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In addition to a sagging stock price, the companys gross margin was down to 27 percent; the company had replaced the vast majority of its executive staff, shuttered manufacturing operations in Germany, reduced output elsewhere, and laid off nearly 25 percent of its overall workforce. Just a few years earlier the company had been on an incredible growth trajectory and seemed poised to revolutionize worldwide power generation. What could have happened in so short a time to change First Solar’s direction so substantially?

BACKGROUND Increased Competition In 2010, First Solar had been the number one producer of photovoltaic (PV) cells and modules in the world, with nearly 13 percent share of the market. Its unique cadmium telluride (CdTe) thin film technology had achieved the lowest levelized cost of electricity (LCOE) in the industry, and was thus the preferred odule choice for many developers of utility-grade solar installations. First Solar had managed to get its manufacturing costs below Sl per watt, setting a new standard for capital efficiency.

However, by 201 1, many other companies had entered the solar module industry, with the goal of taking share from the undisputed leader. Specifically, c-Si (crystal silicon) producers, such as Suntech, Yingli, and Trina from China, had begun to dramatically increase output as well as reduce their overall module costs. By 2013, Suntech had surpassed First Solar as the world’s number one module producer. The Chinese firms had, in a very short time, dramatically changed the solar landscape.

In 2001, China accounted for less than one percent of overall production. By 2012, it produced more than Morgan Hallmon (MBA ‘1 0), Professor Robert Burgelman, and Lecturer Robert Siegel prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright @ 2013 by the Board of Trustees of the Leland Stanford Junior University. Publically available cases are distributed through Harvard Business Publishing at hbsp. arvard. edu and The Case Centre at hecasecentre. org please contact them to order copies and request permission to reproduce materials. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means ” electronic, mechanical, photocopying, recording, or otherwise ” without the permission of the Stanford Graduate School of Business. Every effort has been made to respect copyright and to contact copyright holders as appropriate.

If you are a copyright holder and have concerns, please contact the Case Writing Office at [email protected] stanford. edu or write to Case Writing Office, Stanford Graduate School of Business, Knight Management Center, 655 Knight Way, Stanford University, Stanford, CA 94305-5015. -181- First solar, Inc. in 2013 SM- 190B half of the world’s solar cells and modules. The Chinese government had made leadership in PV solar a major priority, naming it a “strategic emerging industry that should be targeted for preferential treatment” in its twelfth Five Year plan in 2011. TO this end, China had enacted a number of subsidy programs to help the industry get off the ground. These included a virtually unlimited 20 RMB/W (renminbi per watt) capital subsidy for solar producers. In addition, the government approved the “Golden Sun” program, which reimbursed 50 percent of all capital spending on PV solar installations of 500 MW (megawatts) or greater. Furthermore, the program reimbursed 70 percent of capital spending for installations in regions without access to grid electricity.

Solar’s former President Bruce Sohn elaborated on the aggressiveness of the Chinese subsidies: There were so many subsidies that some companies essentially had a negative cost of capital. The government was literally making gifts of land, deferred taxes, free equipment, and other benefits to their domestic companies. Everyone thought this was going to be the next Silicon Valley, and they felt they had to play at any cost. Buoyed by generous government subsidies, Chinese manufacturers flooded the market with lowcost modules, causing price declines for the entire industry. Prices declined so much that in October 2012 IJ. S. anufacturer SolarWorld won a trade complaint with the Department of Commerce accusing Chinese firms of receiving illegal subsidies and ‘dumping cells into the world market at prices much lower than it cost to produce them. 2 In addition, the European Commission ruled in June 2013 to impose provisional nti-dumping duties on Chinese solar cells in response to a similar complaint filed by European manufacturer ProSun . 3 Even in the absence of these regulatory actions, however, it was clear that increased Chinese competition had led to a substantial reduction in profitability for First Solar and many other module manufacturers.

Decline in c-Si prices By 2013 there remained two prevailing technological approaches to producing solar cells: (1 ) high efficiency cells made from high cost crystalline su bstrates (usually silicon); (2) moderate efficiency cells made from thin films on top of commodity substrates (e. g. glass, in the case of First Solar’s modules). First Solar had chosen the latter approach, using thin films of the compound cadmium telluride (CdTe) on a commodity glass substrate to make its modules. First Solar’s module technology strategy was handsomely rewarded when crystalline silicon (cSi) prices were hovering at $300/kg in 2007.

