how to build your marketing budget for software companies

Building Your SaaS Marketing Budget

Stijn Hendrikse
Jun 5, 2021

Having a SaaS marketing strategy is great.

But to establish your SaaS company's marketing plan and marketing spend, you also need an accurate SaaS marketing budget that will drive approved funding into your marketing efforts. 

This is typically owned by your SaaS Chief Marketing Officer and will empower your software company to achieve a set amount of outcomes at the right cost.

When to make your first SaaS marketing budget

In the first week of most engagements I do with SaaS company CEOs, the inevitable question comes up: What should we budget for marketing? How do I get my first SaaS Marketing budget?

There are several guidelines that people usually fall back on, ranging from percentage of annual recurring revenue to one-time, fixed budgets for some of the fundamentals (like getting a website in place). Every situation is different. So how to approach the budget question? (TLDR: Jump to the formula right away here)

You can’t use an average marketing budget

After a couple of brainstorms around this whiteboard, we came up with an alternative to the typical rule of thumb using % of revenue.

In the second part of this article, we go into some algebra, but I promise math camp will only be a quick overview before we make it concrete again.

marketing-budget

Let’s start with some fundamental best practices before we jump into a specific budget calculation:

1. Don’t start what you can’t sustain

Marketing is not a one-time initiative. You need to build a foundation for lasting growth and build ongoing engines on top of this. When you launch a new website, make sure you can keep it fresh and provide a great experience and service to the visitors. Don’t launch an event, a blog, or a series of webinars unless you can keep them going at whatever pace is sustainable for you.

2. Only outsource what you master

Don’t spend money unless you can manage the things you spend it on. For example, don’t spend money on search advertising if you can’t afford someone with the right expertise who can manage this spend with the right focus, and hold either the agency or internal team accountable. Don’t start spending on tactics that you can’t measure or benchmark.

3. Look bigger than you are

Don’t sacrifice quality just to be able to do more. As a fast-growing startup, you want to look bigger than you really are. This starts with credibility, consistency, and predictability.

4. Don't cut corners

For example, your team shouldn’t start with paid advertising or content marketing unless you have a solid infrastructure to nurture and follow up with prospects as they start hitting your site. Don’t run campaigns unless you can do A/B tests. Don’t promote content that’s not good enough to drive engagement from your audience. Don’t hire young, high-energy marketing team members unless you know what they should be working on, and you can provide the right coaching.

5. Know how fast you want to go.

Some budget guidelines that use a percentage of revenue have broad ranges (some say 6% to 20% of ARR). That’s usually because some startups have a mandate to do a “land grab” and capture market share fast (and that’s why they got a big Series A funding check). Other startups are expected to get to profitability as soon as possible. This will drive your marketing budget percentage allocation as either a well-funded b2b SaaS company or a bootstrapped success story that wants to stay profitable.

Balancing speed vs. ROI 

While most startup leaders sell their investors on a j-curve exponential growth model, the reality is that this is a mathematically impossible growth trajectory. In exponential growth, the amount of revenue growth, or new customers added, per invested dollar (aka ROMI, Return on Marketing Investment) stays growing with the same acceleration regardless of your total revenue, market size or spend level, making you grow faster and faster as your budget and resources grow.

Unlimited growth potential?

In theory, a SaaS company could take over the world just by buying more market share (aka leads) and making sure conversion rates to paying customers, and their retention rate, don’t drop.

For instance, imagine you can buy a high-quality lead on a marketplace like Software Advice for $500. Let's say these leads have proven to predictably convert at a 10% rate into paying customers who fit your ICP.

Assuming a decent annual churn rate at 8.3%, a paying client stays for about 10 years. Accounting for a 10% cost to service this client, and an annual ARPU expansion of 5%, your return on the initial investment of $500 would be a whopping 15243%.

Year Cost/lead ARPU Cost to Service LTV
1 -$500     -$500
2   $6,000 -$600 $4,900
3   $6,300 -$630 $10,570
  $6,615 -$662 $16,524
5   $6,946 -$695 $22,775
6   $7,293 -$729 $29338
7   $7,658 -$766 $36,230
8   $8,041 -$804 $43,467
9   $8,443 -$844 $51,065
10   $8,865 -$886 $59,043
11   $9,308 -$931 $67,421
12   $9,773 -$977 $76,217

 

While the numbers in the above table, driven by the fundamental effect of SaaS growth drivers, is the main reason B2B SaaS businesses are such a great investment, applying the above exponential growth curve as a foundation for our growth budget is fundamentally flawed.

The assumption of an unlimited number of high-quality leads, available customers, and sustainable churn and ARPU expansion levels is just not possible.

Limit your budget dreams to a realistic level

In nature, populations may grow exponentially for some period and are then become limited by resource availability.

Your SaaS marketing investments also must account for limited available inventory of paid search clicks, advertising real estate, prospect attention span and ultimately the number of customers who need what you have.

To get a more realistic understanding of our potential growth path and the required investments, we need to apply a so-called logistic growth model. The logistic growth model of your SaaS company pertains to the growth per invested capital unit, which gets smaller and smaller as demand generation channels approach a maximum imposed by the limits of your target market. This is also known as the carrying capacity (for example, the number of customers available in a given market).

