Recurring revenue is one of the most valued phrases in a confidential information memorandum. Maintenance agreements, service contracts, rental fleets, and aftermarket programs promise visibility, and buyers pay for visibility. The logic is sound as far as it goes. Revenue that repeats is easier to forecast, finance, and grow than revenue that has to be won again every quarter.

The problem is that recurring revenue describes the timing of cash, not its profitability. In equipment and field service businesses, a contract can renew on schedule for years while its margin erodes underneath it. A diligence process that tests revenue quality without testing margin quality at the contract level can underwrite a stream of income that grows, renews, and quietly loses money.

Why the premium exists

The case for service revenue rests on real economics. In a 2015 Bain study of 45 European industrial manufacturers, service averaged a 39 percent gross margin, compared with 27 percent for new equipment, and it grew nearly twice as fast between 2010 and 2013. A 2017 McKinsey analysis across 30 industries found aftermarket services averaged a 25 percent EBIT margin, against 10 percent for new equipment.

Those averages hide an important split. The same McKinsey work found that parts sales at most manufacturers carry gross margins above 30 percent, while maintenance services average about 10 percent. It also noted that many companies provide maintenance at no profit in order to drive parts sales.

That distinction matters for investors. The headline attraction of an aftermarket business often comes from parts, consumables, and repair work priced per event. The contracted maintenance that makes revenue look recurring is frequently the thinnest part of the mix. When a deal model applies one average service margin to contracted revenue, it can overstate the profit that the contracts themselves produce.

Where contract margin goes

Contract margin rarely disappears in a single event. It leaks through a handful of predictable mechanisms, most of which are invisible in a consolidated income statement.

Escalators that lag labor costs

Most multiyear service agreements include a fixed annual price escalator, often 2 to 3 percent, or no escalator at all. Labor, the largest cost in delivering field service, has not followed that path. The Bureau of Labor Statistics Employment Cost Index for wages and salaries of private industry installation, maintenance, and repair workers rose about 31 percent from the fourth quarter of 2019 to the second quarter of 2026. Across all private industry, wages and salaries rose 3.1 percent in the 12 months ended June 2026, with total benefit costs up 3.8 percent.

Late 2019 to mid-2026 Cumulative increase
Technician wages (ECI, installation, maintenance, and repair) About 31 percent
Contract price, six annual 3 percent escalations About 19 percent
Contract price, six annual 2 percent escalations About 13 percent
Contract price with no escalator 0 percent

A contract written in late 2019 with a 3 percent escalator has lost roughly 12 points of labor cost coverage since then. One with no escalator has lost all of it. The revenue line still shows a renewal every year.

Technicians are scarce, and scarcity costs money

The pressure on labor cost is structural, not cyclical. The Bureau of Labor Statistics projects about 51,900 openings per year for industrial machinery mechanics, maintenance workers, and millwrights, an occupation with a median wage of $64,100 in May 2025. Most of those openings come from workers retiring or leaving the field. Replacing them means recruiting premiums, overtime, longer ramp times for new hires, and more repeat visits while skills develop.

Turnover also varies sharply by company. Bain’s industrial service research found technician attrition of 10 to 15 percent at the weakest performers, against 1 to 2 percent at the best. A business at the high end of that range pays the cost of replacing a meaningful share of its delivery capacity every year, and that cost lands on contracts priced as though the workforce were stable.

Scope creep and unbilled work

Service agreements define covered work, but the field defines what actually happens. Technicians add a small repair while on site. A customer calls for an extra visit and nobody issues a separate charge. Equipment ages and needs more attention than the visit schedule assumed. Each decision is reasonable on its own. Together they move cost into the contract without moving price.

Travel, density, and the customer the map forgot

Cost to serve depends heavily on where customers sit. A contract 90 minutes from the nearest technician carries the same price as one 15 minutes away if the rate card ignores distance. As a business wins accounts outside its dense core, average drive time rises and billable utilization falls. Bain found that service champions run billable utilization 11 percentage points higher than followers, which is the difference between a margin and a cost center in many field operations.

Renewal rates that measure the wrong thing

A 95 percent renewal rate is usually presented as proof of customer satisfaction. It can also be proof of underpricing, because customers rarely leave contracts that cost them less than the work they receive. High renewal rates paired with flat pricing deserve a closer look, not a higher multiple. The more useful measure is renewal at a reset price: the share of contracts that renewed after an increase above the escalator, and the volume the company lost when it asked.

A hypothetical contract

Consider a hypothetical preventive maintenance agreement priced at $24,000 per year in 2019, with four scheduled visits and a 3 percent annual escalator. At signing, the provider expected 120 technician hours per year at a fully loaded cost of $95 per hour, plus $3,000 in travel and minor parts, for a cost of about $14,400 and a gross margin near 40 percent.

After six annual increases, the price in 2026 is about $28,700. If loaded labor cost tracked the ECI, it is now about $125 per hour. Suppose the equipment has aged and visits now take 135 hours, and travel and minor parts have risen to $4,000. Cost is about $20,900, and gross margin has fallen to roughly 27 percent. None of this appears in the renewal rate, which remains 100 percent.

The numbers are illustrative, but the pattern is common. The contract did not fail. It was simply never repriced.

What to test in diligence

Recurring service revenue deserves its premium when the contracts behind it are priced to their cost and have the mechanisms to stay that way. The following tests separate revenue that repeats from profit that repeats.

Test What it reveals
Gross margin by contract or contract cohort Whether margin is broad based or concentrated in a few accounts
Escalator terms against labor cost growth since signing How much cost coverage each vintage has lost
Actual hours and visits against contract assumptions Scope creep and aging equipment
Billed hours as a share of paid technician hours Utilization, travel burden, and unbilled work
Margin by distance from the nearest branch or technician Hidden cost of low density accounts
Renewal pricing history Whether renewals reset price or simply roll forward
Mix of contract, time and materials, and parts revenue over time Whether high margin event revenue is shrinking relative to thin contract revenue
Technician attrition and time to productivity The durability of delivery cost

Two questions deserve particular attention. First, ask management to show contract margin by vintage. A company that cannot produce it does not know which contracts make money, and neither does the buyer. Second, ask what happened at the last three renewal cycles for the largest contracts. A business that has never walked away from an unprofitable renewal is telling you how it prices.

Where the data does not exist, a sample works. Pulling 30 to 50 contracts across vintages, sizes, and regions, and rebuilding their cost from work orders and payroll records, takes a few weeks. It usually answers the question with enough confidence to price a deal.

What it means after close

The good news is that contract margin problems are usually fixable, and the fix is often worth more than new sales. Repricing at renewal, adding labor-indexed escalators to new agreements, defining billable scope in writing, and charging for travel outside a core radius can restore margin without losing much volume. McKinsey reported that disciplined price increases improved EBIT margins by 3 to 10 percent across ten industries in its aftermarket work.

The harder part is organizational. Contract pricing tends to sit with sales, contract cost with operations, and contract profitability with nobody. Assigning ownership of margin by contract, and reviewing it on a fixed cadence, is often the single change that turns a recurring revenue story into a recurring profit one.

Recurring revenue is a real asset. It is also a promise to deliver work at a fixed price into an uncertain cost future. Investors who underwrite the promise without testing the price are buying the visibility and inheriting the risk.

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