# Peer Review for the R TI Report,

Automobile Industry Retail Price

Equivalent and Indirect Cost Multipliers

# Peer Review for the R TI Report,

Automobile Industry Retail Price

Equivalent and Indirect Cost Multipliers

Assessment and Standards Division

Office of T ransportation and Air Quality

U.S. Environmental Protection Agency

EP A-420-R-09-004

June 2009______________________________________________________________________________ June 4, 2009

MEMORANDUM

SUBJECT: Peer Review for RTI Re por t on “PASSENGER VEHICLE RETAIL PRICE

EQUIVALE NT FACTORS AND INDI RECT COST MULTIPLIERS”

FROM: Gloria Helfand, Assessm ent and Standards Division

Office of Transportation and Air Qual ity, U.S. Environm ental Protection Agency

In July 2008, US EPA contracted with RTI International to upda te EPA’s m e thodology for

accounting for indirect costs associated with changes in direct m a nuf acturing costs. The

resulting report from RTI provi des a description of the new m e thodology, as well as calculations

of new indirect cos t m ultipliers. These indirect cost m ultipliers are intend ed to be used, along

with calculations of direct m a nufacturing cost s, to provide improved estim a tes of the full

additional costs associated with new technologies. The RTI report is enti tled “Passenger Vehicle

Retail P r ice Equivalen t Factors a nd Indirect Cost Multipliers.”

Prior to the r eleas e of the Final Repor t f r om RT I International, EPA provi ded a draft copy of the

report to th ree independ ent expe rts f o r external p eer review, in accordan ce with EPA’s peer

review guidelines. This EPA re port contains docum entation of th e peer review process for the

RTI study.

This document contains three com p onents. Fi rst is the summary of the peer rev i ewers ’

comments and the response to those comments fr om EPA. Following this is the EPA charge

letter to the peer review ers, which d escrib es th eir task and w h at EPA requested from them in

term s of deliverables. L ast is the pe er rev i ewers ’ subm itted biograph i es and their co mments on

the draf t RT I repor t.______________________________________________________________________________ DATE: June 4, 2009

MEMORANDUM

SUBJECT: EPA Response to Comm ents on RTI report entitled “Updating EPA’s

Methodology for Accounting for Indirect Costs Associated with Changes in

Direct M a nu facturing Co sts,” Draft F i nal Report by peer reviewers Morgan

Edwards, Glenn Mercer, and Danilo Santini

FROM: Gloria Helfand, Assessm ent and Standards Division

Morgan Ed wards (formerly of Ford Motor Comp any), Glenn Mercer (form e rly of M c Kinsey &

Com p any), and Danilo Santini (of Argonne National Laboratory) reviewed RTI’s report entitled

“Updating E P A’s Methodology for Accounting for I ndirect Costs Associated with Changes in

Direct Manu facturing Co sts,” Dr aft F i nal Report, Decem ber 2008.

This m e m o i ncludes a summary of comments and responses and actions to comments from EPA

and RTI.



### Comme nt s on Ge neral Appr oa ch

The reviewers expressed support for the concep t that indirect costs should vary with

technological com plexity and with tim e fra m e. Edwards: “This is a logical and reasonable

approach.” Mercer: “I agree with the overall approach and m e t hodology, as it is co nsistent with

and an im provem e nt upon the prior well-accepted RPE m ethodology.” Santin i: “. . . I lik e the

idea of technology complexity, and generally support the argum e nt about its qualitative effect on

multipliers. . . .” The co ncerns th at they expr ess ed cente red on two m ajor issue s: th e role of

prof its in the m u ltipliers, and whether the IC m u ltiplie rs deve loped here sh ould approx im ately

average ou t to the RPE.

Co mm ent : Two reviewers asked for further explan ation on the rem oval of profits from the

indir ect co st m u ltipliers.

Response : This issue is discussed in Section 2 of the final report. The following discussion

elaborates on the discussion in the report.

For regulatory analysis, it is necessary to have estim a tes of the costs associated with n e w

technologies. In a world of com p lete inform a tion, EPA would have estim a tes of all the costs

associated w ith a new technology. For instance, it would be possible to calculate the changes not

only in parts and labor for the new technology, but also the effects on cor porate staff and dealer

costs. W h ile EPA often has reason able es tim ates fo r direct costs (the parts, labor, and utilities

associated w ith a new technology), it often lack s infor m ation on som e of the indirect costs

(including production overhead, corporate ov erhead, and dealer and selling costs).Since com p lete inform ation does not exist, m u ltipliers are an appr oxim a tion to estim a te

the m i ssing infor m ation, based on co mpany average data. T he use of the RPE m ultiplier in

particular includes the implicit assu mption that indirect costs are constant across all technologies

and processes in a com pany. This is not likely to be a good assum ption: som e new te chnologies,

for instance, are likely to require m ore new tooling than others; som e technologies m a y affect the

way a vehicle is m a rkete d, while oth e rs ar e of little in tere st to consum ers. Any m u ltiplier,

including the RPE, is thus only an approxim a tion based on averaging ov er all the activities of the

com pany. It is a proxy when it is no t possible to estim ate actual costs.

Whether pro f it should be included in a m u ltip lier depends on whether th ey are cons id ered

a cost of doing business. The arguments for inc l uding prof its in the m u ltiplier in clud e:

• Profit is the return n ecessary to keep investm e nt in the industr y; as such, it is a cost of

production. While a business, for short periods , can lose m oney, over time it has to earn

enough m oney to keep investors from taking their m oney out of the com p any. Thus,

profit is a cost of doing business.

• In a m arket supply-dem and m odel, profit pe r unit can stay consta nt even though total

prof its dec r e a se in m a rket adjus t m e nt. Co st incr e ases due to a regula tion will lead

consum ers to buy fewer vehicles. In the short run

, com p anies will reduce their

production in response to the reduction in cons um er purchases. This initial new level of

production m a y or m a y not produce profits for th e industry. If profits are negative, over

tim e, producers will adjust the level of invest m ent in the industry to reduce their costs of

production, and they will be able to m a intain reasonable prof its. Thus, including profits

is necessary to iden tify the long -run equilibrium in the m arket.

The argum e nt against including profits include:

• Multip liers are in tended to estim ate costs , not re tail p r ice. N o t all cost ch anges will affect

indirect co sts, even if they affect profit. For instance, if a reg u lation caus e s the price of

an input to increase with no production adjust m ents, it will cause co sts to increase and

profits to decrease, but there is no effect on i ndirect costs. Profits are therefore not the

sam e as indirect costs.