For software businesses, your carrying capacity is also impacted by forces like competitors copying your solution, or government and regulatory bodies only allowing a certain level of market dominance by one provider.

Exponential growth produces a J-shaped curve, while logistic growth produces an S-shaped curve:

Exp-1Exp2-1

We can mathematically model logistic growth by modifying the equation for exponential growth, limiting a growth rate r (growth rate per invested unit of capital and resources) that depends on market share (N) and how close it is to carrying capacity, or market saturation (K).

If a SaaS company has a base growth rate of rmax when it’s still small, we can write this as follows (K and N representing for example number of customers):

 

CodeCogsEqn (3)

 

Let's take a minute to dissect this equation and see why it makes sense.

  • At any given point in time during market share growth, the fraction N/K tells us the customer ocupancy.
  • The ocupancy complement (1-N/K) represents the customer disponibility. The more carrying capacity that has been used up, the more the (1-N/K) will reduce the growth rate.
  • When the market share for your type of solutions in your target market is tiny, N is very small compared to K. The (1-N/K) term becomes approximately 1, giving us back the exponential equation.

The solution for this diferential equation is N(T).

CodeCogsEqn (4)

This fits with our graph above (Logistic Growth): Market share grows near-exponentially at first, but levels off more and more as it approaches K.

Enough with the math already!

Regardless of fancy formulas, what does this really mean? Most B2B SaaS ventures find themselves on the left side of this spectrum, in relatively underdeveloped market segments. So why worry about potential slower growth rates in the distant future?

While it’s true that most of you by definition will pick a high growth segment of the market to focus on, and thus will be living in the land of exponential SaaS growth for a while, you are also “banking” a lot of your planning and investment decisions on the long term value of your clients.

For example, you might be convinced that you can afford a relatively high Customer Acquisition Cost (CAC) because of your exponential growth forecast and the impact on the Customer Lifetime Value (CLV) and its impact or your ability to afford a higher CAC.

Given this long-term investment thesis for your growth capital, it’s important to understand what the limitations of growing in your target market are, and when you need to adjust your approach. All this is critical to have a holistic budget plan to support the right investments today that support your company's growth potential over time.

Many SaaS CEOs have oversold the value of their growth plan as they did not account for the reality that the market they service will get saturated at some point, driven by increased downward pressure on pricing, increased customer churn as some customers leave to competitors, and a predictable slow down of demand generation as your market share grows.

What factors impact a SaaS company's carrying capacity

Your ability to accelerate market growth by spending more will eventually realize diminishing returns.

As a growing SaaS Start-up first or early to a fast-developing new market category, it's important your sales and marketing teams grab. What is the right ROI trade-off to satisfy your investor's comfort level with a land grab of your target market segment vs. reduction in ROI?

Resources needed to fuel SaaS growth can become a limiting factor. Internal factors include: 

  • Available resources
  • Product capability
  • Strategy trade-offs.

On the other hand, external factors include: 

  • Competitive pressure
  • Government regulation
  • Customer expectations
  • Impact on the cost to service
  • Scalability of your own technology.
Let’s look at how you can use all these factors and the limited information you have for them, to budget your growth as accurately as possible.

SaaS marketing budget inputs

When you type into a google search bar “how much to spend on marketing,” you’ll get a long list of search results that cover the following general themes:

  • Make your marketing budget a percentage of revenue. The U.S. Small Business Administration recommends 7-8 percent of gross revenue for marketing and advertising.
  • Take into account your product or company age. Newer means spending more. Younger companies (up to five years old) should spend 12-20% of revenue on marketing, versus older companies about 6-12%.
  • B2C or B2B. B2C can be as much as twice the budgets used in B2B (also known as BTC and BTB marketing).
  • Company size. Smaller companies spend more on marketing as a percentage of revenue.
  • Vertical and market. For startups in the tech sector, you’ll find recommendations around 20-25% of their revenue on marketing, especially when they recently received growth capital.

As you can see, these numbers are all over the place. They don’t really help create an actual budget to support your plan since they don't take into account many critical factors. The biggest missing dimension is the maturity of the market you are in, as discussed in the earlier speed vs. ROI topic.

Startups need to invest in marketing until the desired market share is established and can be sustained. During this phase, you will build up your own brand, and you may need to educate the market if your category is still young. Therefore, a typical startup budget spends at least 20% of revenue on marketing efforts, and sometimes more.

What to include in your first SaaS marketing budget

Let’s first define what’s in your SaaS ‘marketing budget.’

Consider including all the costs for marketing, advertising, public relations, promotions, and any other strategic or tactical investments like Google AdWords, social media, print advertising, sponsorships, sales collateral, user groups, in-person events, and sometimes even sales discounts disguised as promotions.

I also like to include people's costs, since early-stage marketing efforts will be more dependant on the work you can do, than the media you can buy.

