There are a number of common efficiency-oriented metrics used in analyzing the effectiveness of a SaaS company. Important efficiency metrics for SaaS startups include Sales Efficiency (also known as the Magic Number), Human Capital Efficiency, and Capital Efficiency. All three metrics seek to measure success in terms of Annual Recurring Revenue (ARR) creation versus the application of various business inputs. All three will give you a solid sense of how well your startup is performing and investors like to see this information.
Sales Efficiency
Sales Efficiency is commonly calculated as new ARR created in the current quarter, divided by the prior quarter’s Sales & Marketing Expense. It narrowly measures the efficiency of the Sales & Marketing organization. The common rule of thumb is that a Sales Efficiency score above 1.0 suggests the sales strategy is working and efficiently producing more revenue. Higher is better.
Sales Efficiency is commonly calculated as new ARR created in the current quarter, divided by the prior quarter’s Sales & Marketing Expense.
Human Capital Efficiency
Human Capital Efficiency broadens the view of how well a company creates new ARR by measuring the number of humans across the organization it takes to sustain the current level of ARR. It’s simply calculated as total ARR divided by total Full Time Equivalents (FTEs). The more humans it takes to generate and sustain ARR, the less efficient and therefore less profitable the company is likely to be. Higher is better.
Human Capital Efficiency is simply calculated as total ARR divided by total Full Time Equivalents (FTEs).
Capital Efficiency Ratio
And finally, we have the Capital Efficiency Ratio, which is calculated as Total Equity plus Total Debt Minus Cash ÷ ARR. The Capital Efficiency Ratio is the ratio of how much a company has spent growing revenue and how much they’re receiving in return. It is the broadest measure of company effectiveness in generating ARR. A lower Capital Efficiency Ratio is better. I wrote about the Capital Efficiency Ratio recently since this is an excellent metric to help predict how much ARR your SaaS startup will need for its next round.
The Capital Efficiency Ratio is calculated as Total Equity plus Total Debt minus Cash ÷ ARR.
Generally, these three efficiency metrics for SaaS startups point in the same direction, but not always. A company may see great Sales & Marketing success and yet have poor measures in Human Capital Efficiency because it requires a large contingent of Customer Success personnel to keep the customers happy. Likewise, if continued large investments in R&D are necessary to keep the product competitive then your Capital Efficiency Ratio will suffer. It doesn’t matter how efficient your go-to-market strategy is if you’re not getting positive leverage out of spending in other areas of the company. In the end, a company should look at all three efficiency metrics together to measure organizational effectiveness.