In any type of off-take, price will be the central point of negotiations. There are many pricing options available - fixed, floating, pass-through, CAPEX-based, return-based, etc. But before we go into the nitty-gritty of price structuring, let’s get the basics right. Going into the pricing negotiations, your objective is to keep the FOAK project profitable! There are a few challenges to that.
First, your FOAK is about building something solid, so you will be spending a lot of cash before you can have cash rolling back to you, and you are negotiating a price before you even know the exact amount of cash you’ll need to burn. Even if you followed all the steps and had your pilot and demo projects lined up perfectly, you still won’t know how much will your FOAK cost you.
If you think that your FOAK will be on a budget, think again. When you last did any renovations to your house, were you on a budget? I thought so. No way that’s going to happen. Suez Canal was two times over budget. Flamanville nuclear power plant was four times the initial cost. The excellent research by Bent Flyvbjerg showed that cost overruns are common across industries.
Source: How Big Things Get Done. The surprising factors behind every successful project, from home renovations to space exploration. Bent Flyvbjerg and Dan Gardner. 2023
The data is clear. Most projects are at least 30% over budget. Many are 50%+. Keep in mind that most of them are not FOAK types. Nuclear energy and the Olympic games would be closer to what we are looking for. So we are in for 2-3 times over our initial budget. And we haven’t yet started talking about our operational costs.
After Northvolt completed its first lithium-ion cell gigafactory in Sweden in 2021, it filed for bankruptcy in 2024, having spent only three years in operations. The chief reason for closing was the inability to get the so-called scrap rate, the ratio of bad output to good output, to manageable levels. By 2024 it was losing over 10 million euros a day! While you don’t know your CAPEX costs, you sure as hell don’t know what your real operational costs will be like! Such CAPEX and OPEX overruns will kill any cleantech FOAK project. So the key to surviving your FOAK is being flexible on pricing. Here are several pricing schemes to consider.
Pricing schemes
CAPEX-based pricing
This method directly addresses the uncertainty of CAPEX in FOAK projects. The price is determined based on the actual CAPEX expenditure, using a predetermined rate of return and term of depreciation. This method is a good fit if your final product has a low OPEX projection. For example, in wind energy projects, CAPEX is the main expenditure. It doesn’t cost much to operate a wind turbine. Thus, 70-90% of your price will be based on your CAPEX and cost of capital.
This method, while pretty straightforward, has a major drawback. You have an inherent incentive to jack up your CAPEX, as your rate of return is fixed and greater CAPEX means more cash for you. Your client will thus try to pass some of the risks of CAPEX inflation by pushing for a lower maximum CAPEX level to be fixed in the off-take agreement.
In my experience, I’ve used CAPEX-based pricing for wind energy projects. Not that I had much of a choice though. The government would set a maximum CAPEX level for a limited volume of wind energy, and the company, suggesting the lowest CAPEX level would get the off-take, with prices based on this CAPEX.
Return-based pricing
You and your investors are expecting some level of return from your FOAK, so why not make it a cornerstone of your off-take pricing? In this scheme, you fix the level of return on capital and determine the final price with this return as a base. Instead of a hard price, you will have a formula, where the known component will be your rate of return.
This method protects your downside and gives you greater flexibility. However, it pushes all the commercial and merchant risks to your customer. It can be acceptable if your customer is also your shareholder or has a stake in the project. Otherwise, the scheme is rather unattractive for a customer, eliminating any kind of certainty for him. This scheme also has the drawbacks of the CAPEX-based method, as it gives you incentives to increase your CAPEX, or at least not to control it as vigorously, as you otherwise would.
Margin-based pricing
This is similar to return-based pricing, but you fix your operating margin instead of return on capital. If your product’s operating costs take 70-90% of your total costs, then this method might be more relevant for your FOAK. Margin-based pricing often assumes that some or all of the merchant risk is passed through to the customer. Thus, if your product relies heavily on commodities with volatile pricing, the margin-based method is a good way to protect your operational downside.
Another benefit to this method, at least from the customer’s point of view, is the decoupling of CAPEX from pricing. As your operating margins are now protected, you have the incentive to keep your CAPEX as low as possible, freeing up your margin for your investors. This is mirrored as a drawback for you, as now you have to fully bear the CAPEX risk, which, as we’ve seen, is a major risk in all FOAK projects.
Scenario-based pricing
In 2021 I signed a conditional off-take with KAMAZ for up to four GWh of lithium-ion batteries. The particular chemistry we were going to make was nickel-manganese-cobalt, or NMC. At that time, there was a generally accepted view on the price of NMC by the time our factory would be in operation. Our agreement had a couple of tables attached, and each table had three columns - year, price, and volume. Each table represented a specific scenario of the demand of KAMAZ for batteries. In every table, prices for the first year of delivery were up to 50% higher, than market prices, projected at the moment. The volumes were correspondingly small. Then, as volumes were projected to increase, after several years of operations, the price would match the projected average for the market. This is just one example of how to build flexibility into the pricing of your off-take.
