What can we learn from Bruce Henderson for Hydrogen pricing?

Prologue.

The pricing of hydrogen is a complex issue, but the insights of Bruce Henderson can help us to develop effective pricing strategies for this emerging market. In this article you will find some inspiration, and – hopefully – challenge me and others to think further.

Who is Bruce Henderson and what did he say on pricing?

Bruce Henderson, the founder of Boston Consulting Group (BCG), was a pioneer in the field of strategic management and pricing. In his 1966 article "The Experience Curve – The Growth of Manufacturing Costs and the Implications for Corporate Strategy," Henderson introduced the concept of the experience curve and few other insights, which have had a profound impact on pricing strategies in various industries. Lets look at what his insights may mean for pricing discussions as they are emerging in Hydrogen industries.

The Experience Curve: A Groundbreaking Concept

The experience curve, also known as the learning curve or cost curve, is a conceptual model that describes the relationship between cumulative production volume and unit cost. It suggests that as a company produces more units of a product, its unit costs tend to decrease over time due to learning effects, economies of scale, and improved process efficiency.

Henderson's 1966 article highlighted the importance of the experience curve in pricing strategy. He argued that companies that can achieve a lower cost base through experience curve effects can gain a significant competitive advantage by pricing their products lower than their rivals. This pricing strategy, known as "experience curve pricing," can lead to higher market share, increased profitability, and sustainable competitive advantage.

Henderson introduced several groundbreaking insights that have shaped pricing strategies in various industries in many decades:

1. Price-Cost Trade-Off: Henderson emphasized the trade-off between price and cost in pricing decisions. He argued that companies should not focus solely on maximizing profits through high prices but should consider the impact of pricing on cost and market share.
2. Experience Curve Drives Cost Reduction: Henderson highlighted the role of experience curve effects in driving cost reduction. He emphasized that companies should focus on improving their production processes and achieving economies of scale to lower their unit costs and enhance their pricing power.
3. Pricing Strategy for Sustainable Competitive Advantage: Henderson suggested that experience curve pricing can be a key factor in achieving sustainable competitive advantage. By pricing products competitively based on experience curve effects, companies can gain market share, increase profitability, and maintain a competitive edge over their rivals.
4. Dynamic Pricing and Competitive Dynamics: Henderson recognized the dynamic nature of pricing in competitive markets. He argued that companies should continuously monitor their competitors' pricing strategies and adjust their own pricing accordingly to maintain a competitive advantage.

So what do his insights on the experience curve and its implications for pricing strategy could mean for today's emerging Hydrogen market?

Example of pricing thinking in today’s Hydrogen market.

There is a large uncertainty on how to price Hydrogen, as parties see that the product has features of natural gas (including LNG) and power markets, and it’s very versatile in its applications. From literature examples (Potential pricing regimes for a global low-carbon hydrogen market – Clean Air Task Force (catf.us)), one can see few pricing theories evolving in hydrogen:

• Value-based pricing:?Prices are based on the perceived value of low-carbon hydrogen compared to unabated hydrogen.
• Export-driven net-back pricing:?Prices are based on the cost of producing, transporting, and getting Hydrogen to importing markets of hydrogen.
• Import parity pricing:?Prices are based on the price of hydrogen in the exporting country plus the cost of transportation, insurance, and tariffs.
• Linking to alternatives that Hydrogen aims to replace: grey ammonia or electricity or natural gas benchmarks:?Prices could be linked to the prices of other commodities that are related to hydrogen production (ammonia) or that are used in hydrogen production (electricity and natural gas).

And what price levels does it lead to? 7 to 8 EUR/kg delivered in Germany.

It can vary - an example of outcomes can be seen to vary in Europe between 7 to 8 USD or EUR/kg according to EEX hydrix price index (Germany (eex-transparency.com)). There are more indici – eg HyXchange - I focus here on publicly freely available price indici not on paid alternatives – and noting that soon EU Hydrogen bank may produce alternative indications in spring 2024 as results of the first auction get unveiled.

And so what – implied from the thinking of Henderson in 1960s – could we take forward for Hydrogen pricing in our decade?

Value-based pricing aligns with "Price-cost trade-off" insight by considering the perceived value of low-carbon hydrogen to consumers. It takes into account the environmental benefits and the willingness of consumers to pay a premium for a decarbonized product.

Net-back pricing aligns with "Experience curve drives cost reduction" insight by reflecting the true cost of producing, transporting, and importing hydrogen. It takes into account the overall cost structure of the hydrogen supply chain and ensures that producers are able to recover their costs and earn a profit.

Import parity pricing only in part aligns with "Dynamic pricing and competitive dynamics" insight by adjusting prices based on market conditions and competitor behavior. However, it may not always reflect the true cost of producing hydrogen, potentially leading to inefficiencies and market distortions.

Yet, most alignment to Henderson ideas on pricing is – in my view - the idea of linking hydrogen pricing to the prices of other commodities that it aims to replace, such as grey ammonia, electricity, fuel oil or natural gas.

Henderson's "experience curve drives cost reduction" insight suggests that pricing should be based on the cost of production, and linking hydrogen pricing to the prices of these commodities helps to ensure that hydrogen is priced competitively with its alternatives. This pricing strategy also aligns with Henderson's "price-cost trade-off" insight, as it takes into account the perceived value of hydrogen to consumers. By linking hydrogen pricing to the prices of its alternatives, consumers can make informed decisions about whether to switch to hydrogen-based products. In addition, this pricing strategy can help to overcome some of the challenges of pricing low-carbon hydrogen, such as the difficulty of quantifying the value of GHG emissions reductions from perspective of Hydrogen alone. By using the prices of existing commodities as a reference point (assuming in case of grey ammonia and natural gas that external costs of compliance to carbon pricing or tax would be added), hydrogen producers and buyers can set a fair price for their product without relying solely on subjective assessments of its value or cost.

What do you think – which pricing strategy aligns most to lessons of Bruce Henderson from many decades ago?