• Prof it com es f r om intera ctions of sup p ly a nd demand curves, not from inc l uding it in a

multiplier. When the cost of a good increases, th e price increases; in resp onse, though

,

consum ers buy less of it. As a result, the full cost m a y not be passed along to consumers.

W h ether the com p anies prof it with the new le vel of costs depends on the m a rket price

after the m arket adju stm ents.

• If producers were guaranteed a profit when costs increased, why would they object to

cost in creas e s ? In fact, cost in creas e s do typically lead to reduc tions in profit, and

com p anies object to the rules based on those lo sses. In regulatory analys es , these losse s

in m a rkets are com p ared to the ben e fits of the rule (the values resulting from i m proved

air quality, for instance).

The repor t c oncludes tha t prof its sho u ld not be in cluded in th e indirect co st m u ltiplie r s

and does not include them in the calculation. The report uses 5% as the profit share of direct

costs in its c alculation of the RPEs for individual autom a kers w hose profits were negative in

2007. If this 5% value w ere in cluded in the indi rect cos t m ultipliers, the n e w values would all

increase by 0.05, as shown in the table below.Indirect Cost Multiplier s Including 5% Profit.

Technol o gy Comple xity

Time Frame Low Medium High

Sh ort -t e rm effect s 1. 10 1. 25 1. 50

Lo ng -t erm effe ct s 1. 07 1. 10 1. 31

Co mm ent : One reviewer asked whether negative prof its should be rem oved from the calculation

of the RPE.

Response : In recen t years, as th e Appendix ind i cates, som e autom a kers have m a de negative

profits, after having achieved positiv e profits in past years. Pr ofit should reflect the return on

capital. Bec ause owners of capital re ceive bo th p o sitiv e and n egativ e re tur n s, the nega tive

profits should not be ignored; instead, som e lo ng-term average that reflects all returns is

appropriate. For the RPE calculation in Tabl e 3-3, which uses data only for 2007 (2006 for

Daim lerChrysler ) , ac tua l prof it was used f o r the autom akers f o r whom it was positiv e ; f o r

negativ e pro f its (for Ford and GM), the 5% valu e noted by McKinsey (2003) was s ubstitu ted fo r

the nega tive value.

Co mm ent : Several comm ents asked whether th e IC m u ltipliers should include all ind i rect cos t s

in the long run. One reviewer questioned whether the adjustm e nt factors discussed in Section 4

of the report should all be 1 in the long run. “After all, the R P Es incorporate for the long-term

all the various actions and changes m a de by the com panies, whether from regulation or m a rket

forces. In other words, in the long-run, the tota l costs are the only rele vant costs.” Another

reviewer asked whether “every com ponent woul d have to be allocated selling and som e

corporate ov erhead co sts

. ” A third comm ent as ked whether IC m ultipliers should increase with

decreases in production, since all i ndirect costs had to be spread over a sm aller num ber of units

produced.

Response : This issue is discussed in Sec tions 2 and 4 of the final report.

The IC m ult ipliers derived here are intended to be used for changes in costs due to

changes in technologies. That is, they are assum e d to apply only to costs due to the rulem a king.

Som e industry costs are sunk—tha t is, that auto m akers will have to pay regard less o f the

rulem a king—while others will change with the rule. Sunk costs, such as pensions for retirees, by

def i nition w ill no t chang e with inco r poration of the new tech nologies. F o r the purpo se of

estim ating the increm ental indirect costs of a new regulation, new com p onents should be

alloc ated the additional selling and corporate overhead (and other indirect) costs for w h ich the

new com p onents are responsible; th e pre-existing costs are unrelated to the rule. The adjustm e nt

factors presented in Section 4 serve to id entify those additional indirect costs.

W h ether the m u ltipliers will ch ang e with the vo lum e of production dep e nds on how the

ratio of indirect costs to dire ct costs changes with production. The values developed in this

report are av eraged over a num ber of autom a kers with a wide range of production volum e s. Theindir ect co st m u ltipliers f o r thes e co mpanies all f ell in a sm all r ange (s ee Table 3-3 )

. There is

theref ore little bas i s on which to adju st the m u ltipliers for sales volum e.

Whether the IC m u ltipliers develop e d in this stud y should average out , in the long run, to

the RPE for the com pany depends on whether the kinds of technologies considered for the IC

multipliers c r eate indirec t costs sim ilar to thos e f o r the com p anies as a whole. W h ile the

reviewe r s all agre ed with the pr incip l e tha t IC multip lie rs sh ould vary with the com p lexity of the

technology, there is no public information to estim ate how indirect costs vary with different

technolog ies

. Reasons th at the IC m u ltip liers m i ght average o u t to th e RPE m u ltiplier include:

• The RPE is the result of m a ny long-run activit ies. Even though activities differ in the

indir ect co sts, they ave r a g e to the RP E. The tech nologies to which the I C m u ltiplie r s are

applied are no different than the technologi es that the com panies undertake voluntarily.

Reasons tha t the m u ltipliers m i ght not aver age ou t to th e RPE multiplier in clude:

• The activities likely to be proposed in rule m a kings are not averag e OEM activities, so

they need no t average to the sam e level. For ins t a n ce, regu latory require m ents are

typically of sm aller scale and require less overhead than developing an entirely new

vehicle or redesigning an ex isting one. If high-complex ity technologies are roughly

typical of average OEM non-regulato r y activi ties, then low- and m e dium

- c om plexity

technolog ies will have lo wer m u ltipliers.

The report concludes that the IC m u lt ipliers for the three specific example technologies

evaluated (low rolling resistan ce tires, dual clutch autom a ted m a nual transm ission, and gasolinehybrid electric vehicles) ar e lower than the RPE.

Co mm ent : A num b er of the cos t con t ribu tors are gi ven weights of 0 in the developm ent of the

IC m u ltipliers in th e sho r t run, and that num ber increas es for the long -run analys is, “implying

that the cumulative ef f

ect of num erous regula t or y changes will b e a with ering away of indirec t

costs.”

Response : The zero factors for m a ny of the cost contributors, prim arily for the low- and

m edium -complexity technologies, indicate that the engineers w ho developed the factors thought

that those contributors w ould not change due to the new technology. For instance, the

adjustm e nt factors for G & A, Retirem ent, and H ealth Care are all zero for low- and medium

com p lexity technologies, in the sho r t and l ong run s, because th e engineers argued th at no

additional corporate staff (nor their associat ed benefits) would be necess a ry for these

technologies.

