Why Percentage of Total Revenue is a Misleading Metric for SaaS Marketing Budgets.

Discover why the traditional percentage of total revenue approach falls short and learn the key metrics that truly drive sustainable growth in the SaaS world.

When determining how much to spend on marketing, many SaaS companies rely on the age-old metric of percentage of total revenue. But this approach, rooted in traditional consumer goods companies like Coca-Cola, is fundamentally flawed for the SaaS business model. Let’s dive into why this is a terrible metric and explore a more nuanced approach.

The Origin of Percentage-Based Marketing Budgets

The practice of allocating a set percentage of revenue to marketing expenditures originated with consumer packaged goods (CPG) brands and large corporations. Companies like Coca-Cola need to continuously remind consumers to buy their products every time they walk into a store. This makes sense for CPG brands that thrive on repeat purchases. But SaaS businesses operate differently.

SaaS Dynamics vs. CPG Dynamics

In SaaS, the relationship with customers is ongoing and contractual. Once you acquire a customer, significant resources are allocated towards account management, customer success, and ensuring the customer renews their contract. This is in stark contrast to CPG brands that focus primarily on acquiring new customers and driving repeat purchases without the same level of ongoing engagement.

Changing Financial Dynamics in SaaS

The financial landscape for B2B SaaS and tech companies is shifting. Valuation multiples have compressed significantly, impacting how these companies allocate their budgets. For instance, a SaaS company that was previously valued at 25x revenue might now be valued at 5x next 12 months revenue. This drastic change puts pressure on all P&L line items, particularly sales and marketing, which often represent the largest expenditures.

A Better Approach

To truly understand how much to spend on marketing, SaaS companies need to consider several factors:

?? Customer Acquisition Cost (CAC): Understanding the cost to acquire a new customer is crucial. This should include not just the marketing spend but also the costs of sales and onboarding.

?? Customer Lifetime Value (CLV): Calculate the total revenue you expect from a customer over the duration of their relationship with your company. This will help determine how much you can afford to spend to acquire and retain customers.

?? CAC Payback Period: This metric tells you how long it takes to recover the cost of acquiring a customer. A shorter payback period is generally better, but it should be balanced with the potential for long-term revenue.

?? Valuation Multiples and Market Conditions: Given the volatility in SaaS valuations, companies should be agile and adjust their marketing spend based on current market conditions and valuation multiples.

Acting Like a Business Leader

Marketing and sales leaders in SaaS need to act like business executives, not just department heads. This means using a business lens to evaluate every decision. Effective leaders understand that marketing spend should be aligned with overall business goals and financial health, rather than adhering to an arbitrary percentage of revenue.

Conclusion

In conclusion, the percentage of total revenue is a poor metric for determining marketing spend in a SaaS business. Instead, focus on metrics like CAC, CLV, and CAC payback period, and consider the broader financial dynamics at play. By doing so, SaaS companies can make more informed decisions that drive sustainable growth and long-term success.

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