CHAPTER 6. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

TABLE O F CONTENTS

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

**6.1.1 Baseline**  **M arkups**  **.................................................................................................6­2**

**6.1.2 Incremental**  **M arkups............................................................................................6­3** 

**6.1.3 Overall**  **M arkups...................................................................................................6­4** 

**6.2 BASIC**  **A SSUMPTIONS**  **USED TO**  **ESTIMATE WHOLESALER**  **AND**

**MECHANICAL CONTRACTOR**  **MARKUPS.................................................................. 6­5** 

**6.3 ESTIMATION OF**  **W HOLESALER**  **MARKUPS**

**.............................................................. 6­6** 

**6.4 ESTIMATION OF**  **M ECHANICAL**  **CONTRACTOR MARKUPS** 

**.................................. 6­7** 

**6.4.1 Estimation**  **o f**  **Mechanical Contractor**  **Markup Probability**  **Distribution..............6­8**

**6.5 SALES**  **T AX** 

**....................................................................................................................... 6­9** 

**6.6 NATIONAL**  **A CCOUNTS................................................................................................**  **6­11**

**6.7 OVERALL**  **M ARKUPS....................................................................................................**  **6­11**

**6.8 RESULTS..........................................................................................................................**  **6 ­12** 

**6.9 REFERENCES..................................................................................................................**  **6 ­13** 

LIST O F TABLES

**Table 6**  **.3.1 Wholesaler**  **Expenses and**  **Markups*....................................................................** **6­6**

**Table 6.4.1**  **Mechanical Contractor**  **Expenses and**  **Markups***

**................................................. 6­8** 

**Table 6.5.1**  **State Sales**  **Tax Rates** 

**........................................................................................... 6­9** 

**Table 6.5.2**  **National Average**  **Weighted Sales**  **Tax Rates,**  **based on**  **Estimated**

**Commercial R**  **efrigeration Equipment**  **Shipments by**  **State**

**............................... 6­10** 

**Table 6**  **.7.1 Baseline**  **Markups by**  **Distribution Channel**  **and Overall**  **Weighted Average** 

**Markup, Including**  **the Weighted**  **Average Sales**  **Tax Multiplier**  **for**

**Supermarkets**

**...................................................................................................... 6­12** 

**Table 6**  **.7.2 Incremental**  **Markups by**  **Distribution Channel**  **and Overall**  **Weighted**

**Average Markup,**  **Including the**  **Weighted Average**  **Sales Tax**  **Multiplier**

**for Supermarkets** 

**................................................................................................ 6­12** 

LIST O F FIGURES

**Figure 6**  **.1.1 Distribution**  **Channels and**  **Shares for**  **Commercial Refrigeration** 

**Equipment**

**............................................................................................................ 6­1** 

**Figure 6**  **.4.1 Cumulative**  **National Sales­Weighted**  **Distribution of**  **Mechanical**

**Contractor Markups**  **for Commercial**  **Refrigeration Equipment**  **Sales to** 

**Supermarkets**

**........................................................................................................ 6­9** 

**Figure 6**  **.5.1 Cumulative**  **National Sales­Weighted**  **Distribution of**  **Sales Tax**  **Rates for** 

**Commercial Refrigeration**  **Equipment Sales**  **to Supermarkets...........................**  **6­10**

**6­i 6­ii** CHAPTER 6. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

6.1 INTRODUCTION

**To c**  **arry out**  **the life­cycle**  **cost (LCC)**  **calculations described**  **in chapter**  **8, the** 

**U.S. Department**  **o f**  **Energy (DOE)**  **needed to**  **determine the**  **cost to**  **the customer**  **of baseline** 

**commercial refrigeration**  **equipment (CRE).**  **This cost**  **was determined**  **for both**  **baseline**

**equipment and**  **more­efficient equipment**  **the customer**  **would purchase**  **following the** 

**promulgation of**  **new standards.**  **However, the**  **customer price**  **of such**  **equipment is**  **not known** 

**since it**  **depends on**  **how the**  **equipment is**  **purchased. What**  **is known**  **is the**  **manufacturer’s**

**selling price**  **(MSP) for**  **both baseline**  **equipment and**  **the more­efficient**  **equipment as**  **determined**

**in the**  **Engineering Analysis**  **(chapter 5).**  **By applying**  **a multiplier**  **called a**  **“markup” to**  **the MSP,** 

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

**distribution channels.**  **This chapter**  **describes how**  **DOE derived**  **the markups.** 

**The c**  **ost to**  **the customer**  **depends on**  **how the**  **customer purchases**  **the equipment.**  **DOE**

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

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

**sells the**  **equipment directly**  **to the**  **customer through**  **a national**  **account. In**  **the second**  **and third** 

**distribution channel,**  **the manufacturer**  **sells the**  **equipment to**  **a wholesaler,**  **who in**  **turn may**  **sell**

**it directly**  **to the**  **customer or**  **through a**  **mechanical contractor.**  **The wholesaler**  **in this**  **case can**  **be**

**a refrigeration**  **wholesaler focusing**  **on refrigeration**  **equipment, or**  **a grocery**  **warehouser (supply** 

**chain distributor)**  **who sells**  **food and**  **store equipment**  **to the**  **retailer. Figure**  **6.1.1 also**  **gives the** 

**distribution channel**  **shares (in**  **percentage of**  **total sales)**  **through each**  **of the**  **three distribution** 

**channels. The**  **distribution channel**  **shares are**  **based on**  **information from**  **personal**

**communications with**  **Verisae, an**  **asset management**  **firm for**  **the retail**  **food sales**  **industry. 1** 

