6-i

CHAPTER 6. MARKUPS FOR PRODUCT PRICE DETERMINATION

TABLE OF CONTENTS

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

6.1.1 Distribution Channels...................................................................................................... 6-2

6.2 MARKUP CALCULATION METHODOLOGY........................................................... 6-3

6.3 MANUFACTURER MARKUP ...................................................................................... 6-4

6.4 APPROACH FOR CALCULATING WHOLESALER AND CONTRACTOR 

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

6.4.1 Assumptions..................................................................................................................... 6-5

6.4.2 Approach for Wholesaler Markup ................................................................................... 6-7

6.4.3 Approach for Mechanical and General Contractor Markup ............................................ 6-8

6.5 DERIVATION OF NATIONAL WHOLESALER AND CONTRACTOR 

MARKUPS ...................................................................................................................... 6-9

6.5.1 Wholesaler Markups........................................................................................................ 6-9

6.5.2 Mechanical Contractor Markups.................................................................................... 6-10

6.5.2.1 Markups for Mechanical Contractors in the Replacement and New 

Construction Markets................................................................................... 6-11

6.5.3 Estimation of General Contractor Markups................................................................... 6-13

6.6 DERIVATION OF REGIONAL MARKUPS............................................................... 6-14

6.6.1 Regions Being Analyzed................................................................................................ 6-14

6.6.1.1 Estimation of Regional Wholesaler Markup................................................ 6-14

6.6.1.2 Estimation of Regional Mechanical Contractor Markup............................. 6-15

6.6.1.3 Estimation of Regional General Contractor Markup................................... 6-16

6.7 MARKUP FOR MOBILE HOME GAS FURNACES.................................................. 6-17

6.8 SALES TAX .................................................................................................................. 6-18

6.9 OVERALL MARKUPS................................................................................................. 6-18

LIST OF TABLES

Table 6.5.1 Wholesaler Expenses and Markups..................................................................... 6-9

Table 6.5.2 Baseline Markup, All Mechanical Contractors.................................................. 6-10

Table 6.5.3 Baseline Markups for the Replacement and New Construction Markets, 

All Mechanical Contractors............................................................................... 6-11

Table 6.5.4 Mechanical Contractor Expenses and Baseline Markup, Residential and 

Light Commercial .............................................................................................. 6-12

Table 6.5.5 Mechanical Contractor Expenses and Markups Based on Census Bureau 

Data .................................................................................................................... 6-12

Table 6.5.6 General Contractor Expenses and Markups....................................................... 6-13

Table 6.6.1 Regional Wholesaler Markups for Furnaces...................................................... 6-15

Table 6.6.2 Regional Wholesaler Markups for CACs and HPs............................................ 6-15
6-ii

Table 6.6.3 Population-Weighted Regional Mechanical Contractor Markups for 

Furnaces............................................................................................................. 6-16

Table 6.6.4 Population-Weighted Regional Mechanical Contractor Markups for CACs 

and HPs.............................................................................................................. 6-16

Table 6.6.5 Regional General Contractor Markups for Furnaces......................................... 6-17

Table 6.6.6 Regional General Contractor Markups for CACs and HPs............................... 6-17

Table 6.8.1 Average Sales Tax Rates by Census Division and Large State ......................... 6-18

Table 6.9.1 Summary of National Average Markups on CACs, HPs, and Residential 

Furnaces and Boilers.......................................................................................... 6-20

Table 6.9.2 Summary of Markups on Different Types of Residential Furnaces and 

Boilers................................................................................................................ 6-20

LIST OF FIGURES

Figure 6.1.1 Distribution Channels for Residential Furnaces, Central Air Conditioners 

and Heat Pumps ................................................................................................... 6-3

Figure 6.1.2 Distribution Channel for Mobile Home Gas Furnaces........................................ 6-3
6-1

CHAPTER 6. MARKUPS FOR PRODUCT PRICE DETERMINATION

6.1 INTRODUCTION

To carry out its analyses, DOE needed to determine the cost to the consumer of baseline 

products and the cost of more efficient units the consumer would purchase following the 

promulgation of new energy conservation standards. However, the consumer price of baseline or 

higher efficiency equipment is not generally known. For this analysis the price would be 

determined based on engineering estimates of manufacturing costs plus appropriate markups 

based on how the equipment is purchased. 

For wholesalers and contractors, DOE estimated a baseline markup and an incremental 

markup. DOE defined a baseline markup as a multiplier that converts the manufacturing selling 

price of equipment with baseline efficiency to the consumer purchase price for the equipment at 

the same baseline efficiency level. An incremental markup is defined as the multiplier to convert 

the incremental increase in manufacturing selling price of higher efficiency equipment to the 

consumer purchase price for the same equipment. Because companies mark up the price to cover 

business cost and profit margin at each step in the distribution channel, both baseline and 

incremental markups are dependent on the particular distribution channel, as described in Section 

6.1.1.

In this chapter, DOE first addresses the differences between distribution channels and the 

methodology used to derive baseline and incremental markups. DOE then summarizes the results 

in two sections: (1) national markups estimation and (2) regional markups estimation. The reason 

that DOE differentiated markups between national and regional estimations is that additional 

regional standards for all market participants are proposed for furnaces and central air 

conditioners and heat pumps in The Energy Policy and Conservation Act (EPCA), as amended 

by the Energy Independence and Security Act of 2007. Hence, DOE is considering regional 

standards for central air conditioners and heat pumps for two regions (Hot-Humid and Hot-Dry), 

in addition to a base national standard that would prevail in states throughout the rest of the 

country. DOE is also considering regional standards for residential furnaces and boilers that 

would have two regions (North and South). Since the regional division for furnaces is different 

from the division for central air conditioners and heat pumps, regional markup estimations for 

each of these market participants are presented in separate tables as shown in Section 6.6. 
6-2

6.1.1 Distribution Channels

The appropriate markups for determining consumer equipment prices depend on the type 

of distribution channels through which products move from manufacturers to purchasers. At each 

point in the distribution channel, companies mark up the price of the equipment to cover their 

business costs and profit margin. 

