Small Business Impacts in the Low Voltage Dry Type Distribution Transformer Industry

Purpose

For each rulemaking DOE conducts a Regulatory Flexibility Analysis, the purpose of which is to

assess the impacts of standards on the small businesses to which a new rule would directly apply. The

results of this assessment represent a key consideration in DOE’s determination of whether a given

standard level is “economi cally justifie d.” Given the accentuated concerns about small manufacturer

impacts in the LVDT market, DOE is presenting preliminary findings here—essentially the “guts” of the

Regulatory Flexibility Analysis—for the Committee’s negotiations.

In terms of scope, DOE has traditionally focused its small business analysis on U.S. small

businesses with domestic production, given con cerns about ad verse impacts on U.S. employment.

However, while production location is most important in terms of employment impacts, some

companies with foreign production (either contracted or in

‐ house) may have R&D, sales, and

administrative staff in the U.S. As such, DOE considers impacts on these businesses as well, although

potential U.S. employ ment impa cts are usually less severe.

The definition of a small business excludes those businesses with more than 750 employees,

including employees of any subsidiaries and any parent companies.

Overview

DOE consulted NEMA membership lists, contact lists from previous rulemakings, UL qualification

directories, DOE’s compliance and certification database, and conducted additional internet research to

identify any possible manufacturers of distribution transformers. These sources yielded 56 unique

manufacturers; of these, 36 appeared to produce LVDT transformers based on an initial screening and

contac ts. Up on further investigation, DOE found six of these to be either distributors or transformer

engineering firms only.

Of the 30 remaining companies:

 4 firms are large companies with significant market share.

 14 firms met the definition of a small business.

 12 firms could be considered small play ers in the industry but do NOT meet the definition of

a US small business (they have a parent company with more than 750 employees AND/OR

their operations are primarily outside the US). Of these 12:

o 5 were foreign owned AND operated;

o 7 were operated primarily in the US, but had parent companies with more than 750

employees2

2 Table 1 Summary of LVDT Market Structure

DOE attempted to contact all 26 low

‐ volume manufacturers whether they technically met the

US small business definition or not. Those low

‐ volume companies that did not meet the small business

definition would presumably face similar impacts as those meeting the definition, with the exception

that some low

‐ volume players operating as subsidiar ies to larger paren ts may have greater access to

capital, and, in rare instances, shared buying power.

Of the 14 U.S. small businesses, DOE was able to reach 8 companies. (See table below.) Of these

8, two effectively said DOE LVDT transformers was a negligible part of their business and we re not

intereste d in discussing the issue further.

Of the 12 companies that do NOT meet the definition of a small business—but, being low

‐

volume manufacturers, would be expected to have a similar perspective as those who did—DOE was

able to reach 5 companies. (See table below.) Of these 5

, 3 are foreign owned and operated but rely on

the US market for a significant portion of their business, while 2 are U.S. operated.

The Nature of Low

‐ Volume Manufacturer Competition

By and large, low

‐ volume manufacturers do not compete directly with large manufacturers

using business models similar to those of their bigger rivals: Economies of scale disadvantages in

purchasing and production are usually too great a barrier in the DOE

‐ covered LVDT space. The

exceptions to this rule are those companies tha t also compete in the medium voltage market and, to

some extent, are able to leverage that experience and production economies. More typically, however,

low

‐ volume manufacturers have focused their operations on one or two parts of the value chain—

rather than all of it—and trained their sights on market segments outside of th e hig h

‐ volume baseline

efficiency space. 14

Meet US Small Biz Definition 12

Low

‐ volume, But Don't Meet Definition 30 Companies Identifed as LVDT Manufacturers

4

Large Mkt Share

and Don't Meet

Small Biz Def

Reached 5 Reached 8 14

Meet US Small Biz Definition 12

Low

‐ volume, But Don't Meet Definition 30 Companies Identifed as LVDT Manufacturers

4

Large Mkt Share

and Don't Meet

Small Biz Def3

3 In terms of operations, some small firms focus on the engineering and design of transformers,

sourcing production of the cores or even the whole transformer, while others focus on just production,

rebranding for companies that offer broader solutions through their own sales and distribution

networks.