Even though the m u ltipliers for the n e w technolo g ies m a y be low, the average m u ltiplier

f

o r the com p anies ove rall will in f ac t not change v ery m u ch. The f o llowing exam ple, presented

in the table below, demonstra t es tha t thes e m u ltip lie rs af f

ect the ind i rec t costs only of the new

technologies; the indirect co sts associated with the re st of the vehicle rem a in.

Consider a baseline vehicle with a trans action price to the consum er of $25,000. The

RPE for the base vehicle is the com p any averag e, 1.46 (1.4 is the indire ct cost com ponent, and

1.06 is the profit com ponent). These proportions allow breaking the base price into directm a nufacturing cost ($17,123), indirect cost (40% of $17,123, or $6,850) , and profit (6% of

$17,123, or $1,027).

Base Vehicle Dual-Clutch Transm ission Total Cost

Direct Manufacturing Cost $17,123 $500 $17,623

Indirect Cost (40% for base

vehicle, 20% for engine) $6,850 $100 $6,950

Profit (6% f or base vehicle) $1,027 0 $1,027

Total $25,000 $600 $25,600

Ratio of Indirect Cost to

Direct Manufacturing Cost 0.4 0.2 0.394

In this example, a dual-clutch transm ission will be required for the vehicle, and it is

considered a m e dium -complexity technology, with direct m a nufacturing cost of $500. The

indirect co st, accord ing to Table 4-5 in the final report, is 20 % of direct m a nufacturing cost, or

$100, in the short run. T h e short-run multiplier d o es not in clu d e profit. T h e total cos t for the

new transm ission, then, is estim ated to be $600.

The third co lum n sum s t h e direct an d indirect costs and profits for the base vehicle w ith

the new transm ission; costs increas e $600. The ratio of indirect cost to direct m a nufacturing cost

is 0.394, almost the sam e as the ratio of indirect cost to direct m a nufacturing cost for the base

vehicle. Because th e new transm ission is a sm all por tion of the cost of th e vehicle, th e effect of

the new tr an sm ission on the ind i rec t cost m u ltiplier f o r the en tir e vehic l e is sm all.

A sim ilar comparison us ing the long-run m u ltiplier ind i cates that the indirect cos t of the

new transm ission is expected to fall to 5% of its cost, or $25. Adding 6% profit as an estim ate of

capital costs of the transm ission ($30) yields a to tal cost of $555 for the transm ission. The ratio

of total cost to direct m a nufacturing cost would therefore be $25,555/17,623 = 1.45, slightly less

than the RP E m u ltiplier.

A high-complexity tech nology, such as a hybr id powertrain, has a short-run m ultiplier

virtu ally the sam e as the RPE and will thus not no tice ably af f

ect the ratio o f indirec t co st to

direct cost.

The cum u lative ef f

ect of m any regulatory chang es m i ght reduc e the m u ltiplier ove r tim e

, if the base vehicle rem a ins unchanged. The rede sign of a vehicle, as periodically occurs, is

like l y to inv o lve a m u ltiplie r at leas t as larg e as the high-com p lexity m u ltipliers dev e loped here.

Since those redesigns are the choi ce of the automakers, and not re quired by regulatory action, the

multipliers f o r new tech nologies req u ired by reg u la tion do n ot need to account for the indirect

costs as sociated with th e redes i gns.

Co mm ent : Neither RPE m u ltipliers nor IC m u ltiplie rs by the m selves estim ate the ef fect of

technology changes on final m a rket price and quantity.

Response : This issue is discussed in Section 2 of the report.

We agree with this po int. The IC m u l tipliers are a m o re accurate way to estim ate the

shift in prod ucer cos t s th an are the RPE m u ltiplie rs, becaus e the IC m u ltiplie rs es tim ate theeffects on marginal costs of production, and the supply curve reflects m a rginal costs. In

regulatory impact analysis, the shif t in the supply curve will be paired with a dem a nd curve to

calculate m a rket im pacts of a technology change.



### A d ju s t men t s to C a lc u l a t io ns

Co mm ent : One reviewer sought greate r clarity and consistency in the developm ent of the RPE

multipliers. In particu l ar, it should b e clear and more consis tent when values from the McKinsey

study are included in the analysis.

Response : The Appendix tables now provide more detail about adjustments m a de for each

com p any. The McKinsey study as w e ll as a stud y by Sierra Research we re used to improve

estim ates of cost allocations when company repor t inform ation did not align with the categories

used in this study.

Co mm ent : Two reviewers questioned the way that dealer co sts are inclu d ed in the d r aft analys is.

They point o u t that dealer costs are n o t included in the auto m a nufacturers’ accounting

statem ents, since m o st dealers are ind ependent. A s a resu lt, th e deale r values reported f o r the

m a nufacturers do not include all dealer costs.

Response : This issue is discu ssed in Section 3 and, in depth, in Appendix A.2.

The IC m u lt ipliers shou ld include all cost ad justm e nts that affect the m a r ket price of

vehicles. For the final report, da ta f r o m the National Automobile Dea l er s Associatio n were used

to estim a te dealers’ increased costs from new technologies. (T his info rm ation was not included

in the d r aft.) These increased cos t s were adde d to m a nufacturers’ costs in the deve lop m ent of

the es tim ated RPE, and were consid ered in the d evelopm ent of the ICMs.

Co mm ent : Two reviewers expressed c oncern that health care fo r retired workers and other

“legacy ” cos t s are h a ndled appropriately.

Response : This issue is disc ussed in Section 3.2.2.

The report u ses the best available inform ati on to estim ate the share of health care and

other costs for workers who are no longer em ploye d by the m a nufacturers, and to exclude those

costs from the calculations. These costs will not change as the result of new technologies and

should be considered fixed costs.

Co mm ent : One reviewer asked about the “other expens es” m e ntioned in Section 2 of this report.

Response : This issue is discussed in the Appe ndix tab l es for each auto m a nufacturer.

These expenses typically include interest expens es and, for U.S. auto m a nufacturers, the portion

of health care costs associated with retirees. The Appendix tabl es id entify their sources for each

m a nufacturer.

Co mm ent : Two reviewers ques tion e d the use of the McKins ey estim ate of the RPE multiplier

and its constituents. One review er questions its use as a basis for com parison when its m e thod is

not explained, and when other studies are not given the sam e prom inence.Response : This issue is discussed in Section 3.2.2 and Appendix A-1.

