how much revenue do we create?” For those of us growing (or investing in) SaaS businesses, knowing when it’s time to pour resources into growth is a crucial insight.

Of course, equally important is knowing when to pause and reexamine marketing and messaging. A founder who knows her metrics has more control and advance warning of potential bottlenecks such as market calibration, sales adjustments, or cost reduction.

Walk us through the magic number calculation.

CHRISTINA: The standard formula to calculate your magic number is: 

Magic Number = 4* (QR[X] – QR[X-1]) / Sales+MarketingExpenses[X-1]

Where: 

  • QR[X] is the current quarter’s revenue
  • QR[X-1] is the preceding quarter’s revenue, and 
  • Sales+MarketingExpenses[X-1] is all of your sales and marketing expenses from that same preceding quarter.

For instance, if your company’s third quarter was $100M, and sales and marketing expenses for that period came in at $50M, and then your fourth-quarter revenue hit $115M, your current magic number would be 1.2. [(4 * ($115M – $100M)) / $50M = 1.2].

So, how should an operator interpret that magic number? 

CHRISTINA: Basically, a magic number over 1 means it’s time to spend more for growth. When raising capital, most firms want to see a SaaS magic number at or above 0.75. Here are some basic guidelines to help you interpret your own magic number:

  • ≤ 0.75: You’re definitely not ready to put more money into growth. Focus on optimizing your existing spend. 🛑 
  • ≥ 0.75 but ≤ 1.0: You’re probably ready for growth, but there are still a few things to optimize. ⚠️ 
  • ≥ 1.0: Time to increase your sales and marketing spend and grow! ✅ 

If a company’s magic number is below 1, what are some specific steps they can take to improve it?

CHRISTINA: Since the SaaS magic number is a simple metric, the ways to improve it are also pretty simple: either earn more revenue or optimize your sales and marketing spend. Ideally, you want to do both. 

Here are four strategies that I’ve seen work well: 

  • Expand with existing customers. The cheapest customer to acquire is the customer you already have. If you can deliver more value from an upsell or a cross-sell, these expansions will boost your MRR (which directly boosts your SaaS magic number). 
  • Shorten your sales cycle. Sales efficiency is incredibly important for growing SaaS businesses, since longer sales cycles are more expensive and limit how quickly you can grow. That said, shortening your sales cycle can lead to higher churn since you might end up selling to unqualified leads, so it’s important to continuously refine your approach. 
  • Invest in low-cost, high-yield marketing. Your best marketing ROI will come from content marketing, SEO, and cultivating a healthy relationship with the non-buyers on your email list. Quality evergreen content can deliver a steady, high volume of qualified leads and pay dividends for years to come. 
  • Slash underperforming paid channels. Ads work, but it’s easy to overspend on ads if your ROI isn’t as high as it needs to be. Think about simplifying or consolidating your ads. Optimize your ad spend by repeating what works and spending less on what doesn’t. 

Some companies seem myopically focused on their magic number. What are the potential blind spots?

CHRISTINA: That’s very true, and the SaaS magic number isn’t a silver bullet to unicorn status on its own. Like any metric, this one has its limitations, so we need other KPIs to give it context and uncover the full picture. The SaaS magic number is merely a flag (red, yellow, or green)—not a deciding factor. Your gross margins anchor your reality and are a huge factor in how quickly you actually can grow. You should also consider your runway, your customer acquisition cost (CAC) payback periods, churn ratios, and overall cash flow

Since the magic number only uses MRR, you don’t know if that revenue is due to expansions or to new logos. If the bulk of your revenue comes from expansions, then your strength in acquiring new customers could be questionable. Likewise, if most of your MRR comes from new bookings, you need to look at your NRR to understand how well you’re retaining customers and revenue.

What’s the difference between this and the Bessemer magic number?

CHRISTINA: What some folks call the Bessemer magic number is a CAC ratio that tells you how efficiently you can acquire new customers. It specifically looks at how quickly your gross margin pays for new customers. This is important context because the standard SaaS magic number doesn’t account for the expense of running a business. You can calculate it as follows:

Bessemer CAC Ratio = (Gross Margin * New Annual Contract Value[X]) / CAC[X-1] 

If your ratio is over 1, it means you have room to keep investing in sales and marketing. But if it’s less than 1, you need to continue to monitor your spending.

To learn more about the SaaS magic number and other important metrics, check out Cube’s recent blog post on what they consider “The Single Most Important Growth Flag in SaaS.”

We believe culture, diversity, and operational excellence are a key part of building truly great companies. Learn more on our website or by connecting with us on Twitter and LinkedIn.

The ins & outs of SaaS metrics: Finance leader Christina Ross on revenue retention

With all the acronyms being thrown about, you may be left wondering which SaaS metrics are the best indicators of performance? Which ones do investors focus on? Christina Ross, CFO turned CEO/co-founder of Cube, not only analyzes these metrics for her own business, but brings decades of finance experience to the task of automating and optimizing strategic financial planning and analysis for other companies. 