In terms of market focus, many simply compe t e entirely in the DOE exempted space. DOE did

not attempt to contact companies operating entirely in this very fragmented market. Of those that

compete in the DOE

‐ covered market, a few small businesses reported a focus on the high

‐ end of the

market focus, often selling NEMA Premium or better transformers as retrofit op portunities. Others

focus on particular applications or other niches, like data centers, and become well

‐ versed in the unique

needs of a particular customer base.

Small Manufacturer Views on Standards

To facilitate the discussion with manufacturers unfamiliar with the ongoing rulemaking, DOE

used the NEMA Premium level as a familiar benchmark for discussing potential impacts and business

responses to standards. Perhaps due to the wide range of business models, no consistent position on a

hypothetical minimum standard set at NEMA pr emium em erged. Manufacturers had a range of

perspectives on the level of impacts and on how they foresaw their company responding. Those

companies with an established sourcing strategy and/or high

‐ efficiency market focus were not

concerned with the prospect of a standard set at NEMA Premium. Those manufacturers producing

most cores in

‐ house at or near baseline efficie ncy lev els generally had greater reservations about NEMA

Premium, as these companies faced greater levels of conversion costs and uncertainty about impacts on

their businesses.

Beyond those general trends, it would be inaccurate to describe manufacturer positions on an

increase in the standard as falling predi c tably along other dimensions. In

‐ house mitering capability did

not imply greater ease with the prospect of standards set at NEMA Premium. Those companies with

mitering capability were actually among those most concerned with such a level because their machines

were optimized for larger units, often in the MVDT space, and co uld no t be easily dual

‐ purposed. These

companies were also usually the larger of the smaller players and thus were likely more automated and

less flexible than some smaller competitors. Along the same lines, a given company’s perspective on

higher standards did not correlate with the share of revenue expo sed to DOE standards. In a few cases,

the companies that derive the greatest portion of their revenue from DOE

‐ covered LVDT transformers

are positioned at the high end of the market and welcome higher standards. Conversely, a company

generating, say, only a quarter of its revenue from DOE

‐ covered transformers may be competing more

directly with high

‐ volume players at the baseline effi cien cy levels and face significant conversion costs to

continue to operate its current business model with NEMA Premium as the minimum standard.

Consistent with expectations, those manufacturers with concerns about changes to standards

generally said those concerns became more acute with greater stri ngen cy; however, their statements

about their potential responses did not really change with CSL2 to CSL3 to CSL4. That is, DOE’s small4

4 business interviews did not reveal an “inflection point” where manufacturers generally agreed on a level

that would trigger a certain business response (invest or source or exit). More accurately, the

companies that were concerned about standards took the position that any change at all would require

an assessment of how to proceed strategically. Tho s e that said they would probably exit the product

line or have to seriously consider it did not make a distinction between CSL2 and higher levels. In some

instances, those concerned with higher standards were unable to describe differential impacts between,

say, CSL 2 and CSL3 and CS L4, beca use they had not yet studied the impacts. [However, more

sophisticated manufacturers, including large manufacturers, did express serious concerns at CSL4 and

above because of their lack of experience at those efficiencies and with the design options that would

be open to them. In particular, manufacturers expressed concern that ac hieving CSL4 would be very

challenging with low KVAs units, and some expected that much of the industry would move to wound

cores for these KVAs, with which most have little production experience. Relative to CSL4, a NEMA

Premium level would allow them more flexibility in core construction and steel choice across a wider

range of KVA s

. This would mitigate investment impacts and smooth some production processes.]

On the other hand, businesses with a high

‐ efficiency market orientation generally took the

position that they’d be able to compete no matter the standard level. One caveat to that is that two

small businesses with a hig h

‐ efficiency market focus expressed some concern with a standard above

NEMA Premium: While it may move market share their way, it could also begin to commoditize their

niche.

Three of the 13 companies that DOE reached noted the potential of exiting the DOE

‐ covered

LVDT market due to a chan ge in standards, but only one mentioned threat of going out of business

altogether. The other two, based on their exposure to the DOE

‐ covered market, would likely experience

a small reduction in company value from either exiting the business or sourcing cores.