The McKinsey study provided a breakdown of costs into categories used in this report. It

does not include a discussion of data sources or methods. Beca use autom a kers’ annual reports

do not follow a standardized approach, it was not al ways possible to identify cost categories for

each autom a ker. W hen c a tegories were m i ssing, the fi rst draft of this repo rt (the draft reviewed

by the peer reviewers) added the percent contri butions identified in th e McKinsey report, to

ensure th at a ll ca tegor ies were inc l ud ed. In the f i nal draf t, af ter m o re care f u l assessm ent of the

auto m a nufa c turers’ annual reports, it was de termined that the costs in the annual reports

included all the costs that this re port sought to include, but that costs were not reported in the

for m at presented here. In the final report, the McKinsey study, as well as a study by Sierra

Research, w e re used to reallo cate costs am ong categories. In som e cases, the reallocation

occurred among indirect cost contributors; in other cases, the realloca tion occurred between

direct costs and indirect costs. The Appendix tables for indivi dual auto m a nufacturers describe

their spec if ic use.

Co mm ent : The Vyas et al. study included two multip liers: o n e for outso urced parts, and the

other for expenses incurred by the autom a kers. One reviewer noted the s i m ilarity between the

Vyas et al. multiplier fo r outsour ced parts (1.5) and the RPE multipli er d erived in th is report; he

wondered whether the outsourcing of a large share of auto parts productio n m a y have contributed

to this sim ilarity.

Response : This issue is disc ussed in Section 3.1.

The study now notes this change in producti on practices and suggests that 1.5 m a y serve

as a prelim inary estim a te of the RPE m u ltiplier

. Instead of explicitly d i stinguishin g b e tween

outsourced and internal technologi es, this report used different levels of technology. The lowand m e dium-com plexity technologies are assum e d to rely prim arily on outsourced parts, while

the high-complexity technology (hyb rid electric vehicle is the m o tiv ating case) is estim a ted to

rely m ore heavily on components develope d internally to th e autom akers.

Co mm ent : One reviewer suggested that the report us e sales rather than revenues to develop the

weighted av erage RPE multiplier.

Response : This issue is disc ussed in Section 3.3.

The final report uses sales weights.

Co mm ent : Two reviewers noted that the annual re ports that provided th e basis for th e RPE

multipliers “have the v i rtue of being published p ublic num bers pres ented accord ing to standard s

of the Financial Accounting Standard Board (FASB). On the other hand, w ithin the FASB

standards there is considerable leeway on aggregation of indirect cost categories and am ount of

detail provided.” In addition, they “reflect corpor ate strategies rather than funda m e ntal

engineering realities,” and “the adherence to FASB standard s differs am ong U.S., Germ an,

Japanese, and Korean companies.” One reviewer wondered whether it might be possible to get

proprietary infor m ation, as the Federal Trade Co mmission can during investigations of dumping.

Response : This issue is disc ussed in Section 3.2.1.

This report uses publicly available data to faci litate the replicability and the transparency

of the analysis. Additionally, as the reviewers note, wh ile the data m a y not be precise, they arelikely to be broadly accurate, especially when av eraged over com p anies. For these reasons, the

report continues to use publicly availab l e financial s t atem ents.



### Comment s on Clari t y

Co mm ent : Two reviewers requested th at the report provide a deta iled explanation of the link

between the RPE m u ltiplier a nd the f i nal IC m u ltiplie rs.

Response : This issue is disc ussed in Section 4.4.

Table 4-5 sh ows the calculation involved in using the RPE m u ltip lier and the adjus t m e nt

f

actors to g e t the f i na l IC m u ltipliers.

Co mm ent : One reviewer suggested that the disc ussion of the reason fo r revisiting the RPE

approach be moved earlier in the report.

Response : What was Section 4 in the draft, which place s th e role of ind i rec t cos t s in to a

supply/dem a nd fra m ework, is now Section 2 of the report.

Co mm ent : Reviewers asked for further backgr ound on the engineers that provided the

adjustm ent f actors in f o r the IC m u ltiplie rs.

Response : This issue is disc ussed in Section 4.3.

The backgrounds of the engineers ar e now summarized in the report.

Co mm ent : Reviewers asked for further clarification of the scope of the analysis – whether it

included foreign as well as dom estic sales, and heavy duty as well as light duty vehicles.

Response : The annual reports for the autom a kers c over their worldwide autom otive operations.

The dealer costs and pro f its available are for th e U.S. As discussed in A ppendix A-2, the ratios

for U.S. dealers are then adju sted to worldwide levels.

Co mm ent : Two reviewers asked for clarification on the relationship betw een the historic RPE

multipliers (that is, the multipliers d evelope d for 2002-2006) and the RPE m ultipliers for 2007.

One reviewer asked why the m a nufac turing costs for 2007 were different f or the historic RPE

multiplier and the RPE multiplier es tim ated in th e study. Another review er asked wh ether a

perceived d o wnward trend in the m u ltip liers m i ght reflect the outsourcing of com pone nts

between the 1990s and 2000s.

Response : T his issue is discussed in the Appendix.

The histo r ic multipliers (the m u ltipliers develop e d for 2002-2006) are now presented

only as shares of direct m a nuf acturing costs. They are developed using unadjusted infor m ation

from the annual repo rts ; they are no t directly com p arable to th e m u ltipliers developed f o r 2007

(2006 for Daim ler Chrysler). The Appendices give detailed infor m ation on the adjustm e nts

m a de for the 2007 RPE multipliers (for instance, re m oving mainten a nce, repair, and o p erations

costs from Cost of Sales and allo cating it to indirect costs).

A downwar d trend is no t unam biguous in the h i storic RPE multip liers if they are p l otted

over tim e : most differences are sm a ll, and they show both increases and decreases. Whether atrend in the multipliers is associated with out sourcing is an in trigu i ng idea but beyond the scope

of this study.

Co mm ent : Two reviewers m ade a num b er of sp ecific recomm endations for clarifying the

Executive S u mm ary and the Introduction.

Response : These sections have been rewritten to increase clarity.

Co mm ent : Two reviewers sugges t ed consistent rounding an d for m atting for the m u ltipliers.

Response : The report n ow uses consisten t formatti ng. The report chose m u ltipliers as num bers

rather than p e rcen ts for increm entally easier rep l ication of th e calcu l ation s.

Co mm ent : The reviewers provided a num ber of ge neral and specific ed itorial comm ents,

corrections to typographical errors, and recomm e ndations for im proving the report’s structure

and clarity.

