Robert Kittell, P.E., Senior Managing Director, Newmark Knight Frank (March 2011)
A leading international solar company evaluated nearly 20 cities in multiple states across the country before selecting a location for its first North American manufacturing facility. Some shortlisted cities negotiated investments with other companies, while many of those early contenders are still seeking to attract manufacturing plants of their own. The competing states all had programs that targeted solar industry manufacturing.
State, federal, and municipal policies have catalyzed an alternative energy boom with manufacturing tax credits, local tax incentives, loan guarantees, feed-in tariffs, and utility-scale solar parks and wind farms. While incentives rank highly in location decision criteria for clean energy manufacturers, the most successful site selections will be those that pursue a competitive advantage by leveraging economic geography.
America's alternative energy manufacturing sectors have plenty of room to grow, especially as European and Asian companies are seeking opportunities for their developing and proven technologies and processes. In the United States, more than 60 new or upgraded solar manufacturing facilities (valued at $3.8 billion) have already used the first round of federal tax credits, according to the Solar Energy Industries Association (SEIA). The United States installed more wind capacity (10,010 MW) in 2009 than ever, but trailed both Europe (10,500 MW) and China (13,800 MW) according to the American Wind Energy Association (AWEA). Solar and wind manufacturing opportunities will likely continue to arise if the government enacts a proposed $5 billion expansion of the Advanced Manufacturing Tax Credit, along with $500 million in loan guarantees that have similarly supported biofuel refineries and geothermal power plants.
No matter the pace of growth, or which countries achieve their target investment goals, one thing holds true: The leaders of this evolving industry must be more conscientious of where they locate their business and real estate operations - and why.
Clean Energy Enterprise Needs
As cleantech startups commercialize their research, they will face critical decisions: How do we structure our organization and business model to maximize success, and which geographies are the best fit when mapped against our enterprise needs? For established clean energy manufacturers, the question becomes: What is our best growth strategy (acquisition or organic), and how do we optimize our real estate portfolio (considering geography, critical resources and financial return) while minimizing risk?
As the recession thaws, more growth is expected, but many unknowns linger, particularly regarding uncertain U.S. energy and fiscal policies. From Oregon to New Jersey, solar panel manufacturing has clustered in states with the most competitive incentives, according to SEIA. But recent expansions in the wind industry have landed in almost every state in the nation and have not yet begun to develop any discernable clustering patterns. When factoring incentives, economic development policy, and local differentiators, the decision-making equation becomes daunting at an extraordinary scale. Incentives and subsidies alone have proven to be insufficient decision drivers, while optimizing for supply chain only may leave opportunities on the table to significantly reduce capitalization requirements or increase operational flexibility and innovation.
Cautionary tales are telling investors, developers, engineers, and government leaders that the next generation of collaboration must harness the strengths of economic geography, optimally matched to each enterprise's needs, in order to prosper - welcome news for both stakeholders and policymakers.
Harnessing Strengths of Economic Geography: Wind
The United States has become a global leader in installed wind turbine capacity and annual installations, according to the U.S. International Trade Commission (USITC). Likewise, the number of wind industry original equipment manufacturers (OEMs) in the U.S. grew from one (General Electric) in 2004 to five in 2008. Several more are planned or in progress as manufacturers seek to deliver unique systems to the Midwest, California, and offshore sites near the East Coast.
Texas leads America in wind power production and is the fifth largest in the world, at 9,528 megawatts of installed capacity. The state accomplished this feat largely without European-style subsidies and incentives. Conventional wisdom suggests that new manufacturing facilities should relocate in or near Texas to serve its proven demand for wind energy products and services.
When a federally-backed turbine manufacturer approached Newmark Knight Frank for a site selection recommendation, the company explored three regions. Texas was an immediate standout, but the economic geography analysis of the three leading contenders found that the Great Plains and Midwest also offered tremendous potential to maximize financial returns. More importantly, they showed the ability to develop a sustainable, competitive business model.
Location Optimization and Decision Analytics
The goal of Newmark Knight Frank's wind client was to find a community with a suitable business environment for a substantial new manufacturing assembly and corporate office facility, centrally located to U.S. regions that could best use small wind farms or single, on-site wind turbines.
Newmark Knight Frank's decision-making process incorporates expert input within a robust framework:
Risk - Balancing short-term and long-term requirements
Cost and revenue implications - Capital allocations and evaluating CapEx mitigation through strategic cost reduction and economic development incentive offsets, i.e. can the investment and the location provide the opportunity to drive demand and create relationships that enhance the top line
Complex decision criteria - Optimizing multiple factors (suppliers and customers, labor market, site quality, cost) and ensuring that location decision-making is aligned with the entire value chain
Infrastructure and industry dynamics - Assessing the implications of industry presence, competition, and geographic concentrations of infrastructure (physical and non-physical) and their impact on the scalability and sustainability of desired operations
Labor market and talent base - Targeting appropriate markets, skills availability, work force productivity, R&D, and innovation capacity, and evaluating talent supply-and-demand balance across multiple options and markets.
At the wind project's outset, the client's headquarters was in Northern California, providing access to venture capitalists from whom they had secured investment. Its assembly operations were in the Mountain West, and its engineering design unit was based in Europe. The client's leadership and board decided to consolidate their operations into a single optimal location.
