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Why the Magic Number of 1 is So Lonely

Learn how to analyze your magic number and what it means for your business.

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Sarah De Jesus

July 31, 2018 1 min read

Why the Magic Number of 1 is So Lonely

The ‘Magic Number’ is a sales-related SaaS metric that determines your efficiency in generating incremental recurring revenue. In the SaaS community, a Magic Number of 1 or greater is considered ideal, but should you really pour more money into sales and marketing if you have achieved the Magic Number? This post explains why you can’t use the Magic Number 1 in isolation to assess your business performance.

How to Calculate the Magic Number

The Magic Number formula is presented below.  You simply take the growth in recurring revenue from a selected quarter minus the previous quarter’s revenue, annualize it by multiplying by four, and then divide the numerator by the previous quarter’s sales and marketing spend.

 

((Recurring Revenue (Q2) – Recurring Revenue (Q1)) * 4
Sales and Marketing Exp (Q1)

 

A Magic number of 1 means that you will pay back the selected quarter’s sales and marketing spend (denominator) from the incremental revenue generated over the next four quarters (numerator).  It’s been deemed that 1 or better is efficient and a number below 1 means that you need to review your sales and marketing spend before you invest more in that area.

What Could be Wrong with 1?

SaaS metrics are much more meaningful when used with other metrics to tell a story. Can you have a Magic Number of 1 and still have business issues? The answer is yes, because the Magic Number does not consider your current gross margin.

magic number

Have you Considered Gross Margins?

Depending on the stage of your startup, you might only be concerned with high growth and cash balances to sustain that growth. At some point, however, you must move beyond the Magic Number and consider gross margins. If it takes four quarters to pay off your sales and marketing expense, you have depleted all margin and have no margin remaining to cover service and overhead costs. You are not yet break even on this cohort of customers if you have only paid for sales and marketing expenses.

A Magic Number of 1 and 50% Gross Margin

If your gross margin is 50% and your Magic Number is 1, your first year is spent paying back a quarter’s worth of sales and marketing expense from the incremental revenue generated, and the second is year is required to reach breakeven. The higher your gross margin, the faster you reach the breakeven point. And vice versa for a lower gross margin.

You can see from the simple example below that our Magic Number is pegged at 1 and our gross margin is 50%. Based on our level of sales and marketing spend and our gross margin, we reach profitability in month 24. For simplicity, I assumed no churn but any churn would immediately decrease your Magic Number and lengthen the time it takes to reach profitability.

Conclusion                                                                                                                                                                                            

Startups and seasoned businesses must measure metrics that determine the health of their business, but the Magic Number or any other metric in isolation cannot determine the overall health of your business.  SaaS Metrics are most powerful when used together.  A Magic Number of 1 is a great start but make sure you are calculating payback periods, gross margin, and churn so that is not just a lonely number.

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Ed note: Want to dive deeper into essential FP&A topics? Check out OnPlan’s most popular posts of all time here:

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About Author
Sarah De Jesus

As the Director of Professional Services, Sarah is responsible for overseeing all of OnPlan’s software implementations and ensuring customer success. With a decade of experience, Sarah started the first years of her career in a variety of analytical and operational roles across multiple industries and has since specialized in leading end-to-end FP&A software implementations with a proven track record of meeting timelines, budgets, and deliverables. She is passionate about building sustainable processes to scale businesses, mentor teammates, and enhance the service delivery experience. Sarah holds a Bachelor of Mathematics from the University of Waterloo and a Bachelor of Business Administration from Wilfrid Laurier University.

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