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Thursday, September 13, 2007

Smart Bets in Renewable Energy

Smart Bets in Renewable Energy Startups

I have been involved with developing, integrating and selling renewable energy systems for 25 years. During that entire period I have been educating myself about the full range of renewable technologies, their business models and prospects for profitability. I have also studied the historical development of a range of other technologies from automotive to electronics and communications. From observations made about technological development in a wide range of industries I have noticed that the integration of technologies is coupled to enduring financial success. There are some recurring patterns that are useful to think about when considering investing in technology and particularly early-stage investing in renewable energy companies. I will use the solar-electric industry as an example.

When a technological innovation is introduced, it is rarely without competition. Even with patents, trade-secrets, innovation and brilliant engineering, the breakthrough rapidly becomes public knowledge. Fundamental research breakthroughs, lead to fundamental products such as photovoltaic (solar-electric) panels. Large companies (Arco, Siemens, Sharp, Mitsubishi, etc.) jump in as they have the required access to capital. This competition among large firms rapidly moves the product from being scarce to being a commodity, which means that without constant improvement in manufacturing techniques the profit margins are squeezed. When a product reaches commodity status the manufacturers no longer control pricing – the marketplace does. Not the best place to be for an early stage investor looking for high risk premiums. High-risk, early-stage investments are most advisable in innovation that is enough ahead of the market to be ahead of the competition, but within the range of what is currently technologically feasible. The product which is already at or is moving toward commodity status is not a good candidate for investment seeking high returns.

How can the angel investor find great opportunities in clean-tech and renewable energy? It helps to understand the ways that technologies are interdependent.

In distributed renewable energy systems, fundamental products such as photovoltaic solar-electric generators are an enabling technology for other products known as “balance of system (BOS) components” such as inverters, charge controllers, instrumentation, batteries, etc. Remember that acronym – Balance Of System – BOS. The need for these components in order to provide the whole energy system creates a business competition among the makers of such BOS products. These companies that ride on the wave created by the fundamental product breakthroughs are often small engineering-oriented companies that are very nimble and compete for a small but important market. During this early stage of development the overall demand is small and cannot support large investments to create economies of scale or standardized integrated products. As a result, there is no standardization, but plenty of innovation. In this early phase of development all systems are custom systems, with little or no mass-produced, one-box products. This makes it very cumbersome for the customer to purchase, install and use the product.

Among these BOS firms, great ideas for components are brought to market, but often do not succeed because of business issues unrelated to the value of the product. Over time such companies generally merge or fail. Often, innovation from such firms stagnates because it is driven by the originating market circumstances that no longer exist. In other words, their products are chasing a past definition of the problem instead of designing for emerging markets made possible by current developments in other BOS technologies.

The best opportunities come after most of the BOS innovations have been demonstrated. Why? Once the high-risk proof of concept work has been done and paid for by small firms it is available to become part of something bigger. The technology enters into a period when integration of technologies into single, user-friendly products becomes possible. By this time the overall market has grown considerably and it makes sense to make significant investments in integration to turn niche markets into mass markets.

We are at that stage now in solar energy technology which has already been in the first phase of development for 25 years or more. Present circumstances are comparable to the time when Henry Ford’s limited-production automobiles had the final piece fall into place – reliable rubber tires - that made them practical and candidates for mass-production; or when Intel’s development of the microprocessor - the integration of millions of electronic components – became the linchpin of the computer revolution. Such technological tipping points that allow the integration of many technologies to create user friendly, robust, value-laden products are a good place for early stage investors to be.

Building-mounted renewable energy technology now has all the enabling technological developments in place and awaits only the integration into mass-market applications. The financiers of these product developments stand to profit handsomely.

This is the time for astute investors to cash in by backing the integration of technologies into powerful, one-box renewable energy products that will drive the economy of the 21st Century.

© Jonathan Cole

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