Two types of distribution channels describe how most equipment passes from the 

manufacturer to the consumer, as shown in Figure 6.1.1. The first distribution channel applies to 

furnaces, central air conditioners, and heat pumps installed in the replacement markets. In this 

replacement distribution channel, the manufacturer sells the equipment to a wholesaler, who in 

turn sells it to a mechanical contractor, who in turns sells it to the consumer. The second 

distribution channel applies to furnaces and central air conditioners and heat pumps that are 

installed in new construction, and thus includes an additional link in the chain—the general 

contractor. In this new construction distribution channel, the manufacturer sells the equipment to 

a wholesaler, who in turn sells it to a mechanical contractor, who in turn sells it to a general 

contractor, who in turns sells it to the consumer.

a

Figure 6.1.1 illustrates the two main distribution channels for furnaces and central air 

conditioners and heat pumps. These two channels also apply to all of the central air conditioner 

(CAC) and central heat pump (CHP) product classes and five of the six furnace product classes 

(all but mobile home gas furnaces). DOE calculated the markups for non-weatherized gas 

furnaces and used these markups to develop the markups for weatherized gas furnaces, oil-fired 

furnaces, gas boilers, and oil-fired boilers.

 

a One manufacturer uses a one-step distribution chain (manufacturer to contractor) and is the only known exception. 

Several large retailers are trying to step between wholesalers and contractors, but most experts do not expect the 

trend to change the distribution chain significantly in the near term.
6-3

 Replacement:

 

 New Construction:

Figure 6.1.1 Distribution Channels for Residential Furnaces, 

Central Air Conditioners and Heat Pumps

Mobile home gas furnaces are sold as part of mobile homes, so these furnaces have a 

specific distribution chain (Figure 6.1.2). The heating-equipment manufacturer sells to the 

maker of the mobile home, who installs the equipment in the home. The mobile home maker 

sells the home to a reseller, who in turns sells it to a homebuyer. The equipment manufacturer 

markup for mobile home gas furnaces is identical to the manufacturer markup for other furnaces, 

as described in Section 6.3 below. The markup derivation for mobile home gas furnaces is 

described in Section 6.7.

Figure 6.1.2 Distribution Channel for Mobile Home Gas 

Furnaces

6.2 MARKUP CALCULATION METHODOLOGY

As just discussed, at each point in the distribution channel, companies mark up the price 

of the equipment to cover their business costs and profit margin. In financial statements, gross 

margin is the difference between the company revenue and the company cost of sales or cost of 

goods sold (CGS). The gross margin includes the expenses of companies in the distribution 

channel—including overhead costs (sales, general, and administration); research and 

development (R&D) and interest expenses; depreciation and taxes—and company profits. In 

Manufacturer Wholesaler Mechanical

Contractor

Consumer

Wholesaler Mechanical 

Contractor

General 

Contractor

Consumer

Manufacturer Mobile Home 

Manufacturer

Mobile Home 

Reseller

Consumer

Manufacturer
6-4

order for sales of a product to contribute positively to company cash flow, the product’s markup 

must be greater than the corporate gross margin. Products command lower or higher markups, 

depending on company expenses associated with the product and the degree of market 

competition. 

Equipment manufacturers sell most of their products directly to wholesalers. 

Wholesalers sell to contractors at the wholesale price. Wholesalers absorb short-term imbalances 

in supply and demand, allowing manufacturers to operate more efficiently and satisfying 

consumer needs for fast deliveries. In addition, wholesalers are important sources for parts. 

Most contractors compete at the local level. Many carry more than one brand of furnaces and

central air conditioners and heat pumps, and most install the products they sell. The trend is for 

contractors to consolidate into larger companies, following similar trends set by wholesalers and 

manufacturers.

 In addition to the wholesaler and mechanical contractor markups, in new construction the 

general contractor adds a markup. In retrofit installations, sales tax applies to the final consumer 

cost. 

6.3 MANUFACTURER MARKUP 

DOE uses manufacturer markups to transform a manufacturer’s product cost into a 

manufacturer sales price. Using the CGS and gross margin, the manufacturer markup can be 

calculated as follows:

MFG

MFG MFG

MFG CGS

CGS GM MU + =

Where:

MUMFG = Manufacturer markup,

CGSMFG = Manufacturer cost of goods sold, and

GMMFG = Manufacturer gross margin.

6.4 APPROACH FOR CALCULATING WHOLESALER AND CONTRACTOR 

MARKUPS 

For the final rule, DOE examined the manner in which markups change by efficiency 

level and other factors for wholesalers and contractors. DOE determined that markups are neither 

fixed-dollar, nor proportional to all direct costs, which means that the selling price of a product 

may not be strictly proportional to the purchase price of the equipment. Using the available data, 

DOE has found measurable differences between incremental markups on direct equipment costs 

and the average aggregate markup on direct business costs. Additionally, DOE discovered 
6-5

significant differences between average and incremental markups for heating, ventilation, airconditioning and refrigeration (HVACR) wholesalers and for HVAC contractors. Section 6.4.2

and Section 6.4.3 further discusses the differences between average and incremental markups.

The main reason that the selling price of a product may not be strictly proportional to the 

purchase price of the equipment is that businesses incur a wide variety of costs. When the 

purchase price of equipment and materials increases, only a fraction of the business expenses 

increase, while the remainder of the businesses’ expenses stays relatively constant. For example,

if the unit price of an air conditioner increases by 30 percent, it is unlikely that the cost of 

secretarial support in an administrative office will increase by 30 percent also. Certain business 

expenses are uncorrelated with the cost of equipment or cost of goods.

