CHAPTER 6

. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

TABLE OF CONTENTS

6.1 INTRODUCTION

................................ ................................ ................................ ........... 6

- 1

6.2 DISTRIBUTION CHANNEL S

................................ ................................ ....................... 6

- 1

6.3 MARKUP CALCULATION P ROCEDURE

................................ ................................ .. 6

- 2

6.3.1 Manufacturer Markups

................................ ................................ ........................... 6

- 2

6.3. 2 Distributor Markups

................................ ................................ ............................... 6

- 3

6.3.2.1 Baseline Distributor Markup

................................ ................................ .......... 6

- 4

6.3.2.2 Incremental Distributor Markup

................................ ................................ ..... 6

- 4

6.4 SALES TAXES

................................ ................................ ................................ ............... 6

- 8

6.5 SUMMARY OF MARKUPS

................................ ................................ .......................... 6

- 9

LIST OF TABLES

Table 6.3.1 Major Appliance Manufacturer Gross Margins and Markups

............................. 6

- 3

Table 6.3.2 Data for Baseline Markup Calculation: Machinery, Equipment and Supplies Merchant Wholesalers (2007)

................................ ............................... 6

- 4

Table 6.3.3 Data for Incremental Markup Calculation: Machinery, Equipment and Supplies Merchant Wholesalers

................................ ................................ ........... 6

- 6

Table 6.3.4 C oncentration by Four Firms for Commercial Clothes Washer Distributors and Route Operators

................................ ................................ ........ 6

- 7

Table 6.4.1 Average Sales Tax Rates by Censes Division and Large State

........................... 6

- 8

Table 6.5.1 Summary of Markups

................................ ................................ .......................... 6

- 9

LIST OF FIGURES

Figure 6.2.1 Channel for Commercial Clothes Washers

................................ .......................... 6

- 1

6

- iCHAPTER 6. MARKUPS FOR EQUIPMEN T PRICE DETERMINATIO N

6.1 INTRODUCTION

To carry out the engineering and life

- cycle cost (LCC) analyses, the U.S. Department of Energy ( DOE ) needed to determine the cost to the customer of a baseline produc t and the cost of

more

- efficient units. By applying a multiplier called a “markup” to the manufacturers’ equipment costs estimated in the engineering analysis, DOE estimated the consumer prices for

baseline models and more

- efficient equipment.

6.2 DISTRIBU TION CHANNELS

The appropriate markups for determining the consumer equipment price 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 p rice of the equipment to cover their business costs and profit margin. For commercial clothes washers, DOE based the distribution channels (see Figure 6.2.1 ) on data developed by the Consortium for Energy Efficiency (CEE).

Source: CEE, 1998 Figure 6.2.1 Channel for Commercial Clothes Washers

6

- 1The CEE states that the relevant portions of the commercial, family

- sized clothes washer

market can be divided into three areas: laundromats

, private multi

- family housing

, and large

institutions. Included as part of large institutions are military barracks, universities, housing authorities, lodging establishments, and health care facilities. For these three market areas, the CEE data indicate that an overwhelming majority of commercial clothes wa shers are sold through either distributors or route operators. Laundromats generally purchase their equipment through distributors

, while multi

- family housing and large institutions generally lease their equipment from route operators. For purposes of dev eloping the markups for commercial clothes washers, DOE based its calculations primarily on data for the distribution channel that involves only distributors. DOE assumed that the markups and the resulting consumer equipment prices determined for the dist ribution channel involving distributors would be representative of the prices paid by consumers acquiring their equipment from route operators.

6.3 MARKUP CALCULATION P ROCEDURE

A t each point in the distribution channel, companies mark up the price of the eq uipment 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 ). Inputs for calculating the gross margin are all corpora te costs

— including overhead costs (sales, general, and administration)

, research and development (R&D) and interest expenses

, depreciation, and taxes

— and profits. In 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. Individual products may command a lower or higher markup, depending on their perceived added value and the competition they face from similar products in the market.