Response : Most of these suggestions were accepted and are reflected in the final report.Charge Letter Example

Dear Peer R e viewer:

Thank you for agreeing to review the docum ent, Estimating I ndirec t Cost Multipliers for

Individual D o mestic and Forei gn Automobile Manufacturers

. This report describes a m ethod to

account for the indirect costs associated with changes in direct m a nuf acturing costs for the

autom obile industry, by calcu lating multipliers d eri ved from financial statem ents, and it app lies

that m ethod to the m ajor autom akers. W e are sub m itting this docum ent to you for a peer rev i ew

of the m e thodology and the validity of the da ta and assum p tions that go into it.

Our goal for this peer review is to seek your expert input on the data and m e thodology we used

to conduct the analysis. Toward that end, we ask that your review discuss:

1) in general, the overa ll approach and m e thodology;

2) the app r o p riateness of th e datasets and other inputs;

3) the data analysis conducted;

4) the appropriateness of the conclusions;

5) recomm e ndations for any alte rnate data and / o r analys es; and

6) clarity of the presentation.

For this review, no independent da ta analysis is required, nor is it required that you duplicate the

results.

In m a king comm ents, you should distinguish be tween recomm endations for clearly defined

im prove m e nts that can be readily m a de based on da ta or litera ture r easona bly available to EPA,

and im provem e nts that are m o re exploratory or de pendent on inform ation not available to EPA.

The comme nts should be sufficiently clear and detailed to allow a thorough understanding by

EPA or other parties familiar with the work.

Your comments should be provide d as an enclosure to a cover letter that clearly states your

nam e , the nam e and address of your organization, what m a terial was reviewed, a summ ary of

your expertise and qualifications, an d a statem ent of any real or pe rceived conflicts of interest.

Please also send an electronic file with your comm en ts, either via e-m a il or on a diskette, so that

we can create a docum ent that lists both your comments and our responses to those comments.

The comme nts should be sent in care of Glor ia Helfand (helfand.gloria @epa.gov) to the

following address:

U.S. Environm ental Protection Agency

Assessm ent and Standards Division

Office of Transportation and Air Quality

2000 Traverwood Drive

Ann Arbor, MI 48105

When it is finalized, we will in clude your comm e nts as an attachm e nt to the report. We would

appreciate y our not prov iding th e peer rev i ew materials or y our comm ents to anyon e else un til

we m a ke them public.We would also like to receive the results of this review in the shortest time fram e poss i ble, no

later than January 9, 2009. If you have any questions about w h at is required in order to com plete

this review, or if you need additional backgr ound m a terial, please cont act Gloria Helfand by

phone (734-214-4688) or e-m a il (helfand.gloria@epa.gov)

. If you have any questions about the

EPA peer review process itself, please direct them to Ms. Ruth Schenk in the office of our

Deputy Offi ce Director by phone (734-214-4017) or e-m a il (schenk.ruth@epa.gov).

As Gloria Helfand has discussed with you, you w ill be paid a flat fee of $1,500 for this peer

review. This fee was calculated based on an estim ated 15 hours of review tim e at a rate of $100

per hour. In your cover letter pl ease indicate the num ber of ho urs spent on the review; spending

fewer or m o re hours than our estim a te will not af f ect the fee paid for this work, but it will help us

im prove our future estimates. A purchase or der form is also included showing paym e nt

inform ation. You m a y e xpect to receive paym en t in full within forty-five (45) days of

subm itting your comm ents and a cop y of your invoi ce to Dr. Helfand. Please send yo ur invoice

direc tly to:

RTP Finance

Mail Drop MC-D143-02

109 T.W . Al exander Drive

Research Triangle Park, NC 27711

Thank you again for your tim e and consideration.

Sincerely,

Gloria Helfand, Ph.D.

Assessm ent and Standards Division

Office of Transportation and Air Quality

Enclosure

cc (w/o enclosures):

G. Helfand, ASD

G. Janssen, ASDReview er Bio:

January 6, 2009

To:

Gloria Helfand

US EPA, Assessment and St andards Division (OTAQ)

2000 Traverwood Drive

Ann Arbor, Mi chigan 48105

From:

Glenn Mercer

3294 Enderby Road

Shaker Heights, Ohio 44120



### G. Mercer Cover Letter to Accompany My Review of:

“Estimating Indirect Cost Multipliers for Individ ual Dome stic and Foreign

Automobile Manufacturers”

Greetings. This letter is in re sponse to the c over letter inst ructions in the Peer Review

Charge (PR C ) Letter (r elating to r

e view of “E stimating Indirect C o st Mult ipliers for

Indivi dua l Domestic a n d F o reign Autom o bi le Manufacturers”). In that PRC Letter I was

asked to pr ovi de herei n :

o My name a n d the nam e and addr ess of my o r ganizat i o n

o What mate rial I revie w ed

o A summary of my expert ise and qualifications

o A statement of any re al or pe rceived conflicts of interest

o Number of hours I s p ent on this r

e view



### My name and t h e name and addr ess of my org anization

I am a n ind e pendent consul tant , Glenn Mercer, dba as an LLC, Glenn Mercer

Automotive LLC, located at 3294 Enderb y Road, Shaker Heights, Ohio 44120.



### Material reviewed

I reviewed a doc u ment title d “Updating EPA’ s Methodol ogy for Accounting for Indirect

Costs Associated with Change s in Direct Manufacturing Costs,” RTI Project Number0211577.002.004. N o te that this docume nt’s ti tle doe s not matc h th e title given in the

PRC Letter, which is re printe d at t h e to p of t h is page.



### Summary of expertise and qualifications

I spent 21 years with the cons ulti ng firm McKinsey & C o mpany, the last 10 o f which

wholly on a u tomotive projects, which in cluded various automo tive manufacturer

benchmark i ng projects, lead ing to h i g h f a mil i ari t y

wi th th ei r fi n a n cial statemen ts. I

have als o

worked for several years in private equi ty i n th e au to moti v e sph ere, in cl ud i n g

further re view of car maker P& Ls. Fi nall y, I am a D i rector of t h e Internat ional Mot o r Vehicle Program (IMVP), which performs comp arative studies of c ar makers around the

world on a regular bas i s. More data o n my expertise and qu a lifications can be found in

my resume , separately attache d

.