6.4.1 Assumptions 

DOE derived the wholesaler and contractor markups from three key assumptions about 

the costs associated with furnaces and central air conditioners and heat pumps. DOE based the 

wholesaler and mechanical contractor markups on firm-level income statement data, while it 

based the general contractor markups on U.S. Census Bureau data for the residential building 

construction industry. DOE obtained the firm income statements from the Heating, Airconditioning & Refrigeration Distributors International (HARDI) 2010 Profit Planning Report

and from the Air Conditioning Contractors of America (ACCA).

(1; 2)HARDI and ACCA are 

trade associations representing wholesalers and mechanical contractors, respectively. DOE used 

the financial data from the 2007 US Census of Business for developing general contractor 

markups in the same form as the income statement data for wholesalers and mechanical 

contractors. (3; 4) These income statements break down the components of all costs incurred by 

firms that supply and install air conditioning equipment.b The key assumptions used to estimate 

markups using these financial data are:

1. The firm income statements faithfully represent the various average costs incurred by 

firms distributing and installing residential furnaces, central air conditioners and heat 

pumps, and light-commercial furnaces.

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

manufacturer selling price (MSP) of furnaces, central air conditioners and heat pumps,

and boilers (variant costs); and 2) costs that do not vary with the MSP of furnaces, and

central air conditioners and heat pumps ( invariant costs).

3. Overall, wholesale and contractor prices for residential furnaces and central air 

conditioners and heat pumps vary in proportion to wholesale and contractor costs for 

 

b Wholesalers and mechanical contractors to which these reports refer handle multiple commodity lines, including 

residential and commercial air-conditioners and warm-air furnaces.
6-6

residential furnaces and central air conditioners and heat pumps included in the income 

statements. 

 In support of the first assumption, the income statements itemize firm costs into a 

number of expense categories, including direct costs to purchase or install the equipment, 

operating labor and occupancy costs, and other operating costs and profit. Although wholesalers 

and contractors tend to handle multiple commodity lines, including room air conditioners, 

furnaces, central air conditioners and heat pumps, and boilers, the data provide the most accurate 

available indication of the expenses associated with residential furnaces, central air conditioners 

and heat pumps, and boilers.

Information obtained from the trade literature, and from selected heating, ventilating, and 

air-conditioning (HVAC) wholesalers, contractors, and consultants, tends to support the second 

assumption; this information indicates that wholesale and contractor markups vary according to 

the quantity of labor and materials used to distribute and install appliances In the following 

discussion, DOE assumes a division of costs between those that do not scale with the 

manufacturer price (labor and occupancy expenses), and those that do (operating expenses and 

profit). This division of costs led to the estimate of wholesale and contractor markups described 

below. 

In support of the third assumption, the HVAC wholesaler and contractor industry is

competitive, and consumer demand for commercial heating and air conditioning is inelastic, i.e., 

the demand is not expected to decrease significantly with an increase in price of equipment. The 

large number of HVAC firms listed in the 2007 Census indicates the competitive nature of the 

market. For example, there are more than 700 HVAC manufacturers, (5) 5,300 wholesalers of 

heat pumps and air-conditioning equipment, (6) more than 170,000 general residential contractors,

36,000 commercial and institutional building contractors, (7) and 91,000 HVAC contractors(8)

listed in the 2007 Census. Following standard economic theory, competitive firms facing 

inelastic demand either set prices in line with costs or quickly go out of business. (9)
6-7

6.4.2 Approach for Wholesaler Markup 

Using the above assumptions, DOE developed baseline and incremental markups for 

wholesalers using the firm income statement from the Heating, Air-conditioning & Refrigeration 

Distributors International (HARDI) 2010 Profit Report (Appendix 6A.2). DOE used the baseline 

markups, which cover all of the wholesaler’s costs (both invariant costs and variant costs), to 

determine the sales price of baseline models. Here variant costs were defined as costs that vary in 

proportion to the change in MSP induced by increased efficiency standards; in contrast, invariant 

costs were defined as costs that do not vary in proportion to the change in MSP due to increased 

efficiency standards. The baseline markup relates the manufacturer sales price to the wholesaler

sales price. DOE calculated the baseline markup for wholesalers using the following equation:

WHOLE

WHOLE WHOLE WHOLE

WHOLE

WHOLE WHOLE

BASE CGS

CGS IVC VC

CGS

CGS GM MU+ ( + ) = + =

Where:

MUBASE = Baseline wholesaler markup, 

CGSWHOLE = Wholesaler cost of goods sold,

GMWHOLE = Wholesaler gross margin, 

IVCWHOLE = Wholesaler invariant costs, and

VCWHOLE = Wholesaler variant costs.

Incremental markups are coefficients that relate the change in the manufacturer sales 

price of more energy-efficient models, or those products that meet the requirements of new 

energy conservation standards, to the change in the wholesaler sales price. Incremental markups 

cover only those costs that scale with a change in the manufacturer’s sales price (variant costs, 

VC). It calculated the incremental markup (MUINCR) for wholesalers using the following 

equation:

WHOLE

WHOLE WHOLE

INCR CGS

CGS VC MU + =

Where:

MUINCR = Incremental wholesaler markup,

CGSWHOLE = Wholesaler cost of goods sold, and

VCWHOLE= Wholesaler variant costs.
6-8

6.4.3 Approach for Mechanical and General Contractor Markup 

The type of financial data used to estimate markups for wholesalers is also available for 

mechanical contractors and general contractors from ACCA and the 2007 Economic Census. To 

estimate mechanical contractor markups for furnaces and central air conditioners and heat 

pumps, DOE collected financial data from ACCA and from the Plumbing and HVAC 

Contractors (NAICS 23822) series from the 2007 Economic Census. To estimate general 

contractor markups, DOE collected data from the Residential Building Construction series from 

the 2007 Economic Census, which is the aggregation of New Single-Family General Contractors

(NAICS 236115), New Multifamily Housing Construction (NAICS 236116), New Housing 

Operative Builders (NAICS 236117), and Residential Remodelers (NAICS 236118). ACCA 

financial data provides gross margin (GM) as percent of sales for the mechanical contractor 

industry; therefore, baseline markup can be derived with the following equation:

(%) (%)

(%)

Sales GM

Sales MUBASE − =

The census data include the number of establishments, payroll for construction workers, 

value of construction, cost of materials, and cost of subcontracted work at both state and national 

level. DOE calculated the baseline markup for mechanical contractors and general contractors

using the following equation:

Pay MatCost SubCost

V MU CONSTRUCT

BASE + + =

Where:

MUBASE = Baseline mechanical contractor or general contractor markup,

VCONSTRUCT = Value of construction,

Pay = Payroll for construction workers,

MatCost = Cost of materials, and

SubCost = Cost of subcontracted work.

