CHAPTER 6. MARKUPS FOR EQUI PMENT PRICE DETERMINATION

TABLE OF CONTENTS

6.1 INTRODUCTION

.............................................................................................................. 6-1 6.1.1 Baseline Markups

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

........................................................................................... 6-3 6.1.3 Overall Markups

.................................................................................................. 6-4 6.2 BASIC ASSUMPTIONS USED TO ES TIMATE WHOLESALER/DISTRIBUTOR MARKUPS

....................................................................................................................... .. 6-5 6.3 ESTIMATION OF DISTRIBUTOR- WHOLESALER MARKUPS

.................................. 6-6 6.4 SALES TAX

................................................................................................................. ...... 6-7 6.5 OVERALL MARKUPS

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

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

.................................................................................................................... ...... 6-10

LIST OF TABLES

Table 6.3.1 Wholesaler/Distributor Expenses and Markups

................................................... 6-6

Table 6.5.1 Baseline Average Markups by Di stribution Channel and Overall Average

Table 6.5.2 Incremental Average Markups by Distribution Channel and Overall Table 6.4.1 State Sales Tax Rates

........................................................................................... 6 -8

Markup, Including the Sales Tax Multiplier

........................................................ 6-8

Average Markup, Including the Sales Tax Multiplier

......................................... 6-8

LIST OF FIGURES

Figure 6.1.1 Distribution Channels and Shares for Refrigerated Beverage Vending Machines

.............................................................................................................. 6-2

6-i BVM_FINAL_FR_TSD_Chapter6_08-14-09.docCHAPTER 6. MARKUPS FOR EQUI PMENT PRICE DETERMINATION

6.1 INTRODUCTION

To carry out the life-cycle cost (LCC) calcula tions described in chapter 8 of the technical support document (TSD), the U.S. Department of Energy (DOE) needs to determine the cost to the customer of baseline refrigerated beverage vending machines. This cost is determined for both baseline equipment and more efficient equipment that the customer would purchase following the promulgation of new energy conserva tion standards. However, the customer price of such equipment is not known because it de pends on how the equipment is purchased. The manufacturer selling price (MSP) for both baseline equipment and the more efficient equipment is determined in the engineering analysis (cha pter 5 of the TSD). By applying a multiplier called a “markup” to the MSP, DOE was able to estimat e the customer price of equipment purchased through various distribution channels. This chap ter describes how DOE derived these markups.

DOE determines customer prices for be verage vending machines from MSP and equipment price markups using industry balance sheet data and U.S. Census Bureau data. To determine price markups, DOE identifies dist ribution channels for equipment sales and determines the existence and amounts of markups within each distribution channel. For each distribution channel, DOE dis tinguishes between “baseline ma rkups” applied to the MSP for baseline equipment and “incremental markups” a pplied to the incremental increase in MSP for higher efficiency equipment. Overall baseline a nd overall incremental markups are calculated separately based on the product of all baseline markups at each step within a distribution channel or the product of all incremental markups at each step within a distribution channel, respectively. The combination of the overall baseline markup a pplied to the baseline MSP and the incremental markups applied to the incremental increase in MSP for higher efficiency equipment, including sales tax, determines the final customer price.

The cost to the customer depends on how th e customer purchases the equipment. As shown in Figure 6.1.1, DOE defined three distributi on channels to describe how the equipment passes from the manufacturer to the customer. In the first distribution channel, the manufacturer sells the equipment to the bottler/distributor, w ho in turn installs, operates, and maintains the equipment on site at the user’s location. In the second and th ird distribution channels, the manufacturer sells the equipment to a wholesaler/d istributor, who in turn sells it directly to the customer (vending machine operator or site owne r). The site owner purch ases outright a small percentage of the machines from the distri butor and stocks and maintains them on site. Figure 6.1.1 also gives the distribu tion channel shares (in percenta ge of total sales) through each of the three distribution cha nnels. The distribution channel shares are based on industry comments from the public meeting on the advance notice of proposed rulemaking. 1

6-1 BVM_FINAL_FR_TSD_Chapter6_08-14-09.docBeverage Vending Machine Manufacturer

Wholesaler/Distributor

Site Owner Vending Machine Operator Bottler/Distributor

85 % 10 % 5%
Figure 6.1.1 Distribution Channels and Shares for Refrigerated Beverage Vending Machines

The following equation describes how DOE determined the equipment price if a customer (in this case, the bottler/distributo r) purchases directly from the manufacturer:

EQP CUST = MSP BASE x (1+ ST) Eq. 6.1

Where:

EQP CUST = equipment price to the customer ($), MSP BASE = MSP of baseline equipment ($), and ST = sales tax rate (%/100).

