Managing Director & Senior Partner
Related Expertise: Power and Utilities
As renewable energy takes off and battery storage moves closer to the point of consumption, power grids around the world are becoming more decentralized. These distributed energy resources (DER) are transforming energy markets, but questions remain about what this new industry will look like and how DER will be managed. Industry participants will need to adapt their business models to position themselves for success in this evolving market.
From 2010 through 2015, the global market for DER grew at double-digit rates, reaching $130 billion. That growth will continue through at least 2020 as equipment costs continue to decline. (See Exhibit 1.) Technology has advanced rapidly in areas such as photovoltaic (PV) solar, combined heat and power systems, and energy efficiency products such as smart-home technology and heat pumps. Advances in battery storage, energy management systems (EMS), and other integrated solutions will fuel further growth in the DER market.
Moreover, concerns about climate change and reducing carbon emissions are affecting policy decisions and public perception around the world, creating a favorable regulatory market for DER in most countries. Government support will remain important to attracting investment in DER given the lengthy payback time on many projects. However, some DER technologies, such as rooftop PV systems and heat pumps, are already attractive to customers without government subsidies, and other DER technologies are likely to follow.
Companies looking for opportunities in this promising young industry must recognize the demands of its two segments, B2C and B2B. And they must understand how the industry is evolving—where it is consolidating and where it remains fragmented—as they develop business models to suit their customers’ needs.
The B2C segment of the DER market includes residential customers as well as small and midsize enterprises, while the B2B segment comprises commercial and industrial companies. (See Exhibit 2.) Although the needs of B2C and B2B customers differ as a result of location and operational demands, customers in both segments seek to decrease energy costs, and many also want to reduce their carbon footprints.
B2C systems are generally less complicated and involve mostly standardized equipment and components. B2B systems, on the other hand, are usually more customized, which adds complexity to their design, installation, operation, and management. Both segments represent sizable markets that are poised for significant growth.
To address the different needs of these two segments, the DER industry has developed different business models defined by specific customer groups. Some of these models focus on offering specialized skills and products; others generate value by providing more affordable standardized equipment and services. While the characteristics of these models vary greatly, they fall into two main groups: those that focus on local strengths, such as customer access, and those that use scale to gain a competitive advantage in such areas as procurement.
DER market participants in both groups find themselves at a crossroads: Will they remain fragmented and localized, or will they consolidate? A young industry with transformative technology, such as DER, typically moves through three stages:
The DER industry is currently in the second stage—many companies have expanded beyond their niches and now generate between $100 million and $1 billion in annual revenue—but it is on the cusp of consolidation. For example, small companies, particularly in Europe, the US, and China, still dominate the energy service market, in which companies design, build, and optimize generating plants, energy-saving systems, and related projects. The largest of these, such as Ameresco and Getec Energie, have achieved several hundred million dollars of annual revenue. However, it’s unclear if they will bolster their growth through consolidation or if the industry will remain fragmented among a larger number of midsize companies and never move into the third stage.
While the market for manufacturing solar panels, batteries, and other DER equipment is relatively stable and globalized, the installation and service sector remains highly fragmented. Some local providers are gaining ground on national competitors in the US. (See the sidebar, “Local Versus National Rooftop Solar Installers.”) According to the stages of development, this industry could either remain as is, with many local companies serving different segments of the local customer base, or it could consolidate, with a limited number of larger companies that expand their business to serve a broader range of customers nationally. Both scenarios require inexpensive equipment and direct access to customers, as well as customized business models, such as power purchase agreements, that cater to each customer’s needs. (See Exhibit 3.)
Rooftop photovoltaic (PV) solar is arguably the most mature and successful DER technology, and it provides the best example of the differences in the global DER markets and the dynamics between a local and a national business. The three countries with the most mature rooftop PV markets—Germany, Australia, and the US—are developed Western economies with similar customer behaviors, labor markets, and costs of doing business. But the rooftop PV market has played out in drastically different ways in these countries. In Germany and Australia, local providers dominate the markets. In the US, although the market remains fragmented, national participants such as Tesla’s SolarCity division, Vivint Solar, and Sunrun define the competitive landscape.
What has driven the national market in the US? One key factor may be the reliance on equipment leasing and the importance of the investment tax credit. Leasing is less common in Germany and Australia, where most systems are cash sales, and subsidies are not structured as tax credits, as they are in the US.
However, national installers in the US have much higher costs compared with local installers in Germany and Australia. This could undermine the national model for rooftop PV installations in the US, resulting in more local competition. For example, local installers typically have much lower customer acquisition costs than national installers. These and other costs could refocus the US market on local growth. Recently, growing numbers of customers in the US have been moving away from the lease model and are either buying or financing the purchase of solar panels. In addition, some local installers are now pricing installations below the price of their national competitors. This may explain why small installers, like their counterparts in Germany and Australia, have been taking market share from national competitors during the past couple of quarters.
