CHAPTER 6. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

TABLE OF CONTENTS

6.1	 INTRODUCTION .............................................................................................................. 6­1
 

6.1.1 Baseline Markups................................................................................................. 6­3
 

6.1.2 Incremental Markups........................................................................................... 6­3
 

6.1.3 Overall Markups .................................................................................................. 6­4
 

6.2	 BASIC ASSUMPTIONS USED TO ESTIMATE WHOLESALER/DISTRIBUTOR

MARKUPS ......................................................................................................................... 6­4

6.3	 ESTIMATION OF DISTRIBUTOR­WHOLESALER MARKUPS.................................. 6­5
 

6.4	 SALES TAX ....................................................................................................................... 6­7
 

6.5	 OVERALL MARKUPS...................................................................................................... 6­8
 

6.6 RESULTS ........................................................................................................................... 6­8
 

REFERENCES ............................................................................................................................ 6­9
 

LIST OF TABLES

Table 6.3.1 Wholesaler/Distributor Expenses and Markups ...................................................... 6­6

Table 6.4.1 State Sales Tax Rates............................................................................................... 6­7

Table 6.5.1 Baseline Markups by Distribution Channel and Overall Average Markup,

Including the Average Sales Tax Multiplier........................................................ 6­8

Table 6.5.2 Incremental Markups by Distribution Channel and Overall Average

Markup, Including the Average Sales Tax Multiplier ......................................... 6­8
 

LIST OF FIGURES

Figure 6.1.1	 Distribution Channels and Shares for Refrigerated Beverage Vending

Machines.............................................................................................................. 6­2

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CHAPTER 6. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

6.1 INTRODUCTION

To carry out the life­cycle cost (LCC) calculations described in chapter 8, the

U.S. Department of Energy (DOE) needs to determine the cost to the customer of baseline

refrigerated beverage vending machines (BVM). This cost is determined for both baseline

equipment and more­efficient equipment the customer would purchase following the

promulgation of new energy conservation standards. However, the customer price of such

equipment is not known since it depends on how the equipment is purchased. The manufacturer

selling price (MSP) for both baseline equipment and the more efficient equipment is determined

in the engineering analysis (chapter 5). By applying a multiplier called a “markup” to the MSP,

DOE was able to estimate the customer price of equipment purchased through various

distribution channels. This chapter describes how DOE derived these markups.

DOE determines customer prices for beverage vending machines from MSP and

equipment price markups using industry balance sheet data and U.S. Census Bureau data. To

determine price markups, DOE identifies distribution channels for equipment sales and

determines the existence and amounts of markups within each distribution channel. For each

distribution channel, DOE distinguishes between “baseline markups” applied to the MSP for

baseline equipment and “incremental markups” applied to the incremental increase in MSP for

higher efficiency equipment. Overall baseline and overall incremental markups are calculated

separately based on the product of all baseline markups at each step within a distribution channel

or the product of all incremental markups at each step within a distribution channel, respectively.

The combination of the overall baseline markup applied to the baseline MSP and the incremental

markups applied to the incremental increase in MSP for higher efficiency equipment, including

sales tax, determines the final customer price.

The cost to the customer depends on how the customer purchases the equipment. DOE

defined three distribution channels, as shown in Figure 6.1.1, to describe how the equipment

passes from the manufacturer to the customer. In the first distribution channel, the manufacturer

sells the equipment to the bottler/distributor, who in turn installs, operates and maintains the

equipment on­site at the user’s location. In the second and third distribution channels, the

manufacturer sells the equipment to a wholesaler/distributor, who in turn sells it directly to the

customer (vending machine operator or site owner). The site owner purchases outright a small

percentage of the machines from the distributor and stocks and maintains them on­site.

Figure 6.1.1 also gives the distribution channel shares (in percentage of total sales) through each

of the three distribution channels. The distribution channel shares are based on information from

the State of the Vending Industry Report.1

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BVM Manufacturer
 

Wholesaler/Distributor

Site

Owner

Vending Machine

Operator

Bottler/Distributor

68%	 27% 5%

Figure 6.1.1	 Distribution Channels and Shares for Refrigerated Beverage Vending

Machines

The following equation describes how DOE determined the equipment price if a

customer (in this case, the bottler/distributor) purchases directly from the manufacturer:

EQPCUST = MSPBASE x (1+ ST)	 Eq. 6.1

where

EQPCUST	 = equipment price to the customer ($),

MSPBASE	 = MSP of baseline equipment ($), and

ST	 = sales tax rate.