How to calculate your SaaS marketing budget

The following are the basic inputs I like to use when recommending a budget for the marketing plan:

  • Maturity of the Solution/Company (Product-Market-Fit)
  • Maturity of the Market Segment you expect your growth to come from
  • Completeness of marketing foundation (these are one-time investments like branding, website, and marketing infrastructure)
  • Available growth capital and speed expectations (desired time to capture a certain amount of market share)
  • Growth volume expectations (% in ARR growth)

The above inputs will have different levels of impact on the budget needed to reach the desired growth volume, at the expected speed. I've found it helpful to express the budget needed as a function of the various inputs with a formula that allows us to account for the level of impact of each input. So let y(x) be the budget function:

CodeCogsEqn (6)

The outcome “y” is a proxy for your needed budget and will go up or down based on the following terms and their factors. Let's explore these individual variables in the context of your SaaS marketing budget. 

“x”: Desired growth

Calculating any marketing budget starts with establishing how much you want to grow. This x-factor is based on subtracting your current ARR, from the target ARR. You can use any combination of net new customer accounts multiplied by their ACV or net new ARR growth. You need a financial growth target based on these assumptions.

Next, the coefficients that make up the terms of the right side of the formula represent various inputs with different levels of impact, in order of high to lowest impact:

“a”: Cubic exponential impact

These inputs have the largest impact. Most of these are about the maturity of your product or company vs. the market you are in. The larger this number, the less budget you need.

  • Have you reached MVP or Product Market Fit?
  • Do you have established beachheads?
  • Have you confirmed, and are able to reach your ICP?
  • What’s your ACV/ARPU?
  • How many paying customers do you have?
  • When did you get your first paying customer?
  • Do you have accounts providing references? Referrals?
  • What’s your customer logo churn? Revenue churn?
  • Have outside investors put faith in your company by providing growth capital?
  • Has a 3rd party, an influential analyst, started covering you?

“b”: Quadratic exponential impact

These are inputs that describe the maturity of the market you are targeting.

While in a very immature market, you will need more budget to help “make the market” and educate your audience, these inputs will have the reverse effect once a market gets established and your competition increases. A market that gets more crowded will be costlier to target, thus this number b will drive up your budget needs exponentially as it goes up. Example inputs are:

  • How mature is the market you plan to focus on? I think the “crossing the chasm” model from Geoffrey Moore provides a framework for this.
  • What is the Total Addressable Market you are focused on?
  • When did the first customer in this segment pay for a solution like yours?
  • Is there a market analyst/marketplace category that your product fits into? (for example Gartner Magic Quadrant, Forrester Wave, Capterra/G2 Crowd/Software Advice categories).
  • Do you encounter competitors when selling to your prospects? Have you lost deals to the competition?
  • What is the monthly search volume of the top 5 high-intent category keywords?
  • What is the price of pay-per-click advertising?

As it's not easy to calculate these, our team led by Mike Northfield and Brian Graf has created a great spreadsheet model to help you with this. Feel free to contact the team at Kalungi for a free consult where they can help you use this template.

“c”: Linear impact

The speed at which you will realize your growth or the time it will take you to achieve the desired outcomes typically has a linear impact on the investment needed. Short of strange economical anomalies like hyperinflation, you should be able to double your speed by doubling your budget in most of the areas that you control through your marketing investment. You can assume this as a linear relationship between budget and growth since you are already accounting for the non-linear a, b, and d coefficients in this model.

“d”: Fixed impact

Finally, there is a fixed cost to get on the field when it comes to marketing. You need to build a certain foundation, regardless of the amount of growth, or speed that you desire. Here are some examples that will have a fixed budget impact:

Calculating the marketing budget for your SaaS start-up

To go from theory to providing you a simple way to calculate your investment needs, Mike Northfield and Brian Graf at Kalungi have updated multiple budget templates with data from many existing successful SaaS companies based on these updated calculations.

Set up a time to speak with one of our CMOs to use these to complement your marketing planning. Select the "free consultation and demo" when you fill out the form. We don’t provide these templates as a simple download, as they require a small amount of instruction to get you a rock-solid saas marketing budget. The template includes a marketing budget calculator that you can use after the consult to play with multiple scenarios, and update your plans as you grow.

Product-led SaaS growth

Finally, no budget conversation would be complete without addressing the topic of “product-led growth”.

While the integration of product management and engineering, with marketing techniques to drive growth is nothing new, the recent success of so-called product growth-led SaaS Marketing firms has brought new focus to this. Product-led growth is not really different from what used to be called growth hacking, sometimes combined with network effects (products like hotmail.com and Microsoft Office with its document formats grew with product-led growth a long time ago).

Some people advocate moving the budget from pure demand generation (marketing and sales) to R&D to benefit from the higher value fly-wheel effects that a product-led growth approach yields. I don’t think this is an either-or decision.

I strongly advocate for every marketing leader, and their team, in a software company, to work closely with the engineering team and product leaders to integrate nurture, content marketing, promotions, and driving customer engagement into the product, and treating it as another, very valuable, and highly controlled marketing channel with a captive audience (your users and customers).

Here are a couple more links to explore on the topic of creating your B2B SaaS Marketing budget:

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