Let's do the math on marketing budgets.
You're a pre-seed startup, and you need to figure out how much to budget for marketing. Where do you even start?
Google, probably. Or maybe by asking someone you trust who's been through this already, even though their company is a B2C eCommerce and yours is B2B SaaS. Does that convo get you reliable info? Who knows?
Google it is then. But you get results like "startup marketing budgets should be between 5% and 40% of your total budget for the year." Between 5% and 40%, what!? Just an 8x delta. No worries.
Seems less like advice and more like throwing mud at a wall—some of it will stick, but does that tell you anything? (Spoiler: not nearly enough).
I have some thoughts on this. 8x variance isn't a strategy; it's guessing. Guessing doesn't take you from chaos to clarity, so let's focus on clarity and how to get there.
Start by Working Backward
Try visualizing your revenue hypothesis. Maybe you want to think of this as a "goal," but having a revenue goal can be daunting: you're a startup; maybe you haven't done this before; (maybe no one has done this before).
You should at least have an operating model. If you don't, now's the time to put one together. As a founder, you want to spend your funds in ways that are smart. An operating model paints a picture of the rhythm of your business: what your cash flow and revenue might look like as you move through your first year.
An operating model will help you develop your revenue hypothesis, which is one of the things you're going to need to hash out a thoughtful marketing budget.
The method we'll look at here works best for companies that are just starting up and expecting outside sources of operating capital. You're looking to find money to hit your revenue goals (or hypotheses).
Revenue Targets: How Many Customers Do You Need?
Once you have an operating model and have a grip on your revenue hypotheses, you need to answer one simple question to get to your marketing budget number:
How many customers do I need to acquire?
That's it. You have your revenue target on the one side. On the other is the question, "how do I hit that target?" The answer is to "get the number of customers that lands you there."
Essentially, you need x customers to reach y revenue, and your marketing budget is based on how much spend it takes to hit x customers. That's the concept. Let's look at it for real.
Calculating Your Marketing Budget
Everything seems easy enough so far, but we need to dig in a bit more to find the details that matter. Let's think about customers. They're the real problem you need to solve to get to that marketing budget. Here are some variables customers bring with them.
Some of your customers are going to churn.
You need to consider customer acquisition cost (CAC) too.
But you don't need to worry about growth. These numbers will work no matter what your growth target is.
This is important because VCs often want to see your company triple its revenue for each of the first two years, then double it for each of the next three. This is commonly called the "33222 rule."
You don't have to change your marketing budget formula to account for that (or any other) growth model. You can refine it to account for market dynamics, but you're in good shape once you get this engine running.
Let's define some terms we'll use in this marketing budget formula:
- ARR: Annual Recurring Revenue
- ARPC: Average Revenue Per Customer (per month)
- CAC: Customer Acquisition Cost
- CRR: Customer Retention Rate
The formula we'll use looks like this:
[(ARR / (ARPC x 12)) x CAC] / CRR
Let's break that down:
- Start with your hypothetical revenue target
- Calculate your average revenue per customer per month and multiply that by 12 months to get your annual revenue per customer
- Divide your revenue target by your average annual revenue per customer
- Multiply that total by your customer acquisition cost
- Divide that total by your customer retention rate
- That's the marketing budget you need to allocate to hit your hypothetical revenue target
Let's apply that to some real numbers with an example. Suppose that:
- Your revenue target is $5,000,000
- You get $500 revenue from each customer each month
- Your customer acquisition cost is $250
- Your annual retention rate is 80%
Let's plug those numbers into the formula:
[($5,000,000 / ($500 x 12)) x $250] / 0.80
- Now we'll do the calculation step-by-step:
- $5,000,000 / ($500 x 12) = 833.33 customers, to hit $5,000,000
- 833 x $250 = $208,250 in CAC
- $208,250 / 0.80 = $260,312.50 because some customers will churn
But that's not (necessarily) your marketing budget...
What's My Marketing Budget?
It depends on how you calculate your CAC. If you've included all of your operating overhead in that CAC number—things like salaries, contractor and legal fees—you'll need to subtract that from your answer to get the marketing budget.
For example, if you have $160,000 of marketing-team salaries included in the $260k calculation, that money is already leveraged and is subtracted from your total marketing budget, so you have an additional $100k to spend to hit your revenue target.
How you've calculated your CAC matters, so think about whether you're looking for additional allocation or total marketing budget allocation with the number you calculate.
Things You Need to Know to Use This Method
To calculate this marketing budget accurately, you need some good data.
You need to have a revenue hypothesis. You need to know your CAC and what you've included in that calculation. You need to know your average customer revenue and your churn rate.
And you want to project high with your CAC. If you go low on this number, it has a knock-on effect that strongly impacts the calculation, resulting in a marketing budget projection that's far too low to achieve your revenue target. Go high on your CAC to build a little buffer.
At RevPipes, we help startups break down their assumptions and clarify their ideas into actionable numbers they can track and measure to understand how to make these kinds of projections.
Formulas like this, which are data-driven and goal-oriented, work well for getting your startup the action items it needs to hit a revenue target you've set. It tells you directly how many customers you need to acquire and retain, and you can measure against that. Further, the budget can be adjusted for unforeseen increases in CAC.
It's important to gather the necessary data to make accurate projections to use them, but metric-based approaches are powerful because they give you targets you need to execute against.