The following equation describes how DOE determined the equipment price if a distributor sells the equipment to the cu stomer through the wholesaler/distributor:

EQP CUST = MSP BASE x MU DIST x (1+ST) Eq. 6.2

Where:

MU DIST = wholesaler/distributor markup.

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

For each of the wholesaler/distributor markups presented above, DOE further differentiated between a baseline markup and an incremental markup, as described below. The overall markup describes the product of all the markups plus sales tax within a distribution channel.

6-2 BVM_FINAL_FR_TSD_Chapter6_08-14-09.doc6.1.1 Baseline Markups

DOE defined baseline markups as cost multiplie rs that relate the purchase cost to the MSP for each step in the distribution channel.

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

EQP MFGR BASE = MSP BASE x (1+ST) Eq. 6.3

Where:

EQP MFGR BASE = bottler/distributor price to the cust omer of baseline equipment ($).

If sold to a customer by a wholesaler/distributor:

EQP DIST BASE = MSP BASE x MU DIST BASE x (1+ST) Eq. 6.4

Where:

EQP DIST BASE = distributor price to the custom er of baseline equipment ($), MU DIST BASE = distributor markup on baseline equipment, and ST = sales tax rate (%/100).

The use of the markups results in the wholesaler/distributor ( EQP DIST BASE ) prices of baseline beverage vending machine equipment.

6.1.2 Incremental Markups

For the purpose of this analysis, incrementa l markups are cost mu ltipliers that relate incremental changes in the MSP of higher effici ency equipment (from efficiency improvements) to changes in the distributor sales price.

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

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

Where:

EQP MFGR INCR = incremental equipment price to the customer ($), MSP INCR = change in the MSP of higher effi ciency equipment brought about by an increase in efficiency due to new standards ($), and ST = sales tax rate (%/100).

6-3 BVM_FINAL_FR_TSD_Chapter6_08-14-09.docIf sold by a wholesaler/distri butor directly to a customer:

EQP DIST INCR = MFG INCR x MU DIST INCR x (1+ ST) Eq. 6.6

Where:

EQP DIST INCR = incremental wholesaler/distributor price to the customer ($), and MU DIST INCR = incremental wholesaler/distributor markup ST = sales tax rate (%/100).

In Eq. 6.6, the MU DIST INCR term refers to the incremental wholesaler/distributor markup that is applied to the increm ental MSP. The use of the incremental markup results in the incremental wholesaler/distributor ( EQP DIST ) price.

6.1.3 Overall Markups

Overall markups, including both overall base line and overall incremental markups, relate the MSP to the customer price as indicated by the following equations:

EQP CUST BASE = MSP BASE x (WT MFGR BASE + WT DIST BASE x MU DIST BASE ) x (1+ST) = MSP BASE x (1+MU OVERALL BASE ) Eq. 6.7

EQP CUST INCR = MSP INCR x (WT MFGR INCR + WT DIST INCR x MU DIST INCR ) x (1+ST) = MFG INCR x MU OVERALL INCR Eq. 6.8

EQP CUST = EQP CUST BASE + EQP CUST INCR Eq. 6.9

Where:

MU OVERALL BASE = overall weighted baseline markup that is the product of all the weights and baseline markups for each step of the distribution channel, MU OVERALL INCR = overall weighted incremental markup th at is the product of all the weights and incremental markups for each step of the distribution channel, EQP CUST BASE = baseline customer price ($), EQP CUST INCR = incremental customer price ($), EQP CUST = total customer price ($), WT MFGR BASE = weight (percent) of baseline equi pment sales direct to customers, WT DIST BASE = weight (percent) of baseline e quipment sales through wholesalers, WT MFGR INCR = weight (percent) of higher efficiency equipment sales direct to customers, WT DIST INCR = weight (percent) of higher efficiency equipment sales through wholesalers, and ST = sales tax rate (%/100).

The use of the overall baseline and overall incremental markups results in the baseline customer price ( EQP CUST BASE ) and the incremental customer price ( EQP CUST INCR ). For a particular higher efficiency level that increa ses the MSP of equipment, the total price of equipment to the customer ( EQP CUST ) is the sum of the baseline customer price ( EQP CUST BASE ) and the incremental customer price ( EQP CUST INCR ).