Because of the size of its turbines (nacelles), the company assumed transportation costs would drive the location decision. So Newmark Knight Frank developed a logistics network optimization model to quantify inbound and outbound costs. According to the model, all of the candidate locations under consideration were on par with the exception of its current Mountain West assembly operation. This was a significant discovery and represented a departure from conventional thinking. Because of the client's willingness to explore preconceived notions, the process could focus on identifying the best overall business environment, as opposed to optimizing for logistics only, an important distinction for long-term business success.
Comparative analysis of real estate alternatives, airport proximity, logistics, operating cost, and incentives narrowed down the candidate locations to Kansas City, Missouri, and Denton, Texas. At this stage, the consulting team usually expects to begin negotiating with the two finalists. However, since the available facilities did not accommodate the client's unique needs, the company decided that a build-to-suit facility would be the only feasible alternative.
Newmark Knight Frank's extensive operations analysis and supply chain modeling resulted in a series of small compromises and creative solutions that appeased both client and real estate partners. Through strategic cost reductions and capital generation, the client was able to use monetized incentives as equity in the building in Kansas City.
Missouri Governor Jay Nixon authorized a $5.6 million incentive package through community development block grants, jobs training, employee recruitment, and sales tax exemptions for equipment and machinery, which lowered the risk to the developer. The developer agreed to put in the remaining amount for the construction cost after some concessions from the company on overall facility layout and customization. Although each project change and creative solution seemed minimal, they collectively helped to advance a strategic target industry for the Kansas City region, and foster an environment where the project could realize its potential.
Across the country, solar developers are signing 20- to 30-year power purchase agreements (PPAs) with local utilities for multiple-megawatt solar power plants. Along with tax incentives, economic development professionals often structure arrangements for manufacturing facilities to initially sell solar panels to these proposed utility-scale projects. It remains to be seen if there will be new demand to sustain these photovoltaic (PV) module plants after initial orders are filled. A mature industry will likely include consolidation and closures, so investors and developers face a number of potential industry outcomes.
The U.S. solar industry faces challenges similar to the wind industry: A market size driven primarily by policy, an uncertain political and economic climate, and generation costs many times higher than traditional gas and coal-fired plants. Subsidies, feed-in tariffs, and mandates are all subject to shifting political winds, while commoditization, cutthroat competition, procurement risk, and over-supply cycles loom large. Despite this uncertainty, most forecasts are still projecting robust growth for the U.S. solar industry. Congress showed bipartisan support by recently passing a one-year extension of the Section 1603 Treasury Grant Program for solar projects.
Even for the grid-tied market, policy and local economics dwarf even the most fundamental element of the solar power generation equation - insolation, the sun's ability to provide power - in driving PV manufacturing demand. Add to this the massive capitalization requirements, the need for a skilled labor force, complex operational and supply chain challenges, potential acquisitions or consolidations, along with risk mitigation, reversibility, and global factors, the real estate portfolio optimization equation begs for a comprehensive approach with a structured decision-making methodology.
An unsophisticated approach may boil down to a PV manufacturer with tremendous growth opportunities, but with simultaneous capitalization constraints and top line growth demands from investors. The easy answer would be to go where the incentives are. Though this approach may lead to short-term viability, ignoring the economic geography may lead to a high-profile collapse of the enterprise.
In California and Massachusetts, some of yesterday's alternative energy success stories have become today's uncomfortable headlines: plant closings, millions of lost taxpayer dollars, and hundreds of disenfranchised workers. The end result? The inevitable acquisition of a project pipeline by a well-positioned competitor or the offshoring of a manufacturing operation, depriving a community of its quest for a greener economy.
Improved productivity, supply chain initiatives and leveraging scale are driving down solar's per-watt costs dramatically. Manufacturers who embrace applied economic geography will place themselves at a competitive advantage and are setting the foundation to become the long-term industry success stories.
Leveraging Geography for Competitive Advantage
After spending three years studying and advising in this realm, we believe that much of the alternative energy industry is struggling with the concept of "where to locate," and that it ties back to the underlying principles of "knowing thyself." An enterprise must be able to identify and acknowledge its true differentiators, core short-term and long-term markets (non-policy driven), core values, operating baseline, five-year plan, and critical needs of the business before it seeks to optimize business geography initiatives.
Newmark Knight Frank strongly believes when we advise manufacturing companies that this is about a total cost equation and, where possible, a total quantification of all qualitative factors that contribute to a location decision. We integrate labor, operations, logistics, regional differentiators, risk, and soft factors - then filter against data sets, both desktop and empirical (substantiated by ground truth) to indicate geographic plausibility. Addressing incentives and economic development opportunities is crucial no doubt to these capital driven and cash starved assets in the alternative energy sector. However, once these federal and local incentives go away, it will be back to basics:
• competitive structural costs
• the ability to innovate and respond to market forces with the right mix of physical, human and political capital
• a reasonably optimal position within a domestic or global supply chain - and flexibility to respond to the rapidly changing supply chain landscape of alternative energy
• a business climate and local partners in the state/community who want your industry and operations to be successful, profitable, and sustainable.
The mission critical outcome must be an enterprise built upon solid financials and human factors that are rooted in compatible economic geography - for the long term. Short-term opportunistic variables must be acknowledged (an available building that allows for quick start-up, a recent customer order requiring proximity, a private equity investor who has other operations that they want to be included in the search), but in the end it will be about whether the business process matches the geography.
The wind and solar industries face a confluence of market factors that includes huge potential, high risk, formidable competition, vast government support, and staggering capitalization requirements. These drivers have created a business dynamic with potential outcomes ranging from "fantastic failure" to "moonshot." The manufacturers that focus on matching geography to enterprise needs will position themselves best to achieve operational excellence and economic sustainability