Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

We all know that being big just works. When you have more money, more people, more markets, you get more power and greater efficiencies and you win.

But what if it doesn't always work that way?

The big three residential solar companies -- SolarCity, Sunrun and Vivint Solar -- lead in a high-growth industry. Bloomberg New Energy Finance forecasts 2.6 gigawatts of solar panels to go up on U.S. homes this year, double the installations of two years ago. By 2020, it should be 3.6 GW a year.

Investors apparently aren't buying it.

Less Big
The big 3 solar companies are valued at $3.3 billion, less than half the level of a year ago
Source: Bloomberg

Granted, they haven't been helped by the flame-out of SunEdison, whose attempt to buy Vivint was just the final chapter in a familiar tale of corporate hubris. Investors, apt to paint in broad strokes, saw that implosion and re-evaluated the whole sector.

But there's another, more fundamental issue, that came out in different ways when the companies reported earnings earlier this month.

Costs, or at least certain types of cost, are proving to be stubborn. Here is how solar providers' overall costs to install panels has moved since the start of 2015.

The Right Direction
Overall, apart from SolarCity, unit costs have fallen over the past year or so
Source: The companies

Much of this decline has come at the installation level, which includes the cost of the panels, inverters and labor to get the whole thing mounted on your roof. And while there is some benefit to being a big player in that regard -- for example, you buy panels by the thousand rather than dozens -- the general deflation in solar equipment costs benefits all participants to some degree.

Shrunk Costs
The average combined cost of a solar module and inverter has dropped below $1 a watt and keeps falling
Source: Bloomberg New Energy Finance

More stubborn are the costs of acquiring customers and general overhead.

Sunblock
The cost of finding customers and running national organizations has proven to be stickier
Source: The companies

This has been a theme since at least last October when SolarCity scaled back growth plans to deal with bloated costs. It also came up again in the company's latest shareholder letter:

As our infrastructure had been built to handle ~1.25 GW of annual capacity, we will be reducing our cost structure to accommodate our current forecasted volume run rate and positioning ourselves to report one of the lowest Cost per Watt in our history in the fourth quarter of 2016.

Having expanded too fast, SolarCity announced on Wednesday that layoffs are imminent.

There are several reasons why reaping economies of scale in this business isn't as straightforward as you might think. One is the patchwork of regulations across states, and even counties or cities -- and its potential to change. The most glaring example of this is Nevada, where an unfavorable regulatory ruling at the end of 2015 forced the likes of SolarCity to just pull out from there.

All of this also limits the potential for standardizing approaches across the country in general. Chris Nelder, now with the Rocky Mountain Institute but at one time a solar-system installer, sums up the bureaucratic challenge this way:

Basically, there was a different tiny king with a different tiny kingdom every couple of miles.

Indeed, as anyone in Silicon Valley will tell you, scaling any business requiring a lot of labor is incredibly tough. And since the residential solar business is essentially a specialty finance and construction operation, it is labor intensive.

Besides cutting back, solar firms are expanding their value proposition to win more customers and defray the costs. Vivint, for example, is pushing a "smart home" service. SolarCity is, of course, about to be folded into Tesla in order to bail it out offer an end-to-end home energy and electric vehicle product. Sunrun, meanwhile, talked on its latest earnings call of "broader smarthome energy management services" -- as well as offering services to the local grid, based on aggregating the power of lots of solar-connected homes.

Besides the issue of costs, this expansion of services reflects another threat: commodification. The irony of the growth of SolarCity and its peers is that they have helped bring down the costs of solar equipment and make solar more mainstream -- and thereby have lowered the barriers to competition.

An increasing share of residential solar installations now come without long-term leases; instead, homeowners are snaring cheap loans to just buy systems outright. That's why SolarCity revamped its loan offering earlier this year.

But when solar power just becomes a home improvement project backed with a loan, any local or regional installer can partner with a bank or other lender to do the job. Sure, they probably pay a bit more per watt for the equipment, but they also aren't carrying a national sales force, warehouses, and corporate office expenses.

GTM Research estimates that the aggregate market share of the big three U.S. providers has been falling since a peak in the third quarter of 2014 and is now under 50 percent. The next seven largest players, meanwhile, have been gaining.

There is likely to be demand for leasing for years to come -- at least until federal tax credits likely run out or step down at the start of the next decade -- but the market is shifting against it.

For the big three, that headwind to growth and pressure on margins will keep growing -- which is a big problem because breakneck growth has been the key to raising capital. And when that falters, things turn sour pretty quickly, as those falling stock prices and SolarCity's dive beneath Tesla's umbrella show. They will, of course, try to leverage their brands and national reach into strengths, offering more services to differentiate themselves from an army of local and regional competitors. And we're about to find out if that works.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Sunrun uses a model that mixes doing its own installations for some homes and using local contractors. It says the cost of "Sunrun built" systems is lower, with an installation cost of $2.27 a watt in the second quarter, which would imply an all-in cost of $3.14 a watt. This would still be higher than for either SolarCity or Vivint.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Timothy L. O'Brien at tobrien46@bloomberg.net