Analogously, DOE estimated the incremental mechanical contractor and general 

contractor markups by only marking up those costs that scale with a change in the 

manufacturer’s sales price (variant costs, VC) for higher energy efficiency products. As stated in 

Section 6.4.1, DOE assumes a division of costs between those that do not scale with the 

manufacturer price (labor and occupancy expenses), and those that do (other operating expenses 

and profit). Hence, DOE categorized the Census cost data in each major cost category and 

estimated markups using the following equation:

CONT

CONT CONT

INCR CGS

CGS VC MU + =

Where:
6-9

MUINCR = Incremental contractor markup,

CGSCONT = Contractor cost of goods sold, and

VCCONT= Contractor variant costs.

6.5 DERIVATION OF NATIONAL WHOLESALER AND CONTRACTOR 

MARKUPS

6.5.1 Wholesaler Markups 

Wholesalers reported median data in a confidential survey that HARDI conducted of 

member firms.2 In the survey, HARDI itemized revenues and costs into cost categories, 

including direct equipment expenses (cost of goods sold), labor expenses, occupancy expenses, 

other operating expenses, and profit. DOE presents these data in full in Appendix 6A.1, Detailed 

Data for Equipment Price Markups. Table 6.5.1 summarizes them as cost-per-dollar sales 

revenue in the first data column.

Table 6.5.1 Wholesaler Expenses and Markups

Descriptions

Per Dollar

Sales Revenue

$

Per Dollar Cost 

of Goods

$

Direct Cost of Equipment Sales: Cost of goods sold 0.734 1.000 

Labor Expenses: Salaries and benefits 0.161 0.219

Occupancy Expense: Rent, maintenance, and utilities 0.038 0.052 

Other Operating Expenses: Depreciation, advertising, and insurance. 0.054 0.074

Operating Profit 0.013 0.018

Baseline Revenue: Baseline revenue earned per dollar cost of goods sold 1.362

Wholesaler Baseline Markup (MUWHOLE BASE) 1.362

Incremental Revenue: Increased revenue per dollar increase cost of goods sold 1.091

Incremental Markup (MUWHOLE INCR) 1.091

Source: Heating, Air Conditioning & Refrigeration Distributors International. 2010. 2010 Profit Report (2009 Data).

In this case, direct equipment expenses (cost of goods sold) represent about $0.73 per 

dollar sales revenue, so for every $1 wholesalers take in as sales revenue, $0.73 is used to pay 

the direct equipment costs. Labor expenses represent $0.16 per dollar sales revenue, occupancy 

expenses represent $0.04, other operating expenses represent $0.05, and profit accounts for $0.01 

per dollar sales revenue.

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

by dividing each figure in the first data column by $0.73 (i.e., cost of goods sold per dollar of 

sales revenue). The data in column two show that, for every $1.00 the wholesaler spends on 

equipment costs, the wholesaler spends $0.219 to cover labor costs, $0.052 to cover occupancy 

expenses, $0.074 for other operating expenses, and $0.018 in profits. This totals to $1.362 in 

sales revenue earned for every $1.00 spent on equipment costs. Therefore, the wholesaler

baseline markup (MUWHOLE BASE) is 1.362 ($1.362 ÷ $1.00).
6-10

DOE also used the data in column two to estimate the incremental markups. The 

incremental markup depends on which of the costs in Table 6.5.1 are variant and which are 

invariant with MSP. For example, for a $1.00 increase in the MSP, if all of the other costs scale 

with the MSP (i.e., all costs are variant), the increase in wholesale price will be $1.362, implying 

that the incremental markup is 1.362, or the same as the baseline markup. At the other extreme, 

if none of the other costs is variant, then a $1.00 increase in the MSP will lead to a $1.00 

increase in the wholesale price, for an incremental markup of 1.0. Actually, DOE believes that 

the labor and occupancy costs will be invariant and that the other operating costs and profit will 

scale with the MSP (i.e., be variant). In this case, for a $1.00 increase in the MSP, the wholesale

price will increase to match changes in ”other” operating costs and operating profit of $0.067, 

which when divided by 73.4 cents in cost of goods sold yields an increase of $0.091, giving a 

wholesaler incremental markup (MUWHOLE INCR) of 1.091. See appendix 6.A for cost details.

6.5.2 Mechanical Contractor Markups 

The HVAC contractors, defined here as mechanical contractors, reported median cost 

data in an ACCA financial analysis of the HVAC industry. These data are shown in Table 6.5.2. 

Table 6.5.2 Baseline Markup, All Mechanical Contractors

Description

Contractor Expenses or Revenue

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods

$

Direct Cost of Equipment Sales: Cost of goods sold 0.73 1.00

Gross Margin: Labor, occupancy, operating expenses, and profit 0.27 0.37

Revenue: Baseline revenue earned per dollar cost of goods 1.37

Baseline Markup (MUMECH CONT BASE) 1.37

Source: Air Conditioning Contractors of America. 2005. Financial Analysis for the HVACR Contracting Industry.

