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I've been covering the solar industry for The Motley Fool since 2010, and over just three years the industry has gone through an incredible transformation. Solar once required massive subsidies to be competitive, but today there are utility-scale projects being built without subsidies and leases are being offered to homeowners with $0 down and lower energy bills to boot.

There have also been major changes in who holds the best strategic position in solar. First Solar (NASDAQ: FSLR  ) was once the undisputed king of solar, but it's now virtually shut out of the distributed solar market because its panels aren't efficient enough. SolarCity (NASDAQ: SCTY  ) is a relative newcomer to the industry, but it's now once of the most valuable companies in solar.

So, who is in the best strategic position to win in the future? Let's explore that question.

What won yesterday won't win tomorrow
In any business, you try to differentiate yourself from competitors to gain a competitive advantage. In solar, the differentiators have changed in the last few years, and I think they will do so again before we reach a long-term steady state.

In 2010, cost was by far the biggest differentiator among solar module manufacturers. First Solar had a wide lead and generated margins that competitors couldn't come close to touching. But polysilicon solar costs dropped rapidly over the past three years, and today costs are hardly the only thing differentiating panels. In fact, SunPower (NASDAQ: SPWR  ) , which has some of the highest costs per watt in the industry, has among the industry's highest margins. Quality and efficiency have become more important and replaced cost as a major differentiator.

FSLR Gross Profit Margin (Quarterly) Chart

FSLR Gross Profit Margin (Quarterly) data by YCharts

In 2013, the emerging differentiator among solar companies is business model innovation. SolarCity has used a leasing model to grow installations and opened up new financing options like securitization of its lease payments. For SunPower, First Solar, and Canadian Solar (NASDAQ: CSIQ  ) , captive demand from utility-scale projects has helped them outperform manufacturers which didn't have the same capabilities. Right now, downstream capabilities are the biggest differentiator in solar, but will that trend pass like the cost advantage did for First Solar?

While offerings like leases have been a big winner this year, I don't think they will be a long-term differentiator in solar. Just look at how fast they've expanded in the last few years. Companies like SunPower, SolarCity, Sunrun, and Clean Power Finance are all offering leases, and, as investors get comfortable with the model, the options will grow. All you need is installation partners, and there are hundreds of those around the country.

The analogy I make to solar leasing is auto leasing. When auto leases were introduced they may have been a competitive advantage for early adopters, but today everyone offers them. What would keep Home Depot from offering solar installations and financing through a major bank in the future instead of SolarCity? Will Lowes, homebuilders, Best Buy, or whoever is selling solar in a decade need leasing companies of today, or will a bank do the job? 

Then there's the challenge of predicting the best financing model of the future. If solar costs keep falling, why wouldn't a homeowner get a solar loan for $10,000 to buy a system instead of leasing? The point is that in the future I don't think 90% of distributed solar installations will be done with a lease, so the leaders today will at least need to adapt. 

In my opinion, the solar lease itself isn't a differentiator long-term the way it is today. The installation and financing of solar will only get more competitive, and companies like SolarCity won't be able to generate $2 or more in value per watt installed once consumers become more educated about a system's costs and when larger competitors emerge. Don't get me wrong, these are important products for companies to offer just like leases are to automakers -- I just don't think they'll define winners and losers long-term because they're too easy for others to replicate.

What's unknown is how service plays a role in the future of solar. SolarCity, SunPower, Sunrun, and others view service as a key part of their lease offering, but that's not consistent with other industries. You don't lease shingles on your roof, your air conditioner, or appliances in your kitchen. But if something goes wrong you can just call a repair company. Will an analogous service industry evolve in solar instead of being rolled into a lease? I think it will. 

The differentiator of the future
When I look at the future of solar, I think the product itself will become more and more important. The panels, monitoring equipment, and storage options will be what sells a system, not the fact that you can get a lease or a loan for a system.

Continuing the auto analogy, now that leases, loans, and cash sales are offered by almost every dealer, the financing isn't the biggest driver of a sale, the product is. That's why I see products like SolarCity's DemandLogic or SunPower's X-Series panels becoming differentiating products in the future.

I also think the days of viewing panels strictly as a commodity are coming to a close. As costs have fallen, efficiency, form factor, and energy system offerings will become more important. We've already seen this trend begin to play out. SunPower is sold out of panels for the next 18 months and is building another 350 MW of capacity, the only major player to add capacity this year. If efficiency didn't matter and solar panels were commodities, we would see SunPower struggle -- but instead Suntech Power went out of business, LDK Solar is struggling to survive, and Chinese manufacturers are generating the lowest margins in the industry.

Foolish bottom line
The solar industry is still evolving rapidly, and investors need to stay nimble as a result. What's important to keep in mind is that what has led the industry in the past may not be what wins in the future. I think product differentiation will continue to be more important in the future as costs fall across the industry.

