Low Price the Path to Market?

I think one of the most challenging questions a clean energy entrepreneur faces is at what price does a particular clean energy technology become “cost effective.” How one answers the question will shape people’s understanding of the big opportunity and define how the company pursues a path to market. It’s a critical question to get right because it can make the difference in gaining the confidence of investors, raising money, and (more importantly) achieving market success.

My experience is that the question of cost-effectiveness is deceptively simple on the surface—we all have an intuitive understanding of what electricity costs and it seems obvious that the key to growing the market for clean electric power is to bring its cost in line with utility power costs. In part that’s because we tend to think of electricity as an undifferentiated commodity. As a result, we immediately leap to the conclusion that the only path to market is to beat the commodity price.

That pretty much describes the set of assumptions I brought along when I started in the commercial solar power industry. However, my experience “in the trenches” selling clean energy solutions to businesses has opened up a more nuanced view of price in clean energy markets. The bottom line is that there are large market segments out there for startups selling clean energy at a premium price—it just takes smart, opportunistic entrepreneuring to identify, find, and serve them.

Before you scroll down to the bottom of this post and flame me in the Comments section, please hear me out: I am not going to contradict basic laws of economics. A simple demand curve will tell you that the lower the price of clean energy, the bigger the potential market. My point is that there are segments of the electricity market that value clean energy for more than its commodity energy value (work potential).

Smart entrepreneurs will realize they can gain traction in these segments, generate revenue, build substantial businesses, and then harness scale economics to make clean energy ever cheaper. Trying to hit the “Holy Grail” of cheap clean energy out of the gate is such a huge and impossible task that most startups will likely die pursuing that path to market. (And yes, I know some people will flame me for expressing that opinion.)

Clean Energy is a Premium Priced Product

In today’s electricity markets, clean energy is a premium priced product. (Note: This seems so obvious to me that I almost edited this section out of the post. But, I get such interesting reactions from people when I talk about this that I decided to leave it as is.) Let’s look at some examples that demonstrate this:

• Green power programs adoption: Over the last 5 years of so there have been a number of preliminary introductions of so-called “green power” to electric utility customers in the US and Europe in which customers pay extra to get energy generated from renewable resources. Paul Komor’s Renewable Energy Policy contains a thorough summary of the results of these various programs as well as a great bibliography for more study. In the US, typical participation rates for these programs was in the range of 3%-6% of ratepayers. As Komor observes, “For a new product that costs more than the product it competes against…3 to 6 percent is quite impressive. And this rate was accomplished as these retailers were just learning how to market green power” (Komor, p 98).
  

• RPS programs growth: The last few years have seen an explosion in renewable portfolio standards (RPS) programs in which states require that utilities procure an increasing amount of energy from renewable generators with the goal of hitting a specified target or standard. These programs have enjoyed broad popular support and the short-term results are promising in that most states appear to be hitting their targets easily. In all these cases, states have authorized utilities to procure renewable energy at “above-market” prices. Under these programs the states, on behalf of ratepayers and voters, are effectively authorizing utilities to charge a premium for clean power.
  

• Green tag growth: In parallel with the growth of RPS, the “green tag” market is off and running. Often called a tradable renewable energy certificate (REC or TREC), a green tag is a financial instrument that is created when eligible renewable energy is generated and represents the renewable attributes of clean power as distinct from the electricity itself. These green tags are then made available for purchase, officially or unofficially, by buyers who want to claim the benefits of renewable energy but can’t take physical delivery of the generator output. Groups like Bonneville Environmental Foundation have been making great strides in defining green tag markets with programs that enable consumers and organizations to make their operations “green” by buying green tags to cover their energy use. For this dicusssion, the important point is that anyone buying a green tag is by definition paying a premium for clean energy because, in addition to the green tag price, they’re stil paying the utility for the commodity electricity they use.
  

• Solar power growth: Solar PV has been growing at a rate in excess of 35% in California for several years now and more recently in New Jersey and the Southwest. One of the reasons for this is the introduction of state and utility incentives that have brought the cost of solar down significantly. However, even with the rebates, a solar power system represents a large capital investment ($500K-$2MM) that typically takes 7 to 10 years to pay for itself with an IRR of 10%-13%. Considering that these businesses are investing in something that is “non essential” and they’re willing to accept a level of return that is much lower than what can be achieved with other types of infrastructure investments, there is a clear premium being paid (in cost of capital) for clean energy buy these buyers.