**r Manufacture** 

**National Account** 

**Consumer Consumer**  **Wholesaler or**  **Wholesaler Distribution** 

**Mechanical Contractor** 

**(New Construction**  **or Replacement)** 

**Consumer**

**Replacement 86%**  **7% 7%** 

**& New** 

**Construction**

Figure 6.1.1 Distribution Channels and Shares for Commercial Refrigeration Equipment

**6­1 The**  **following equation**  **describes how**  **DOE determined**  **the equipment**  **price if**  **a**

**customer purchases**  **directly from**  **the manufacturer**  **through a**  **national account:** 

EQP CUST **=** MFG BASE **x** MU NATL ACCT **x (1+**  **ST)** Eq. 6.1

**where:**

EQP CUST **= equipment**  **price to**  **the customer**  **($),**

MFG BASE **= manufacturer**  **selling price**  **of baseline**  **equipment ($),** 

MU NATL ACCT **= national**  **account markup,** 

ST

**= sales**  **tax rate.** 

**The f**  **ollowing equation**  **describes how**  **DOE determined**  **the equipment**  **price if**  **a**

**wholesaler sells**  **the equipment**  **to the**  **customer through**  **the wholesaler**  **distribution channel:** 

EQP CUST **=** MFG BASE **x** MU WHOLE **x (1+**  ST **)** Eq. 6.2

**where:**

MU WHOLE **= wholesaler**  **markup**

**The f**  **ollowing equation**  **describes how**  **DOE determined**  **the equipment**  **price if**  **a**

**mechanical contractor**  **sells the**  **equipment to**  **the customer**  **through the**  **wholesaler distribution** 

**channel:**

EQP CUST **=** MFG BASE **x** MU WHOLE **x** MU MECH **CONT x**  **(1+** ST **)** Eq. 6.3

**where:**

MU MECH CONT **= residential**  **and light**  **commercial mechanical**  **contractor markup** 

**The m**  **arkup multiplier**  **to the**  **equipment price**  **is thus**  **lessened for**  **shorter distribution**  **channels.**

**For e**  **ach of**  **the 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.** 

6.1.1 Baseline M arkups

**DOE d**  **efined baseline**  **markups as**  **cost multipliers**  **that relate**  **the purchase**  **cost to**  **selling**

**price for**  **each step**  **of the**  **distribution channel.** 

**If s**  **old to**  **a customer**  **by the**  **manufacturer through**  **a national**  **account, the**  **following**

**equation defines**  **the equipment**  **price:**

EQP NATL ACCNT BASE **=** MFG BASE **x** MU NATL ACCT BASE **x (1+ST)**  Eq. 6.4

**where:**

EQP NATL ACCNT BASE **= national**  **account price**  **to the**  **customer of**  **baseline equipment**  **($),**

MU NATL ACCT BASE **= national**  **account markup**  **on baseline**  **equipment.**

**6­2 If**  **sold to**  **a customer**  **by a**  **wholesaler­distributor:**

EQP WHOLE BASE **=** MFG BASE **x** MU WHOLE BASE **x (1+ST)**  Eq. 6.5

**If s**  **old to**  **a customer**  **by a**  **mechanical contractor:** 

EQP MECH CONT BASE **=** MFG BASE **x** MU WHOLE BASE **x** MU MECH CONT BASE **x (1+ST)**  Eq. 6.6

**where:**

EQP WHOLE BASE **= wholesaler**  **price of**  **baseline equipment**  **($),**

EQP MECH CONT BASE **= mechanical**  **contractor price**  **of baseline**  **equipment ($),** 

MU WHOLE BASE **= wholesaler**  **markup on**  **baseline equipment,** 

MU MECH CONT BASE **= mechanical**  **contractor markup**  **on baseline**  **equipment.**

**The u**  **se of**  **the markups**  **results in**  **the wholesaler**  **(** EQP WHOLE BASE **) and**  **mechanical**

**contractor (**  EQP MECH CONT BASE **) prices**  **of baseline**  **CRE equipment.** 

6.1.2 Incremental M arkups

**Incremental m**  **arkups are**  **cost multipliers**  **that relate**  **incremental changes**  **in the** 

**manufacturer selling**  **price of**  **higher efficiency**  **equipment that**  **result, in**  **this case,**  **from efficiency** 

**improvements, to**  **changes in**  **the wholesaler**  **or contractor**  **sales price,**  **as shown**  **in the**  **following**

**equations:**

**If s**  **old to**  **a customer**  **by the**  **manufacturer through**  **a national**  **account, the**  **following**

**equation defines**  **the equipment**  **price:**

EQP NATL ACCNT INCR **=** MFG INCR **x** MU NATL ACCT INCR **x (1+ST)**  Eq. 6.7

**where:**

EQP NATL ACCNT INCR **= incremental**  **equipment price**  **to the**  **national account**  **customer**

**($),**

M FG INCR **= change**  **in the**  **manufacturer selling**  **price of**  **higher efficiency** 

**equipment b**  **rought about**  **by an**  **increase in**  **efficiency due**  **to new** 

**standards (**  **$),**

MU NATL ACCT INCR **= national**  **account incremental**  **markup.**

**If s**  **old by**  **a wholesaler**  **directly to**  **a customer,**  **or by**  **a mechanical**  **contractor after**  **passing**