The following tables illustrate how the small busi n esses are positioned along key dimensions

and summarize their individual assessment on higher standards. NOTE THAT THE ANSWERS ARE

SCRAMBLED IN RANDOM ORDER ACROSS EACH ROW. IN OTHER WORDS, THE CELLS IN ANY GIVEN

COLUMN DO NOT PERTAIN TO ANY ONE MANUFACTURER. This presentation is intended to show the

range and dis t ribution of metrics and manufacturer positions while protecting the confidentiality of

each manufacturer. The amount of revenue associated with DOE

‐ covered LVDT transformers for each

company was rounded to the nearest 5%.

Of the Six US Small businesses:

 An average of 38% of total company revenue comes from DOE

‐ covered LVDT Distribution

Transformers.

 4/6 produce in th e U.S .; however, the majority of the volume produced by these six is produced

outside the country.

 3/6 also compete in MVDT market.

 3/6 have in

‐ house mitering or wound core capability.5

5 Table 2 Responses from US Small Businesses

Issue: 

### Answers to each question are scrambled in each row to protect

confidentiality. A given column does NOT represent one

manufacturer’s complete set of answers.

Revenue from

DOE-covered

LVDT 

### 35% 25% 20% 5% 65% 80%

Expected

Impact and

Response to a

standard set at

a NEMA

Premium Level Unsure. But

probably don’t

have ability to

meet. No impact. Not a significant

impact.

Probably would

source cores;

depends on

steel prices. Would probably

exit product line.

Minimum of

$750K

investment in

new machinery. Significant

impact, but

would likely

invest to make

in house,

although

source a

greater share

of cores. Unsure. If

capital too

great, they’d

exit the LVDT

market.

Also in MVDT? Yes No Yes No. No Yes.

Produce in US? Yes No. No Yes Yes Yes.

Share of cores

sourced

currently. 100% 0% Varies

depending on

pricing. 0% 20% 0%

In-house

mitering or

wound core

capability?* Yes. Yes. No. Yes. No. No.

Capital and

one-time R&D

investments Unknown $1.6 M for

NEMA Premium Not provided.

Not a concern. $0 Unknown $750K to

$1.5M6

6 Table 3 Low Volume Manufacturers

Issue: 

### Answers to each question are scrambled in each row to protect

confidentiality. A given column does NOT represent one

manufacturer’s complete set of answers.

Share of Revenue

from DOE-covered

LVDT 

### 100% Up to 40% 100% 35% 35%

Expected Impact

and Response to a

standard set at a

NEMA Premium

Level Unclear; significant

investment in that

there would be

investment would be

R&D for new

designs. No Impact.

Already in high

efficiency focus. No Impact.

Already in high

efficiency focus. No Impact.

Already in high

efficiency focus. Big Impact.

Would likely

source cores.

Also in MVDT

Market? No No Yes No No

Produce in US? No No Yes No Yes

Share of cores

sourced currently 100% 0% Varies 0% Varies

In-house full

mitering or wound

core capability?* Yes Yes Yes No Yes

Capital and onetime R&D

investments $0 $1.5M minimum Unknown but

significant R&D $0 $07

7 Estimated Capital Conversion Costs—Entire Industry

To calculate conversion costs, DOE took two approaches. First, it aggregated estimates from

manufacturers gathered during interviews and discussions and scaled those estimates to represent the

market share of those not interviewed or those unable to estimate costs. For the second approach, DOE

interviewed equipment manufacturers and modeled the incremental equi pment nee ds that would be

required by the industry based on the design options available to them and the fact that capacity needs

rise as steels get thinner and units get heavier. The two approaches yielded similar results. CSLs 1

through CSL 4 below represent the first approach, CSL5 through CSL 7 represent DOE’s modeled

estimates be cause most manufacturers were un able to provide estimates for these levels due to much

greater uncertainty over how they would proceed.

The two tables below represent conversion cost estimates under two different scenarios related

to small businesses. In the first table, DOE assumes most small manufacturers opt to source their cores

subject to DOE

‐ standards. The second table assumes most small manufacturers invest to maintain

production of DOE

‐ covered LVDT transformers in

‐ hou s e, a scenario DOE views as less likely.