6-4 BVM_FINAL_FR_TSD_Chapter6_08-14-09.doc6.2 BASIC ASSUMPTIONS USED TO ES TIMATE WHOLESALER/DISTRIBUTOR MARKUPS

DOE based the wholesaler/distributor mar kups on U.S. Census Bureau data for the “Other commercial equipment merchant wholes aler” segment of durable goods and merchant wholesalers category of Wholesale Trade. Three key assumptions used to estimate markups for the beverage vending machine wholes aler/distributor industry were:

1. The data accurately represent the various costs incurred by firms distributing and installing beverage vending machine equipment.

2. The costs can be divided into two categories: (1) costs that vary in proportion to the MSP of beverage vending machine equipment (varia ble costs), and (2) costs that do not vary with the MSP of beverage vending machine equipment (fixed costs).

3. Wholesaler/distributor prices va ry in proportion to the stated wholesaler/distributor costs.

In support of the first two assumptions, the cost data are categorized correctly to reflect the direct costs to purc hase or install the equipment, opera ting labor and occupancy costs, and other operating costs and profit.

Although the beverage vending machine wholes aler/distributors may handle multiple commodity lines (including non-refrigerated vend ing machines and other equipment), the data provide the most accurate availa ble indication of beverage vending machine equipment costs. DOE searched for but did not find data on two topi cs that relate to the price determined by the markup analysis. The first is the division and app lication of fixed and variable costs, and the second is the level of competition.

In the case of the division and application of fixed and variable costs to determine baseline and incremental markups, DOE relied on prior analysis of the heating, ventilation, and air conditioning wholesalers, contractors, and consultants, including information obtained from the trade literature. 2,3 This analysis indicates that whol esaler and contractor markups vary according to the quantity of labor and materials us ed to distribute and install appliances, with markups on labor tending to be much larger than markups on materials. The analysis implies that these distribution channel markups vary more w ith sales volume than with other factors, including appliance efficiency. Distribution chan nel labor inputs also vary more with sales volume than with appliance cost or efficiency. DOE assumed a division of costs between those that do not scale with the MSP (labor and occ upancy costs) and those that do (operating costs and profit). This division of costs led to the estimation of wholesaler/distributor markups, as described below.

In the case of the beverage vending machin e industry, the level of competition among the wholesaler/distributors of be verage vending machine equipment and customer demand for beverage vending machine equipment is relatively inelastic (i.e., the dema nd is not expected to decrease significantly with an increase in price of the equipment). The large number of wholesaler firms listed in the U.S. Census Bure au data (2002) indicates that the market is relatively competitive in nature, as there are about 450 wholesaler/distributors of beverage

6-5 BVM_FINAL_FR_TSD_Chapter6_08-14-09.docvending machine equipment. 4 Following standard economic theory, competitive firms facing elastic demand either set prices in line with costs or quickly go out of business. 5

6.3 ESTIMATION OF DISTRIBUTOR-WHOLESALER MARKUPS

DOE derived markups for wholes aler/distributors from U.S. Census Bureau data (2002) for Other Commercial Equipment Merchant Wholesalers (North American Industry Classification System [NAICS] 423440). This sector includes establishments primarily engaged in distributing and wholesaling refrigerated bevera ge vending machines and other equipment to restaurants and hotels (NAICS 4234401) and stores (NAICS 4234402). The U.S. Census Bureau data for this sector include revenue and expense data in total dollars rather than in typical values for an average or representative business. Because of this, DOE assumed that once converted to a percentage basis, the total dollar values that the U.S. Census Bureau reported represented revenues and expenses for an average or typi cal contracting busine ss. Table 6.3.1 summarizes the expenses for wholesaler/distr ibutors as expenses per dollar sales revenue in the first data column (TSD appendix C contains dollar values from the survey). The direct cost of sales represents about $0.69 per dollar sa les revenue to the wholesaler /distributor. Labor expenses account for $0.13 per dollar sales revenue, occupa ncy expenses and other operating expenses account for $0.10 per dollar sales revenue, and pr ofit accounts for $0.09 per dollar sales revenue.