**through a**  **wholesaler:**

EQP WHOLE INCR **=** MFG INCR **x** MU WHOLE INCR **x (1+**  **ST)** Eq. 6.8

EQP MECH CONT INCR **=** MFG INCR **x** MU WHOLE INCR **x** MU MECH CONT INCR **x (1+ST)**  Eq. 6.9

**where:**

EQP WHOLE INCR **= incremental**  **wholesaler price**  **($),**

EQP MECH CONT INCR **= incremental**  **mechanical contractor**  **price ($),** 

**6­3**MU WHOLE INCR **= incremental**  **wholesaler markup,** 

MU MECH CONT INCR **= incremental**  **mechanical contractor**  **markup.**

**In t**  **hese equations**  MU NATL ACCTINCR, MU WHOLE INCR **and** MU MECH CONT INCR **refer to**  **the**

**incremental n**  **ational account,**  **incremental wholesaler,**  **and incremental**  **mechanical contractor** 

**markups, r**  **espectively, which**  **are applied**  **to the**  **incremental MSP.**  **The use**  **of the**  **incremental**

**markups r**  **esults in**  **the incremental**  **wholesaler (**  EQP WHOLE INCR **) and**  **incremental mechanical** 

**contractor (**  EQP MECH CONT INCR **) prices.** 

6.1.3 Overall M arkups

**Overall m**  **arkups, including**  **both overall**  **baseline and**  **overall incremental**  **markups, relate** 

**the manufacturer**  **selling price**  **to the**  **customer price**  **as indicated**  **by the**  **following equations:** 

EQP CUST BASE **=** MFG BASE **x (**  WT NATL ACCNT BASE **x** MU NATL ACCT BASE + WT WHOLE BASE **x** MU WHOLE

BASE + WT MECH CONT BASE **x** MU WHOLE BASE **x** MU MECH CONT BASE **) x**  **(1+** ST **)**

**=** MFG BASE **x (1+**  MU OVERALL BASE **)** Eq. 6.10

EQP CUST INCR **=** MFG INCR **x** (WT NATL ACCNT INCR **x** MU NATL ACCT INCR + WT WHOLE INCR **x** MU WHOLE

INCR + WT MECH CONT INCR **x** MU WHOLE INCR **x** MU MECH CONT INCR **) x**  **(1+** ST **)**

**=** MFG INCR **x** MU OVERALL INCR Eq. 6.11

EQP CUST = EQP CUST BASE + EQP CUST INCR Eq. 6.12

**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 that**  **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 NATL ACCNT BASE **= weight**  **(percent) of**  **baseline equipment**  **sales through**  **national**

**accounts,**

WT WHOLE BASE **= weight**  **(percent) of**  **baseline equipment**  **sales through** 

**wholesalers,**

WT MECH CONT BASE **= weight**  **(percent) of**  **baseline equipment**  **sales through**  **mechanical**

**contractors,**

WT NATL ACCNT INCR **= weight**  **(percent) of**  **higher efficiency**  **equipment sales**  **through**

**national accounts,** 

WT WHOLE INCR **= weight**  **(percent) of**  **higher efficiency**  **equipment sales**  **through**

**wholesalers,**

WT MECH CONT INCR **= weight**  **(percent) of**  **higher efficiency**  **equipment sales**  **through**

**mechanical contractors.** 

**6­4 The**  **use of**  **the overall**  **baseline and**  **overall incremental**  **markups results**  **in the**  **baseline**

**customer p**  **rice (**  EQP CUST BASE **) and**  **the incremental**  **customer price**  **(** EQP CUST INCR **). For**  **a particular** 

**higher efficiency**  **level that**  **increases manufacturer**  **selling price**  **of equipment,**  **the total**  **price of** 

**equipment t**  **o the**  **customer (**  EQP CUST **) is**  **the sum**  **of the**  **baseline customer**  **price (**  EQP CUST BASE **)**

**and t**  **he incremental**  **customer price**  **(** EQP CUST INCR **).**

6.2 BASIC ASSUMPTIONS U SED TO ESTIMATE WHOLESALER AND

MECHANICAL CONTRACTOR MARKUPS

**DOE d**  **erived the**  **wholesaler and**  **mechanical contractor**  **markups from**  **three key** 

**assumptions about**  **CRE costs.**  **DOE based**  **the wholesaler**  **markups on**  **industry balance­sheet** 

**data and**  **based the**  **mechanical contractor**  **markups on**  **U.S. Census**  **Bureau data**  **for the**  **plumbing,**

**heating, and**  **air conditioning**  **(PHAC) industry.**  **2 DOE**  **obtained the**  **industry balance**  **sheet data** 

**from the**  **Heating, Airconditioning**  **& Refrigeration**  **Distributors International**  **(HARDI), the**  **trade**

**association representing**  **wholesalers of**  **refrigeration and**  **heating, ventilating,**  **and air** 

**conditioning (HVAC)**  **equipment. DOE**  **put the**  **U.S. Census**  **Bureau Plumbing,**  **Heating, and** 

**Air­Conditioning Contractors**  **data that**  **was used**  **for developing**  **mechanical contractor**  **markups**

**into the**  **same format**  **as the**  **balance sheet**  **data for**  **wholesalers. These**  **balance sheets**  **break out** 

**the components**  **of all**  **costs incurred**  **by firms**  **that supply**  **and install**  **PHAC equipment.**  **The**

**three key**  **assumptions used**  **to estimate**  **markups using**  **these financial**  **data are:** 

**1. The**  **f irm**  **balance sheets**  **accurately represent**  **the various**  **average costs**  **incurred by**  **firms**

**distributing and**  **installing CRE**  **equipment.**

**2. The**  **w holesaler**  **and contractor**  **costs can**  **be divided**  **into two**  **categories: (1)**  **costs that** 

**vary in**  **proportion to**  **the MSP**  **of CRE**  **equipment (variable**  **costs); and**  **(2) costs**  **that do** 