However, most US customers still favor lease options and power purchase agreements that national installers, because of their greater access to capital, are better positioned to offer. National companies are also better positioned to offer innovations such as storage integration. Nonetheless, in the near term, national installers must continue to lower costs to maintain market share amid rising competition from local installers.
A Fragmented Industry
In one scenario, the DER industry would remain fragmented. In the B2C segment, where energy management systems are less complex than those in B2B, local suppliers could easily install standardized systems and equipment tailored to the mass market by manufacturers. Customers would use DER primarily to operate independently of the main power grid or to improve efficiency and reduce costs by incorporating DER into their energy use. Local installers would be the main beneficiary of this scenario, creating value from the installation of each standardized component or system kit. This would result in lower margins, giving small installers an edge over large competitors with higher overhead.
Under this scenario, success would depend on understanding local customers’ needs, another advantage for small installers. This fragmented market would be much like the one that exists for services such as plumbing, heating and air-conditioning installation, and electrical services, with local craftspeople serving local customers.
On the other hand, this scenario could also offer opportunities for large installers. These companies, which could provide greater expertise, such as digital configuration and consulting services, would handle the more complex B2B market. They could charge a higher price for their services, but they would need to remain agile and lean to compete in the local market. The advanced services they offer could include local design, execution, operations, and optimization of DER systems—which they could offer without significantly increasing overhead.
A Move to Consolidate
In this scenario, the DER industry would continue its evolution to the next stage of development, dominated by large companies with more sophisticated solutions that benefit from integration. Customers would look for systems that are highly integrated, such as PV systems connected to battery storage and controlled with advanced EMS. They also would demand enhanced grid services from transmission and distribution companies. The dominant providers in this market would be large companies with strong digital, IT, engineering, and design capabilities, although they would still use local partners and subcontractors for installation.
In both the B2B and the B2C markets, large companies would be able to offer products and services that can integrate DER into customers’ businesses. In the B2B market, these products and services would include grid-based storage and aggregation services, in which a city buys power on behalf of its residents and uses its purchasing power to reduce prices. The B2B market would also include virtual power plants, which combine generation such as solar and small combined heat and power (CHP) systems with battery storage to create reliable power supplies. B2B customers would see large national or global providers as trusted partners, and only the most efficient companies with strong economies of scale would win projects in the commercial and industrial sectors.
In the B2C market, large DER providers would offer solar, storage, and EMS. These systems would still incorporate standardized equipment, but it would be integrated into large systems such as smart-home solutions and would have aggregation capabilities. These capabilities would allow providers to cluster many of these small systems together to offer greater functionality—for example, to provide grid services. Large DER providers would also be able to offer community energy plans in which neighborhoods share or trade locally produced energy with other groups in a peer-to-peer operating mode, likely on a national level.
As DER evolves, we believe B2C and B2B will take different paths. The B2C segment will remain fragmented, while B2B will consolidate. Three trends support this view.
EMS use software to analyze and optimize consumption patterns, which can lead to significant savings. In the B2C space, this will likely trigger software standardization. For example, “standard” EMS might offer basic functionality, while advanced systems would provide more sophisticated analysis. As a result, software makers may consolidate, while installers will remain fragmented.
In the B2B market, however, demands for customized software will be much greater. Enterprise customers will require extensive IT capabilities and advanced systems that provide more sophisticated analysis. Only large companies will be able to provide such services, supporting the move toward consolidation in B2B.
Battery Price Decline
As battery technology matures, prices will decline and batteries will become a standard component in many DER systems, which will lead to more system integration and increased DER complexity. This could result in greater consolidation in the B2B market, where many companies need complex, heavily customized DER systems. In addition, rapidly declining battery costs will unlock new applications for industrial and commercial customers in B2B, allowing them to generate power on site and store it for later use. This will likely increase product complexity and reduce competition because only large companies that can offer advanced DER systems will be able to compete in this increasingly complex space.
At the same time, lower battery prices will encourage more standardization in the B2C market, where integration is less of an issue than price. The lower costs will boost the B2C market by encouraging both consumer and commercial demand for PV, creating more fragmentation. In many countries, PV already produces electricity for a lower cost than power supplied from the grid, and lower battery prices in the US will reduce PV electricity costs there as well.
Understanding customers is a differentiating factor in the DER industry. New products and financing options—such as leases for rooftop solar panels and storage equipment—will require a better understanding of customer needs, not only for installation and service but also for sales.