Table 6.3.1 Wholesaler/Distribut or Expenses and Markups Description Wholesale Firm Expenses or Revenue Per Dollar Sales Revenue $ Per Dollar Cost of Goods Sold $ Direct Cost of Equipment Sales: Cost of goods sold Labor Expenses: Salaries and benefits Occupancy Expense: Rent, maintenance, and utilities Other Operating Expenses: Depreciation, advertising, and insurance Profit 0.69 0.13 0.10

0.09 1.00 0.19 0.07 *
0.07 * 0.13 Baseline Markup ( MU WHOLE BAS E ): Revenue per dollar cost of goods sold 1.46 Incremental Markup ( MU WHOLE INCR ): Increased revenue per dollar increase cost of goods sold 1.20

Source: U.S. Census Bureau. Decembe r 2005. Wholesale Trade, Miscellane ous Subjects: 2002 . EC02-42SX-SB, Table 4. Detailed Type of Operation for the United States: 2002; Table 6. Gross Margin and Its Components for Merchant Wholesalers for the United States: 2002; and Table 7. Gross Profit and Its Components for Merchant Wholesalers for the United States: 2002.
* Because data were not available to calculate the individu al values for Occupancy and Other Operating Expenses in the “Per Dollar Cost of Goods Sold” column, the values were calculated from the “Per Dollar Sales Revenue” value by arbitrarily dividing the total in half. Evidence from other rulemakings indicates that the Occupancy Expense value in the “Per Dollar Cost of Goods Sold” column is often slightly lower than the value for Other Operating Expenses. If this were the case in this category, then the effect would be to understate the incremental by 1 or 2 points (i.e., it may be 1.21 or 1.22 instead of 1.20).
DOE converted these expenses per dollar sales into revenue per dolla r cost of goods sold by dividing each figure in the first data column by $0.69. The data in the last column show that for every $1.00 the wholesaler/distr ibutor spends on equipment cost s, the wholesaler/distributor earns $1.00 in sales revenue to cover the equipment cost, $0.19 to cover labor costs, $0.07 to cover occupancy expenses, $0.07 for other operating expenses, and $0.13 in profits. This totals

6-6 BVM_FINAL_FR_TSD_Chapter6_08-14-09.doc$1.46 in sales revenue earned for every $1.00 sp ent on equipment costs and results in a wholesaler/distributor baseline markup ( MU DIST BASE ) of 1.46 ($1.46 ÷ $1.00).

DOE was also able to use the data in th e last column in Table 6.3.1 to estimate the incremental markups by separating the fixed and vari able costs. For example, if all of the other costs scale with the equipment price (i.e., all co sts are variable), the increase in wholesaler/ distributor price will be $1.46, impl ying that the incremental markup is 1.46 or the same as the baseline markup. However, if none of the other costs are variable, then a $1.00 increase in the equipment price will lead to a $1.00 increase in the wholesaler/distri butor price, for an incremental markup of 1.0. DOE assumes the labor and occupancy costs to be fixed and the other operating costs and profit to scale with the equipmen t price (i.e., be variable). In this case, for a $1.00 increase in the equipment price, the whol esaler/distributor pr ice will increase by $1.20, giving a wholesaler/distri butor incremental markup ( MU DIST INCR ) of 1.20 ($1.20 ÷ $1.00).

DOE recognizes that there is a possibility of case-to-case devia tion in the markups developed from the above financial data. Based on the analysis of U.S. Census Bureau data for wholesalers, DOE calculated a standard devia tion from the mean of 12.1 percent (see TSD appendix C for further details). DOE assumed th at the variation determined for the baseline markup applied to the incremental markup as we ll. For the baseline markup of 1.46, a standard deviation of 12.1 percent translates into an absolute value of approximately 0.06. For the incremental markup of 1.20, a standa rd deviation of 12.1 percent transl ates into an absolute value of 0.024.

The national level census data on distribution of beverage vending machine units suggest that over 95 percent of new units sold pass through bottler/distributors or wholesaler/distributors. Uncertainty in the quantitative va lue of markups is in troduced into the LCC analysis through the use of the Excel-spreadsheet based Crystal Ba ll program. DOE applied the same baseline and incremental markup to all sales of bevera ge vending machine units passing through wholesaler/distributors.

6.4 SALES TAX

The sales tax represents State and local sales taxes that are applied to the customer price of beverage vending machine units. The sales ta x is a multiplier that increases the customer equipment price. DOE derived sales taxes representative of the combined State and local sales tax rates from the Sales Tax Clearinghouse, 6 shown in Table 6.4.1. The St ate level combined tax rates can be applied to the estimated value of State level beverage vending machine equipment shipments to obtain the total purchase cost to the customer located in any State.