The following equation describes how DOE determined the equipment price if a

distributor sells the equipment to the customer through the wholesaler/distributor:

EQPCUST = MSPBASE x MUDIST x (1+ST)	 Eq. 6.2

where

MUDIST	 = wholesaler/distributor markup.

The markup multiplier to the equipment price is thus lessened for shorter distribution

channels.

For each of the wholesaler/distributor markups presented above, DOE further

differentiated between a baseline markup and an incremental markup, as described below. The

overall markup describes the product of all the markups plus sales tax within a distribution

channel.

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6.1.1 Baseline Markups

DOE defined baseline markups as cost multipliers that relate the purchase cost to the

selling price for each step in the distribution channel.

If sold to a customer by the manufacturer, the following equation defines the equipment

price:

EQPMFGR BASE = MSPBASE x (1+ST) Eq. 6.3

where

EQPMFGR BASE = bottler/distributor price to the customer of baseline equipment

($).

If sold to a customer by a wholesaler/distributor:

EQPDIST BASE= MSPBASE x MUDIST BASE x (1+ST) Eq. 6.4

where

EQPDIST BASE = distributor price to the customer of baseline equipment ($), and

MUDIST BASE = distributor markup on baseline equipment.

The use of the markups results in the wholesaler/distributor (EQPDIST BASE) prices of

baseline BVM equipment.

6.1.2 Incremental Markups

For the purposes of this analysis, incremental markups are cost multipliers that relate

incremental changes in the MSP of higher efficiency equipment (from efficiency improvements)

to changes in the distributor sales price.

If sold to a bottler/distributor directly by the manufacturer, the following equation defines

the equipment price:

EQPMFGR INCR = MSP INCR x (1+ST) Eq. 6.5

where

EQPMFGR INCR = incremental equipment price to the customer ($), and

MSPINCR = change in the MSP of higher efficiency equipment brought about

by an increase in efficiency due to new standards ($).

If sold by a wholesaler/distributor directly to a customer:

EQPDIST INCR = MFGINCR x MUDIST INCR x (1+ ST) Eq. 6.6

where

EQPDIST INCR = incremental wholesaler/distributor price to the customer ($), and

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MUDIST INCR = incremental wholesaler/distributor markup.

In equation 6.6, the MUDIST INCR term refers to the incremental wholesaler/distributor

markup that is applied to the incremental MSP. The use of the incremental markup results in the

incremental wholesaler/distributor (EQPDIST) price.

6.1.3 Overall Markups

Overall markups, including both overall baseline and overall incremental markups, relate

the MSP to the customer price as indicated by the following equations:

EQPCUST BASE = MSPBASE x (WTMFGR BASE + WTDIST BASE x MUDIST BASE ) x (1+ST)

= MSPBASE x (1+MUOVERALL BASE ) Eq. 6.7

EQPCUST INCR = MSPINCR x (WTMFGR INCR + WTDIST INCR x MUDIST INCR) x (1+ST)

= MFGINCR x MUOVERALL INCR Eq. 6.8

EQPCUST= EQPCUST BASE+ EQPCUST INCR Eq. 6.9

where

MUOVERALL BASE = overall weighted baseline markup that is the product of
 

all the weights and baseline markups for each step of the distribution channel,
 

MUOVERALL INCR = overall weighted incremental markup that is the product
 

of all the weights and incremental markups for each step of the distribution
 

channel,
 

EQPCUST BASE = baseline customer price ($),
 

EQPCUST INCR = incremental customer price ($),
 

EQPCUST = total customer price ($),
 

WTMFGR BASE = weight (percent) of baseline equipment sales direct to customers,
 

WTDIST BASE = weight (percent) of baseline equipment sales through
 

wholesalers,
 

WTMFGR INCR = weight (percent) of higher efficiency equipment sales direct to
 

customers, and
 

WTDIST INCR = weight (percent) of higher efficiency equipment sales through
 

wholesalers.
 

The use of the overall baseline and overall incremental markups results in the baseline

customer price (EQPCUST BASE) and the incremental customer price (EQPCUST INCR). For a

particular higher efficiency level that increases the MSP of equipment, the total price of

equipment to the customer (EQPCUST ) is the sum of the baseline customer price (EQPCUST BASE)

and the incremental customer price (EQPCUST INCR).

