A Clear-Eyed Look at Residential Solar’s Customer Value & Acquisition Costs

by Lynn Jurich CEO Sunrun Solar

Sunrun has been building a new kind of home energy service for homeowners for ten years, and we’re just getting started. Our country, our electricity grid and the world all need local, clean and affordable energy. But when an industry disruption is in early days, analysts and investors — not to mention industry incumbents, policymakers and regulators — all seek to understand how to look at it as a business. That’s what we do best. Ed and I had spent years evaluating business models for value creation potential as venture capitalists, as private equity professionals, and at Stanford Business School, where we founded Sunrun. We saw an opportunity to bring business model innovation to the monopoly utility market by going direct-to-consumers with solar as a service. It’s working — both for customers and for Sunrun shareholders.

This is the first of several blog posts in which Ed or I will share some key insights on how to look at value creation in residential solar and aim to clear up some misconceptions.

The model works today with significant upside. We’re tremendously excited about new technologies and regulatory frameworks that will further enhance value and enable us to serve our customers for decades to come. But today, I’m going to focus on customer acquisition costs, a foundational building block of the business and one that is widely mischaracterized.

Industries with recurring customer revenue structure around customer lifetime value (CLV) versus customer acquisition cost (CAC): how much sales and marketing spend is required per customer and what is the margin from that customer over time. When you ask SaaS business analysts or Wall Street or flip through the Harvard Business Review, most experts operate from a starting point that acquisition cost appropriate if it’s approximately a third of lifetime value (put differently the ratio of CLV to CAC should be 3:1. Spend more and the business model may be broken — you’re likely not making money after considering other expenses. Spend less and you are leaving money on the table by missing profitable customers. With its long-term cash flows, solar-as-a-service is a good fit for this rubric.

Let’s look at how we stack up.

Solar-as-a-service customers are contracted 20+ year customer relationships with virtually zero churn (more on this later). An increasingly mature financing market allows us to realize most of that 20-year value upfront. I see industry analysts surprised at the marketing spend of $3,000 to $6,000 thousand in fully-loaded acquisition cost. However, the margin of these contracts, discounted back to today, is in the range of $10,000–20,000. That 3:1 ratio is right in the sweet spot — in fact, this customer value math is conservative. It doesn’t include any value from customers renewing their contracts after 20 years, additional products and services like batteries and other home energy management offerings, and the fact that as many of our customers move we will sell them a system on their new house. We have no plans to increase CAC and indeed see strong opportunities to bring it down, but as these potential additions to customer lifetime value materialize, one could argue that the industry would rationally spend even more to acquire customers. This would drive the industry’s growth up from current 20–30% year-over-year growth rates.

If you find yourself questioning the math, keep reading. The actual performance of residential solar leaders backs it up and demonstrates the path to nationwide scale.

1) Is customer acquisition in residential solar sustainable?

Any business that establishes a long-term customer relationship — whether that be wireless, enterprise software, insurance or even a magazine subscription — has to consider the lifetime revenue that customers will generate when planning its sales and marketing investment. With most consumer businesses, customer life tends to be short, two to three years, since consumers outgrow products and competition is tough.

Let’s use an example: how much should such a company spend to acquire customers to deliver $14,000 of contracted value?

The 3:1 rule of thumb for CLV:CAC spend is not a hard and fast rule, but it works. Optimal spend would be around $4,667 (1/3 of $14,000) for these customers.

Now consider the acquisition costs of service industries like wireless, competitive retail electricity, or insurance. In these industries, customer lifetime value ranges between $450-$1,800 based on the revenue and margin per customer and the average churn. To generate $14,000 in lifetime value will require between 11 and 31 customers depending on the industry.

At the same time, the cost to acquire a customer can range from $150–800. So to achieve this lifetime value, the investment in acquisition costs requires $3,000–9,000 in sales and marketing. Life churn rates increase or margin decreases due to competition, additional investment would be required.

So both the best practice rule of 3:1 and the wireless and retail energy comps would indicate that to deliver $14,000 of customer value, you should spend $3,000 to $6,000 in CAC.

You may have guessed that $14,000 is representative of the margin for a single Sunrun residential solar customer. The reality is, our acquisition costs are right in that $3,000 to $6,000 range, while our margin increases as install costs decline. It’s the invisible hand at work.

