Yesterday, the rumors of solar leasing company Sunrun integrating vertically came true. The company acquired REC Solar's residential solar business, AEE Solar, and SnapNRack. AEE Solar is a wholesaler for solar related products, and SnapNRack makes racking for solar installations.

This creates a more formidable competitor to SolarCity (NASDAQ:SCTY) and changes the landscape of residential solar for a number of companies. Here's what you should take away from this deal.

The race to integrate is on
Until now, SolarCity and Vivent have been the only two residential solar installers who were vertically integrated, owning origination, installation, and financing. The Sunrun acquisition brings a leading financing firm and fourth-largest installer REC Solar together to make three companies who have vertically integrated.

Scty Installers

SolarCity workers installing a residential solar system. Source: SolarCity.

It's become apparent in recent quarters that operational scale is increasingly important for residential solar installers, and the vertically integrated model has been stealing market share from specialist companies. Being able to spread operating costs over a larger swath of projects and marketing to a broader base has proven its advantage, and this is the business plan of the future.

This leaves Clean Power Finance and SunPower (NASDAQ:SPWR) as the two major companies with leasing arms that rely on third-party dealers to install and originate projects, but that may change. SunPower could acquire downstream installers, like it did in utility and commercial solar, and Clean Power Finance could look for alternatives as well. 

Spwr Residential Close Up

A residential solar system from SunPower. The company is going to have to decide if this is a business it wants to put money in to compete. Source: SunPower.

What happens now?
Considering the success SolarCity has had gaining share over the past year, it's not surprising other companies are following their strategy. Operational and brand scale are needed to compete in the solar market today, and that's what SolarCity, Vivent, and Sunrun are building.

I think the next question is whether or not SunPower follows suit. It's built a decent sized residential solar business by partnering with small dealers, but it may be squeezed out by larger rivals in the residential business. It could choose to acquire partners to expand this business, stay the course, or choose to focus on downstream markets like utility and commercial solar, where it currently holds a large share. Given the new shape of the industry, I think an acquisition or two may be in play before long. 

The other thing to consider is that competition will now heat up for residential solar companies. If we have three or four large installers with lots of overhead, they'll need to sell quickly to keep installation crews busy. That increases bargaining power for savvy buyers who can get companies to bid against each other.

Foolish bottom line
We're still early in the growth of residential solar, but we're already seeing that SolarCity's vertically integrated model is winning, and competitors are following it. Next we'll have to see if that means margins move lower as competition heats up. 

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Travis Hoium manages an account that owns shares of SunPower and personally owns shares and has the following options: long January 2015 $5 calls on SunPower, long January 2015 $7 calls on SunPower, long January 2015 $15 calls on SunPower, long January 2015 $25 calls on SunPower, and long January 2015 $40 calls on SunPower. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days.

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