**not vary**  **with the**  **manufacturer selling**  **price of**  **CRE equipment**  **(fixed costs).** 

**3. Wholesaler**  **a nd**  **contractor prices**  **vary in**  **proportion to**  **wholesaler and**  **contractor costs** 

**included in**  **the balance**  **sheets.**

**In s**  **upport of**  **the first**  **assumption, the**  **balance sheets**  **itemize firm**  **costs into**  **a number**  **of**

**cost 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 air**  **conditioners, furnaces,**  **and boilers)**  **the**

**data provide**  **the most**  **accurate available**  **indication of**  **CRE equipment**  **costs.**

**Previous D**  **OE analysis**  **of the**  **HVAC wholesalers,**  **contractors, and**  **consultants, including** 

**information obtained**  **from the**  **trade literature,**  **support the**  **second assumption.**  **3,4 This**  **analysis**

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

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

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

**vary more**  **in relation**  **to sales**  **volume than**  **in relation**  **to other**  **factors, including**  **appliance**

**efficiency. Distribution**  **channel labor**  **inputs also**  **vary more**  **with sales**  **volume than**  **with**

**appliance cost**  **or efficiency.**  **DOE assumed**  **a division**  **of costs**  **between those**  **that do**  **not scale** 

**with the**  **manufacturer selling**  **price (labor**  **and occupancy**  **costs), and**  **those that**  **do (operating** 

**costs and**  **profit). This**  **division of**  **costs led**  **to the**  **estimate of**  **wholesaler and**  **mechanical**

**contractor markups**  **described below.** 

**6­5 In**  **support of**  **the third**  **assumption, the**  **HVAC wholesaler**  **and contractor**  **industry is** 

**competitive and**  **customer demand**  **for commercial**  **heating and**  **air conditioning**  **is relatively** 

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

**equipment. The**  **large number**  **of wholesaler**  **firms listed**  **in the**  **2002 Census**  **indicates the** 

**competitive nature**  **of the**  **market. For**  **example, there**  **are almost**  **1,400 wholesalers**  **of**

**refrigeration equipment,**  **and 87,000**  **HVAC contractors.**  **5 Following**  **standard economic**  **theory,**

**competitive firms**  **facing inelastic**  **demand either**  **set prices**  **in line**  **with costs**  **or quickly**  **go out**  **of**

**business. 6** 

6.3 ESTIMATION OF W HOLESALER MARKUPS

**Wholesalers r**  **eport median**  **data in**  **a confidential**  **survey that**  **HARDI conducted**  **of**

**member firms.**  **7 In**  **the survey,**  **HARDI itemizes**  **revenues and**  **costs into**  **cost categories,** 

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

**other operating**  **expenses, and**  **profit. It**  **reports data**  **for various**  **industry segments,**  **including the** 

**Controls and**  **Refrigeration industry**  **segment in**  **terms of**  **industry median**  **values. DOE**  **presents**

**these data**  **for Controls**  **and Refrigeration**  **in terms**  **of specific**  **types of**  **expense within**  **these**

**categories in**  **appendix C.**  **Table 6.3.1**  **summarizes these**  **expenses as**  **cost per**  **dollar sales** 

**revenue in**  **the first**  **data column.**  **As shown**  **in this**  **column, the**  **direct equipment**  **expenses (cost** 

**of goods**  **sold) represent**  **about $0.70**  **per dollar**  **sales revenue.**  **In other**  **words, for**  **every $1** 

**wholesalers take**  **in as**  **sales revenue,**  **they use**  **$0.70 to**  **pay the**  **direct equipment**  **costs. Labor** 

**expenses account**  **for $0.20**  **per dollar**  **sales revenue,**  **occupancy expenses**  **account for**  **$0.03,**

**other operating**  **expenses account**  **for $0.04,**  **and profit**  **accounts for**  **$0.03 per**  **dollar sales** 

**revenue.**

Table 6 .3.1 Wholesaler Expenses and Markups*

Description Wholesale F irm Expenses or Revenue

Per D ollar

Sales Revenue Per D ollar Cost

of Goods Sold

Direct C ost 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 **$0.70**

**$ 0.20** 

**$0.03**

**$0.04**

**$0.03 $1.00** 

**$ 0.28** 

**$0.05**

**$0.06**

**$0.04**

Baseline M arkup ( MU WHOLE BASE ): **Revenue per**  **dollar cost**  **of goods**  **sold** 1.43

Incremental M arkup ( MU WHOLE INCR ): **Increased revenue**  **per dollar**  **increase cost**  **of goods**  **sold** 1.10

***** **Source: H**  **eating, Airconditioning**  **& Refrigeration**  **Distributors International.**  **2005. 2005**  **Profit Report**  **(2004 Data).** 

**The last**  **column of**  **Table 6.3.1**  **shows the**  **data converted**  **from costs**  **per dollar**  **revenue**

**into revenue**  **per dollar**  **cost of**  **goods sold.**  **DOE did**  **this conversion**  **by dividing**  **each cost** 

**category in**  **the first**  **data column**  **of Table**  **6.3.1 by**  **$0.70 (i.e.,**  **equipment expenditure**  **per dollar** 

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

**equipment costs,**  **the wholesaler**  **earns $1.00**  **in sales**  **revenue to**  **cover the**  **equipment cost,**  **$0.28**

**to cover**  **labor costs,**  **$0.05 to**  **cover occupancy**  **expenses, $0.06**  **for other**  **operating expenses,**  **and**

**$0.04 in**  **profits. This**  **totals to**  **$1.43 in**  **sales revenue**  **earned for**  **every $1.00**  **spent on**  **equipment**