Data reported in this analysis are not as detailed as that provided by the other sources, 

containing only cost of goods sold and gross margin. Since the gross margin is the sum of labor, 

occupancy expenses, operating expenses, and profit, the gross margin allows for the 

determination of the baseline markup. The first data column in Table 6.5.2 provides the cost of 

goods sold and gross margin as expenses per dollar of sales revenue. The only important 

difference is that the direct cost of equipment sales in this table includes installation costs as well 

as the cost of goods sold. As shown in the table, the direct cost of sales represents about $0.73 

per dollar sales revenue to the contractor and the gross margin is $0.27 per dollar sales revenue. 

The mechanical contractor expenditures per dollar sales revenue in Table 6.5.2 are quite similar 

to the wholesaler expenditures per dollar sales revenue reported in Table 6.5.1.

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 $0.73. For every $1.00 the mechanical 

contractor spends on equipment costs, the mechanical contractor earns $1.00 in sales revenue to 

cover the equipment cost, and $0.37 to cover the other costs. This totals $1.37 in sales revenue 

earned for every $1.00 spent on equipment costs, for a baseline markup (MUMECH CONT BASE) of 1.37 
6-11

for mechanical contractors, since the contractor earns $1.37 in sales revenue for every $1.00 

spent to purchase the equipment. This is the beginning point for the determination of mechanical 

contractor markups.

6.5.2.1 Markups for Mechanical Contractors in the Replacement and New 

Construction Markets

The baseline markup derived above for mechanical contractors is the average value for 

all contractors including the replacement and new construction markets. This section describes 

how DOE further derived the baseline and incremental markups for these two markets. As above, 

the ACCA financial data provided gross margin data, which allows for the determination of only 

the baseline markup for the two markets, since the gross margin is the sum of all contractor labor 

and operating expenses plus profit. Calculation of the incremental markup uses Census Bureau 

data, because this was not possible with the ACCA data as the variant costs are not provided 

separately. 

Table 6.5.3 summarizes the gross margin and resulting baseline markup data for all 

mechanical contractors that serve the replacement and new construction markets. 

Table 6.5.3 Baseline Markups for the Replacement and New Construction Markets, All 

Mechanical Contractors

Description

Contractor Expenses or Revenue by Market Type

Replacement New Construction

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods

$

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods

$

Direct Cost of Equipment Sales: Cost 

of goods sold

0.70 1.00 0.75 1.00

Gross Margin: Labor, occupancy, 

operating expenses, and profit

0.30 0.43 0.25 0.33

Baseline Markup (MUMECH CONT BASE): 

Revenue per dollar cost of goods

NA 1.43 NA 1.33

Source: Air Conditioning Contractors of America. 2005. Financial Analysis for the HVACR Contracting Industry.

Using the baseline markup data from Table 6.5.3 and results of a financial analysis, DOE 

calculated that the baseline markups for the replacement and new markets are 4.4 percent higher 

and 2.9 percent lower, respectively, than that for all mechanical contractors serving all markets

shown in Table 6.5.2. 

DOE then used the ACCA data to calculate the baseline markup of 1.32 specifically for 

the residential and light commercial building construction sectors only as shown in Table 6.5.4. 
6-12

Table 6.5.4 Mechanical Contractor Expenses and Baseline Markup, Residential and 

Light Commercial

Description

Contractor Expenses or Revenue

Per Dollar

Sales Revenue

$

Per Dollar Cost of 

Goods

$

Direct Cost of Equipment Sales: Cost of goods sold 0.76 1.00

Gross Margin: Labor, occupancy, operating expenses, and profit 0.24 0.32

Baseline Markup (MUMECH CONT BASE): Revenue per dollar cost of goods 1.32

Source: Air Conditioning Contractors of America. 2005. Financial Analysis for the HVACR Contracting Industry.

The markup deviations derived above (i.e., 4.4 percent higher and 2.9 percent lower for 

the replacement and new construction markets, respectively) derived for all mechanical 

contractors were then applied to the baseline markup of 1.32 for the more specific residential and 

light commercial building construction sector. This resulted in baseline markups of 1.38 and 

1.28, respectively, for the replacement and new construction markets served by mechanical 

contractors for the residential and light commercial building construction sectors. 

Calculation of the incremental markups for each market type required separation of the 

invariant and variant costs. Since this was not possible using the ACCA data, DOE used more

detailed 2007 Census Bureau data for all plumbing, heating, and air-conditioning contractors.

The Census Bureau data were used to calculate the baseline and incremental markups as shown

in Table 6.5.5. (Appendix 6A.2 contains the full set of data.)

Table 6.5.5 Mechanical Contractor Expenses and Markups Based on Census Bureau Data

Description

Contractor Expenses or Revenue

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods

$

Direct Cost of Equipment Sales: Cost of goods sold 0.68 1.00

Labor Expenses: Salaries (indirect) and benefits 0.17 0.26

Occupancy Expense: Rent, maintenance, and utilities 0.02 0.03

Other Operating Expenses: Depreciation, advertising, and insurance. 0.04 0.06

Net Profit Before Taxes 0.09 0.13

Baseline Markup (MUMECH BASE): Revenue per dollar cost of goods 1.47

Incremental Markup (MUMECH INCR): Increased revenue per dollar increase cost of goods sold 1.18

Source: U.S. Census Bureau. 2007. Plumbing, Heating, and Air-Conditioning Contractors. Sector 23: 238220. Construction: 

Industry Series, Preliminary Detailed Statistics for Establishments, 2007.