Even modest improvements in thin film module efficiencies seemed enough to compensate for the extreme differences in basic materials costs. At that time, however, the predominant use for crystalline silicon had been the semiconductor microelectronics industry, while PV solar was merely one f a number of minor alternate uses for the material. As the solar industry grew rapidly, the number of c-Si producers and, indeed, China’s 12th Five Year Plan for National Economic and Social Development. Greentech Solar, “Breaking News: Final Commerce Determination on Chinese Solar Cell Tariff,” October 12, 2012. Official Journal of the European Commission, Commission Regulation (EC)) No. 513/2013. 2 – 182 – overall volume of material produced increased substantially. By 2009, the volume of c-Si used for solar had actually surpassed that used for microelectronics for the first time in history. The additional silicon supply caused pricing to plummet dramatically. By 2012, prices for c-Si had fallen to roughly $30/kg, nearly 10 percent of their peak price. At this price point, cell and module producers who had adopted the high efficiency strategy saw their fortunes change.

Their prices became much more competitive, and they began to successfully beat First Solar in bids for utility scale projects. If declines continued in c-Si pricing, it would be extremely difficult for First Solar to lead the industry in cost, which had been its largest advantage to date. Elimination of Subsidy Markets erhaps the biggest factor in the growth Of the modern PV solar generation market was the creation of government subsidies to encourage development and innovation in this field.

The governments of Europe, led by Germany, had created a very robust feed-in-tariff (FIT) system, which catalyzed the entire solar market. These tariffs provided a fixed wholesale rate/kilowatthour that utilities would pay for solar generation, and mandated that they accept all solar capacity up to a specific upper limit. Thus, despite its relatively low insolation, Germany had 34GW (gigawatts) of installed capacity in 2013, more han any other nation in the world. 4 The subsidy markets of Europe comprised nearly 75 percent of worldwide PV solar capacity in 2010.

In 2008, the global financial crisis sent shockwaves throughout the planet, destabilizing the governments of Europe and the rest of the world. Facing pressure on public spending in general, most governments responded to the new stresses on their budgets by placing stricter caps on the amount of power that could be “fed-in,” reducing the overall tariff rate, or accelerating the rate at which the tariff would decline over time. As a result of these overnment actions on subsidies, the solar industry experienced its first year- over-year decline in 2009.

This trajectory only worsened with time as Europe’s share of new worldwide solar installations shrank from 75 percent in 201 0 to less than 10 percent as of January 2013. 5 While the U. S. had yet to Offer a full- blown countrynide feed-in tariff, it did encourage solar development through the Investment Tax Credit (ITC), Department of Energy (DOE) loan guarantees, and treasury grants. Congress voted in 2008 to extend the ITC for an additional eight years, which provided a 30 percent subsidy on all capital nvestment in solar manufacturing and producing facilities.

The complexity of the subsidy vehicle, however, limited the market to primarily utility-scale projects and those few players with sufficient access to credit, scale, and engineering capability to build large solar installations. Nonetheless, it represented a small glimmer of hope in a world of quickly eroding subsidies. The significant reduction in demand from subsidy markets led to a massive glut of module supply, which further intensified competition amongst manufacturers. Sohn explained how severe the oversupply problem had become for the industry: 4 5

Bundesnetzagentur – Photovoltaikanlagen: Datenmeldungen sowie EEG- Verg?tungsstze. Estimated from booking opportunities in First Solar QI 2013 Analyst Day presentation. – 183 At the worst point, there was a 2-to-l supply to demand imbalance. When you’re faced with those economics, you start to see companies make very irrational moves, Suppliers weren’t just selling modules below their COGS [Cost of Goods Sold], but some were starting to sell them below their bill of materials.

No one was turning a profit, but you had to sell or go bankrupt First Solar’s margins were further squeezed as a result, forcing it to shut down perations in Germany, lay off a few thousand associates (workers), and suspend plans to build a new factory in Vietnam. By all accounts, however, the company fared far better than the many more nascent, less well- capitalized companies who went bankrupt. Solyndra, Q-cells, and many others shuttered their doors in response to falling prices. Solyndra was particularly disheartening for the LJ . S. olar industry as it had just two years prior received a $535 million loan guarantee from the DOE and was heralded by President Obama as “the future” of both energy production and American usiness. Sunpower, which had been the second largest American producer of solar cells, needed a $1. 56 billion capital infusion from French oil giant Total to survive amidst changing market conditions. Even the Chinese company SunTech, the world market share leader, finally collapsed under more than $1 billion in debt in March of 2013, entering a restructuring agreement with the local government of Wuxi. Management Turmoil The extreme changes in the market outlook that had plagued the company since the global financial crisis took their toll on First Solar’s management team. There had been substantial turnover at the top in only a few short years. Most notably, chief executive Rob Gillette, who had come from the aerospace division of Honeyn. vell, was fired after only two years of service at the company. Former CEO and chairman, Mike Ahearn, stepped back in to replace him as CEO. While the changes at the top were the most visible, nearly all of First Solar’s management team had churned since 2010.