In developing markups for manuf acturers and distributors, DOE obtained data about the

revenue, CGS , and expenses of firms that produce and sell the products of interest. DOE’s approach categorizes the expenses into two categories: fixed costs , which are fixed labor and

occupancy expens es that increase in proportion to the amount of labor required to produce or sell the product, and variable costs , which are variable operating costs that do not scale with labor and vary in proportion to CGS . Together, fixed and variable costs represent t he gross margin.

6.3.1 Manufacturer Markups

DOE uses manufacturer markups to transform a manufacturer’s production costs into a manufacturer sales price. Using the CGS and gross margin , DOE calculated the manufacturer markup ( MU MFG ) with the following equati on:

MU MFG = CGS MFG + GM MFG
CGS MFG

6

- 2W here:

MU MFG = m anufacturer markup,

CGS MFG = m anufacturer’s cost of goods sold or m anufacturer p roduction c ost ( MPC ),

and

GM MFG = m anufacturer’s gross margin.

The manufacturer’s CGS (or MPC ) plus its gross margin equals the manufacturer selling price ( MSP ).

DOE developed an average manufacturer markup by examining the annual Securities and Exchange Commission (SEC) 10

- K reports filed by three publicly traded manufacturers primarily eng aged in appliance manufacturing and whose combined product range includes

commercial clothes washers ( Table 6.3

. 1 )

.

Table 6.3

. 1 Major Appliance Manufacturer Gross Margins and Markups

Mfr A Mfr B Mfr C

Average Net Revenues (Million) $3 59 $ 5,443 $ 10,000

Corporate Gross Margin 26.5 % 14.5 % 22.3 %

Markup 1. 36 1. 17 1. 2 9

6.3.2 Distributor Markups

DOE based the distributor markups for commercial clothes washers on financial data for

the secto r Machinery, Equipment and Supplies Merchant Wholesalers from the 2007 U.S. Census Business Expenses Survey (BES), which is the most recent available survey. 1 This sector includes the subsector Laundry Machinery, Equipment, and Supplies, Commercial, Merchant Wholesalers, which specifically sells commercial clothes washers. However, as few data are available for this detailed subsector, DOE relie d on the 2007 BES data for Machinery, Equipment and Supplies Merchant Wholesalers to estimate distributor markups

.

DOE organized the financial data into statements that break down cost components incurred by firms in this category. DOE assumes that the income statements faithfully represent the various average costs incurred by distributors . Although firm s in this sector handle multiple commodity lines, the data provide the most accurate available indication of expens es for selling

commercial clothes washers

.

The 2007 BES data provided for Machinery, Equipment and Supplies Merchant

Wholesalers only contain total sales and detailed operating expenses. In order to construct a complete data set to estimate markups, DOE needed to estimate CGS and gross margin. The 1997 Business Expenses Survey provides total sales, gross margin

, and detailed operating expenses of Machinery, Equipment and Supplies Merchant Wholesalers. 2 DOE found that gross

6

- 3margin as a percent of sales has been roughly co nstant in this category from 1992 to 20 10

, averaging 27.1%

. 3 Therefore, DOE assumed that the fractions of CGS and gross margin as a percent of sales in 200 7 are the same as in 1997. Following this assumption, DOE calculated t he

CGS

, gross margin

, and net profit for Machinery, Equipment and Supplies Merchant

Wholesalers from the 200 7 BES

.

6.3.2.1 Baseline Distributor Markup

The baseline markup relates the manufacturer sales price of baseline products to the

distributor sales price. D OE considers baseline models to be equipment sold under existing market conditions ( i.e., without new energy efficiency standards). DOE calculated the baseline markup ( MU BASE ) for distributo rs as an average markup using the following equation:

MU B ASE = CGS Dist + GM Dist
CGS Dist

W here:

MU BASE = b aseline distributor markup,

CGS Dist = d istributor’s cost of goods sold, and

GM Dist = d istributor ’s gross margin

.

Table 6.3

. 2 shows the calculation of the baseline distri butor markup.

