Budgeting for SaaS Companies: Don’t Break the Bank on Sales & Marketing
May 30, 2013
SaaS expert Jason Lemkin offers tips for setting a realistic SaaS sales and marketing budget that fuels growth without burning through profits.
When it comes to SaaS budgeting metrics and spending benchmarks, you’ve probably heard experts suggest that sales and marketing expenditures should match a company’s first-year Annual Contract Value (ACV).
The idea, after all, is that SaaS companies can get away with investing a significant amount of capital on sales and marketing in the first year of a contract if it means that the revenue they draw in years two, three, and four will be pure profit.
The unfortunate news, however, is that SaaS spending isn’t quite that simple, says SaaS expert Jason Lemkin, who co-founded EchoSign and served as its CEO until the company was acquired by Adobe in 2011.
“In the context of generating pure profit on the backend of a contract, spending 100 percent of ACV on sales and marketing in the first year of a customer’s contract seems like a no-brainer,” explains Lemkin. “The problem with that, of course, is ensuring that you have sufficient capital to stem the tide and survive that first year.”
Simply put, spending 100 percent of first-year ACV on sales and marketing inherently burns cash upfront. And if your SaaS company doesn’t have a lot to begin with, Lemkin says that could put you in an uncomfortable situation during that first year.
“If you blow your budget on sales and marketing,” Lemkin says, “how will you deliver all of the other services — product support, customer service, etc. — that new SaaS customers need in the first year of their contracts?”
The Sales and Marketing Metric You Can Count On
Unfortunately, Lemkin says, there’s no magic sales and marketing spending formula that applies to all SaaS businesses.
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“If you’re a $10 million SaaS business with VC financing, then spend away if you can justify it on the backend of deals,” Lemkin explains. “But if you’re an early-stage company with just a few million in revenue, unless you’re extremely well funded, you’ll likely have to be a bit more disciplined in how you spend your sales and marketing dollars.”
The one thing to plan on, Lemkin says, is that sales expenditures will account for at least 25 percent of first-year ACV. The reason is simple: No new SaaS company can support a purely bonus-driven compensation model, so you’ll need to pay your salespeople a living wage.
“Most SaaS businesses’ goal is to grow 100 percent year over year,” Lemkin says. “But at the end of the day, one human can only close so much business. So, your sales team will need to scale as your business scales, which will force you to keep sales spending at a relatively fixed percentage of ACV.”
The One Spending Variable that SaaS Companies Can Control
While sales might be a fixed cost relative to ACV, Lemkin says marketing is a different story.
“In my mind, marketing is the variable you can play with when you’re growing,” Lemkin says. “Once you know what percentage of ACV you have to commit to sales, you can perform some simple, bottom-up calculations to determine how much you can afford to spend on marketing.”
Are You Ready for the Challenges of Scaling Your Company?
The good news is that once a SaaS company achieves initial traction (which Lemkin says is around $1 million in revenue), most of its marketing expenditures will be on lower-cost inbound tactics and lead qualification.
And when money is tight, that’s where a SaaS company can regain control of its spending metrics and ensure that it has enough cash left over to onboard and service new customers.
It’s a delicate balance, Lemkin says. If you don’t spend enough on sales and marketing, you won’t create the growth that you need. But if you spend too much, you’ll burn through the capital you have and you might not survive long enough to see the profit on the backend.
“One thing I do know: the common metric of sales plus marketing expense equals first-year ACV is a useful yardstick for SaaS businesses that are truly in the scaling phase,” Lemkin explains. “But you’ll need to modify it to match the cash coming in, and the cash on your balance sheet, to make it really work for your SaaS business.”
How have you calculated your SaaS sales and marketing spending?