6.2 BASIC ASSUMPTIONS USED TO ESTIMATE WHOLESALER/DISTRIBUTOR

MARKUPS

DOE based the wholesaler/distributor markups on U.S. Census Bureau data for the

“Other commercial equipment merchant wholesaler” segment of durable goods and merchant

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wholesalers category of Wholesale Trade. Three key assumptions used to estimate markups for

the BVM wholesaler/distributor industry were:

1.	 The data accurately represent the various costs incurred by firms distributing and
 

installing BVM equipment.
 

2.	 The costs can be divided into two categories: (1) costs that vary in proportion to the MSP

of BVM equipment (variable costs), and (2) costs that do not vary with the MSP of BVM

equipment (fixed costs).

3.	 Wholesaler/Distributor prices vary in proportion to the stated wholesaler/distributor costs.

In support of the first two assumptions, the cost data are categorized correctly to reflect

the direct costs to purchase or install the equipment, operating labor and occupancy costs, and

other operating costs and profit.

Although the BVM wholesaler/distributors may handle multiple commodity lines

(including non­refrigerated vending machines and other equipment), the data provide the most

accurate available indication of BVM equipment costs.

DOE searched, but did not find data on two topics that relate to the price determined by

the markup analysis. The first is the division and application of fixed and variable costs, and the

second is the level of competition.

In the case of the division and application of fixed and variable costs to determine

baseline and incremental markups, DOE relied upon prior analysis of the HVAC wholesalers,

contractors, and consultants, including information obtained from the trade literature.2,3 This

analysis indicates that wholesaler and contractor markups vary according to the quantity of labor

and materials used to distribute and install appliances, with markups on labor tending to be much

larger than markups on materials. The analysis implies that these distribution channel markups

vary more with sales volume than with other factors, including appliance efficiency.

Distribution channel labor inputs also vary more with sales volume than with appliance cost or

efficiency. DOE assumed a division of costs between those that do not scale with the MSP

(labor and occupancy costs), and those that do (operating costs and profit). This division of costs

led to the estimation of wholesaler/distributor markups as described below.

In the case of the BVM industry, the level of competition among the wholesaler/

distributors of BVM equipment and customer demand for BVM equipment is relatively inelastic

(i.e., the demand is not expected to decrease significantly with an increase in price of the

equipment). The large number of wholesaler firms listed in the U.S. Census Bureau data (2002)

indicates that the market is relatively competitive in nature, as there are about 450

wholesaler/distributors of BVM equipment.4 Following standard economic theory, competitive

firms facing inelastic demand either set prices in line with costs or quickly go out of business.5

6.3 ESTIMATION OF DISTRIBUTOR­WHOLESALER MARKUPS

DOE derived markups for wholesaler/distributors from U.S. Census Bureau data (2002)

for Other Commercial Equipment Merchant Wholesalers (North American Industry

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Classification System 423440). This sector includes establishments primarily engaged in

distributing and wholesaling refrigerated beverage vending machines and other equipment to

restaurants and hotels (NAICS 4234401) and stores (NAICS 4234402). The U.S. Census Bureau

data for this sector include revenue and expense data in total dollars rather than in typical values

for an average or representative business. Because of this, DOE assumed that the total dollar

values that the U.S. Census Bureau reported, once converted to a percentage basis, represented

revenues and expenses for an average or typical contracting business. Table 6.3.1 summarizes

the expenses for wholesaler/distributors, as expenses per dollar sales revenue, in the first data

column (appendix C contains dollar values from the survey). The direct cost of sales represents

about $0.69 per dollar sales revenue to the wholesaler/distributor. Labor expenses account for

$0.13 per dollar sales revenue, occupancy expenses and other operating expenses account for

$0.10, and profit accounts for $0.09 per dollar sales revenue.

Table 6.3.1 Wholesaler/Distributor Expenses and Markups

Description

Wholesale Firm Expenses or Revenue

Per Dollar

Sales Revenue

Per Dollar Cost

of Goods Sold

Direct Cost of Equipment Sales: Cost of goods sold

Labor Expenses: Salaries and benefits

Occupancy Expense: Rent, maintenance, and utilities

Other Operating Expenses: Depreciation, advertising, and insurance

Profit

$0.69

$0.13

$0.10

$0.09

$1.00

$0.19

$0.07*

$0.07*

$0.13

Baseline Markup (MUWHOLE BASE): Revenue per dollar cost of goods sold 1.46

Incremental Markup (MUWHOLE INCR): Increased revenue per dollar increase cost of goods sold 1.20

Source:	 U.S. Census Bureau. December 2005. Wholesale Trade, Miscellaneous Subjects: 2002. EC02­42SX­SB