Table 6.3

. 2 Data for Baseline Markup Calculation: Machinery, Equipment and Supplies

Merchant Wholesalers (200 7 )

Kind of business item Amount ($ million )

Sales $328,820 Cost of Goods Sold (CGS) $239,710 Gross Margin (GM) $89,110 Baseline Markup = (CGS+GM)/CGS 1. 37

Source: U.S. Census, 200 7 Business Expenses Survey (for Sales) and 1997 Business Expenses Survey (for CGS and GM shares)

6.3.2.2 Incre mental Distributor Markup

Incremental markups are coefficients that relate the change in the manufacturer sales price of higher efficiency models to the change in the distributor sales price. DOE considers

6

- 4higher efficiency models to be equipment sold und er market conditions with new efficiency standards. The incremental markup reflects a situation in which the distributo r faces an increase in CGS for a particular product due to new or amended standards.

Unfortunately, empirical evidence regarding applia nce distributor markup practices when a product increases in cost (due to increased efficiency or other factors) is lacking. DOE

understands that real

- world markup practices will vary depending on the market conditions faced by distributo rs, on the magnitu de of the change in CGS associated with an efficiency increase and on any associated changes in wholesale costs. Pricing may also involve rules of thumb that are difficult to know and to incorporate into DOE’s analysis.

Given the uncertainty about actual markup practices used by appliance distributors , DOE uses an approach that reflects the following two key concepts:

1. Changes in the efficiency of the goods sold are not expected to increase economic profits. Thus, DOE calculates markups/gross margins t o allow cost recovery for wholesale companies in the distribution chain (including changes in the cost of capital) without changes in company profits.

2. Efficiency improvements impact some distribution costs but not others. DOE sets markups and prices to c over the distribution costs expected to change with efficiency but not the distribution costs that are not expected to change with efficiency.

The incremental markup approach is described in more detail in Dale et al. (2004). 4

To estimate incremental distributor markups, DOE divides distributor s’ operating expenses into two categories: (1) t hos e that do not change when CGS increases due to amended

efficienc y standards (“fixed”), and (2) t hose that increase proportionately with CGS (“variable”). DOE defines fixed costs to include labor and occupancy expenses

, because these costs are not likely to increase as a result of a rise in CGS due to amended efficiency standards. All other expenses, as well as the net profit, are assumed to vary in proportion to CGS. Although it is possible that some of the other expenses may not scale with CGS, DOE is inc lined to take a more conservative position and in clude these as variable costs. Note that u nder DOE’s approach, a high fixed

- cost component y ields a low incremental markup.

DOE calculated the incremental markup ( MU INCR ) for distributo rs using the follo wing equation:

MU INCR = CGS Dist + VC Dist
CGS Dist

W here:

MU INCR = i ncremental distributor markup,

CGS Dist = d istributor ’s cost of goods sold, and

6

- 5VC Dist = d istributor ’s variable costs.

Table 6.3

. 3 shows the breakdown of operating expenses using the 2007 BES data. The incremental markup is calculated as 1.18.

Table 6.3

. 3 Data for Incremental Markup Calculation: Machinery, Equipment and Sup plies Merchant Wholesalers

Amount ($ million )

Sales 328,820
Cost of Goods Sold (CGS) 239,710

Gross Margin (GM) 89,110
Labor & Occupancy Expenses (“Fixed”)
Annual payroll 32,871
Employer costs for fringe benefits 6,638
Contract labor costs, including temporary help 572

Purchased communication services 808
Purchased repairs and maintenance to machinery and equipment 763
Purchased repairs and maintenance to buildings, stru ctures, and offices 462
Lease and rental payments for machinery and equipment 492
Lease and rental payments for buildings, offices, stores 2,655
Purchased electricity 583
Purchased fuels (except motor fu els) 220
Water, sewer, refuse removal, and other utility payments 111

Fixed Subtotal: 46,175
Other Operating Expenses & Profit (“Variable”)
Expensed equipment 329
Purchases of packaging materials and cont ainers 390
Purchases of other materials, parts, and supplies (not for resale) 1,321
Expensed purchases of software 178
Data processing and other purchased computer services 275
Commission expense 1,213
Purchased transportation, shipping and warehousing services 2,446
Purchased advertising and promotional services 1,211
Purchased professional and technical services 1,404
Depreciation and amortization charges 2,461

