The Economics of Residential Solar Installation

Residential solar dealer profit margins look at lot like those for conventional electrical, plumbing, and HVAC contractors.  What should dealers do?

Over the past year, Woodlawn Associates has worked with nearly 20 residential solar dealer-installers on projects to optimize the costs of customer acquisition and installation. These projects were quite tactical, but it is worth considering some of the more strategic findings and their implications.

Typical dealer profit margins are low

The average dealer in our most recent project had revenue of $4.60 per Watt DC ($5.54 per Watt AC) over the past 12 months.  The typical dealer had a cost to install of $3.71 per Watt—80% of revenue.  Earlier this year, we found dealers spend an average of 17% of revenue to acquire customers.  This leaves only 3% for general and administrative expenses and profit, suggesting typical installer profits are slim.  Consider that over the past year Real Goods Solar, the only publically traded firm in the residential installation industry, had G&A  expenses alone that averaged 6% of revenue.  (Real Goods also lost money during this period.)

Electrical, plumbing, and HVAC contractors typically have operating margins of one to four percent of revenue.  The data suggests  the average solar dealer is not doing any better than these more traditional contractors.  However, our work suggests several ways firms can set themselves apart.

A differentiated customer acquisition strategy can help

The purchase of grid-tied solar is never urgent.  There is no particular reason homeowners have to buy now and not next month or next year.  The lights will stay on in any event, and we have other things to do!  On the other hand, if your roof is leaking or it is 100 degrees in your house, you are unlikely to put off calling for a year.

This is why the cost of customer acquisition is so high in solar.  Customers have to be found and sold to.  They have to be convinced to act now instead of later.  It’s a complicated sale and often requires making a 20 year commitment.  Fundamentally, then, dealers with a differentiated, cost effective way of reaching customers and getting them to act will be able to earn returns in excess of the industry average.

For example, dealers like Vivint and Galkos have done very well with door-to-door canvassing.  However, it seems like virtually every dealer is canvassing now, albeit often not well.  It remains to be seen whether firms can develop a sustainable advantage through marketing execution.

Another question is whether firms can leverage an existing customer base to get a proprietary advantage.  For example, could telecom firms like DirecTV or Dish Network also sell solar power?  Could competitive energy suppliers also sell solar, or solar companies also sell retail energy?  Could Vivint Solar or ADT leverage their alarm monitoring customer bases?

Finance another new profit opportunity

The importance of financing is another reason solar is different than conventional contracting, and finance has created two profit opportunities for solar dealers.  Initially, the few firms with access to a lease or PPA program may have been able to charge more than firms only able to sell cash systems.  However, the price of utility power puts a limit on this type of activity and there are enough third-party finance providers today to ensure most dealers have competition that also offers financing.

Given the complexities of structuring lease funds and dealing with tax equity, however, there are still relatively few firms that can offer competitive financing—far fewer than the number of dealers.  Dealers that can do this well themselves will make money on it, but if financing drives the majority of profit potential for these firms, over time I’d expect them to focus more on financing and to shed the lower-margin, harder-to-scale installation parts of the business.

One caveat to this is that there is considerable operational friction between dealers and third-party finance providers.  Dealers regularly complain about the paperwork back-and-forth and unpredictability of timing of financiers’ responses.  There is even extra work, as dealers make a system design that then must be reviewed and approved by their finance provider.  Dealers with their own financing capability may avoid this friction.

Scale helps improve core hardware cost

According to our research, large dealers typically pay $0.19 / Watt less for standard crystalline silicon modules and inverters than small dealers.  Assuming a net cost benefit of $0.10 per Watt after the cost of internal distribution, large dealers should have a two percentage point advantage in operating margins simply from this purchasing effect.

Beyond the obvious fact that as dealers grow their purchasing costs improve, this also suggests that dealers that have also have significant commercial, utility, or distribution operations should have a cost advantage over other companies with similarly-sized residential businesses.

To date, scale has had little impact on non-hardware installation cost

One of the most surprising things we’ve found in our work is that large dealers have essentially the same installation costs as small dealers when you exclude modules and inverters—they don’t seem to get significant operational efficiencies from their scale.

We’ve found three reasons for this.  Large dealers do no better than small ones at permitting and interconnect—probably because these areas are so balkanized they don’t benefit from centralization.  Second, large dealers spend more on project management and certain other non-core installation labor expenses, probably reflecting the challenge of managing multiple remote branches.  Finally, large dealers spend more on vehicles, freight, and tools.  This may reflect the diffusion of responsibility across managers in large organizations.  In a small dealer the owners sign every check.

What this tells me is that I’d rather see a dealer with double the market share in a particular region than one that has the same scale but that is spread out geographically.  Such a dealer would avoid the overhead of running far-flung operations, allow the owners to keep a close eye on expenses, and perhaps gain some efficiency in dealing with the local permitting and utility authorities.

The counterintuitive conclusion that scale doesn’t yield operational efficiencies, though, also suggests that this may be an area where large dealers have further opportunities to improve.  They should be able to benchmark across branches, standardize system designs, and reduce BOS hardware and labor expenses relative to small dealers.

Consumer price decreases will slow unless dealers get more efficient

Finally, it’s been obvious for some time that given the plummeting price of PV modules, they would soon cease to be the most important driver of installed cost.  That time has arrived.  In our work we’ve found labor to be the largest single driver of installation cost, accounting for 30% of the total cost at $1.12 per Watt.  (Our labor cost includes all the labor required to do the installation, including site survey, design, permitting, and project management, in addition to the labor cost incurred at the home.)

With many installers now paying well under $1.00 per Watt for modules, the price of solar will not continue to fall as it has historically unless dealers find ways to reduce non-hardware costs faster.  With the expiration of the Investment Tax Credit on the horizon, the industry needs to redouble its efforts to reduce these costs.