The biggest decision growing companies from every business vertical have to make is to figure out the marketing budget. A business should spend approximately 10% of its revenue on marketing as a rule of thumb. However, if you go with the above percentage allocation, there are two issues. First, this rule came decades ago when doing business was not as competitive as it is today. Second, this is very generic; some industries need to be more aggressive and spend much on marketing.
If you have just started a SaaS business or planning to start one, you must get your marketing budget right. In this article, we will talk about the right allocation of the marketing budget for SaaS companies.
How Much Should Be the Marketing Budget for SaaS Companies?
There are different ways to decide your marketing budget. Foreign experts have different approaches. As per industry experts, if you are in the first three years of your business, you should spend anywhere between 75% and 120% of your total revenue (Annual Recurring Revenue) on marketing. After five years of running the business, the number can go down to 50% of Annual Recurring Revenue.
Some experts suggest finalizing the marketing strategy based on the growth you want to achieve, known as Growth Delta. Growth Delta is the difference between your current revenue and the revenue you want to achieve. For example, your current ARR is $10 million, and you want to get $30 million in revenue, then your growth delta is $20 million. As per experts, you should spend 40% of your growth delta on marketing. In the above example, that number would be $8 million.
Above, we have discussed two approaches you can take to decide your marketing budget. Both are equally good; you can decide which one suits you better.
Why Is the Cost So High?
You know most businesses spend 10% of their revenue on marketing, and as a SaaS company, you will have to pay much higher. You must understand why you need to spend so much higher. Let us look at the reasons for the same:
Cost of Product/Service:
As a SaaS company, you are not manufacturing any product, so there is no raw material, supply chain, or inventory cost. Companies manufacturing products have to think in terms of per product. Every product that goes out has a cost linked to it. For SaaS companies, the cost is server infrastructure and customer support team. For you, as you increase your customers, the cost per customer is decreasing.
For a product-based company, if the customer is not satisfied with the product, the businesses have to either re-deliver the product or issue a refund; in either case, it is a loss of inventory. For a SaaS company, if the customer is not satisfied, they can offer the customer an extended trial period, offer some discount in pricing, etc.
For the above reasons, the operating profit for SaaS companies is very high – somewhere between 70 and 80%. With such high gross profit, SaaS companies can and should allocate more budget to marketing.
Selling Service is Costlier:
The SaaS business is very competitive, and since there is no physical product to sell, the companies have to put in extra efforts to set them apart from the crowd. Since they don’t have a physical product to showcase and sell, they have to spend long hours (sales and marketing) to ensure that the potential customers have a complete idea of their service.
Every SaaS company needs an exceptional sales and marketing team since the company will get sales only if the employees are good enough to convince the potential customer how the services will save them money and help them grow.
Another way to reach out to potential customers is through content marketing; you can generate leads by reaching out to trial version users of your service and make them understand the benefits of paid version through webinars, podcasts, video series, blogs, etc. Using these options, your potential customers will be drawn to your services. Content marketing comes with its own cost – you need to put in money to create content regularly and spend on marketing to reach your customers.
Growth and Spending
SaaS companies are constantly under pressure from investors to increase their recurring revenue. The only way to achieve it is to put as much as possible in the marketing (in the initial few years). The average spending of existing SaaS companies is around 45%. However, the fastest-growing companies are investing more than 100% into marketing.
So if you have just started your business and you aim to grow fast, you now have the numbers you need to allocate to your marketing team.
Let’s have a look at a simple example for this:
One of the popular SaaS companies is ServiceNow. Let us look at their 2019 financials; the company generated total revenue of $3.46 billion. Their gross profit was $2.66 billion (77% of revenue, in line with our numbers earlier). Their sales and marketing spend were $1.5 billion that is 44% of their revenue.
The marketing spend here is not based on growth delta but the percentage of total revenue. A big company like ServiceNow is spending 44% of their revenue on marketing, so if you are a startup, your percentage has to be much higher.
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If you are a startup and your spending is more than 100% of your revenue, you should not worry after going through the above number. As discussed, growth in the SaaS business will only come if you are spending. There is a massive ROI for the companies that invest in new customers – companies with higher marketing budgets see faster growth rates, which is what any company dreams for.
If you are still unsure about how much to spend on marketing, it is always better to consult an expert.