Image source: SolarCity.

There's growing evidence that loans for residential solar installations will eventually be the main source of financing, changing the lease dominated industry we see today. GTM Research predicts that leases will fall from 72.3% of the market in 2014 to just 46% in 2020 as falling costs and more loan offerings converge to make buying solar more affordable. 

SolarCity (SCTY.DL) could see this transition coming and in late 2014 it introduced a loan product called MyPower. Like a solar lease, it tied the customer's payment to a solar system's energy production, but unlike a lease, the homeowner owned the system once the loan was paid off. But last week the company shut down MyPower after the product failed to take off. This is curious in an industry where loans are increasingly important and the reasons it failed are telling for SolarCity.

The failure of MyPower
I think SolarCity's failure of MyPower was driven by two factors. The first is that it didn't price systems sold through MyPower competitively. Pick My Solar did some research on this and found that systems were priced at $5.10 per watt, well above what competitive installers would charge. When you consider that SolarCity's cost per watt in the fourth quarter was $2.71, that implies the company was charging enough to generate a 47% gross margin on sales. That's crazy in a highly competitive industry.

The second fault is that MyPower was incredibly complex. Loans were set up as 30-year products, came with annual escalators that increased the cost of energy each year, and came with early balloon payments. Balloon payments were based on the federal tax credit, but SolarCity found that many of its customers didn't have income high enough to qualify for the tax credit.  

Add in the fact that customers weren't able to pick their own equipment and what's the point of buying your solar system from SolarCity?

Where SolarCity has backed itself into a corner
The problem for SolarCity is that it's built its business on financing solar systems itself. Leases are owned by SolarCity and can be chopped up to different financing parties with SolarCity keeping the leftover value. This leads to very high margins -- assuming leases and loans perform as contracted -- and generates a lot of value for SolarCity shareholders. That's exactly what it tried to do with loans, too.

On the financing side, SolarCity's problem with loans is that it simply can't run a loan business more efficiently than a bank -- because that's what banks do. So, it doesn't want to compete 1-on-1 with banks for loan products, hence the more complex model.

On the sales side, SolarCity doesn't want to get into the competitive solar installation business, which is much lower margin than installing and financing systems. Think about this from a customer's perspective, why would you buy a 5 kW solar system from SolarCity for $25,000 when you could buy the same 5 kW system from an independent installer for $18,000?  

Is the industry changing around SolarCity?
SolarCity's entire value proposition to investors has been that it can build systems for cheaper than anyone else and can finance them for less as well. That could lead to a lot of value because customers are signing 20-year contracts to buy energy from the company.

But if the basic assumption that customers would rather buy energy rather than buying the solar system itself is wrong, that's a problem for the model. And if someone else -- like a bank -- can finance solar systems for less than SolarCity, that's another problem.

I think that residential solar will eventually be a far less complex proposition than it is today. Customers will put in an online request for equipment options and prices, they'll pick what they want, and then finance it in the way that makes sense to them. With costs being as low as they are today, we're not far from lots of customers even being able to afford to write a check for a solar system.

These changes are happening around SolarCity and the failure of MyPower shows that the company's model that worked in the past may not work in the future. Customer needs are changing and SolarCity is going to have to change with them. SolarCity has promised another loan product is on the way, so stay tuned because it could be the company's most important new product in years.