As PAYGo Solar Matures, Funders Can Do More to Close the Energy Gap
As pay-as-you-go (PAYGo) solar enters its second decade, the industry finds itself at a crossroads. Nearly a billion people remain without access to reliable energy, underlining the continued importance of off-grid energy solutions. But despite having already enabled energy access for an estimated 27 million customers, only a handful of PAYGo providers can claim to be consistently profitable. Here are some priorities we see for the sector that funders can help advance.
Smaller PAYGo providers need access to affordable debt finance
Only a handful of PAYGo companies have achieved profitability, and these tend to be among the largest players in the industry. One reason is that firm-level economics and access to affordable capital (increasingly debt) improve with scale. As a result, smaller players often struggle to obtain the affordable capital needed to expand their businesses, limiting the competition necessary to promote business model innovation and scale. Investors can help a more diversified set of players flourish by prioritizing lending to promising, earlier-stage businesses with objectively strong fundamentals.
Development capital is needed to expand rural coverage
Energy access is most dire in rural areas. Grants and patient equity can help PAYGo providers (especially earlier-stage companies that require more runway to prove their business models) to experiment and innovate at the last mile. Sustainable models that can reach even more rural and dispersed populations will be key to achieving the scale needed to close the energy gap, but getting there means leaving space for innovation.
Sustainable models that can reach even more rural and dispersed populations will be key to achieving the scale needed to close the energy gap, but getting there means leaving space for innovation.
For example, there has been some movement toward disaggregation —in other words, breaking up the PAYGo sector’s complex, vertically integrated value chain into specialized providers of software solutions, credit scoring and after-sales service. This disaggregation promises to free up last-mile distributors to focus on the hard work of getting solar products into the hands of the hardest to reach. It has also paved the way for the emergence of a new cohort of “second generation” providers that aim to serve new markets and customers that have been historically overlooked. With access to funding still heavily skewed toward the largest PAYGo companies, grants and patient equity can help smaller providers further the frontier of rural access and unlock opportunities for scale.
PAYGo is a credit business — companies need to get credit right before pursuing growth
Credit risk management should be firmly ingrained in a PAYGo provider’s culture from the start for it to have a chance at achieving scale and sustainability. This requires a meaningful investment early on, which can be a difficult commitment to make when a company is struggling to make ends meet. Companies, especially smaller ones, may decide that they are better off spending scarce funds on growth in the near term as investors reward competitors that are doing the same, while hoping they can weather declining repayment rates and implement credit risk policies when profitability improves.
This shouldn’t be viewed as an either-or choice, however. As CGAP notes in its technical guide to credit risk management, "Getting Repaid in Asset Finance," there are low-cost ways to mitigate risk and expand credit risk management capabilities, even for growth-stage companies. Investors should push their investees to build out their credit operations and culture early on in the life of the business, which will have an important long-term impact on their capacity to scale and achieve profitability.
PAYGo companies need a variety of financing mechanisms
The menu of available financing structures also needs to mature. Banks are often reluctant to extend the local currency debt PAYGo companies require to effectively mitigate currency fluctuations, presenting an opportunity for investors in local banks like development financial institutions (DFIs) to incentivize greater local currency lending. Flexible working capital facilities for large and small companies alike will allow more efficient allocation of investment funds and help unlock lower rates for customers. Securitization of PAYGo portfolios and the entry of servicing companies will facilitate engagement of a broader range of investors. Additionally, blended finance approaches can help to de-risk and crowd-in commercial investment. A coordinated action by donors and DFIs with an interest in expanding access to renewable energy and finance — who are often key stakeholders in the banks best positioned to help — can facilitate the development of these blended finance facilities.
Quality should come before quantity
Innovation is about more than just business models: It’s also about how funders choose to allocate their capital. Indeed, how investors measure “success” can determine the long-term trajectory of the industry. And while the prevailing focus amongst investors on topline growth and scale is understandable, it risks creating problems over the long term.
The most obvious issue with a focus on growth is that it ignores the fundamental business model challenges many PAYGo firms face. When investors prioritize growth over strong fundamentals, they risk rewarding unsustainable business models and redirecting funding away from smaller, more innovative companies that are necessary for the long-term health of the industry.
Defining “success” as scale also creates incentives for smaller firms to copy the same formula used by their larger peers in hopes of attracting funding. This can, in turn, discourage diversity and experimentation, both of which are key to driving the development of more sustainable business models and approaches that reach customers at the last mile.
Instead of focusing on short-term growth, investors should prioritize companies that are addressing the business model challenges that make it harder to reach each subsequent segment of the underserved, such as credit risk management, high costs of operations and the ability to attract and retain customers. Instead of focusing only on larger companies that can bear debt, investors can do more to structure appropriate financing vehicles that meet the needs of earlier-stage businesses. A base of growing businesses with strong foundations will increasingly attract commercial investors.
Finally, a common set of metrics, such as PAYGo PERFORM, can accelerate development outcomes
Importantly, coordination between funders is critical to the long-term health of the PAYGo solar industry. . Of course, this requires an early and ongoing dialogue between commercial investors and early-stage counterparts. Commercial investors should convey what is needed to win their investment, while their early-stage counterparts lobby for innovative businesses that don’t fit the current mold but have the potential to be disruptive.
Adopting a common language and clear signals that allow for the objective and transparent measurement of outcomes is a critical first step. These can be grounded in common metrics, such as the PAYGo PERFORM KPIs, which can be further developed and focused as the industry evolves. This isn’t to say that every prospective investee needs to have the same KPI profile; healthy industries rely on diversity to drive innovation. But by using the PERFORM KPIs publicly, making adjustments as understanding progresses and encouraging companies they support to do the same, funders can strengthen market signals and improve decision-making.
Ultimately, these efforts will work best if the most promising businesses (across generally agreed upon dimensions) with the most potential to achieve sustainability are rewarded and valuations don’t become overbaked across investor types due to misaligned goals, signals and incentives.
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