Based on my hundreds (probably thousands) of investor conversations over my 10 years in this business, I expect readers may want to dive (deep) into this $14,000 customer value claim. Let’s do that next and then talk about how this is actually understated.

2) Detailed calculation of residential solar customer value

The value of a customer to Sunrun relates in large part to the size of the system installed on their roof. Each is unique but Sunrun’s average is a bit more than 7 kW — or about 24–30 individual solar panels.

For solar-as-a-service, or solar leasing, the industry quotes a 30-year customer life, including a 10 year renewal period, with a 6% discount rate. The Project Value we assign to this already nets out the carefully calculated cost to service and insure the system over that period — that’s all the operational expenses after installation. In round numbers, this comes to approximately $31,500 (or $4.50 / watt x 7kW). To make things simpler and not yet get into the value associated with a customer renewing their contract after 20 years, let’s remove that too and bring the value down by $3,500 (the discounted value of the renewal years 20 through 30). This leaves $28,000 of value. We are approaching $14,000 (or $2.00 / watt) of costs to install this system. This leaves $14,000 of margin — in just the 20-year contracted period, after operations and maintenance expense, and after installation costs.

Per the above, a rational actor and market dynamics would move acquisition costs to 1/3 of that $14,000k or $4,667. In Q2 2016, you will note, we spent about $4,900 and just under that — $4,667 — in Q4 2015.

3) How certain is this customer value?

Customer churn is a major negative lever for customer lifetime value for most industries. There is always the risk that customer relationships could shorten and not pay back the expense of acquiring them. But in residential solar, churn is a positive factor. Here’s why:

Once a house has solar panels, it virtually never loses them. New home buyers walking into a solar home almost never choose to remove them and default on payments. Over thousands of home sales and service transfers to date, including after foreclosures and other complex situations, Sunrun has recovered 99+% of expected customer value. That makes churn value-neutral.

Furthermore, once a homeowner chooses solar, they have the opportunity to do so again it for the rest of the homes they purchase. We therefore get to bring Sunrun solar to them for a second or third time.

The underlying quality of these contracts is high. This is borne out by almost 10 years of history on our current contracts and less than 1% loss rates throughout the last ten years. You can see publicly available data from our securitization (registration required) — which includes assets over 5 years old — performing at a BBB investment grade rating.

Finally, the discount rate applied to all future cash flows in this analysis is an unlevered 6%. We have been consistently financing approximately 85% of our contracted value upfront at about a 4.5% cost of capital so a 6% unlevered discount rate would imply about 10% discount rate on the remaining 15% of cash flows, a cost of capital well supported by the quality of the assets. We’ve discussed this in our earnings calls [link] at length. These low rates are achieved because of the strong quality our contracts have demonstrated, gaining trust from debt markets.

To put this in context, these advance rates mean that we realize the vast majority of this contracted value in Year 1, in line with all acquisition costs. This is in contrast to SaaS businesses where upfront costs may not be recovered in realized revenue until multiple years into a contract.

In fact, we are approaching positive cash flow in our development business, whereby we generate cash when we install a customer in year 1, even after adding in our general and administrative expenses.

4) Why these costs will come down over time

All of this is not to say that lowering acquisition costs isn’t a strong focus. And industry acquisition costs will continue to come down.

Residential solar acquisition today has two elements that will improve structurally in the future: (1) product awareness and (2) a highly customized experience. First, we not only explain solar and financing options to our customers — we educate them on their electricity bill itself so they understand how solar can deliver it at lower costs, from their rooftop, with benefits to the grid. As more and more people have happy solar neighbors and customer awareness and understanding increases, this education expense will recede.

Second, rapid scaling as seen in recent years means there is significant opportunity to improve efficiency in the multi-step process between delivering a proposal and installing a system. As the industry matures, we should see companies more carefully stage their mid-funnel spending on elements like site audits and permitting, and adopt standard procedures like a deposit at the point of customer booking as seen in peer industries. This will reduce the spend that is embedded in the sales and marketing line.

With growth and scale (we have now reached one million solar homes in the US), residential solar is gaining relevance for national brands including energy sector players like retail electricity providers. Growing partnerships with these brands will continue to bring solar to new homeowners through lower cost cross-selling efforts.

Finally, the long-term winners in this market will differentiate in part through organic growth through low-cost referral acquisitions from a happy and scaled customer base.

5) Should we actually be spending more to acquire residential solar customers?

