Sales efficiency is a lesser-known metric that is rarely discussed in popular SaaS communities but almost always evaluated in the financial and investment markets. It’s the metric everyone knows is important, but no one talks about. I view it as a leading SaaS health indicator, and it also can show when investments in sales and marketing are too low.
Sales efficiency (also referred to as the Magic Number) can be calculated by taking current quarter new revenue annualized, divided by prior quarter sales & marketing expenses.
For example, if you spend $2 on sales & marketing in Q3 and generate $2 of ARR in Q4, your ratio is 1.
If you spend that same $2 in Q3 but generate only $1 in ARR in Q4, your ratio is 0.5. In this scenario, it will take you two years to recover your sales and marketing investment (that is if the customer doesn’t churn within those two years! If they do, you won’t recover it fully).
What makes a good SaaS Magic Number depends on who you ask.
While each investor or banker has their own guidelines for what they think a good ratio is (and that may even vary by the stage of the company, growth targets, etc), there is some consensus on a general rule of thumb.
- A ratio between 0-0.5 usually indicates the company doesn’t have a sustainable investable growth model and better sales efficiency is needed.
- A ratio of 0.5-1 is much better. While this isn’t necessarily capital efficient (which would make it a hard ratio for a bootstrapped company to maintain for any length of time), it does indicate sales & marketing efficiency and many investors view this as acceptable.
- A ratio of 1 or greater indicates strong sales efficiency and a capital-efficient growth model. But there is a caveat here—if it’s much higher than 1 you are probably under-investing in sales and marketing and are leaving growth on the table.
When you have good sales efficacy, it’s a great time to scale the sales team. Tom Tunguz explains it best:
“To make it more concrete, if a startup invests $500k in marketing and sales this quarter and generates $1M in incremental revenue, net of the cost to provide the service, for the next 12 months, the sales efficiency would be 2. Sales efficiency is a helpful, high-level indicator….When these figures exceed one, it’s likely time for a business to invest more capital into the sales and marketing efforts.“
And as I mentioned, on the flip side, a lower ratio can indicate areas to improve efficiency. From the OpenView Partners SaaS benchmarking report:
“Sales and marketing spend peaks at 50% of ARR at the expansion stage. Too many companies underinvest in sales productivity, saddling them with huge costs without the ROI…You should be carefully monitoring your sales efficiency and looking for ways to improve or maintain it year-over-year. Look out for the ‘leaky bucket’ problem, where you spend significant sums to acquire new customers, but then they churn shortly thereafter (churn bait).“
The SaaS Sales Efficiency Calculator
We chose to keep our SaaS Sales Efficiency (below) relatively basic. If you know your current quarter recurring revenue, your prior quarter recurring revenue and your prior quarter fully loaded sales & marketing expenses, we’ll instantly calculate your Magic Number estimate.
A couple of things to note here (that apply to all of our tools). First, your data is private. We don’t share anything with anyone. And second, the only time we ask you for your name and email address is if you want your results emailed to you.
Please give us feedback and by all means, tell us if you find a bug. These calculators are brand new and we all make mistakes. As always, we hope you find these tools useful as you grow your SaaS business.
And we’ve got more SaaS calculators and report cards!
I hope you’ll check out our other tools:
- The Married2Growth SaaS CAC Calculator helps estimate your customer acquisition costs using a few simple inputs.
- The Married2Growth SaaS LTV Calculator helps estimate your customer lifetime value with a few simple inputs.
- The Married2Growth SaaS Sales Maturity Report Card gives you a look at your sales organization’s strengths and weaknesses with recommendations.
- The Married2Growth Sales-Driven SaaS Marketing Report Card helps you spot areas of opportunity to improve your marketing results.