Recurring Revenue

Recurring revenue is the portion of a company's revenue that is highly predictable, stable, and expected to continue in the future with a high degree of certainty. Think of it as the financial equivalent of a steady, reliable paycheck rather than a one-off bonus. This income isn't generated from a single transaction but from ongoing payments for a service or product. The classic examples are subscription models, like your monthly Netflix or Spotify fee, but they also include long-term maintenance contracts and other service agreements. For a value investing practitioner, a business built on recurring revenue is often seen as a golden ticket. Why? Because this predictability dramatically reduces the uncertainty in forecasting future earnings and cash flow, making it far easier to assess a company's long-term worth. Unlike a company that relies on one-time, “lumpy” sales (like building a bridge or selling a mansion), a business with strong recurring revenue has a stable foundation, allowing it to weather economic storms and invest for growth with confidence. It's a key ingredient in many of the world's most durable and profitable enterprises.

The appeal of recurring revenue goes far beyond simple predictability. It's the engine behind some of the most powerful business models, creating immense value for shareholders over time.

• Fortress-Like Stability: Predictable revenue streams act as a buffer during economic downturns. While customers might delay buying a new car, they are far less likely to cancel the critical software that runs their business or the insurance policy protecting their home. This stability makes the business less risky.
• Powerful Moat Creation: Many recurring revenue models create high switching costs. Once a business integrates its operations with a specific Software-as-a-Service (SaaS) platform, or a factory is built around a certain type of machinery with a service contract, the cost and hassle of switching to a competitor become enormous. This customer “stickiness” is a formidable competitive advantage, or moat.
• Profit-Multiplying Operating Leverage: The magic of many recurring revenue businesses, especially in software and media, is their incredible scalability. The cost to serve one more customer is often close to zero. Once Netflix has produced a show, it costs them virtually nothing extra for another million people to stream it. This means that as revenue grows, the marginal cost stays flat, and profit margins can expand dramatically.
• Pricing Power: A loyal, locked-in customer base is far more likely to accept gradual price increases over time. This ability to raise prices without losing business is a hallmark of a truly great company and a direct driver of long-term profit growth.

Not all recurring revenue is as obvious as a monthly bill. As an investor, you need to learn to spot it in its various forms, from legally binding contracts to deeply ingrained consumer habits.

This is the highest-quality recurring revenue, backed by a formal agreement.

• Subscriptions: The most famous model. This includes SaaS (e.g., Adobe, Microsoft), media (e.g., The New York Times, Spotify), and memberships (e.g., Amazon Prime, Costco).
• Maintenance & Support Contracts: Often seen in industrial and technology sectors. Companies like Otis Elevator or Schindler don't just sell an elevator; they sell a 20-year service contract with it. The same goes for jet engines, medical equipment, and complex enterprise software.

This revenue isn't guaranteed by a contract, but it's driven by powerful forces like habit, convenience, or a captive ecosystem.

• Consumables (The “Razor-and-Blades” Model): The initial product (the “razor”) is sold once, often at a low margin, to lock the customer into purchasing high-margin, proprietary consumables (the “blades”) for years to come. Classic examples include Keurig's coffee pods, Gillette's razor blades, and printer ink cartridges.
• Habitual Purchases: While not contractually recurring, revenue from products that are part of a daily or weekly routine can be incredibly reliable. Think of a morning coffee from Starbucks, a can of Coca-Cola, or a consumer's preferred brand of laundry detergent. This loyalty is a function of strong brand equity.

While recurring revenue is fantastic, it's crucial to look under the hood. Not all recurring streams are created equal. A “no-commitment, cancel-anytime” gym membership is far less valuable than a non-cancellable, three-year enterprise software contract embedded deep within a client's operations. When analyzing a company, focus on the quality of its recurring revenue and keep an eye on these critical metrics:

1. Customer Churn: Also known as the attrition rate, this is the percentage of customers who cancel their subscriptions over a given period. High churn is a red flag, as it means the company is constantly spending money to replace lost customers, like trying to fill a leaky bucket.
2. Customer Lifetime Value (CLV): This is the total net profit a company can expect to generate from an average single customer over the entire duration of their relationship. A high CLV indicates a loyal and profitable customer base.
3. Customer Acquisition Cost (CAC): This is the total cost of sales and marketing to sign up one new customer. The golden rule is that a healthy business must have a CLV that is significantly higher than its CAC (a common benchmark is CLV / CAC > 3). If it costs more to acquire a customer than you'll ever make from them, the business model is broken.