Using the data in Table 6.5.5, the incremental markup is 20 percent lower than the 

baseline markup. DOE assumed that this deviation applies equally to the baseline markups 

calculated for the replacement (1.38) and new construction markets (1.28). This yields 

incremental markups of 1.104 and 1.024, respectively, for the replacement and new construction 

markets served by mechanical contractors.
6-13

6.5.3 Estimation of General Contractor Markups 

DOE derived markups for general contractors from U.S. Census Bureau data for the 

residential building construction sector. The residential construction sector includes 

establishments primarily engaged in construction work, including new construction work, 

additions, alterations, and repairs. The U.S. Census Bureau data for the construction sector 

include detailed statistics for establishments with payrolls, similar to the data reported by 

HARDI for wholesalers. The primary difference is that the U.S. Census Bureau reports itemized 

revenues and expenses for the construction industry as a whole 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. Similar to the 

data for wholesalers, Table 6.5.6 summarizes the expenses for general contractors as expenses 

per dollar sales revenue in the first data column (Appendix 6A.3 contains the full set of data). 

Table 6.5.6 General Contractor Expenses and Markups

Description

Wholesale Firm Expenses or Revenue

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods

$

Direct Cost of Equipment Sales: Cost of goods sold 0.68 1.00

Labor Expenses: Salaries (indirect) and benefits 0.08 0.12

Occupancy Expense: Rent, maintenance, and utilities 0.01 0.01

Other Operating Expenses: Depreciation, advertising, and insurance. 0.03 0.05

Net Profit Before Taxes 0.20 0.30

Baseline Markup (MUGEN CONT BASE): Revenue per dollar cost of goods 1.48

Incremental Markup (MUGEN CONT INCR): Increased revenue per dollar increase cost of goods sold 1.35

Source: U.S. Census Bureau. 2007. Residential Building Construction. Sector 23: 236115-236118. Construction: Industry Series: 

Preliminary Detailed Statistics for Establishments: 2007.

As shown in the first column, the direct cost of sales represents about $0.68 per dollar 

sales revenue to the general contractor. Labor expenses represent $0.08 per dollar sales revenue, 

occupancy expenses represent $0.01 per dollar sales revenue, other operating expenses represent 

$0.03, and profit makes up $0.20 per dollar sales revenue.

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 $0.68. The data in column two show that, for 

every $1.00 the general contractor spends on equipment costs, the general contractor earns $1.00 

in sales revenue to cover the equipment cost, $0.12 to cover labor costs, $0.01 to cover 

occupancy expenses, $0.05 for other operating expenses, and $0.30 in profits. This totals to 

$1.48 in sales revenue earned for every $1.00 spent on equipment costs. Thus, the general 

contractor baseline markup (MUGEN CONT BASE) is 1.48.

DOE was also able to use the data in column two in the table above to estimate the 

incremental markups, after classifying the costs as either invariant or variant. At one extreme, if 

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

general contractor price will be $1.48, implying that the incremental markup is 1.48, or the same 
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as the baseline markup. At the other extreme, if none of the other costs are variant, then a $1.00 

increase in the equipment price will lead to a $1.00 increase in the general contractor price, for 

an incremental markup of 1.0. DOE believed the labor and occupancy costs to be invariant and 

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

case, for a $1.00 increase in the equipment price, the general contractor price will increase by 

$1.35, giving a general contractor incremental markup (MUGEN CONT INCR) of 1. 35.

6.6 DERIVATION OF REGIONAL MARKUPS

6.6.1 Regions Being Analyzed

For furnaces, DOE is analyzing regional standards for northern and southern States. The 

northern region represents those states with average HDD greater or equal to 5,000 and the 

southern region represents those states with average HDD less than 5,000. To carry out the lifecycle cost calculation for different regions, wholesalers, mechanical, and general contractors in the

furnace industry are therefore divided into north and south subgroups. A list of the states in 

each region is provided in Appendix 6A. Furthermore, regional baseline and incremental 

markups are derived using the region/state level data from the 2010 HARDI Profit Report and 

the 2007 Economic Census.

For CACs and HPs, DOE is analyzing regional standards for Hot-Humid, Hot-Dry, and 

Rest of Country regions. The states are grouped such that the populations of the two hot 

regions generally average fewer than 5,000 heating degree-days (HDD). The Hot-Humid 

region has high relative humidity while the Hot-Dry region (California, Nevada, Arizona, and 

New Mexico) does not. The Rest of Country is the same as the northern region in the furnace 

analysis and includes those states that average 5,000 annual heating degree-days or more.

6.6.1.1 Estimation of Regional Wholesaler Markup 

Based on the regional income statement from the 2010 HARDI Profit Report, DOE 

estimated baseline and incremental markups for the seven HARDI regions (Northeastern, MidAtlantic, Southwestern, Great Lakes, Central, Southwestern, and Western) with the methodology 

shown in Table 6.5.1. Next, each state in each region was assigned the HARDI regional baseline 

and incremental markups for the region to which it belongs. Third, population-weighted baseline 

and incremental averages were calculated for the northern and southern regions as a whole.

Results are summarized in Table 6.6.1.
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Table 6.6.1 Regional Wholesaler Markups for Furnaces

Markup Rate Detailed Relative Rate

North

Baseline 1.369 1.004

Incremental 1.081 1.004

South

Baseline 1.361 0.998

Incremental 1.102 0.998

 

In the CAC and HP analysis, each state was assigned to one of the seven HARDI regions. 

The assignments for the northern states were identical to the furnace analysis. The southern 

states were assigned to the HARDI regions corresponding either to Hot-Humid or Hot-Dry. A 

relative markup factor was estimated for the HARDI regions and population-weighted average 

relative markup factors for the each of the three climate regions used in the analysis. These 

climate zone average relative markup factors were assigned to each state in each climate region

and applied to individual households when they were sampled for the analysis. The average 

relative markup factors and resulting regional markup rates are shown in Table 6.6.2.