Solar investors should know by now that it's far easier to cut costs than it is to improve technology, and that's why I'll side with the technology leaders every day of the week.

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Read/Post Comments (3) | Recommend This Article (4)

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  • Report this Comment On December 26, 2013, at 4:05 PM, 8James38 wrote:

    The author of this article has missed an important factor. Present grid characteristics can absorb variable power only up to a specific limit - which may go as high as 20%, but is usually lower.

    The following are points to consider:

    After this limit is reached, more variable input destabilizes the grid. Germany is having major problems with this, and was dumping excess variable power into the European grid - to the point that Poland began installing switching devices to prevent excess power from German Solar maximum output from destabilizing the Polish grid.

    In Germany, electric rates have risen sharply, and major industrial equipment has been damaged by unstable power. Some large companies have been forced to install their own auxiliary generators to protect themselves from unstable grid power.

    Building sufficient backup capacity to keep the grid stable is not cost effective, since even the most economical generating facility, the CCGT (Combined

    Cycle Gas Turbine) adds so much cost to the overall project, which must usually include major extensions to the grid, which will be in use only part of the time, that running the "backup" 24/7 is significantly cheaper than installing and using the Solar or Wind sources.

    Since we must quit using fossil carbon, which is the major source for additional atmospheric CO2 and is therefore the major cause of Climate Change, all options must be considered based on their total carbon footprint.

    For example, replacing Coal with Natural Gas has proven doubtful, since leaks of Methane from production to use have exceeded the savings in CO2 gained by replacing Coal.

    There is one source for 24/7 grid level power that has a very small carbon footprint, and that is the LFTR (Liquid Fluoride Thorium Reactor) - a completely fail-safe Nuclear Reactor design that will produce power cheaper than coal - about equal to the CCGT. Since it uses no water in the reactor and the fuel is liquid so the reactor runs at nearly atmospheric pressure, explosion is impossible. In the unlikely event of a fuel spill, the Molten Salt fuel simply hardens on the floor. As one researcher has said, a fuel spill from a LFTR is measured in square meters, not square kilometers. No widespread dispersal of Radioactivity is possible under any circumstance, and these reactors cannot be used for weapons proliferation.

    No matter how efficient wind/solar become, and even if the grid compatibility problems are solved, wind and solar have problems. To expand them to grid level would require ecologically damaging huge areas of land, tremendously expensive grid extensions, or both. The construction of such massive solar and wind installations would also have a very large carbon footprint. Grid level storage of energy is still beyond our capacity.

    For these reasons, the far more economical LFTR and other adaptions of the MSR (Molten Salt Reactor) design will be the power source choice of the future, especially since these reactors can be designed to use present stockpiles of Nuclear "Waste" as fuel, giving power for 200 years with little mining of additional material needed.

    Read "Super Fuel - Thorium, the Green Energy Source for the Future" by Richard Martin

    "Thorium - Energy Cheaper Than Coal" by Robert Hargraves

    And See:

    timothymaloney dot net/thorium-energy pdf

    for an excellent introduction to Thorium and its power potential.

    Also see this presentation by Kirk Sorenson of Flibe Energy: A fascinating lecture that is both enjoyable and clear:

    Thorium: An energy solution - THORIUM REMIX 2011 - YouTube

  • Report this Comment On December 27, 2013, at 10:19 AM, GreenWaveEM wrote:

    Good article, thanks; I agree with your observations and find them thought-provoking. I have followed solar for about seven years, and am encouraged with what has been happening for the last couple of years.

    As for 8James38's comment, it is quite interesting, but it clearly advocates another solution for energy supply perhaps as a vested interest of the commenter. The comment dismisses solar too quickly, but I am interested in the issues he/she mentions. Are there ways to avoid the 20% limit quoted? And since we are only at about 1% with PV electricity, how much will the 20% limit growth for the next several years? As far as the thorium reactor, I have heard of it before, but if it is so good, why is there no talk of building one, at least in the USA? I may research some of these topics online, later.

  • Report this Comment On December 27, 2013, at 5:57 PM, 8James38 wrote:

    GreenWave, please do research the topic.

    I have no vested interest but for my concern for the survival of the biosphere - upon which we and the rest of life on the planet depend.

    There is growing interest and research being done on the MSR/LFTR globally.

    The US is seriously dropping the ball on this one. Obama and his advisers have not woken up to the importance of this reactor design - which is ironic, since it was developed, built, and tested here.

    Motley Fool and all large investors who are interested in making both serious profits and helping the world survive need to investigate this project.

    These reactors can be built in standard modules and shipped. They can be used in ocean vessels.

    They are extremely versatile and safe.

    This is indeed a major coming technology.

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