Company president Sohn, components business president TK Kallenbach, utility group president and CFO Jens Meyerhoff, and Vice President of R David Eaglesham all left the company. These departures caused changes and in virtually every function across the company. During this time of upheaval, the companys management was sharply divided on the core strategy. Specifically, one camp wanted to aggressively build market share in the nascent space, while another urged for financial austerity to focus on preserving the company’s gross margin under extreme competitive and market pressures.

Margin and market share, however, were often at odds with one another as preserving gross margin usually meant leaving large, strategic deals on the negotiating table. Sohn commented on is own experience: I wanted to get into markets quickly and build the dominant brand. We had a major opportunity to do that as the leading player. To sign the big deals wanted in China, India, Saudi Arabia and Thailand, you had to give a little bit on margin. 6 -184- Reuters, “In Suntech’s China home, high hopes for a bailout ” , March 21, 2013. We just couldn’t get any of those [deals] done. They wouldn’t clear the gross margin hurdle.

Maintenance of gross margin was also extolled by the investment analyst community, which closely followed this metric and punished the company’s stock price as it declined. The competing priorities of short-term profit maximization and long-term market position paralyzed the company’s sales, business development, and manufacturing activities, frustrating many in management and eventually leading to significant attrition. SURVIVING THE TURMOIL Much had changed for First Solar by May 2013. Indeed, the future no longer looked quite as rosy as it once had years earlier, yet the company did seem to have left the worst behind it.

The stock price had rebounded sharply from its historical low of $1 7 per share, buoyed by strong revenue and earnings performance for the previous few quarters. Given the tumultuous market environment and increased competition in the module space, some considered it miraculous that the company had managed to stay afloat. Several key business model decisions along with good financial discipline had kept the company solvent during this time, and, unlike some other high profile firms in the space, able to compete for the future.

Mix Shift to Systems With the acquisition of Turner Renewable Energy in 2007, First Solar made its first foray into the systems business. The companys downstream integration had been driven by a desire to better control the full system cost of solar ower, of which First Solar’s modules were only -50 percent of the equation. The acquisitions of Optisolar in 2009 and Next Light in 2010 cemented First Solar’s presence in the systems business, and provided critical access to utility and IPP (independent power prod ucer) end-customers that many of the other ”75 module manufacturers lacked.

By 2013, First Solar’s vertical integration into the systems business had become a key competitive advantage. It provided direct access to end- customers, allowed for better control of the complete delivered energy cost, and differentiated the company from most other module manufacturers who equired Engineering Procurement & Construction (EPC) or joint venture (JV) partners to successfully bid for a utility scale Purchased Power Agreement (PPA). First Solar was a one-stop shop, providing turnkey solutions for utilities while creating an exclusive market for its modules.

In addition, First Solar had continued to expand across the systems value chain, moving beyond EPC and venturing into full-blown Operation and Management (O&M) of power plants (see Exhibit 1). The shift in First Solars business model from modules to systems could be seen most readily in the company’s finances. Revenues from the systems usiness comprised merely 20 percent of revenue in 201 0, however, they represented more than 90 percent of company revenues by 201 2 (see Exhibit 2).

This fundamental shift in strategy had maintained a market for the company’s modules and partially shielded First Solar from the intense competition in that part of the PV solar value chain. – 185 First solar, Inc. in 2013 SW 190B Sustainable Markets Perhaps the biggest philosophical shift to occur at First Solar was the transition from the subsidy markets of Europe to more sustainable markets elsewhere. The modern age of PV solar electricity had been catalyzed by the eed-in-tariff schemes of Germany, Spain, France, and other European nations, but the financial crisis of 2008-2009 all but dismantled the vast majority of these subsidies.