Table 6.6.2 Regional Wholesaler Markups for CACs and HPs

Markup Rate Detailed Relative Rate

Hot-Humid

Baseline 1.343 0.986

Incremental 1.076 0.986

Hot-Dry 

Baseline 1.402 1.029

Incremental 1.123 1.029

Rest of Country (North)

Baseline 1.367 1.004

Incremental 1.095 1.004

6.6.1.2 Estimation of Regional Mechanical Contractor Markup

The 2007 Economic Census provides Geographic Area Series for the Plumbing and 

HVAC Contractors (NAICS 23822) sector, which contains state-level sale and cost data 

including value of construction, cost of subcontract work, cost of materials, and payroll for 

construction workers. By using the equation mentioned in Section 6.4.3, DOE was able to 

estimate baseline markups for each state. Since the Census does not provide more disaggregated 

cost data, DOE was not able to differentiate between invariant and variant cost. 

As an alternative, DOE calculated a statewide relative baseline markup, which equals the 

quotient of each state’s baseline markup and national average markup. The relative values are

multiplied times the mean markups for all four categories of mechanical contractor markup: both 

baseline and incremental markups for both new construction and replacements. The advantage of 
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taking this approach is that DOE is able to estimate regional markups for both distribution 

channels by using ACCA financial data supplemented with the U.S. Census data. For example, 

as shown in Table 6A.4.1, the relative mechanical contractor markup value for California is 

1.043, which would be multiplied times the mean markup factor of 1.28 for new construction, 

yielding a mechanical contractor baseline markup of 1.335. If instead the incremental markup on 

a replacement unit was needed, the 1.043 relative markup value would be multiplied times the 

mean incremental markup factor for replacements of 1.104, yielding a mechanical contractor 

markup value of 1.151. Lastly, DOE divided all states into northern and southern regions and 

then population-weighted baseline and incremental average markups were calculated for both 

regions, as shown in Table 6.6.3.

Table 6.6.3 Population-Weighted Regional Mechanical Contractor Markups for Furnaces

North Region South Region

Replacement

Baseline 1.384 1.376

Incremental 1.107 1.101

New Construction

Baseline 1.284 1.276

Incremental 1.027 1.021

In the CAC and HP analysis, as was done in the furnace analysis, a relative mechanical 

contractor markup value was calculated for each state. The baseline and incremental markups 

for individual household observations depended on the state to which the household was 

assigned in the sampling process. However, DOE calculated the population-weighted baseline 

and incremental average markups for each region. These values are shown in Table 6.6.4. 

Table 6.6.4 Population-Weighted Regional Mechanical Contractor Markups for CACs and 

HPs

Hot-Humid Hot-Dry Rest of Country

(North)

Replacement

Baseline 1.354 1.429 1.384

Incremental 1.084 1.144 1.107

New Construction

Baseline 1.256 1.326 1.284

Incremental 1.005 1.061 1.027

6.6.1.3 Estimation of Regional General Contractor Markup

In order to derive regional general contractor markups for the residential building 

construction sector from the 2007 Economic Census, DOE combined four Geographic Area 

Series: (1)New Single-Family General Contractors (NAICS 236115), (2)New Multifamily 

Housing Construction (NAICS 236116) , (3)New Housing Operative Builders (NAICS 236117),
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and (4)Residential Remodelers (NAICS 236118). Each series consists of statewide cost data 

required to calculate baseline markups for each state as illustrated in Section 6.4.3. Although 

there is only a new construction (no replacement) channel for general contractors, the same 

technique shown for mechanical contractors can still be employed to estimate regional baseline 

and incremental markups. First, a statewide relative markup can be derived by dividing each 

state’s baseline markup with the national average markup. Then, the relative markup can be 

applied to both baseline and incremental markups; they are multiplied by different mean values 

(1.48 for baseline and 1.35 for incremental). The final results are summarized in Table 6.6.5

below.

Table 6.6.5 Regional General Contractor Markups for Furnaces 

North Region South Region

Baseline Markup 1.482 1.582

Incremental Markup 1.352 1.443

As with furnaces, for the CAC and CHP markets, there is only a new construction (no 

replacement) channel for general contractors. The same technique shown for mechanical 

contractors can still be employed to estimate regional baseline and incremental markups. First, a 

statewide relative markup can be derived by dividing each state’s baseline markup with the 

national average markup. Then, the relative markup can be applied to both baseline and 

incremental markups; they are multiplied by different mean values (1.48 for baseline and 1.35

for incremental). The final weighted average results are summarized in Table 6.6.6 below.

Table 6.6.6 Regional General Contractor Markups for CACs and HPs

Hot-Humid Hot-Dry Rest of Country 

(North)

Baseline Markup 1.498 1.779 1.481

Incremental Markup 1.364 1.619 1.351

6.7 MARKUP FOR MOBILE HOME GAS FURNACES 

Based on the shipment forecast for the year 2016 (see Chapter 9), 50% of the mobile 

home gas furnaces go to new construction, and the other 50% go to replacements. In a comment 

to DOE, (10) the Manufactured Housing Institute (MHI) indicated that the total markup of the 

mobile home manufacturer and the mobile home retailer has traditionally been a factor of 2.22 in 

the new construction channel. Thus, DOE applied this number to the estimated MSP of a mobile 

home gas furnace for both the baseline and for incremental costs. As for those units purchased 

for replacement, DOE used the same baseline and incremental markups estimated for nonweatherized gas furnaces, which are 2.65 and 1.70 respectively.
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6.8 SALES TAX 

The sales tax represents state and local sales taxes that are applied to the consumer price 

of the equipment. The sales tax is a multiplicative factor that increases the consumer equipment 

price.

DOE derived state and local taxes from data provided by the Sales Tax Clearinghouse. (11)

These data represent weighted averages that include county and city rates. DOE then derived 

population-weighted average tax values for each Census division and large state, as shown in 

Table 6.8.1 below. Detailed sales tax data by each state can be found in Appendix 6A.5.

