How not to calculate a SaaS marketing budget

I hear this question often from software-as-a-service (SaaS) providers: "How much should we spend on marketing?"

If these marketers have experience working in the traditional, on-premise licensed software world, they're usually familiar measuring marketing spend as a percentage of annual revenue.

That metric is often used to allocate and track marketing budgets for licensed software companies, and they typically spend somewhere between 5 and 8 percent of annual revenues on marketing.

Unfortunately, in most cases neither that metric nor that benchmark are very useful for SaaS providers.

SaaS marketers are usually better off with a metric more appropriate to the unique SaaS business model: marketing spend as a percentage of the lifetime value of the customer.

That measure better accounts for the fact that revenues extend over the life of the subscription, and they aren't recognized in a large up-front license fee. (I've written extensively on this topic and the impact on marketing. See, for example, "Three deadly SaaS marketing mistakes.")

But what if you choose to stick with the old standard marketing as a percentage of annual revenue? What are the consequences of using the wrong metrics and benchmarks? A few bad outcomes are possible:
  • Under-funding: A business fixated on measuring marketing as a percentage of annual revenue is likely to under-fund marketing and choke off the fuel for customer acquisition.
  • Over-pricing: To bump up annual revenues to better cover customer acquisition expenses, the company may over-price their solution relative to the value perceived by the customer.
  • Over-promising: A business plan that shows artificially low spending on marketing relative to annual revenues may be attractive to investors on paper, but disappointing in reality.
  • Under-funding: A plan that expects an unrealistically rapid return on marketing spend is likely to be under-funded and unable to sustain marketing activity over an extended period of time.
  • Inadequate attention to renewals: A SaaS company focused on annual revenues vs. lifetime revenues may be ignoring existing customers and securing renewals in favor of attracting new customers.
  • Swinging for the fences: A focus on high short-term returns may lead companies toward magic bullet, quick-fix marketing solutions and spending a burst of money on programs that will likely flop.
Bottom line: If you measure the wrong thing, you'll probably do the wrong thing.