The $14,000 customer value stated above doesn’t include the ways that customer value could increase. This is a more-likely-than-not scenario.

First, this value does not take into account renewal of the contract beyond 20 years. These systems have 30+ year lives, will have been maintained by us, and produce a commodity people need, electricity, cheaper than the utility. If the customer decides they want to upgrade, Sunrun is the likely company they would chose, especially because we will know exactly when renewal will occur as well as that customer’s history and energy consumption habits. After applying selling costs for this renewal value, this would add $3,200 in lifetime value.

In addition to significant value in the customer renewal, here are a few other ways customer value is likely to increase:

First, the assumptions to arrive at that representative average $28,000 estimate are conservative. In many markets, our systems receive renewable energy credits (RECs) that can be traded. We’re only able to monetize the initial few years of what are ten to fifteen year streams of value. Taking account of the full REC value will depend on the market value of RECs but for a system in major solar markets like New Jersey or Massachusetts, this would be $1,300–2,300 at a steep 10% discount rate.

Even more exciting, we are listening to what our customers want to help manage their energy costs and access the best new technology for comfort and peace of mind. Overall energy spend is one of the largest line items in a household’s budget. We believe there are significant opportunities to broaden the home energy service we provide and increase customer lifetime value.

In the coming years, utility rates will rise and they will likely become more complicated, charging homeowners based on the time of day that electricity is used. Sunrun will provide to its customers tools and services to protect against bill surprises — and even lower their bills further with smart devices that shift power consumption in the background to when it is inexpensive.

Home batteries will support this and also provide backup power during power outages. We size the additive lifetime value after selling costs and all COGS to be $2,500 for an initial battery with a ten year lifetime, incorporating the value created through load management, backup power, demand response and other grid services. (To put this in context, homeowners already pay $3,000–5,000 to install generators that serve only for backup).

We also have the opportunity to wrap around services that support comfort, peace of mind and security. As just one example, smart monitoring services can read the signatures of different appliances in the electricity consumption tracked by the monitors Sunrun will already have installed — and alert a homeowner that their air conditioner is beginning to fail. Warranty services will cover the cost of replacing it. This is something retail electricity providers are already having success bringing to homeowners. Through services like this, we see opportunities to add $1,500 in lifetime value.

We will have opportunities to increase the size of systems — as costs go down, efficiency goes up, and customer electricity load may increase. Electric vehicles (EVs) will grow into the mainstream and EV drivers will add significant load. A modest upsize in system size of 2 kW in year seven of a contract yields $2,600 in additional lifetime value.

From home batteries to EV chargers to solar panels, we expect homeowners will want new devices to work together, talk to each other and be proactively monitored and maintained, making it attractive to add these to their existing Sunrun relationship.

And this does not even consider value streams that may begin accruing when regulators and utilities fully value and build markets around the benefits to the grid from distributed solar — such as the value of deferring grid infrastructure spending that is made unnecessary by smart distributed technology.

We estimate that these opportunities could add $12,000 to each customer relationship in customer lifetime value. Solar is just the starting point, and when all these are taken together, one-time customer acquisition costs are low by comparative standards.

Taken together, the $14,000 in customer value from an average residential solar customer is just the beginning. Looking at this long-term value creation in relation to our upfront costs demonstrates the durability of our business model, the approach that will deliver the industry’s most valuable and satisfied customer base, and the foundation that will enables Sunrun to serve our customers for decades to come.

1Industry comparison assumptions: (1) Wireless customer value- $600 annual ARPU, 1.25% monthly churn rate, 40% margin based on industry leader public disclosures. (2) Retail Electricity customer value — $959 annual ARPU, based on average residential household electricity usage (10,093 kWH from EIA, 2014) and $0.095/kWh rate, 2.5% monthly churn rate, 16% margin. (3) Auto Insurance customer value — $954 annual ARPU based on NAIC Auto Insurance Database Report 2012/2013, 0.9% monthly churn based on J.D. Power & Associates 2015 U.S. Insurance Shopping Survey Results, 25% margin.

2Industry comparison acquisition cost assumptions: (1) Wireless — estimated based on industry sources (2) Retail Electricity — estimated based on industry sources (3) Auto Insurance — estimated based on publicly reported research by William Blair & Co (Direct Insurers Paying Less to Attract Customers).

3Industry comparisons calculated based on customer value and acquisition costs noted above.

Originally published at www.sunrun.com on September 9, 2016.