### Statement of any real or perc eived conflicts of interest

I believe there are no such conf licts involve d in m y par ticipat ion in this projec t. I a m

not affi liate d (nor is a n y member of m y i m mediate or extended fa mily) with EPA, the

University of Mic h iga n Transporta tion Rese arch Institute

, RTI Inter n ational, or any

automaker named in t h e report

. I do hol d s h ares in several OEMs , but only t h rough

aggregated mutual funds. I have no interest in a n y company which mi gh t directly

benefit from changes in regulat o r y

calcula tio ns to which this repo rt might lead. I di d

work for M c Kinsey & Company for many years, as noted, an d some McKin s ey work is

used in the report, but this was without m y foreknowledge, a n d in fact in my

recommendatio ns I s u ggest dele ting the McKins ey work from the repo rt, so I cannot be

charged wi th using m y reviewer status to pr omote McKinsey’s interests or reputation. I

am personally acqua i nted wit h Davi d Gans s, an EPA e m plo y ee, w h o I believ e d

suggested my name as a revi ewer of this document, but I have no professional or

fina ncial relations h ip with David.



### Number of hours I spent on this review

I ha ve spe n t roughl y eleven hours on this r e view. T h i s breaks down int o

one for a

detailed read of th e docu men t , two for writin g down m y i n itia l not e s and reac tions, a n d

eight for writing these comment s into the formal language and specific structure as

required in the Peer Review Ch ar ge letter. This ei ght hour b lock incl udes two dra f ts of

my review letter, as I refined my pers pectives and checked my results.

### G. Mercer Review of:

“Estimating Indirect Cost Multipliers for Individ ual Dome stic and Foreign

Automobile Manufacturers”

This memo represents my r e vi ew o f t h e d o cu m e n t

, Estimating Indirect Cost M u

ltipliers

for Indivi dual D o

mesti c

and Fo rei g

n Aut o

mo bile Ma nufa cturers (he r einafter re ferred to

as “ Estimating ”). My review is split in to two parts. I n t h e first par t, I directly address

the six questions posed in the Peer Review Charge (PRC ) letter I received alongside my

copy of Estimating

. T h is part will be brief and make ge neral poi n t s

. In the s econd

part, I wi ll go int o

m u ch more de tail, o n a page-by

- pa ge basis, of my review of

Estimating

. T h ro ugho ut t h is doc u ment I wil l fla g in bold font , and t h en reca pitulate i n

my conclusions, areas I consider pr oblematic as regards understanding Estimating ’s

results.

(Preliminar y point: the Peer Review Charge letter titles the docum e nt “Estima t ing

Indirect Cost Multipliers for Individu al Domestic and Foreign A u tomobile

Manufact u rers,” which I fi nd misl eading

. I much prefer the (di f f e ren t ) ti tl e on th e

document i tself, “Updating EPA’s Metho d ol ogy for Accounti n g for Indirect Costs

Associated with Change s in Direct Manufacturing Costs, ” wh i c h I con s i d er a mu ch mo r e

accurate description of the report’s contents.)



## Part I: The Six Questions

The PRC le tter asked me to discuss six top-leve l questions. I includ e them below, with

my br ief re ply to each.

1. Overall approach a n d methodology? I agree with the overa ll approach an d

methodology, as it is co nsistent with and a n im pr ovement upon the prior w e llaccepted RPE methodology. The improve ments of varying the enhanced RPE

factors (in Estimating labeled IC Ms) by tec hno lo gy c o mplexity and time period

make good sense to me. I do not know of a better m e thod of estimating the

indirect cost impact of regulated change s to vehicle tec hno lo gies than the one

proposed, short of act u ally tracki ng e v ery si ngle indir ect cost related to each

specific technology, across a range of OEMs, which I would assume is an

u n reason a bly slow, difficu lt, an d costly a ppr oach. As a metho d fo r getti ng a

goo d first a pprox imati o n wit h o u t in- d epth engineering wo rk, t h e a pproach

Estimating lays ou t looks soun d to me.

2. Appro p riat eness of da ta sets and ot her inputs? There are two ma in sets of

inputs in Es timating. F i rs t, public fina ncial st atemen ts of the car companies are

obtained. These statements have the great advantages of being bot h free and

easily available, and the great disadv antages of being accounting statementsthat do not reliably tie to actual engineering cost eq uat i ons. (For example,

depreciation of tooling is an accounting co nvention tha t is ea sil y divorced from

actual t ool i n g life

. ) A ddit io n all y , the statements reflect corporate strategies

rather tha n fundame n tal en gineer ing realities

. (For example, a car maker may

decide for marketing reason s to not “charge” its cars wi th th e fu l l co st of

technol o gy work, while ano ther m a y “mark up” its R&D work when transferred to

vehicle divi sions.) However, on t h e on e h a nd I kn ow of no better data set

reasonably available to EPA 1 , a n d on the othe r hand on e expects that the various

problems with these data wash out in the averaging of mult iple OE Ms’ results

across mult iple years. The second da ta set is the opinions collected from “a

team of engineers” that are translated into the technology-c omplexity a n d ti medimensio n adjustment factors. I complete ly concur wit h the a ppr oa ch of aski ng

experienced engineers for their input in order to derive these factors. However,

the report gives no data as to ho w man y engineers were employed in

this work, or their q ualifications. I think Estimating woul d benefit great l y

from revealing this information, even if each engineer’s name and employer were

disguised for confid entialit y purposes.

3. Data analysis conducted. The analysis of the data see m s sound to me, in that

most of the arithmetical steps followed we re described, and I trust the a u thor s to

have gotte n t h e calcul ations rig h t

. If I were to make a sugge stio n, however, on

page 3-10 t h e aut h ors do ma ke quite a l e ap, f r o m t h e ad ju st m e n t fact o r s

detailed in Tables 3-3 and 3

- 4, to the “final ICMs” show n in Table 3-5. It might

be hel p ful t o walk the reader through the calculations used in one of those

final ICMs, just for transparency’s sake.

4. Appropriateness of the conclu sions. I am not sure how to a ddre ss this que s tion

since Estimating does not really have explicit co nclusions: rather, it presents an

improved methodology for calc ulating the indirect cost impact on a car maker of

adopting newly-regulated technologies (presumably with reverse engineering

techniques used to estimate the direct cost impacts, in terms of materials and

labor )

. T o the extent the pa per i mplicit ly c o ncludes tha t IC Ms are a superior

method, then I find the conclusions appropriate.

5. Recommendations for any alternative data a n d/or a n al y s es. See point #2 above.

For the raw financial data sets, I do not see any a l terna tive t h at w o ul d not

involve ver y

deep dive s int o

speci fic car makers’ books , which woul d be both

hard to do and pro b le matic in ter ms of permissions. For the engineering

opi n ions, I would be more comf ortable tha t this “data s et” is solid if I knew how

many e n gi neers, with what qual i f icatio ns, w e re invo lve d.