Table 4. Detailed Type of Operation for the United States: 2002

U.S. Census Bureau. December 2005. Wholesale Trade, Miscellaneous Subjects: 2002. EC02­42SX­SB

Table 6. Gross Margin and Its Components for Merchant Wholesalers for the United States: 2002

U.S. Census Bureau. December 2005. Wholesale Trade, Miscellaneous Subjects: 2002. EC02­42SX­SB

Table 7. Gross Profit and Its Components for Merchant Wholesalers for the United States: 2002

*Because data were not available to calculate the individual values for Occupancy and Other Operating Expenses in the “Per

Dollar Cost of Goods Sold” column, the values were calculated from the “Per Dollar Sales Revenue” value, by arbitrarily

dividing the total in half. Evidence from other rulemakings indicates that the Occupancy Expense value in the “Per Dollar Cost

of Goods Sold” column is often slightly lower than the value for Other Operating Expenses. If this were the case in this category,

then the effect would be to understate the incremental by 1 or 2 points (i.e., it may be 1.21 or 1.22 instead of 1.20).

DOE converted these expenses per dollar sales into revenue per dollar cost of goods sold,

by dividing each figure in the first data column by $0.69. The data in the last column show that,

for every $1.00 the wholesaler/distributor spends on equipment costs, the wholesaler/distributor

earns $1.00 in sales revenue to cover the equipment cost, $0.19 to cover labor costs, $0.07 to

cover occupancy expenses, $0.07 for other operating expenses, and $0.13 in profits. This totals

$1.46 in sales revenue earned for every $1.00 spent on equipment costs. This results in a

wholesaler/distributor baseline markup (MUDIST BASE) of 1.46 ($1.46 ÷ $1.00).

DOE was also able to use the data in the last column in Table 6.3.1 to estimate the

incremental markups by separating the fixed and variable costs. For example, if all of the other

costs scale with the equipment price (i.e., all costs are variable), the increase in

wholesaler/distributor price will be $1.46, implying that the incremental markup is 1.46, or the

same as the baseline markup. However, if none of the other costs are variable, then a $1.00

increase in the equipment price will lead to a $1.00 increase in the wholesaler/distributor price,

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for an incremental markup of 1.0. DOE assumes the labor and occupancy costs to be fixed and

the other operating costs and profit to scale with the equipment price (i.e., be variable). In this

case, for a $1.00 increase in the equipment price, the wholesaler/distributor price will increase by

$1.20, giving a wholesaler/distributor incremental markup (MUDIST INCR) of 1.20 ($1.20 ÷ $1.00).

DOE recognizes that there is a possibility of case­to­case deviation in the markups

developed from the above financial data. Based on the analysis of U.S. Census Bureau data for

wholesalers, DOE calculated a standard deviation of 12.1 percent (see appendix C for further

details). DOE assumed that the variation determined for the baseline markup applied to the

incremental markup as well. For the baseline markup of 1.46, a standard deviation of 12.1

percent translates into an absolute value of 0.056. For the incremental markup of 1.20, a

standard deviation of 12.1 percent translates into an absolute value of 0.024.

The national level census data on distribution of BVM units suggest that over 95 percent

of new units sold pass through bottler/distributors or wholesaler/distributors. Uncertainty in the

quantitative value of markups is introduced into the LCC analysis through the use of the Excelspreadsheet based Crystal Ball program. DOE applied the same baseline and incremental markup

to all sales of BVM units passing through wholesaler/distributors.

6.4 SALES TAX

The sales tax represents State and local sales taxes that are applied to the customer price

of BVM units. The sales tax is a multiplier that increases the customer equipment price. DOE

derived sales taxes representative of the combined State and local sales tax rates from the Sales

Tax Clearinghouse,6 shown in Table 6.4.1. The State level combined tax rates can be applied to

the estimated value of State level BVM equipment shipments to obtain the total purchase cost to

the customer located in any State.