(SIDEBAR: This opens up some very interesting questions about “the competition” for clean energy startups. If the primary value to a customer is the “clean” in “clean energy”, then the competitive landscape should properly encompass the wide range of potential mechanisms by which your customer can secure that attribute. In other words, if you sell solar power systems, you should think about how you will compete in a market where your customers could secure “peace of mind” by simply purchasing green tags from someone like BEF or even their utility. If you sell green tags, you should be thinking about the negative yield scenario that could result when your customers can generate their own clean energy on-site for something close to or less than what they pay for utility energy. This is a subject for an entirely new post, so I’ll stop now before I digress completely.)

A Clean Energy Adoption Curve

Hopefully at this point you agree with me that a binary view of price in clean energy markets is insufficient to capture the clean energy opportunity or to formulate a market entry plan. Here’s the way I think about the opportunity in broad strokes.

• There is a large and growing number of electricity buyers out there who value clean energy enough to consider paying a premium for it.
  

• For any given price, a certain segment of those buyers will decide “it’s worth it” and take the leap.
  

• The lower the price, the larger the proportion of willing buyers.
  

• The more mature and accepted a clean energy product, the lower the risk of buying it, and the larger the proportion of willing buyers.

If you think that sounds familiar, I agree that it sounds like a good old-fashioned Rogers technology adoption curve. Paul Komor explores this idea in depth with regard to consumers (Komor, pp 118-120); I think it’s an invaluable model for thinking about commercial/industrial customers as well. Below is an attempt to draw such a curve for clean energy correlating it to “clean value” and the willingness of customers to pay a “price premium.”

Admittedly the model above is a little clunky and it borders on the painfully obvious. But I think it serves to illustrate the concept that I’m trying to get across: that there is a smarter way to enter the market trying to appeal to the broadest market on the basis of low price.

Market Entry Strategy: Revenue Now, Holy Grail Later

Entrepreneurs are impatient and overconfident by nature. Clean energy entrepreneurs are no different. This is the only explanation I can come up with for why I constantly hear clean energy business plans that hinge on beating utility pricing from the start. Why else do otherwise smart people choose the hardest, most expensive, and most failure-prone path to market?

Let’s try an analogy. If you were the commander of an army preparing to sack a vast walled city surrounded by smaller towns, would you

(a)     immediately attack the big city because that’s where all the gold is; or

(b)     take the smaller towns one at a time thereby securing a place to billet your troops comfortably with plenty of food and water, give them some easier “wins” to hone their skills and gain strength, gather intelligence on the city’s defenses, and then use your foothold in the towns to launch the big attack?

And now, if you had a business with a promising technology that made it possible for your customers to generate clean energy, would you

(a)     spend vast amounts of money and time trying to minimize cost and maximize efficiency so that you could finally deliver a product that beats utility electric pricing; or

(b)     spend just the right amount of money to make sure your product works reliably, sell the product to the people who value what it does and are willing to pay a premium for it, learn from initial customer experiences, use the revenue to offset your capital needs while you refine the product and bring the price down, thereby opening the door to new market segments, until one day you have the perfect product and the market position to credibly bring it mainstream?

In both examples above, option (b) provides a lower-cost, less-risky, incremental path to success. The essence of a good market entry strategy is that it’s capital efficient—it represents the optimal path to generating revenue for the least invested capital while positioning the company for a big win in a big market. For clean energy startups, I believe the best path to market is often via niche market opportunities—finding the “early adopters” who for any number reasons may be more receptive to an initial product offering and less sensitive to price. By targeting those customers first, you can spend less developing the product, get to market sooner, spend less money marketing the product, begin learning with real customer feedback, and get to the very hard work of growing and managing a real business.

In the end, a good market entry strategy will result in you as an entrepreneur retaining maximum ownership of your company; and, believe it or not, your investors will like it better, even if it means they have to share more of the ownership with you!

Postscript: In this post I’ve oversimplified some complex marekt entry issues in order to make an important point. Hopefully readers will forgive my decision to leave some things out. In subsequent posts I’ll try to explore some of these ideas in more detail and hopefully provide some more specific examples.