**costs. T**  **herefore, the**  **wholesaler baseline**  **markup (**  MU WHOLE BASE **) is**  **1.43 ($1.43**  **÷ $1.00).** 

**DOE a**  **lso used**  **the data**  **in the**  **last column**  **to estimate**  **the incremental**  **markups. The** 

**incremental markup**  **depends on**  **which of**  **the costs**  **in Table**  **6.3.1 are**  **variable and**  **which are** 

**fixed. For**  **example, for**  **a $1.00**  **increase in**  **the manufacturer**  **equipment price,**  **if all**  **of the**  **other**

**6­6 costs**  **scale with**  **the manufacturer**  **selling price**  **(i.e., all**  **costs are**  **variable), the**  **increase in** 

**wholesaler price**  **will be**  **$1.43, implying**  **that the**  **incremental markup**  **is 1.43,**  **or the**  **same as**  **the**

**baseline markup.**  **However, if**  **none of**  **the other**  **costs are**  **variable, then**  **a $1.00**  **increase in**  **the**

**manufacturer selling**  **price will**  **lead to**  **a $1.00**  **increase in**  **the wholesaler**  **price, for**  **an**

**incremental markup**  **of 1.0.**  **DOE assumes**  **that the**  **labor and**  **occupancy costs**  **will be**  **fixed and** 

**that the**  **other operating**  **costs and**  **profit will**  **scale with**  **the manufacturer**  **selling price**  **(i.e., be** 

**variable). In**  **this case,**  **for a**  **$1.00 increase**  **in the**  **manufacturer selling**  **price, the**  **wholesaler**

**price w**  **ill increase**  **by $1.10,**  **giving a**  **wholesaler incremental**  **markup (**  MU WHOLE INCR **) of** 

**1.10 ($1.10**  **÷ $1.00).** 

**DOE r**  **ecognizes that**  **there is**  **a possibility**  **of case­to­case**  **deviation in**  **the markups** 

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

**wholesalers, DOE**  **calculated a**  **standard deviation**  **of 4.2**  **percent. DOE**  **assumed that**  **the**

**variation determined**  **for the**  **baseline markup**  **applied to**  **the incremental**  **markup as**  **well. For**  **the**

**baseline markup**  **of 1.43,**  **a standard**  **deviation of**  **4.2 percent**  **translates into**  **an absolute**  **value of** 

**0.06 and**  **f or**  **the incremental**  **markup of**  **1.10, a**  **standard deviation**  **of 4.2**  **percent translates**  **into**

**an absolute**  **value of**  **0.05. However,**  **the national**  **data on**  **distribution of**  **CRE units**  **suggests that** 

**only about**  **14 percent**  **of new**  **units sold**  **actually pass**  **through wholesalers.**  **The case­to­case** 

**deviation of**  **wholesale markup**  **thus has**  **a very**  **small impact**  **on the**  **overall cost**  **of equipment**  **and**

**can be**  **neglected. DOE**  **applied the**  **same baseline**  **and incremental**  **markup to**  **all sales**  **of CRE** 

**units passing**  **through wholesalers.**  **Further details**  **of these**  **data are**  **shown in**  **appendix C.** 

6.4 ESTIMATION OF M ECHANICAL CONTRACTOR MARKUPS

**DOE d**  **erived markups**  **for mechanical**  **contractors from**  **U.S. Census**  **Bureau data**  **for**

**Plumbing, Heating,**  **and Air­Conditioning**  **Contractors (North**  **American Industry**  **Classification**

**System 238220).**  **This sector**  **includes establishments**  **primarily engaged**  **in installing**  **and**

**servicing plumbing,**  **heating, and**  **air­conditioning equipment,**  **which may**  **include new**  **work,**

**additions, alterations,**  **maintenance, and**  **repairs. The**  **U.S. Census**  **Bureau data**  **for the**  **PHAC**

**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 PHAC**  **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. As**  **with the** 

**data for**  **wholesalers, Table**  **6.4.1 summarizes**  **the expenses**  **for mechanical**  **contractors, as** 

**expenses per**  **dollar sales**  **revenue, in**  **the first**  **data column**  **(appendix C**  **contains the**  **full set**  **of**

**data). The**  **direct cost**  **of sales**  **represents about**  **$0.66 per**  **dollar sales**  **revenue to**  **the mechanical** 

**contractor. Labor**  **expenses account**  **for $0.17**  **per dollar**  **sales revenue,**  **occupancy expenses** 

**account for**  **$0.02 per**  **dollar sales**  **revenue, other**  **operating expenses**  **account for**  **$0.03, and**  **profit**

**makes up**  **$0.12 per**  **dollar sales**  **revenue.**

**DOE c**  **onverted these**  **expenses per**  **dollar sales**  **into revenue**  **per dollar**  **cost of**  **goods sold,** 

**by dividing**  **each figure**  **in the**  **first data**  **column by**  **$0.66. The**  **data in**  **the last**  **column show**  **that,**

**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,**  **$0.26 to**  **cover labor**  **costs, $0.03**  **to**

**cover occupancy**  **expenses, $0.05**  **for other**  **operating expenses,**  **and $0.18**  **in profits.**  **This totals** 

**6­7 $1.52**  **in sales**  **revenue earned**  **for every**  **$1.00 spent**  **on equipment**  **costs. This**  **results in**  **a**