1 A better solu tion would be to ask individual car c o mpanies f o r inter n al cost ac countings for n u merou s

technol o gy samples, which I am assumin g is unrea son a bly slow, c o stly, and difficult for the c u rrent

purpose s of E P A.6. Clarity of t h e present a tion. Here I m u st sa y, ca ndidly, lies Estima ting’s weakest

performanc e. The text is rife with what I would consider confusing

statements, critical omission s, and inconsistencies. Most of Part II of my

review will focus on page-by-pa ge ident i fica tion of t h ese. While w h at I have j u st

said may s eem harsh, I will point out that it is much be tter to have a sound

methodology in a weak presentation (as I consider Estimating to b e ), t h an a

superb presentation of a weak method, as no amount of edit ing will im prove a

fundament a lly- f lawed approac h

. Estimating needs some editing, but the

u n d erly in g wo rk is v ery go od , and a welcome addition to the field (which to my

knowledge has not been upda ted since Vyas et al. in 2000; I do no t have access

to the Sierra Research report of 2007).

Summary: My overall opinion is t h at Estimating does good sol i d m e thodologic ally-s ound

work i n im provi ng and updat i ng the RPE m e th odology, within the constrai nt of using

onl y reasonably-avai l a b le da ta sets, but presents its res u lt s in a way that undermines

confidence in those resu lts. A r o und of rigorous editin g would correct this, to me, the

o n ly sig n if ican t f l aw in th e repo rt.

(The Peer Review Charge lette r also asked that reviewers flag which of their comments

relate to document im provement s that can be read il y made base d o n data o r literature

reasonably available to EPA, a n d which wo ul d req u ire i n formati o n not avai labl e to EPA.

I would assert that no ne o f my su g g e stio n s wo u l d f a ll in to th e seco n d categ o ry : my

comments are wholly related to e i ther reor gani zi ng or clarify in g t h e data a l ready in the

document , or acquiri n g mo dest a m ount s of readily-available new data.)



## Part II: Detailed Comments

Section 1: Ex ecu t

ive Su mmary and Int r

oductio n

Generally, I think the Introduction (and Executive Summary) “start i n the

middle” and so fail to offer the reader any context for the report, leading to

more confusion later on. It launches into a discussion of t h e fa ilings of RPE, and

proceeds into a description of how the authors will improve RPE, but gives very short

shrift to: a) moti vati on, and b) de fini tio n s o f terms. As regards both issu es, I th ink a

statement along these lines woul d be very welcome:

o When devising regulations for car technolo gy the regulat o r must trade off costs and

benefits

o Costs of ne w regulate d auto technol o gy fa ll into two categories, direct and indirect

costs (defined as: ....)

o Direct costs include the materials and labo r required to make the components, and

these can be estimated via reverse engineeringo But indirect costs in clude corporate overheads and ot her costs whic h are very hard

to estimate

o Past approaches to do so include th e RPE m e thod, defi ned as x

, y

, z...

o Flaws in this RPE method include a, b, an d c...

o Thus this current doc u ment attempts to fix these flaws via the IC M method, defined

as....

That is my general point for t h e Intr oduction. Specific p o in ts in clud e:

o The second paragraph on 1-1 me ntio ns t h e ANL anal ysi s : it wo ul d help to s h o w in a

table the three “very similar” estima tes, just to enlighte n the reade r

o This paragr aph a lso m e ntio ns d iff erent le vels for outsourced and insourced parts:

one short sentence explaining why these leve ls would be expected to be different

would be helpful. A n d if th e rest of Estimating is goin g to focu s on on e versu s th e

other (outsourced or made i n te rnally), or a ssume a blend of the two, it should be

made clear here, perhaps i n a fo otno te.

The Executive Summary does a slightly be tte r job of explaining tha n does the

Intro d ucti o n , but my s

a me critique appl ies. For exampl e, o n page ES-1 the f i rst

paragraph helpfully la ys out wh at RPEs are used for... but th en there is a leap to the

second paragraph which starts into what the aut h ors di d. T h ere is no i n terve n ing

discussion of why there was any need at all to revise the RPE me thodology: we have to

wait until Section 4 to find that out.



### Section 2: Conv entio n

al Approach

Generally I thought t h i s section w as sound t h roughout

. So I have only specif i c detaile d

poi n ts mos tly, and one small me thodol ogica l question:

o On page 2- 1, i n t h e f i rst paragra p h, the phra se “all dom e stic autom o tive production”

is used. T h is raises s e vera l small and large issues. Fi r s t, definitional: where is

“domestic?” USA? USA and Ca nada? If one of those, then why is VW in the mix?

Is “domestic” for Hyundai only pr oducti on i n Korea? &tc

. M o re br o a dly

, i f (as it

seems from looki ng at the fi nancial statements the auth ors have chosen) the data

being used are global, then we have the cha l l e n g e o f d eci d i ng w h ether RPEs/ICMs

based o n gl obal pro d uction are ri ght for cars made in the US A. I w o ul d presume

they are (since the regulato r will r e quire t h e same t echnologies of call cars,

regardless where produced), but th is should be made clear. Generally, I wo uld

suggest deleting the word “domestic” unless it has a s p ecial meaning here

that is not reve aled

.

o In t h e seco nd a n d thir d para graphs o n t h is page sim ila r phrases a b out expa nding

the indirect cost categories from ANL are used within a few line s of each other.These two paragraphs coul d be c o mbi n ed and cleaned up to el iminate the possibly

confusi n g r e dundancy

.

o Footnote 1 on this page me ntio ns that “other expenses” are excluded, presumably

because they are too small to m atter? In a n y case, the rationale for such exclusion

shoul d be provi ded. When i n do ubt

, please explain the re asoning be hind a l l

methodological decisi ons, provi d in g numerical eviden ce if possible.

o Footnote 5 on the page defi nes selling costs as the sala ries of sa lespeople, et c.

