One of the mysteries I hoped to solve when I embarked upon this little SaaS metrics mathematical journey was the reality behind “The SaaS Company Magic Number” introduced by then Omniture CEO, Josh James, and immemorialized by my pal Lars Leckie over at Hummer Winblad. In principal, this number tells you how aggressively you should be spending to build up your customer base: “the key insight is that if you are below 0.75 then step back and look at your business, if you are above 0.75 then start pouring on the gas for growth because your business is primed to leverage spend into growth. If you are anywhere above 1.5 call me immediately.”-Lars Leckie’s Blog
In this installment of the SaaS metrics series, I will show why this benchmark works, and introduce what IMHO is the single most important SaaS financial metric for measuring the overall health of a SaaS business. Now, being as Josh and Lars have already laid claim to “The” SaaS Magic Number, I really have no alternative but to put all humility aside and dub my latecomer SaaS metric as “Joel’s” SaaS Magic Number (After all, I did similarly snag “The” Top Ten Do’s and Don’ts of SaaS, so it’s all good.)
SaaS Metrics Rule of Thumb #9 – Joel’s SaaS Magic Number
The truth be told I feel a bit guilty about the name, because Joel’s SaaS Magic Number is neither magic, nor mine really. It’s simply the the average customer rate of return, or rather the inverse of the average customer baseline break-even, 1/BE0, that has so consistently popped up as a driver and a constraint in the SaaS metrics rules-of-thumb.
| Joel’s SaaS Magic Number |
= |
Average Customer Rate of Return |
Where “ARR” is the average recurring revenue per customer, “ACS” is the average recurring cost of service per customer, and “CAC” is the average customer acquisition cost. Customer rate of return is powerful, because it measures the economics that make a SaaS business work (or not), whereas the individual revenue and cost metrics are simply accounting figures that in isolation say little about the health of the business. Let’s recap some of the things we know about this nifty magic number from earlier SaaS metrics rules-of-thumb.
| Joel’s SaaS Magic Number Rules-of-Thumb |
| J |
[ ARR - ACS ] ÷ CAC |
average SaaS customer rate of return |
| 1/J |
BE0 |
best case SaaS company time to profit |
| limiting |
g = a = J |
maximum, profitable rate of growth g or churn a |
| approaching |
g ⇒ J or a ⇒ J |
dramatically delays SaaS time to profit |
| exceeding |
g ≥ J or a ≥ J |
SaaS company will never be profitable |
| increasing |
⇑J by ⇑ARR or ⇓TCS |
upselling & lower TCS accelerate profitability |
| recommended |
J > g + a |
in high growth & churn scenarios |
| benchmark |
J ≥ 50% |
per year is generally very healthy |
Intuitively, the long run profitability of SaaS companies requires
the recurring contribution of current customers to cover the acquisition cost of new customers,
therefore the average customer rate of return for SaaS companies
must exceed both the current customer churn rate and the new customer growth rate.
So, what is a good value for Joel’s SaaS Magic Number? Well, I don’t think anyone could argue with 1, a valiant goal, but rather optimistic. Read more »