Taxes and license fees 917
Other operating expenses 2 6,448
Net profit before taxes 24,342

Variable Subtotal: 42,935
Incremental Markup = (CGS+Total Other Operating Expenses and Profit)/CGS 1.18

S ource: U.S. Census, 2007 Business Expenses Survey ; U.S. Census, 1997 Business Expenses Survey

By dividing expenses into fixed and variable components, the incremental markup approach envisions that distributo rs cover costs without ch anging profits. Alth ough distributo rs may be able to reap higher profits for a time, DOE’s approach assumes that competition in the appliance distributor market, combined with relatively inelastic demand ( i.e., the demand is not

6

- 6expected to decrease significantly with a relat ively small increase in price ), will tend to pressure margins back down.

To measure the degree of competition, DOE estimated the four firm concentration ratio (FFCR) of commercial clothes washer sales in the two sectors included in the distribution

chan nels: distributors and route operators

. The FFCR represents the market share of the four largest firms in the relevant industry. G enerally, an FFCR of less than 40% indicates that the industry is not concentrated

, and an FFCR of more than 70% indicates th at an industry is highly

concentrated. 5

, 6

The 2007 Economic Census reports the FFCR of m erchant wholesalers (including laundry equipment distributors) and service providers (including route operators) in aggregate and for many detailed subsectors. 7

, 8 Th e FFCR of commercial cl othes washer sales is equal to the sector FFCR times the percent of total sales within each sector accounted for by major appliances , which are estimated from the financial reports of distributors and route

operators

. 9

, 10

, 11

, 12 DOE approximates the weighted aggregate FFCR for commercial clothes washer sales by weighting these sector FFCRs by the market share of each sector ( Table 6.3

. 4 )

.

Table 6.3

. 4 Concentration by Four Firms for Commercial Clothes Washer Distributors and Route Operators

Sector Four Firm

Concentration Ratio

( % of Sector Sales) % of Revenue

Accounted for by CCW Four Firm

Concentration Ratio (% of CCW Sales ) Mark et
Share (%

of CCW

Sales )

Distributors 60.3 85 51.3 33.3

Route operators 26.5 5.1 1.4 66.6

Weighted Aggregate FFCR 18.0

Source: 2007 Economic Census (Note that distributors are represented by the sector NAICS 4238503 “ Laundry and dry

- cleaning equipment and supplies merchant wholesalers” and route operators are represented by the sector

NAICS 81231 “coin

- operated laundries and drycleaners”)

DOE’s estimation of the weighted average FFCR for commercial clothes washer sales is further supported by a 20 1 1 IBISWorld Industry Report, which states that concentration in the

sector is low. 13 Note that the sector is referred to in the IBISWorld report as “Janitorial Equipment Supply Wholesaling,” rather than “ Service establishment equipment and supplies

merchant wholesalers ” as in the U.S. Economic Census

.

6

- 76.4 SALES TA XES

The sales tax represents state and local sales taxes that are applied to the consumer equipment price. 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 and population data from the U.S. Census

. 14

, 15 DOE derived population

- weighted average tax

values for each Census “Reportable Domain” (large s tates and groups of states) , as shown in

Table 6.4

. 1

.

Table 6.4

. 1 Average Sales Tax Rates by Censes Division and Large State

Reportable Domain State(s) Tax Rate (February 2013)

1 CT , ME, NH, RI, VT 5.13%

2 MA 6.25%

3 NY 8.40%

4 NJ 6.95%

5 PA 6.40%

6 IL 8.05%

7 IN, OH 7.06%

8 MI 6.00%

9 WI 5.45%

10 IA, MN, ND, SD 6.88%

11 KS, NB 7.14%

12 MO 7.50%

13 VA 4.00%

14 DE, DC, MD, WV 5.41%

15 GA 7.10%

16 NC, SC 6.98%

17 FL 6.6 5%

18 AL, KY, MS 7.25%

19 TN 9.45%

20 AK, LA, OK 8.66%

21 TX 7.95%

22 CO 6.10%

23 IA, MT, UT, WY 5.32%

6

- 824 AZ 7.15%

25 NV, NM 7.38%

26 CA 8.45%

27 AK, HI, OR, WA 5.66%

DOE then derived a U.S. average tax value of 7

. 11 % for commercial clothes w ashers based on the product’s saturation within each Census division. 16

6.5 S UMMARY OF MARKUPS

Table 6.5

. 1 summarizes the markups at each stage in the distribution channel and the average sales tax.