6-7 BVM_FINAL_FR_TSD_Chapter6_08-14-09.docTable 6.4.1 State Sales Tax Rates State Combined State and Local Tax Rate % State Combined State and Local Tax Rate % State Combined State and Local Tax Rate % Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Dist. of Columbia Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas 8.15 1.45

7.15

8.25 9.00 6.40 6.00 0.00 5.75 6.70 6.95 4.40 6.05

8.40 7.00 6.80

6.90 Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina 6.00 8.75 5.00 6.00 5.00 6.00 6.85 7.00 7.10 0.00 6.00 7.50 0.00 6.95 6.40 8.25 6.80 North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming 5.75 6.85 8.10 0.00 6.25 7.00 7.05 5.50 9.40 8.05 6.70 6.05 5.00 8.75 6.00 5.40 5.40

The distribution of sales tax rates ranges from a minimum of 0.00 percent to a maximum of 9.4 percent with a mean value of 7.1 percen t. DOE applied the average sales tax to the customer equipment price irrespective of the di stribution channel and th e market in which the customer is located.

6.5 OVERALL MARKUPS

DOE multiplied the direct and wholesaler/dis tributor markups described above by the average sales tax multiplier to obtain the overa ll baseline and incremental markups shown in Table 6.5.1 and

Table 6.5.2. DOE based overall markups on one of two distribution channels according to how the equipment is purchased: ei ther directly or through a wholes aler/distributor and the State into which the beverage vending machine unit is delivered. Table 6.5.1 presents two markups for the overall baseline markup and the overall weighted average baseline markup, and

Table 6.5.2 presents the same informati on for overall incremental markups.

Table 6.5.1 Baseline Average Markups by Distribution Channel and Overall Average Markup, Including the Sales Tax Multiplier Manufacturer Direct Whol esaler/Distributor Overall Weighted Average Markup 1.0 1.46 1.069 Sales Tax Multiplier 1.071 1.071 1.071 Overall Markup 1.071 1.564 1.145

Table 6.5.2 Incremental Average Markups by Di stribution Channel and Overall Average Markup, Including the Sales Tax Multiplier Manufacturer Direct Whol esaler/Distributor Overall Weighted Average

6-8 BVM_FINAL_FR_TSD_Chapter6_08-14-09.docMarkup 1.0 1.20 1.030 Sales Tax Multiplier 1.071 1.071 1.071 Overall Markup 1.071 1.285 1.103
DOE used the overall markups to estimate th e customer price of baseline equipment, given the manufacturer cost of baseline equipment. For example, if the MSP of a baseline beverage vending machine unit is $1,000, DOE can multiply this by the average overall baseline markup to estimate that the baseline customer pri ce of the beverage vending machine unit sold is $1,145. Similarly, DOE used the overall incremental markup to estimate changes in the customer price, given changes in the MSP above the baseline due to increases in equipment efficiency. For example, if a new energy conservation standard increases the beverage vending machine MSP by $100, DOE can multiply this price ($100) by the av erage overall incremental markup (1.103) to estimate a customer price increase of $103.

6.6 RESULTS

The overall baseline and overall incremental markups are those presented in section 6.5. These markups will be used with the MSPs to gene rate customer prices fo r refrigerated beverage vending machines. Supporting data for the calcul ation of baseline and incremental markups are provided in Appendix C of the TSD.

6-9 BVM_FINAL_FR_TSD_Chapter6_08-14-09.docREFERENCES

1. Comments by Royal Vendors, No. 29 at p. 39 and Dixie-Narco, No. 29 at p. 40.

2. Dale L., D. Millstein, K. Coughlin, R. Van 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: Berkeley, CA. Report No. LBNL-52791.

3. M. Metoyer as reported in M. Skaer. What Should You Charge? Try These Tested Formulas. Air Conditioning, Heating and Refrigerator News . March 26, 2001.

4. U.S. Census Bureau. 2002 Economic Census Release Date: 12/3/2004 Sector 42: Wholesale Trade: Industry Series: Product Lines by Kind of Business for the United States: 2002 < http://factfinder.census.gov/servlet/IBQTable?_bm=y &­ MFG=10971:42&-ds_name=EC0242I3&-_lang=e n>. 2002. (Accessed on April 16, 2007.)

5. Pindyck R. and D. Rubinfield. Microeconomics . 2000. Prentice-Hall.

6. The Sales Tax Clearinghouse. < https://thes tc.com/STRates.stm> (Last accessed on June 4, 2009.)

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