The Services Premium: Aftermarket and MRO vs. OEM Economics

Introduction

The distinction between aftermarket/services revenue and original equipment (OEM) revenue is one of the most important analytical frameworks in industrials banking, and it is also one of the primary value-creation levers that PE sponsors use to transform their portfolio companies. Aftermarket revenue (spare parts, maintenance, repair, overhaul, and related services) typically generates 2-3x higher EBITDA margins than new equipment sales because the economics are fundamentally different: customers are locked into the installed equipment platform, replacement parts have limited competitive alternatives, and maintenance cannot be deferred without risking equipment failure.

For PE sponsors, increasing the services revenue share of an industrial portfolio company from 25% to 45% over a hold period simultaneously improves margins (higher-margin revenue replaces lower-margin revenue), reduces cyclicality (services revenue is more stable than equipment sales), and drives valuation multiple expansion (the market assigns higher multiples to recurring services revenue than to transactional equipment revenue). This "services transformation" is one of the most reliable post-acquisition value-creation strategies in the PE industrials playbook.

Aftermarket Revenue (Industrials Context)

Revenue generated from spare parts, maintenance, repair, overhaul, and related services for equipment already installed and operating in the field. Aftermarket revenue is distinguished from OEM revenue (sales of new equipment) by its recurring nature (equipment must be maintained continuously), its captive customer base (the customer is locked into the installed equipment platform), and its premium margins (spare parts carry 50-70% gross margins vs. 25-35% for new equipment). The aftermarket revenue percentage is the single most important determinant of a capital goods company's valuation multiple.

The margin premium comes from three structural sources.

Captive installed base. Once a customer installs a piece of equipment, they need compatible spare parts and qualified service for the life of that equipment (typically 10-30 years). The OEM and authorized service providers have a built-in advantage because they designed the equipment, hold the technical data, and manufacture the original parts. Customers face significant switching costs: third-party parts may not fit correctly, may void warranties, or may not meet quality specifications. This captive dynamic supports 50-70% gross margins on spare parts versus 25-35% on new equipment.

Non-discretionary demand. Equipment maintenance is not optional. A chemical plant running 24/7 cannot defer pump replacement. An airline cannot skip engine overhauls. A factory cannot ignore hydraulic system leaks. This non-discretionary nature means aftermarket revenue persists through economic downturns when new equipment purchases are deferred. GE Aerospace derives approximately 70% of revenue from aftermarket services, which sustained the company through the pandemic-driven collapse in new engine deliveries.

Service-level agreements and contracted maintenance. Increasingly, industrial companies sell maintenance services under multi-year contracts (annual maintenance agreements, power-by-the-hour contracts, guaranteed uptime programs) that convert episodic repair events into predictable recurring revenue streams. Rolls-Royce's TotalCare model, where airlines pay per engine flight hour rather than for individual overhaul events, is the most advanced example: it transformed Rolls-Royce from a volatile engine OEM into a predictable services business and was central to its margin recovery from 1% to 17% operating margin. These contracts improve revenue visibility, deepen customer relationships, and create barriers to competitive substitution.

PE sponsors systematically increase the aftermarket revenue share of their industrial portfolio companies through several coordinated initiatives.

Investing in service infrastructure. Many small industrial companies underinvest in service capabilities because they focus on manufacturing and view service as an afterthought. PE sponsors invest in service personnel (field technicians, applications engineers), service facilities (repair depots, parts warehouses), and service technology (remote monitoring systems, predictive maintenance software) that enable the company to capture more of the aftermarket revenue from its installed base.

Building a parts catalog. Some manufacturers do not actively sell spare parts because they lack a parts catalog, inventory management system, or e-commerce platform. PE sponsors invest in building comprehensive parts catalogs (documenting every replaceable component in the company's equipment), establishing parts inventory with appropriate stocking levels, and creating online ordering systems that make it easy for customers to purchase directly from the OEM rather than seeking third-party alternatives.

Launching contracted maintenance programs. Converting customers from "call when it breaks" to "annual maintenance agreement" creates recurring revenue, improves asset uptime for the customer, and deepens the relationship. These contracts typically include scheduled preventive maintenance visits, priority emergency response, and discounted parts pricing, creating a value proposition that is attractive to customers while locking them into the OEM's service ecosystem.

Implementing IoT and remote monitoring. Equipping installed equipment with sensors and connectivity enables real-time performance monitoring, predictive maintenance alerts, and data-driven service scheduling. This technology layer creates a recurring revenue stream (monthly monitoring fees or subscription-based analytics) and positions the OEM as the preferred service provider because it has the data advantage (knowing exactly when each component needs attention before the customer does).

The services premium directly affects how industrials bankers position sell-side processes, evaluate acquisition targets, and advise PE sponsors.

Sell-side CIM framing. The CIM should prominently feature the aftermarket revenue percentage, aftermarket margin profile, installed base analysis (how many units in service, average age, replacement cycle), and any trend showing aftermarket share increasing over time. The narrative should explicitly connect the aftermarket percentage to the appropriate valuation tier.

Buy-side screening. When sourcing acquisition targets for PE sponsors, bankers should prioritize companies with large installed bases and under-monetized aftermarket potential. A company with 50,000 units in the field but only 15% aftermarket revenue share has significant untapped service potential that a PE sponsor can capture through the transformation playbook described above.