Table 6 .5

. 1 Summary of Markup s

Markup Baseline Incremental

Manufacturer 1.285

Distributor 1.37 1.18

Sales Tax 1. 11

Overall 1. 95 1. 68

6

- 9REFERENCES

1. U.S. Census Bureau, Economic Census, Business Expenses Su rvey, Wholesale Trade, Machinery, Equipment and Supplies Merchant Wholesalers, 2007. (Last accessed February, 2013.)

< http://www.census.gov/wholesale/www/hi storic_releases/annual_historic_releases.html

>

2. U.S. Census Bureau, Economic Census, Business Expenses Survey, Wholesale Trade, Machinery, Equipment and Supplies Merchant Wholesalers , 1997. Washington, D.C.

3. U.S. Census Bureau, 2010 Annual Wholes ale Trade Survey . 2010: Washington, D.C. http://www2.census.gov/wholesale/pdf/awts/2010_awts_salesinv_nomsbo_table2.pdf

4. Dale, L., D. Millstein, K. Coughlin, R. V. Buskirk, G. Rosenquist, A. Lekov, and S. Bhuyan, An Analysis of Price Determination and Markups in the Air

- Conditioning and Heating Equipment Industry , 2004. Lawrence Berkeley National Laboratory.

5. University of Maryland University College, Note on Industry Structure, 2002. (Last accessed February, 2013.)

< http://info.umuc.edu/mba/public/AMBA607/IndustryStructure.html >

6. QuickMBA, Industry Concentration, 2010. (Last accessed February, 2013.)

< http://www.quickmba.com/econ/micro/indcon.shtml >

7. U.S. Census Bureau, 2007 Economic Census, Establishment and Firm Size: (Including Legal Form of Organization ), Wholesale Trade Subject Series , 2007.

8. U.S. Census Bureau, 2007 Economic Census, Establishment and Firm Size: (Including Legal Form of Organization), Other Services (Except Public Administration) Subject

Series , 2007.

9. Mac

- Gray Corporation, For m 10

- K Annual Report Pursuant to Section 13 of 15(d) of the Securities Exchange Act of 1934, 2011. (Last accessed November, 2012.)

< http://www.sec.gov/Archives/edgar/data/1038280/000104746912002365/a2207800z10

- k.htm#ds11601_item_8._financial_statements_and_supplementary_data >

10. Coinmach Corporation, 10

- K Annual Report for Fiscal Year 2005, 2005

< http://www.sec.gov/Archives/edgar/data/91693/000095012305007218/y09552e10vk.ht

m#106 >

11. Coinmach Corporation, 10

- K Annual Report for Fiscal Year 2007, 2007.

< http://www.sec.gov/Archives/edgar/data/1282858/000095012307008319/y35770e10vk.

htm >

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- 1012. Alliance Laundry Syst ems, Alliance Laundry Holdings LLC Reports 2004 Sales and Earnings , 2005. Ripon, W.I.

13. Culbert, K., Janitorial Equipment Supply Wholesaling in the US , 2011. <ibisworld.com>

14. Sales Tax Clearinghouse, I., State sales tax rates along with combined av erage city and

county rates, 2013. 2013.) < http://thestc.com/STrates.stm >

15. Sales Tax Clearinghouse Inc., State Sales Tax Rates Along with Combined Average City and County Rates, 2014. (Last accessed Janua ry 10, 2014.)

< http://thestc.com/STrates.stm >

16. U.S. Energy Information Administration, Residential Energy Consumption Survey , U.S. Department of Energy, Editor. 2009.

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