Table 6.4.1 State Sales Tax Rates

State

Combined

State and Local

Tax Rate [%]

State

Combined

State and Local

Tax Rate [%]

State

Combined

State and

Local Tax Rate

[%]

Alabama 8.05 Kentucky 6.00 North Dakota 5.50

Alaska 1.15 Louisiana 8.60 Ohio 6.75

Arizona 7.65 Maine 5.00 Oklahoma 8.15

Arkansas 8.00 Maryland 5.00 Oregon 0.00

California 7.95 Massachusetts 5.00 Pennsylvania 6.25

Colorado 6.15 Michigan 6.00 Rhode Island 7.00

Connecticut 6.00 Minnesota 6.70 South Carolina 5.80

Delaware 0.00 Mississippi 7.00 South Dakota 5.25

Dist. of Columbia 5.75 Missouri 6.85 Tennessee 9.40

Florida 6.70 Montana 0.00 Texas 7.95

Georgia 6.90 Nebraska 6.30 Utah 6.45

Hawaii 4.00 Nevada 7.50 Vermont 6.00

Idaho 5.05 New Hampshire 0.00 Virginia 5.00

Illinois 7.55 New Jersey 6.00 Washington 8.45

Indiana 6.00 New Mexico 6.55 West Virginia 6.00

Iowa 6.60 New York 8.25 Wisconsin 5.40

Kansas 6.95 North Carolina 7.05 Wyoming 5.35

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The distribution of sales tax rates ranges from a minimum of zero percent to a maximum

of 9.4 percent with a mean value of 6.8 percent. DOE applied the average sales tax to the

customer equipment price irrespective of the distribution channel and the market in which the

customer is located.

6.5 OVERALL MARKUPS

DOE multiplied the direct and wholesaler/distributor markups described above by the

average sales tax multiplier to obtain the overall baseline and incremental markups shown in

Table 6.5.1 and Table 6.5.2. DOE based overall markups on one of two distribution channels

according to how the equipment is purchased: either directly or through a wholesaler/distributor,

and the State into which the BVM unit is delivered. Table 6.5.1 presents two markups for the

overall baseline markup and the overall weighted average baseline markup, and Table 6.5.2

presents the same information for overall incremental markups.

Table 6.5.1	 Baseline Average Markups by Distribution Channel and Overall Average

Markup, Including the Sales Tax Multiplier

Manufacturer Direct Wholesaler/Distributor

Overall Weighted

Average

Markup 1.0 1.46 1.147

Sales Tax Multiplier 1.068 1.068 1.068

Overall Markup 1.068 1.559 1.226

Table 6.5.2 Incremental Average Markups by Distribution Channel and Overall Average

Markup, Including the Sales Tax Multiplier

Manufacturer Direct Wholesaler/Distributor

Overall Weighted

Average

Markup 1.0 1.20 1.064

Sales Tax Multiplier 1.068 1.068 1.068

Overall Markup 1.068 1.282 1.137

DOE used the overall markups to estimate the customer price of baseline equipment,

given the manufacturer cost of baseline equipment. For example, if the MSP of a baseline BVM

unit is $1,000, DOE can multiply this by the average overall baseline markup to estimate that the

baseline customer price of the BVM unit sold is $1,559. Similarly, DOE used the overall

incremental markup to estimate changes in the customer price, given changes in the MSP above

the baseline due to increases in equipment efficiency. For example, if a new standard increases

the BVM MSP by $100, DOE can multiply this price ($100) by the average overall incremental

markup (1.282) to estimate a customer price increase of $128.

6.6 RESULTS

The overall baseline and overall incremental markups are presented in section 6.5. These

markups will be used with the MSPs to generate customer prices for refrigerated beverage

vending machines. Supporting data for the calculation of baseline and incremental markups are

provided in appendix C.

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REFERENCES
 

1 State of the Vending Industry Report. 2006. "Operators slow to invest; sales rise 3 points in

2005", Automatic Merchandiser, www.amonline.com (Accessed on June 25, 2007), pp. 40­

62. August 2006.

2 Lawrence Berkeley National Laboratory (LBNL) 2004. “An Analysis of Price Determination

and Markups in the Air­Conditioning and Heating Equipment Industry.” LBNL­52791

3 Mark Metoyer as reported in Mark Skaer, “What should you charge? Try These Tested

Formulas,” Air Conditioning, Heating and Refrigerator News, March 26, 2001.

4 U.S. Census Bureau. 2002. 2002 Economic Census Release Date: 12/3/2004

Sector 42: Wholesale Trade: Industry Series: Product Lines by Kind of Business for the

United States: 2002 at http://factfinder.census.gov/servlet/IBQTable?_bm=y&­

MFG=10971:42&­ds_name=EC0242I3&­_lang=en (Accessed on April 16, 2007.)

5 Pindyck, R. and D. Rubinfield. 2000. Microeconomics, Prentice­Hall.

6 The Sales Tax Clearinghouse. https://thestc.com/STRates.stm (Accessed on June 25, 2007.)

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