Wonder why non-wires alternative procurements are failing to meet the frothy expectations of five years ago? One reason is that most distributed energy resource (DER) aggregators have quietly pivoted to other more profitable business models. Some firms have pivoted to become DER management “software as a service” (SaaS) providers (e.g., AMS, Comverge, Enbala, STEM, and Sunverge). Other firms (e.g., Tesla, SunRun) have refocused on their hardware sales (e.g., solar PV and battery storage). Several firms have opted instead to partner with other firms that will provide customer acquisition and engagement support, DER aggregation software and/or provide operational capability to interface with markets/utilities.
These and other firms experienced the modern Gothic romance of retail energy – beautiful theory met the ugly reality of retail energy. DER aggregation business model of the past 2 decades is not very profitable. There often isn’t sufficient gross margin available to cover all the risk adjusted costs. Costs involving customer acquisition; complex, custom installations often involving 3rd party finance, installers and equipment; resource management software development and maintenance (or outsource to a 3rd party); operations center; and back-end customer engagement management and market/utility settlement. Then there is the financial risk exposure from non-performance if the aggregated DER do not perform to contracted or market requirements and related revenue recognition issues.
There are 5 key business considerations for any retail energy business:
- Standardization – packaged hardware, software and standardized installations are essential to achieve acceptable gross margins – mass customization (i.e., unique engineered solutions) is a death knell.
- Risk management – it is essential to determine which life-cycle risks (e.g., customer acquisition/support, DER installation/finance, software platform, and/or operational management) to assume in a transaction is key as there is insufficient profit margin to address all the inherent risks.
- Partnering – it may be necessary to fill capability gaps or mitigate risks, but it is significantly dilutive given the typically thin overall net profit margins.
- Revenue recognition – financial accounting for performance-based contracts is a major issue for services firms, particularly venture-backed businesses.
- Size matters – retail energy services businesses often require a very large number of customers to spread customer engagement and fixed costs in order to achieve financial sustainability.
However, aggregation in 2020 – or rather orchestration of customer DER (and independent DER) is adapting into very different business models to address these “laws” of retail energy. While many of the DER aggregators of the 2000-2019 period have pivoted, other firms are transitioning to fill the void. For example, large retail energy services and power marketing firms are expanding their services to provide market intermediation for customer DER (e.g., Shell New Energies and Enel-X). Operational platforms are expanding beyond inside the utility DERMS platforms to create market enabling platforms (e.g., OATI and Siemens). Traditional demand side management program administrators (e.g., ICF and Willdan) are developing and implementing programmatic DER aggregations for utilities to address specific system and grid needs.
These new orchestration models largely involve a narrower scope of services in line with the strategic capabilities of the respective firms. In one example, the focus is on the non-trivial ability of an aggregator to optimize a portfolio and execute dispatch to meet stringent operational requirements. In this case, the customer DER already exists and another firm (e.g., utility, energy retailer, CCA) manages the customer engagement. In another example, the “aggregator” is responsible for orchestrating the customer acquisition, DER installation and engagement – the utility or another entity manages the operations of the portfolio.
With the continued growth of customer DER adoption driven by rate designs and incentives it is likely the aggregator model of the past 20 years is dead and new aggregator models will continue to emerge. The implication for regulators and utilities is that DER utilization policies like NWA procurements will increasingly be unproductive as they are based on the old aggregator business model paradigm. The call for a change has already been heard in a number of DER related working groups around the country. The call is to shift to more programmatic approaches or DER value-based rates that significantly reduce the risks for DER providers and resolve the revenue recognition issues. But, these also require the utility to re-assume the operational risks of non-performance. Additionally, this may involve the utility assuming a greater role in covering customer acquisition and engagement costs as in traditional DER programs.
A focus on the potential risk adjusted contribution to margin and revenue recognition implications for market participants will help regulators, utilities and stakeholders understand how competitive aggregation will develop over this decade. This is also a critical lesson that institutionalizing specific business models without an understanding of the financial and risk dimensions of those models can create barriers to business innovation that seeks to address the inherent issues.