**mechanical c**  **ontractor baseline**  **markup (**  MU MECH CONT BASE **) of**  **1.52 ($1.52**  **÷ $1.00).** 

Table 6 .4.1 Mechanical Contractor Expenses and Markups*

Description Mechanical C ontractor Firm

Expenses or Revenue

Per D ollar

Sales Revenue Per D ollar Cost

of Goods Sold

Direct C ost of Equipment Sales: **Cost of**  **goods sold** 

Labor Expenses: **Salaries (indirect)**  **and benefits** 

Occupancy Expense: **Rent, maintenance,**  **and utilities** 

Other Operating Expenses: **Depreciation, advertising,**  **and insurance** 

Net Profit Before Taxes **$0.66**

**$ 0.17** 

**$0.02**

**$0.03**

**$0.12 $1.00** 

**$ 0.26** 

**$0.03**

**$0.05**

**$0.18**

Baseline M arkup ( MU WHOLE BASE ): **Revenue per**  **dollar cost**  **of goods**  **sold** 1.52

Incremental M arkup ( MU WHOLE INCR ): **Increased revenue**  **per dollar**  **increase cost**  **of goods**  **sold** 1.23

***** **Source: U**  **.S. Census**  **Bureau. 2002.**  **Plumbing, Heating,**  **and Air­Conditioning**  **Contractors: 2002.**  **Report EC02­231­238220,**  **Table 4.**  **Detailed**

**Statistics for**  **Establishments: 2002.** 

**DOE was**  **also able**  **to use**  **the data**  **in the**  **last column**  **in Table**  **6.4.1 to**  **estimate the** 

**incremental markups**  **by being**  **able to**  **separate the**  **fixed and**  **variable costs.**  **For example,**  **if all** 

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

**mechanical contractor**  **price will**  **be $1.52,**  **implying that**  **the incremental**  **markup is**  **1.52, 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 mechanical**  **contractor 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**  **equipment price**  **(i.e., be**  **variable). In**  **this**

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

**$1.23, g**  **iving a**  **mechanical contractor**  **incremental markup**  **(** MU MECH CONT INCR **) of** 

**1.23 ($1.23**  **÷ $1.00).** 

6.4.1 Estimation o f Mechanical Contractor Markup Probability Distribution

**Mechanical c**  **ontractor costs**  **differ in**  **various regions**  **of the**  **country for**  **reasons including** 

**availability of**  **labor, cost**  **of living,**  **union versus**  **non­union workforce,**  **and others.**  **Because**

**many mechanical**  **contractor costs**  **differ systematically**  **by state,**  **DOE characterized**  **the markups** 

**developed from**  **U.S. Census**  **Bureau data**  **with a**  **probability distribution**  **based on**  **a state­by­state** 

**analysis of**  **U.S. Census**  **Bureau data**  **for PHAC**  **contractors. The**  **state­by­state analysis**  **provided**

**a distribution**  **on the**  **relative markups**  **of mechanical**  **contractors in**  **the United**  **States. DOE**  **then**

**applied the**  **State­level index**  **to the**  **single­point baseline**  **and incremental**  **markups calculated** 

**above to**  **create State­level**  **markups. Because**  **the state­by­state**  **distribution of**  **CRE units**  **varies**

**by type**  **of customer**  **(e.g., supermarkets**  **may be**  **more prevalent**  **relative to**  **convenience stores**  **in**

**one part**  **of the**  **country than**  **another), a**  **national­level distribution**  **of the**  **mechanical contractor** 

**markup index**  **is different**  **for each**  **class of**  **building.**

**Figure 6**  **.4.1 shows**  **the cumulative**  **probability distribution**  **of the**  **State markup**  **index that** 

**DOE used**  **to characterize**  **the mechanical**  **contractor baseline**  **and incremental**  **markups for** 

**supermarkets.**

**6­8**Mechanical Contractor Markups for Supermarkets

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

1.35 1.4 1.45 1.5 1.55 1.6 1.65 1.7

MarkupCumulativePercentage Mechanical Contractor

Markup for Supermakets

Figure 6.4.1 Cumulative National Sales­Weighted Distribution of Mechanical Contractor

Markups for Commercial Refrigeration Equipment Sales to Supermarkets

6.5 SALES T AX

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

**of CRE**  **units. The**  **sales tax**  **is a**  **multiplicative factor**  **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, 8**  **shown in**  **Table 6.5.1.**  **The State**  **level combined**  **tax rates** 

**can be**  **applied to**  **the estimated**  **value of**  **State level**  **CRE equipment**  **shipments to**  **obtain the**  **total**