In scenario-based pricing, you draw up several scenarios of demand levels and corresponding prices. In my case, KAMAZ wasn’t sure whether it would be able to make electric cars in a few years but was quite certain that it would continue manufacturing electric buses. So we had two scenarios - one with demand for electric cars, and one without, and the scenario with electric cars assumed lower prices. Importantly, we did not rely on our CAPEX estimations. Instead, we benchmarked our prices to what was currently available in the market and what was projected for the next ten years.
Your five-step framework to negotiate the best price for the off-take
Pricing negotiations are rarely clear-cut. You are dealing with a whole lot of uncertainty here. So, how do you approach it? How do you make sure that you get the best deal? Here is a five-step framework for you, based on my experience and those of negotiators and founders I know.
Step 1. Know your customer’s motivation
Run-of-a-mill customers do not sign off-takes with FOAKs. It’s too risky. They want predictable quality, prices, and delivery dates. If something from this list isn’t to their liking, they will look elsewhere. Your customer is talking to you for a reason. They might need your technology in their next best-selling product. They might need it to avoid regulatory penalties. Other startups might be in too early stage. The list goes on.
When I was on the buy side in the wind energy business, I had a pressing need for a technology that I could scale locally. That is why, Lagerwey, the Dutch startup with a wind turbine technology, was able to charge us much more than GE. The US giant had comparable technology and was arguably less risky to deal with. Their pass to localization, however, was uncertain and left our team out of key technologies.
The Dutch on the other hand allowed full localization and were ready to provide next-generation turbine design as well. They were able to charge us several times more for the license and we also paid handsomely for parts, that were to be manufactured by them during the transition period.
Find out why your customer is talking to you. What exactly motivates them to take this extra risk. This will be your best leverage in price negotiations.
Step 2. Determine if you are CAPEX or OPEX-intensive
What type of business are you in? Are you CAPEX-intensive like wind and solar, or are you OPEX-intensive, like green cement? Look at the price structure. If more than 80% of your price is return on capital, then you are CAPEX-intensive. If your OPEX is of greater share of your price, then this is what you need to protect.
A CAPEX-intensive business will do well with a CAPEX-based or return-based pricing. The OPEX-based will be better off with the margin-based scheme, or even a reduced version of - merchant pricing, accounting just for fluctuations in the prices of underlying commodities.
Step 3. Determine how competitive your market
In the case of the KAMAZ off-take that I’ve described above, the battery markets were already quite competitive. This ruled out CAPEX-based or even margin-based pricing schemes. In an already competitive market, a scenario pricing tied to specific off-take milestones might work best. This way, you will be able to match your competitors in a gradual way. In less contested markets, you can rely more on pricing mechanisms based on your actual costs or required return.
Step 4. Determine how much you depend on commodity prices
Often your FOAK will rely on an extensive chain of suppliers, and some of them will set the price based on the market rates for their goods. If you can secure your supplier's prices, you will have much more control over your OPEX. For example, a green hydrogen producer may secure a long-term power purchase agreement with a renewable energy supplier at a fixed price, or a battery manufacturer may secure a long-term fixed-price agreement for lithium, cobalt, or graphite.
If these options are available, you will be able to focus on protecting your CAPEX via CAPEX or return-based pricing, or, even agree on a fixed price, if your CAPEX share is not large. If, on the other hand, it is not possible for you to fix your suppliers' prices, then full or partial pass-through pricing with a fixed operating margin will be the way to go.
Step 5. Determine if a buy-out is possible
Sometimes, it is extremely hard to negotiate a good price for your FOAK. If that is the case, then offering your customer a buy-out option could give you some leverage. A buy-out clause allows your customer to buy your FOAK facility at some point in the future. Normally, such a balance sheet transaction will not be on the cards. After all, FOAKs are built by startups for a reason. Still, there may be some instances when a customer might consider transferring the FOAK facility to its balance sheet.
This might allow the customer to integrate your product more tightly into its supply chain and somewhat reduce costs. At the same time, a buy-out does not necessarily mean that your participation in the project is over. More likely that after the buy-out your team will stay on and continue running the facility for a fee.
Final remarks
You won’t be negotiating prices only during your binding off-take negotiations. Your price negotiations will start the moment you meet your customer for the first time. They will drag along your off-take process from MOU to Term Sheet. They will be muted during the MOU’s and LOI’s. They will become much more pronounced during the Term Sheet phase. And they’ll be (almost) fixed when you sign an off-take.
The key to negotiating a good price for your off-take is knowing your weaknesses and unknowns and knowing the reasons why your customer is willing to take the risk of contracting a FOAK. The former is needed to protect your downside. The latter allows you to get the best terms. Your final price scheme is likely to be a blend of several methods. It will depend on the nature of your technology, current market conditions, and how badly your customer needs your product.
So, start negotiating early by learning the true motivations of your customers. Learn about your own risks as much as possible, by gradual scaling through pilot and demo stages. Slowly fix the main principles of cooperation in LOIs and MOUs and then agree on the general pricing mechanism in the term sheet, before legally finalizing it in the fine details in the off-take. In the end, remember, that the pricing mechanism is a balance of covering your and customers’ risks.