Table 4 Estimated Capital Conversion Costs

– Entire Industry



### Under Assumption that Most Small Businesses Opt to Source Cores

CSL1 CSL2 CSL3 CSL4 CSL5 CSL6* CSL7*

Capital

Conversi

on Costs $ 3.0 $ 5.3 $ 8.0 $ 11.4 $ 14.3 $ 23.8 $ 23.8

Product

Conversi

on Costs $ 1.0 $ 3.0 $ 4.0 $ 5.0 $ 8.0 $ 8.0 $ 8.0

*Conversion to SA1 lines

Under Assumption That Most Sm all B usinesses Invest to Maintain Current Production

CSL1 CSL2 CSL3 CSL4 CSL5 CSL6* CSL7*

Capital

Conversi

on Costs $ 4.4 $ 7.7 $ 12.5 $ 15.9 $ 18.8 $ 32.2 $ 32.2

Product

Conversi

on Costs $ 2.6 $ 3.9 $ 5.2 $ 6.5 $ 14.0 $ 14.0 $ 14.0

*Conversion to SA1 lines Industry Conversion Costs ($M)8

8 Disproportional Impacts on Small Businesses

Because of the largely fixed nature of the one

‐ time conversion expenditures distribution

transformer manufacturers would incur as a result of standards, small manufacturers who choose to

invest to maintain in

‐ house production will likely be disproportionately impacted compared to large

manufacturers. The below example illu strates the impact of $1 million investment in mitering

equipment and other tooling and a $200K investment in R&D, testing and engineering time and expense

associated with a standard change. As Table 5 indicates, small manufacturers face a greater relative

hurdle in complying with standards should they opt to con tinue to maintain co re production in

‐ house.

These calculations assume annual capital expenditures of 2.5% and 3%, respectively, for large and small

manufacturers. DOE also assumes R&D expenses of 2.5% and 3% of revenue for large and for small

manufacturers, respectively.

Table 5 Example of Relative Impacts of Conversion Costs on Small Manufacturers

Domestic Employment Impacts

DOE estimates they are between 1,500 and 2,500 employees associated with DOE

‐ covered LVDT

production. Most of these employees are located outside of the U.S. Typically, high

‐ volume units are

made in Mexico, taking advantage of lower labor rates, while custom designs are made closer to the

manufacturer’s customer base or R&D cent ers. DOE does not expect large changes in domestic

employment to occur due to a standard. Most production already occurs outside the U.S., and, by and

large, manufacturers agreed that most design changes necessary to meet higher efficiency standards

would increase labor expenditures, not decrease it.

In terms of sm all businesses, DOE does not expect a large negative impact on US employment at

CSL 3 and below. Those businesses that are unsure whether they would continue to produce units at

these levels either already produce outside the country or, if they are in the country, have very low 

### Capital Conversion

Cost as a Percentage

of Annual Capital

Expenditures Product Conversion

Cost as a Percentage

of Annual R&D

Expense Total Conversion

Cost as a

Percentage of

Annual EBIT

Large Player 54% 11% 22%

Small Player 202% 49% 97%9

9 levels of employment dedicated to the LVDT DOE

‐ covered space. Any slight negative impacts among

these players would likely be offset by slight positive impacts at those small companies that do invest to

produce at higher efficiency levels (which generally require more labor) or by increases in employment

at domestic core makers, u nder the assumption tha t at least some share of newly sourced cores goes to

domestic core makers. There is greater uncertainty and risk with levels at CSL 4 and above because of

the industry’s lack of experience producing cores at those levels.10

10 

### Attachment: Interview Questions

1. Do you make distribution transformers covered by DOE low

‐ voltage energy efficiency standards

in

‐ house? For medium voltage?

If yes, for ONLY the DOE

‐ covered transformers:

2. Do you cut the steel and make the cores in

‐ house or do you source some or all of the cores?

a. If you source, what share of your DOE

‐ covered transf ormers empl oy sourced cores or

sourced laminations?

b. If you source some cores, what is the typical reason for doing so? (Can’t produce units

of that efficiency, not economic, other, etc.)

3. Do you make your transformers in domestic facilities?

4. What share of your busin e ss by revenue is associated with distribution transformers (both in

DOE scope and out of DOE scope)?

5. What share of your business by revenue is associated with DOE

‐ covered distribution

transformers? If you make both LVDT and MVDT, please break each out.

6. Do you make any mitered core or wound core designs in house? Do you make an y NEMA

premium units in

‐ house?

7. In the event a new efficiency standard required mitered or wound core designs, how would you

expect to respond (source DOE

‐ covered cores, invest in mitering or wound core e quipm ent, exit

product line, etc)? Why? Please describe the business impacts and considerations of these

various responses.