Suntech Power is officially in bankruptcy, and once again, one of the flagship companies in the industry is now deciding how to pay back as much as it can to creditors. If we look back, there are some very notable bankruptcies in solar. Energy Conversion Devices was once a hot technology, Q.Cells was once the largest solar manufacturer in the world, and of course we all remember Solyndra. But this doesn't mean the solar industry is in trouble. In fact, the opposite is true.
In a normal business cycle, bankruptcies are a healthy sign of a maturing industry. In the case of solar, companies with poor cost structures or weak technology will fall by the wayside, leaving their market share to healthier companies with better technology. Since the solar market has around 70 GW of supply and only about 30 GW of demand right now, companies will have to go bankrupt to bring the industry into balance.
More companies will fall
If there's more than double the capacity the world currently demands for solar modules, then more companies will fall. In China, the balance sheet is a huge differentiator, which is why I think Yingli Green Energy (NYSE:YGE) and LDK Solar (NASDAQOTH:LDKYQ) are next on the chopping block.
We may also see consolidation of some suppliers, making one larger, more powerful company. Now that China has let Suntech go bankrupt, I think it's more likely that companies see this as a warning sign and make preemptive moves to stay alive. In the end, fewer companies will be left in the solar industry, which is a good thing in a maturing industry.
Costs drive companies out
A lot of focus in solar over the past two years has been about cost differentiation. This is the first thing that will get a company in trouble, as Q.Cells, Solyndra, and Energy Conversion Devices found out. Canadian Solar (NASDAQ:CSIQ), now the third largest module maker in the world, said earlier this week that its manufacturing costs have fallen from $1.31 per watt in Q2 2011 to $0.51 per watt in Q2 2012. Companies that can't keep up with that rapid reduction in costs will find themselves with falling margins and growing losses.
That's why First Solar's (NASDAQ:FSLR) module business is in trouble right now. It makes modules that are less efficient than Chinese modules, such as Canadian Solar's, and now has higher costs. Costs aren't the only thing that will sink a company in solar, but they're still key.
Differentiation is the new key
What we're seeing with recent bankruptcies is that product differentiation has to be combined with low costs to survive. Suntech's cost structure wasn't terribly different from that of any other Chinese solar manufacturer, but they're also making the same product as these competitors. So when the company ran into a fraud at an investment it made, the company couldn't fall back on a superior product to keep customers from fleeing.
This is the challenge that faces companies such as Yingli and LDK, which have much worse balance sheets than their competitors. Installers are looking for stable companies with long-term warranties, and now that Suntech is gone, it will make them think twice about going with either of those companies, which make essentially the same product as JinkoSolar, for example, which has a better balance sheet.
Differentiation is the only thing that's kept SunPower (NASDAQ:SPWR) alive over the past two years. Installers value higher-efficiency products, and now that module costs are only about 20% of an installation's entire cost, a higher-efficiency module makes financial sense. Few companies are differentiated on the product side, but SunPower is, and that's why it's my top stock in solar.
Foolish bottom line
If you're a solar investor, like me, don't be freaked out by bankruptcies in the industry. Bankruptcies are a good sign, and the industry needs a few more big companies to fall before it will reach a normal state. What investors need to do is focus on the best companies with good fundamentals and differentiated products. Start with First Solar and SunPower on your quest for solar profits.
Fool contributor Travis Hoium manages an account that owns shares of SunPower. He also owns shares of and has options on SunPower. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.