In this blog series, we’ll hear firsthand from Christina about how to calculate and interpret the most helpful measurements of enterprise software success. To start off, we asked her about two metrics that help businesses measure customer retention and growth: gross revenue retention and net revenue retention.

At a high level, what is revenue retention and why does it matter?

CHRISTINA: Revenue retention is a measure of how much revenue a business keeps from the same customer base over a certain time period. You can track it by month, quarter, year, week, or even day. 

One important note is that revenue retention only refers to existing customers. Acquiring a new customer—and the associated revenue they bring in—can be 5 to 25 times more expensive than retaining one (in terms of time, resources, and finances). Thus, revenue retention is a good measure of sustainability and profitability. Customers with reliable revenue retention have a stable runway and are more profitable in the long run.

Can you get the same insights by tracking customer or logo retention?

CHRISTINA: Not all customers are created equal. One customer might constitute 30% of a company’s revenue while another just makes up 0.05%. Losing any customer hurts, but those that represent a greater share of revenue will hurt a lot more. Tracking revenue retention alongside customer retention can help you get the full picture, especially when you look at both gross revenue retention (GRR) and net revenue retention (NRR). 

What exactly is gross revenue retention (GRR) and why is it important to track? 

CHRISTINA: Gross revenue retention is the percentage of revenue a business retained from the start of a specific period. It shows how successful you’ve been in retaining customers at current price points or contract values.

GRR = (MRR – Churn – Contractions) / MRR

MRR is your monthly recurring revenue at the start of the month, churn is the amount lost (in dollars) to customers who are no longer customers, and contractions is the amount lost from customers who downgraded to a less expensive plan. Even if you earn new sales or upgrade revenue in a given month, this formula looks only at revenue retention as opposed to acquisition. The closer GRR is to 100%, the better. That said, this depends on your customers’ size, since higher churn is often expected from SMBs. 

If GRR is low, it could signal a few problems with your business’ health. For example, you might not be solving the right problem. People won’t stick around if the problem you’re solving is too small to warrant your price for the solution. Other issues might be that your customer experience is frustrating, or your customers simply don’t use the product enough. If people only log in once a month, you’re not building trust or loyalty with them.

How is net revenue retention (NRR) different?

CHRISTINA: GRR doesn’t account for new customers or expansions. It only looks at what you started with and how much you’ve lost, while net revenue retention (also known as “net dollar retention” or NDR) is the total change in recurring revenue. It tracks both your business’ ability to retain and acquire revenue from existing customers.  

NRR = (MRR + Expansions – Churn – Contractions) / MRR

As you can see, what’s different here is that we’re accounting for expansions, or the new money a group of customers have spent with your business. Even though NRR is a growth indicator, it’s still a retention metric, so we don’t include new sales. NRR measures how well a business’ cross-sell and upsell strategies are working.

Experts say a good median NRR for private companies is 104%, and generally NRR > 100% indicates growth, while NRR < 100% indicates decline. Businesses with high NRR are offering the right things customers need as they grow. On the other hand, when NRR is consistently low, this should sound alarm bells. It could mean the company isn’t offering the right upgrades to incentivize customers to move up the value ladder. Maybe the customer success experience is frustrating, or there’s not enough brand loyalty to prevent switching.

What does the combination of GRR and NRR tell us?

CHRISTINA: The best insights come from cross-referencing NRR and GRR. SaaS companies that have both high GRR and high NRR are in a great place and can focus on acquiring new customers. But if you have high GRR and low NRR, it means you’re good at keeping customers, but need to get better at selling to them again, perhaps by rethinking the upgrades you’re offering. And if you have both low NRR and low GRR, there are likely some larger underlying issues that need to be addressed quickly. This might require you to radically invest in customer support or take a hard look at the problem you’re trying to solve.

If there’s a problem with GRR or NRR, how can we improve these metrics?

CHRISTINA: At the end of the day, people are the ones who make the decision to churn or not. So while we might calculate revenue retention metrics separately from customer churn, in practical terms, there’s no separating them. When it comes to increasing GRR, the best strategies focus on keeping your customers involved and happy—improving the overall customer experience, building trust, or adding more integrations. 

Much of this will indirectly improve NRR as well, because it reduces churn and contractions. If you want to double down on NRR, focus on expansions—improving customer service, refining your value ladder, or adopting a customer expansion strategy. All of this can be informed by cohort analysis, which might help you hone in on what you need to do to better support the specific customer groups that are responsible for the majority of your churn.

Of course, don’t forget that these revenue metrics only look at existing customers, so it’s best to combine them with other KPIs for a full picture of what’s happening in the business. GRR doesn’t account for any growth and NRR may obscure and cloak a churn problem. To learn more about these and other important SaaS metrics, check out our recent blog post on GRR and NRR.

We believe culture, diversity, and operational excellence are a key part of building truly great companies. Learn more on our website or by connecting with us on Twitter and LinkedIn.