The primary driver of growth for the overall industry had disappeared, leaving most solar manufacturers bankrupt. First Solar was perhaps the first company in the industry to make the very difficult transition away from the subsidy markets. In May 2012, the company articulated its Long-Term Strategic Plan (LTSP), in which it promised to look to sustainable markets (those in which solar power is competitive with fossil ueled plants) for future growth.

As part of the LTSP, the company engaged in a series of painful restructuring events from late April 201 2 through early 201 3 to shed assets and employees to “right-size” the organization for the new reality of sustainable market competition. Sustainable markets were characterized by three qualities: (1 ) demand outstrips electrical supply; (2) a high cost Of electricity; (3) good solar resources. The electrical markets of Europe exhibited virtually none of these characteristics.

For this reason, European sales went from greater than 70 ercent of total revenue in 201 0 to less than 9 percent in 2013. 7 Instead, First Solars project pipeline included many more projects from sun-drenched locations in North America, South America, the Middle East, Africa, and India. In these markets, the company could be competitive with traditional fossil- fueled grid power without the need for huge subsidies. Financial Strength Throughout the period of oversupply and increased competition, First Solar had remained financially conservative.

The company continued to produce cash from operations, which allowed it to maintain a very healthy balance sheet. Without any external infusion of cash, the company had remained solvent and further expanded into the systems business. As financing was a critical component of the EPC business, a strong balance sheet was essential for successful participation as Sohn explained: Having a cash flow positive business made us very bankable with lenders when putting together a bid. Lenders knew that we were going to be around in 10 years to repay the loan.

Also, the power companies knew that we’d be around to set-vice or replace any of our components. As more and more players Went bankrupt, this became a big selling point. First Solar’s financial conservatism was in stark contrast to many of its rivals. In more prosperous times, the company had often boasted that it had the strongest net cash position in the industry. As many of the Chinese competitors had borrowed heavily to expand quickly and gain market share, First Solar had become one of the only companies in the industry with a positive 7 First Solar 201 2 Annual Report. 186 net cash position (see Exhibit 3). If trends continued and competition worsened in this market, cash on hand would be vital to surviving until after the eventual shakeout. Indeed, First Solar’s financial strength had already seen it through the first wave of the shakeout, which had brought down poorly capitalized upstarts such as Solyndra. Technological Bets A large amount Of the pain that First Solar had endured over the past few years had been caused by cost improvements in the higher efficiency c-Si module technology.

The company had made a bet on CdTe technology, which seemed to offer much less of a cost advantage than previously believed. Former CTO, Eaglesham, once described the technology approach as a “portfolio strategy’ in which the company would make many different bets hich could be quickly put into production should they prove winners. Indeed, the company had experimented with copper indium gallium selenide (CIGS), another thin film PV solar technology, but eventually shuttered this effort after failing to commercialize a product.

In April 2013, First Solar announced that it would acquire the technology of c- Si solar cell manufacturer Tetra Sun. This was the first c-Si technology that the company had ever acquired, and it hoped to have commercial Tetra Sun products in production by mid-2014. Acquiring c-Si solar cell technology had any benefits for First Solar: (1) it served as a hedge against falling silicon prices; (2) it provided a whole new efficiency improvement vector for the company; and (3) it allowed the company to compete in space constrained environments (e. . , rooftop and commercial installations) where CdTe cells were inappropriate. This last point was extremely important in the new context of sustainable markets as more than 50 percent of worldwide PV installations in QI 2013 were for non utility-scale projects (see Exhibit 4). 8 More recently, First Solar completed the acquisition of GE’s PrimeStar Solar, nother CdTe thin film module manufacturer. 9 The deal was valued at roughly $80 million, and gave First Solar access to a slightly higher efficiency CdTe technology.

The deal also included terms under which GE would buy First Solar modules for use in its solar and wind installations worldwide. WHAT’S NEXT First Solar in 2013 had become a very different company from what it had been just three years prior. In many ways, the company had been forced to grow up much faster than it would have liked. Subsidy markets were a thing Of the past, competition had increased significantly in the module business, CdTe was no longer the undisputed technology for cost leadership, and the company was now in the hands of a new management team, which would have to face all these new challenges.

However, the future still looked bright for the company. PV solar still had a massive potential market, even if only sustainable markets were addressed. In addition, First Solar’s systems business gave it a temporary competitive advantage over the rest of the industry. Finally, the companys strong cash position meant that it would be strongly positioned to withstand the fierce competition in the market, should an eventual shakeout occur.

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