Table 6.8.1 Average Sales Tax Rates by Census Division and Large State

Census Division/State Tax Rate (2010)

New England 5.55%

Mid Atlantic 6.62%

East North Central 6.94%

West North Central 6.86%

South Atlantic 6.44%

East South Central 7.90%

West South Central 8.42%

Mountain 6.50%

Pacific 5.21%

New York 8.45%

California 9.15%

Texas 8.05%

Florida 6.70%

6.9 OVERALL MARKUPS 

The overall markup for each distribution channel is the product of the appropriate 

markups, as well as sales tax in the case of replacement applications (Table 6.9.1). 

DOE used the overall baseline markup to estimate the consumer product price of baseline 

models, given the manufacturer cost of the baseline models. As stated above, DOE considers 

baseline models to be product sold under existing market conditions (i.e., without new energy 

conservation standards). The following equation shows how DOE used the overall baseline 

markup to determine the product price for baseline models.
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( ) CPPBASE = COSTMFG × MU MFG × MUBASE ×TaxSALES = COSTMFG × MUOVERALL _ BASE

Where:

CPPBASE = Consumer product price for baseline models,

COSTMFG = Manufacturer cost for baseline models,

MUMFG = Manufacturer markup,

MUBASE = Baseline replacement or new home channel markup,

TaxSALES = Sales tax (replacement applications only), and

MUOVERALL_BASE = Baseline overall markup.

Similarly, DOE used the overall incremental markup to estimate changes in the consumer 

product price, given changes in the manufacturer cost from the baseline model cost resulting 

from an energy conservation standard to raise product energy efficiency. The total consumer 

product price for more energy-efficient models is composed of two components: the consumer 

product price of the baseline model and the change in consumer product price associated with the 

increase in manufacturer cost to meet the new energy conservation standard. The following 

equation shows how DOE used the overall incremental markup to determine the consumer 

product price for more energy-efficient models (i.e., models meeting new energy conservation 

standards). 

( )

BASE MFG OVERALL INCR

STD MFG OVERALL BASE MFG MFG INCR SALES

CPP COST MU

CPP COST MU COST MU MU Tax

_

_

= + ∆ ×

= × + ∆ × × ×

Where:

CPPSTD = Consumer product price for models meeting new energy 

conservation standards,

CPPBASE = Consumer product price for baseline models, 

COSTMFG = Manufacturer cost for baseline models,

ΔCOSTMFG = Change in manufacturer cost for higher energy efficient models,

MUMFG = Manufacturer markup,

MUINCR = Incremental replacement or new home channel markup,

TaxSALES = Sales tax (replacement applications only),

MUOVERALL_BASE = Baseline overall markup (product of manufacturer markup, 

baseline replacement or new home channel markup, and sales tax), 

and

MUOVERALL_INCR = Incremental overall markup.

National average baseline and incremental markups for each market participant are 

summarized in Table 6.9.1. Based on the ratio of housing starts and gas furnace shipment 
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forecasts for the year 2016 (see Chapter 9), DOE estimated that 25 percent of gas furnaces, 50

percent of mobile home gas furnaces, and 10 percent of oil-fired furnaces go to new 

construction. On the other hand, 75 percent of gas furnaces, 50 percent of mobile home gas

furnaces, and 90 percent of oil-fired furnaces go to the replacement market. By weighing the 

markups by market shares of different types of furnaces, final total markups for each type of 

furnace are listed in Table 6.9.2

Table 6.9.1 Summary of National Average Markups on CACs, HPs, and Residential 

Furnaces and Boilers 

Baseline Markup Incremental Markup

Manufacturer 1.26 1.26

Wholesaler 1.362 1.091

Mechanical Contractor 

(new construction/replacement)

1.280/1.380 1.024/1.104

General Contractor 

(new construction only)

1.48 1.35

Sales tax (replacements only) 1.070 1.070

Table 6.9.2 Summary of Markups on Different Types of Residential Furnaces and 

Boilers 

Total markup (on manufacturing 

cost) Baseline Markup Incremental Markup

Non-weatherized gas furnace 2.94 1.83

Oil-fired furnace

Hot-water gas boiler 2.83 1.77

Hot-water oil-fired boiler

Mobile home gas furnace 2.77 2.29
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REFERENCES

1. Heating, Air Conditioning & Refrigeration Distributors International 2010 Profit Report. 

2. 2005 Financial Analysis for the HVACR Contracting Industry. s.l. : Air Conditioning 

Contractor of America.

3. U.S. Census Bureau, Data set for Sector 23, EC0723A1, Construction: Geographic Area 

Series, Detailed Statistics for Establishments. 2007.

4. U.S. Census Bureau, 2007, Data set for Sector 23: EC0723I1, Construction: Industry Series, 

Preliminary Detailed Statistics for Establishments: 2007. 

5. U.S. Census Bureau, 2007, Manufacturing Industry Series: Detailed Statistics for the United 

States: 2007. Air-Conditioning and Warm Air Heating Equipment and Commercial and 

Industrial Refrigeration Equipment Mnufacturing. Data set for Sector 31: EC073111 . 

6. U.S. Census Bureau, 2007, Wholesale Trade: Industry Series: Preliminary Summary Statistics 

for the United States: 2007. HVAC Equipment Merchant Wholesaler. Data set for Sector 42: 

EC0742111. 

7. U.S. Census Bureau. 2007. Construction: Industry Series: Preliminary Detailed Statistics for 

Establishments: 2007. New Single-Family General Contractors, New Multifamily Housing 

Construction (Except Operative Builders), New Housing Operative Builders Resi. 

8. U.S. Census Bureau. 2007. Plumbing, Heating, and Air-Conditioning Contractors. Sector 23: 

238220. Construction: Industry Series, Preliminary Detailed Statistics for Establishments, 2007. 

9. Pindyck, R. and Rubinfeld, D. Microeconomics. s.l. : Prentice Hall, 2000.

10. Manufactured Housing Institute, Comment #13, personal communication. Docket # EERM/STD-01-350. August/13/2001.

11. The Sales Tax Clearinghouse. [Online] https://thestc.com/STRates.stm.