Years ago, the Sara Lee baking company spent months in the lab to develop a new product that they imagined would fly off the shelves: the easy-bake cake. Mix, pour, and heat — it was simple, easy, and revolutionary. Better yet, all the trial focus groups raved about it. So Sara Lee took it to market and… well, it didn’t sell.
So they went back to the drawing board, tweaked the recipe, packaging, and brought it back to the focus groups. Again they loved it, again Sara Lee put it on the shelves, and again it wouldn’t sell.
What was the problem?
Sara Lee did not understand its market. Yes, the company was dead right that easy-bake cakes made sense for hardworking mothers. But what they didn’t understand was that moms wanted to feel like they had really given the cakes a special touch.
Include a cracked egg in the recipe. It was easy enough to package the mix with a powdered egg, but then it just wouldn’t have that special touch. From then on, the mix flew off the shelves.
The moral of the story is that sometimes you can have a product that is smart and tailored to meet the needs of your potential customer, but if you don’t understand their preferences, you will strike out every time. Energy efficiency financing has struggled with just this marketing problem for quite some time, which is frustrating, because it makes such good sense.
Market Segmentation vs. Market Classification
The problem (along with the Sara Lee story), as it was explained by Richard Kaufmann, a senior adviser to Department of Energy Secretary Steven Chu, is that energy efficiency advocates haven’t done enough to understand market segmentation. Sure, they understand market classification — residential single family, residential multi-family, commercial, industrial. But the range of motivating behaviors for the owners, building managers, and tenants who actually make the decisions on how and when to improve their properties within these real estate classifications has been left largely unaddressed.
For instance, within the residential classification there is a do-it-yourself segment. These people want to be involved in the project, not only cracking the egg, but baking the whole thing from scratch. The idea of someone swooping in with opaque contracting terms and retrofitting their homes is frightening. Conversely, the make-it-easy crowd wants to sign the dotted line and come home the next day to new windowpanes, and don’t want to be troubled with all the details. For them, simplicity, convenience, and a lack of disruption to their lives is key to the value proposition.
This makes a big difference when trying to match financing options for energy efficiency projects. If companies are serious about lowering customer acquisition costs, they need to learn their market segments — and learn them well. A make-it-easy client will be less interested in all the steps of the project, and so will be more likely to pay to have those things done for them. A do-it-yourself client will be inherently distrustful of financing options that cut them out of the loop.
There are many other segments too. Conservative clients (not politically, but people who aren’t early adopters) need a big name before they get interested in signing up. Independent clients who want flexible contract terms — lease rather than buy, for example. Among commercial building owners, some want to be “green” to differentiate their property within the market and some are motivated only by the cost of capital for the loan; some owners will look deeper to go for every cost effective improvement that boosts the net operating income of the property; others will place pleasing their tenants above all other concerns and only move when an anchor tenant requests an energy upgrade; and another class of owners might only consider a whole-building retrofit when they refinance or make major changes to the building.
As clean energy providers learn to better match financing and service delivery to the real needs and motivations of their customers, a similar set of questions remain in meeting the needs of investors. While the total economic opportunity of building energy retrofits remains large, the investments themselves are quite small compared to traditional real estate projects. The potential yields of these investments are modest but very stable and, like a bond investment, an excellent hedge against inflation for institutional investors. However, entering this market today is complex and can seem risky, pushing some investors to seek higher rates of return for their capital and driving up interest rates to borrowers.
Energy efficiency still has a clear path to the top. But no matter how good the investment, these smart, economically-productive energy upgrades will not sell themselves. The real task in front of the clean energy industry is to better understand the real estate market and what motivates owners and investors.
Solving this challenge will start with finding what drives customer decisions, then using that market segmentation to get this product to scale. Regulatory solutions can help, and requirements to cut pollution and upgrade energy performance in buildings help focus owners attention. But until these consumer behavior questions are resolved by entrepreneurs and investors, the potential for energy efficiency will not be fully realized.
Adam James is a Special Assistant for Energy Policy at the Center for American Progress; Bracken Hendricks is a Senior Fellow at the Center for American Progress.