**purchase cost**  **to the**  **customer located**  **in any**  **state.**

Table 6 .5.1 State Sales Tax Rates

State Combined

S tate and

Local Tax

Rate State Combined

S tate and

Local Tax

Rate State Combined

S tate and

Local Tax

Rate

**Alabama 8.05%**  **Kentucky 6.00%**  **North D**  **akota 5.50%** 

**Alaska 1.15%**  **Louisiana 8.60%**  **Ohio 6.75%** 

**Arizona 7.65%**  **Maine 5.00%**  **Oklahoma 8.15%** 

**Arkansas 8.00%**  **Maryland 5.00%**  **Oregon 0.00%** 

**California 7.95%**  **Massachusetts 5.00%**  **Pennsylvania 6.25%** 

**Colorado 6.15%**  **Michigan 6.00%**  **Rhode I**  **sland 7.00%** 

**Connecticut 6.00%**  **Minnesota 6.70%**  **South C**  **arolina 5.80%** 

**Delaware 0.00%**  **Mississippi 7.00%**  **South D**  **akota 5.25%** 

**Dist. o**  **f Columbia**  **5.75% Missouri**  **6.85% Tennessee**  **9.40%**

**Florida 6.70%**  **Montana 0.00%**  **Texas 7.95%** 

**Georgia 6.90%**  **Nebraska 6.30%**  **Utah 6.45%** 

**Hawaii 4.00%**  **Nevada 7.50%**  **Vermont 6.00%** 

**Idaho 5.05%**  **New H**  **ampshire 0.00%**  **Virginia 5.00%** 

**Illinois 7.55%**  **New J**  **ersey 6.00%**  **Washington 8.45%** 

**Indiana 6.00%**  **New M**  **exico 6.55%**  **West V**  **irginia 6.00%** 

**Iowa 6.60%**  **New Y**  **ork 8.25%**  **Wisconsin 5.40%** 

**Kansas 6.95%**  **North C**  **arolina 7.05%**  **Wyoming 5.35%** 

**6­9 The**  **distribution of**  **sales tax**  **rates ranges**  **from a**  **minimum of**  **zero percent**  **to a**  **maximum**

**of 9.4**  **percent with**  **a mean**  **value of**  **6.8 percent.**  **DOE applied**  **sales taxes**  **to the**  **customer**

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

**located.**

**A weighted­average**  **n ational**  **level sales**  **tax rate**  **is calculated**  **by multiplying**  **the shares**  **of**

**state level**  **shipments for**  **each of**  **the four**  **sectors by**  **the tax**  **rates in**  **Table 6.3.1.**  **This provides**  **a**

**weighted national**  **average sales**  **tax rate**  **for the**  **four sectors**  **based estimated**  **CRE equipment** 

**sales to**  **each of**  **the four**  **sectors as**  **shown in**  **Table 6.5.2.** 

Table 6 .5.2 National Average Weighted Sales Tax Rates, based on Estimated

Commercial Refrigeration Equipment Shipments by State

Supermarkets

and Grocery

Stores

(44511) Convenience

a nd Specialty

Stores (44512,

4452, and 4453) Gasoline

S tations with

Convenience

Stores (44711) Warehouse

C lubs and

Supercenters

(45291)

**Weighted S**  **ales**

**Tax Rate**  **by**

**Retail Sector**  **6.77% 6.66%**  **6.81% 6.73%** 

**Weighted S**  **ales**

**Tax Rate**  **all**

**Retail Sectors**  **6.76%**

**Because the**  **state­by­state distribution**  **of CRE**  **units varies**  **by type**  **of customer** 

**(e.g., supermarkets**  **may be**  **more prevalent**  **relative to**  **convenience stores**  **in one**  **part of**  **the**

**country than**  **another), a**  **national­level distribution**  **of the**  **sales tax**  **markups is**  **different for**  **each**

**class of**  **building.**

**Figure 6**  **.5.1 shows**  **the cumulative**  **probability distribution**  **of the**  **state tax**  **rates that**  **DOE**

**used to**  **characterize sales**  **tax markups**  **for supermarkets.** 

Sales Tax Rates, CRE Sales to Supermarkets

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00%

Combined State and Local RatesCumullativePercentofEquipmentSales Sales Tax Rates

Figure 6.5.1 Cumulative National Sales­Weighted Distribution of Sales Tax Rates for

Commercial Refrigeration Equipment Sales to Supermarkets

**6­10**6.6 NATIONAL A CCOUNTS

**Equipment p**  **urchased through**  **national accounts**  **constitutes about**  **86 percent**  **of the**  **usual**

**distribution of**  **CRE equipment**  **to customers.**  **Large customers**  **of CRE**  **equipment use**  **national**

**accounts to**  **circumvent the**  **typical distribution**  **channel, thereby**  **allowing them**  **to negotiate** 

**significantly lower**  **equipment prices**  **directly with**  **the manufacturer.**  **The manufacturer**  **in turn** 

**must cover**  **additional expenses**  **related to**  **the distribution**  **(as opposed**  **to the**  **manufacture) of**  **the**

**equipment, but**  **gains in**  **terms of**  **negotiating agreed**  **upon sales**  **volumes with**  **the customer.** 

**To c**  **apture the**  **price savings**  **realized from**  **equipment purchased**  **through national** 

**accounts, DOE**  **derived a**  **national account**  **markup, assuming**  **that the**  **resulting equipment**  **price**

**increase was**  **one half**  **of that**  **realized from**  **a distribution**  **through the**  **wholesaler channel.**  **In**

**other words,**  **if the**  **price increase**  **resulting from**  **the wholesaler**  **markups is**  **$100, the**  **national**

**account markup**  **is such**  **that the**  **price increase**  **is one­half**  **of that,**  **or $50.**  **DOE based**  **the use**  **of a** 

**national account**  **markup that**  **is one­half**  **of that**  **realized from**  **the wholesaler**  **distribution channel** 

**on the**  **assumption that**  **the resulting**  **national account**  **equipment price**  **must fall**  **somewhere**

**between the**  **manufacturer selling**  **price (i.e.,**  **a markup**  **of 1.0)**  **and the**  **customer price**  **under the** 

**wholesaler distribution**  **channel. Because**  **DOE did**  **not know**  **typical values**  **for the**  **actual**

**national account**  **equipment price,**  **it chose**  **a value**  **of one­half.** 

**To i**  **llustrate the**  **development of**  **the national**  **account markup**  **further, this**  **section**

**provides the**  **following example**  **of how**  **DOE derived**  **it. For**  **example, using**  **a baseline** 

**manufacturer selling**  **price of**  **$1,000 for**  **a CRE**  **unit delivered**  **to a**  **supermarket and**  **baseline**

**wholesaler markups**  **of 1.436,**  **the resulting**  **baseline customer**  **equipment price**  **for sales**  **through a** 

