Commercial and industrial solar companies may be overlooking an obvious route to higher profits, writes Danin Kahn.
Following the voluntary administration of Todae Solar in July 2020, I believe its important for the C&I solar sector to understand the real risks and challenges as well as the opportunities in the market. The scale of a C&I solar company plays a critical role in its ability to succeed and the strategy it deploys. Before we focus on scale it’s worth pointing out some of the other challenges the industry faces, both external and internal.
External market factors buffeting the industry include declining electricity tariffs, lower LGC prices, uptake of offsite PPAs and the current economic downturn.
The internal factors impacting the industry are declining margins due to pricing pressure, unfavourable contracting terms, reduced ability to differentiate (commoditisation), diminishing importance placed on track record, scarcity of repeat business, insufficient provisioning, uncommercial warranties and low importance placed on O&M and service.
There is not a lot the industry can do about the external factors, but the industry could be more collaborative and forward thinking regarding some of the internal factors. Examples may be the development of a standard or benchmark to manage onerous customer requests and contracting terms, or ensuring that the industry works towards a minimum provisioning requirement for defect liabilities and performance guarantees.
This would benefit companies that are appropriately provisioning by ensuring they don’t become uncompetitive and benefit companies that might be under-provisioning by ensuring they have funds allocated to manage long-term requirements for projects they win.
Regardless of market challenges, the industry faces a particular challenge of how and when to scale – and the implications of this are often overlooked by C&I solar companies.
Although there might be many factors for determining success, let’s focus on profitability as the KPI for success in this case. In order to achieve desired levels of profitability, companies need to ensure they maintain operating costs (mostly wages) at a certain percentage of revenue to allow some of the gross profit generated to convert to net profit.
As can be seen from the chart, companies with very few employees have a lower cost per employee but also lower revenue per employee. As companies grow to about 20-30 employees the revenue per employee increases as the company grows and takes on more work, but the average cost per employee is still relatively low. This is because most of the employees are acutely focused on either selling or delivering revenue – without many support services (and likely without robust systems and processes).
Once companies scale to 50-90 employees we see the revenue per employee decline as well as the average cost per employee increase. This is a compounding negative that is caused by the company’s inability to grow revenue without more support services and senior people that either don’t directly bring in sales or don’t directly deliver revenue, such as IT, HR, marketing, finance, process improvement, safety, etc.
The sweet spot
Once this layer of management and resource is in place it then allows the business to scale efficiently, with most new employees bringing in sales or revenue. As a team grows above 80, average employee costs start to decrease and revenue per employee increases, creating a compounding positive or economies of scale.
The real profitability sweet spots are for emerging companies of 15-30 staff or established companies with more than 100 staff.
Conducting a high-level analysis of key industry players, we can determine that most companies are between 20 and 50 employees, likely resulting in some players still having to work through some of the scale challenges.
If this all makes sense, it begs the question as to why the Australian C&I PV industry is yet to really consolidate to take advantage of the benefits of these economies of scale.
Danin Kahn is an energy consultant and was the founder and CEO of Todae Solar.