In the B2C segment, equipment standardization will result in fragmentation because it will allow local companies, which are most familiar with the needs of their local customers, to install systems that meet those needs. Many equipment manufacturers already offer standardized system kits, such as plug-and-play batteries, solar systems, electric vehicle chargers, and other equipment, and local companies handle a significant share of this installation business. Large companies provide little value in this area because they cannot compete with local competitors on price or customer access. For B2C customers that require a higher level of customization, local companies can partner with other local providers to develop and install more complex systems with multiple components and more sophisticated EMS to increase system efficiency or encourage aggregation.
In the B2B segment, companies will consolidate to provide the comprehensive solutions that commercial and industrial customers demand. They will address the need for customized delivery options among customers looking to manage consumption more effectively. These companies will have strong capabilities in design, technical sales support, IT, EMS, aggregation, and customized solutions for different industry segments. They also will have a sales network with industry experts who can understand clients’ needs and provide services across multiple sites. Local partners or subcontractors will handle system installations.
In this new, divergent industry, the spectrum of DER opportunities reflects customer segments, technology clusters, and locations. By assessing the market attractiveness of these options in terms of size, growth, margins, and regulatory stability against their own competitive capabilities, companies can identify the most attractive DER opportunities.
To capitalize on these opportunities, companies will need to alter their existing business models. Developing the proper business model will require a four-step process:
The coming market changes will require different types of DER participants to adapt their business models in different ways.
Large utilities can use their scale to deliver customized options for large B2B companies on a cross-regional or national level and potentially move into more complex B2C solutions. They can differentiate their services by adopting innovative business models that combine their long-standing strength in energy delivery with the new possibilities that DER offers for energy management, efficiency, and cost savings. Utilities’ role as a market platform, single-service provider, and solutions integrator will mesh well with the emerging technologies of DER.
For large commercial and industrial companies in the B2B market, utilities can design and operate DER assets under long-term contracts of ten years or more. Utilities’ longevity makes them trusted partners in these types of relationships. Large customers will also benefit from the economies of scale that utilities can offer in areas such as procurement and the delivery of large volumes of electricity.
In addition, utilities can use their IT and technical expertise to offer customers access to markets that balance supply and demand almost in real time, a service that is beyond the capabilities of small DER providers. For large customers, this can add to DER’s value. Utilities can enhance their platform and services by partnering with service companies, enabling utilities to offer more customized capabilities and increase their customer orientation.
As the market evolves, utilities may provide more integrated energy services, bundling them according to customers’ needs. And utilities’ market power will enable them to extend financing to customers in some situations.
In the B2C market, the utilities’ role is more challenging. Their overhead is higher than that of small installers, and their existing delivery systems and cost structures are not well suited for adding DER at the residential and small-business level. However, utilities’ access to a large number of customers is a strength for them because the costs for acquiring B2C customers can be high. In the future, utilities, especially retail electric providers, could position themselves between equipment makers and installers—for example, through a partnership or franchise agreement—and deliver complex systems to midsize businesses. This could significantly decrease their customer acquisition costs. In this arrangement, utilities would provide a platform for customized, complex systems offering services such as on-site usage optimization, aggregation, and residual energy supply.
Energy Service Companies
Energy service companies can benefit from their detailed knowledge of B2B customers, transforming themselves into integrated service providers for the B2B market. This strategy offers only limited potential for the B2C market, but service companies that focus on the B2B segment can position themselves in the B2C market as single providers of technical expertise and services. Many of these companies already offer comprehensive contracting and financing options, but they are relatively small—with less than $1 billion in annual revenue—which limits their ability to take advantage of market changes. To compete effectively with utilities and other larger DER market participants in both the B2B and the B2C markets, they may need to grow or merge.
Given the large amount of capital required to enter the manufacturing business, service companies and utilities will have difficulty challenging equipment makers. This will give manufacturers a chance to boost market share by creating or expanding existing partnerships with service companies, utilities, and other DER providers.
In the B2C market, equipment makers can focus on standardization of hardware and software as well as development of system kits, such as easy-to-install solar and battery systems. They can collaborate with a network of wholesalers, distributers, and installers to secure market share.
In the B2B sector, equipment manufacturers can use their specialized product engineering and services expertise to avoid commoditization and develop expertise in both standalone and integrated systems for B2B customers. By partnering with utilities, manufacturers can offer more advanced contracting and financing options.
As the DER industry evolves, participants must find their sweet spot by focusing on customers’ needs. Sophisticated planning and configuration can address more complex demands in both the B2C and the B2B markets. Large commercial and industrial customers require providers with the scale to deliver fully customized products as well as advanced services and individualized EMS.
At the same time, market participants must remain flexible in the face of rapidly changing market conditions such as digitization and declining battery prices.
Companies that wish to take advantage of these changes, however, must act now. In key markets, such as the US, EU, and many Asian countries, DER participants are already staking out their segment of the markets. Companies that fail to adopt the proper business model may find themselves left behind by the evolving market for DER.