**wholesaler (without**  **sales taxes)**  **is $1,436**  **($1,000 x**  **1.436). The**  **dollar value**  **increase due**  **to the** 

**above distribution**  **channel markups**  **is $436**  **($1,436 ­ $1,000).**  **Under the**  **assumption that** 

**national account**  **customers realize**  **equipment price**  **increases equal**  **to one**  **half of**  **that through** 

**the wholesale**  **distribution channel,**  **the dollar**  **value of**  **the equipment**  **price increase**  **under the** 

**national account**  **is $218**  **(one­half of**  **$436). The**  **resulting equipment**  **price is**  **$1,218**

**($218 +**  **$1,000), which**  **results in**  **a deduced**  **national account**  **baseline markup**  **of approximately** 

**1.218 ($1,218**  **÷ $1,000).**  **A similar**  **calculation results**  **in a**  **deduced national**  **account incremental** 

**markup of**  **1.054 ($1,054**  **÷ $1,000).** 

6.7 OVERALL M ARKUPS

**DOE m**  **ultiplied the**  **wholesaler, mechanical**  **contractor, and**  **national account**  **markups**

**described above**  **by the**  **weighted average**  **sales tax**  **multiplier to**  **obtain the**  **overall baseline**  **and**

**incremental markups**  **shown in**  **Table 6.7.1**  **and Table**  **6.7.2. DOE**  **based overall**  **markups on**  **one**

**of three**  **distribution channels**  **according to**  **how the**  **equipment is**  **purchased: through**  **a national** 

**account; a**  **wholesaler; or**  **a wholesaler**  **and a**  **mechanical contractor,**  **and the**  **State into**  **which the** 

**CRE unit**  **is delivered.**  **Table 6.7.1**  **presents three**  **overall markups**  **for the**  **overall baseline** 

**markup, and**  **Table 6.7.2.**  **presents the**  **same information**  **for overall**  **incremental markups**  **for**

**supermarkets, as**  **an example.** 

**6­11**Table 6.7.1 Baseline Markups by Distribution Channel and Overall Weighted Average

Markup, Including the Weighted Average Sales Tax Multiplier for

Supermarkets

Wholesaler Mechanical

C ontractor

(Includes

Wholesaler) National

A ccount

(Mfg

Direct) Overall

W eighted

Average

Markup

Distributor(s)

M arkup **1.436 2.182**  **1.218 1.301** 

Sales T ax

Multiplier **1.068 1.068**  **1.068 1.068** 

Overall

M arkup **1.533 2.330**  **1.300 1.389** 

Table 6.7.2 Incremental Markups by Distribution Channel and Overall Weighted

Average Markup, Including the Weighted Average Sales Tax Multiplier for

Supermarkets

Wholesaler Mechanical

C ontractor

(Includes

Wholesaler) National

A ccount

(Mfg Direct) Overall

Distributor(s)

M arkup **1.107 1.362**  **1.054 1.079** 

Sales T ax

Multiplier **1.068 1.068**  **1.068 1.068** 

Overall

M arkup **1.182 1.454**  **1.125 1.152** 

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

**given the**  **manufacturer cost**  **of baseline**  **equipment. For**  **example, if**  **the manufacturer**  **selling**

**price of**  **a baseline**  **CRE unit**  **is $1,000,**  **DOE can**  **multiply this**  **by the**  **weighted­average overall** 

**baseline markup**  **to estimate**  **that the**  **baseline customer**  **price of**  **the CRE**  **unit sold**  **is $1,390.** 

**Similarly, DOE**  **used the**  **overall incremental**  **markup to**  **estimate changes**  **in the**  **customer price,** 

**given changes**  **in the**  **manufacturer selling**  **price above**  **the baseline**  **due to**  **increases in**  **equipment**

**efficiency. For**  **example, if**  **a new**  **standard increases**  **the CRE**  **manufacturer selling**  **price by** 

**$100, DOE**  **can multiply**  **this price**  **($100) by**  **the weighted­average**  **overall incremental**  **markup**

**(1.152) to**  **estimate a**  **customer price**  **increase of**  **$115.**

6.8 RESULTS

**The o**  **verall baseline**  **and overall**  **incremental markups**  **are presented**  **in section**  **6.7. These** 

**markups will**  **be used**  **with the**  **MSPs to**  **generate customer**  **prices for**  **commercial refrigeration** 

**equipment. Supporting**  **data for**  **the calculation**  **of baseline**  **and incremental**  **markups are** 

**provided in**  **appendix C.** 

**6­12**REFERENCES

**1 Personal**  **communication with**  **Verisae, June**  **2006**

**2 U.S.**  **Census B**  **ureau. 2002.**  **Plumbing, Heating**  **and Air­Conditioning**  **Contractors (PHAC):** 

**2002. Report**  **EC­02­231­238220.**

**3 Lawrence**  **Berkeley National**  **Laboratory (LBNL)**  **2004. An**  **Analysis of**  **Price Determination** 

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

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

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

**5 U.S.**  **Census B**  **ureau. 2002.**  **Electrical, Hardware,**  **Plumbing, and**  **Heating Equipment**  **and**

**Supplies: 2002.**  **Report EC­02­421­17.** 

**6 Pindyck,**  **R. and**  **D. Rubinfield.**  **2000. Microeconomics,**  **Prentice­Hall.**

**7 Heating,**  **Air Conditioning**  **& Refrigeration**  **Distributors International**  **(HARDI). 2005.**  **2005**

**Profit Report**  **(2004 Data).** 

**8 The**  **Sales Tax**  **Clearinghouse. Accessed**  **https://thestc.com/STRates.stm.**

**6­13**