Later o n t h e defi niti on is expa nde d and ma de clearer but here it rin g s o d d l y to a n

automotive person, as very few car ma kers employ the i r own salespeople:

overwhelmi n gl y t h ey use indepe ndent dealers. I would suggest th is f o otn o te read

more as: “includes salaries of marketing staff, advertising c o sts, dealer support

costs, etc.” Also, I would ima g ine “travel” is hardly material to this analysis.

o On page 2-3, in the possessive Forb es should be For b es’s, I belie ve.

o The active/legacy health care cost i ssue raised on pages 2-3 and 2-4 is an

important one. I be lieve you have tr eated it fairly, but if I were to

suggest y o u have another se t of eyes look at an y part of t his report , it

would be here, possibly by r e cruiting a seasoned Wall Street equity

analyst, s uch as John Casesa, to re vie w these assumptions, as the se

analysts spend a lot of time on this issue.

o In t h e seco nd paragra p h of pa ge 2-3 th e a u t h ors ment i o n that corporate overhead

varies grea tly. Rather tha n just letting that statement stand (w hich raises questions

in the reader’s mind), I wo uld suggest inserting one se ntence explaining why this

might be the case (e.g. difference s in accounting definitions, etc.).

My methodological question rega rds the McKinsey numbers us ed for comparison

purposes. Since the reader is not told McKinsey’s methodol og y in an y g r eat d e p t h ( i t is

mentio ned briefly i n t h e Appendix ), a n d sinc e the reader can see the McKinsey numbers

vary significantly from the a u thor s’, and sin ce the a u thors make no adjustment to their

own numbers based on differenc es from t h e McKinsey data, and since no attempt is

made to explai n why t h e McKi nsey results are different – why include the McKinsey

case at all ? It seems only to muddy the waters, by per f orming no explana tor y role. I

have no ax e to grind as rega rds McKinsey ( I used to work there!), but I cannot see how

its data advances the cause of Es timating

. J u st saying that the results are included “for

comparison” is not enough, in my view. (As an analogy, one might imagine a sports

article whose authors calculate that the best team in coll ege football is USC, then

mentio n t h at the BCS system be lieves it is a c tually Florid a... and then en d the article

without discussing ho w or why the two choices are different!)



### Section 3: Propo sed Approach

Here again I thought the s ection was strong, so I ha ve detailed comments only:o The explanation in the first paragraph of pa ge 3-1 is ill ustrative of the kind of

explanation that I think the aut h ors would do well t o

in clude in the Introduction.

o It might be helpful somewh ere on page 3-2 to comment on why the 1.454 in Table

3-1 is so similar in magnit ude to, but different conceptu ally, from the 1.494 in Table

2-4.

o The last two parag raphs on page 3-4 st art to blur the d e finitional clarity

that is crucial to readers trying to understand the authors’ thinking. The

sentence that begins “For op erations we have considered three areas ..... “ w o uld be

clearer if re written as “ F or operations, we have considered thr ee areas of indirect

costs that are likely to be affected by change in a pa rt or techno l o gy : R& D a n d

retooli n g (t hrough...et c .), indirect labor costs (t hrough... e tc.), a n d i n direct cos ts

linke d to m a terials use d (due to... e tc.).” In ad d i ti on

, th e au th o r s mig h t wan t to

make the example cost categories linked to labor here (health care, retirement,

corporate overhead) similar or identical to those linked to labor in Table 3-2, w h ere

onl y trai ni ng is menti o ned. Fi nall y, t h e la st paragraph on page 3- 4 jumps int o

direct

costs in the middle of a pape r t h at m o st ly d i sc usses indirect cost s ( addit i o n al l abor

due t o

a ne w technol o gy wo ul d be addi tio n al DIRECT la bor cost , y e s?), a n d T able 3

-

2 bl urs bot h direct and i n direct c o sts. I t h i n k it would be ve ry good practice to

include per h aps at the very outse t of the report a s i ngle pie c h art s h owing dir ect

costs of a new regulat e d part (m aterials, la bor) a n d the n t h e i n dire ct costs (e.g.

labor retrai ning costs, hig h er warranty cost s due to use of a new material), and then

also avoid conflating the two categories in the middle of th e report. My gue ss is this

confusion results from the authors’ being so close to the indirect-cost work that they

might not have stepped back and started wi th a n intr oduction to the tota l cost

situation.

o I found the complexity-level a d jus tments clear, com p elling, and we ll la id out.

o As mentioned in my P art 1, I t h i n k it would be hel p ful t o

show a s ample calc ulation

of at least one of t h e numbers in Table 3-5 on page 3-10.



### Section 4: Comp aring RPE M u

ltip lie r and Indirect Cost Multiplier

Approaches

I ha ve onl y three com ments on t h is short section (besides a nit t o

pick: if in t h e

Section’s title RPE is not sp elled out, why is ICM?).

As mentioned early on in this letter, an explanatio n up front o f what issues the paper is

trying t o

a d dress woul d be quite helpf u l

, a n d i n fact a lot of mater i al in this section (on

page 4-1 ) addresses those issues , and c o ul d be replicat ed in short e r form in t h e

Introduction.On page 4-2 I admit I became totally lost. An economist (or someone w h o

remembered his college Econ 101 class better! ) might find this ex planation as to why

profi ts mus t be left out of the multiplier quite clear, but I coul d not follow it at all. This

entire section in fact seems a bit rushed. C o uld o n e pa ge be spent walking the reader

through the profit t o pic in more detail? A n d could the actual impa ct on the ICMs of

leaving profits out be shown, so, if the effect was small, a reader might be able to

con clude “Even though I did n o t understand why profits are le ft out, I can see doing so

does not c h ange the f i nal an swer much, a n d so I am ha ppy with this methodological

choice.”

Finally, building on my feeling t h a t this section is ru shed, I would sugge st one small and

one larger change. Th e small change is to poi n t out o n pa ge 4-2 that a decr ease in

quantity mi ght indeed reduce social costs... but wouldn’t it a l so INCREASE indirect

costs, as a mortizati on of tooli n g, etc., would go up per unit o f out p ut? Frank l y, I co uld

see deleting the whole social co s t para graph o n page 4-2, as it ra ises a whole new topic

outside the scope of E s

timating

.

The large r change I suggest is to wrap up the w h ole pape r with an

illustration of the implications of the report. That is, one coul d la y out:

o Typical RP Es that wo uld be used i f t h is pa per ha d no t been written

o Typical IC Ms that now will be used, thanks to this pa per

o An example of the impact on the cost calculation of a hypot h etical regulated

technol o gy X: first

, under the RP E regime; t h en, as a l o w, medi um, a n d hi gh ICM

item, showi n g bot h (unchangin g) direct costs and (changin g) indirect costs, at the

three ICM l e vels and t h en over t i me. (Thu s if I am counting right, seven cost

figu res wou l d be sh own

, each a total cost per unit assu ming X volumes, br oken into

direct and indirect costs.) This w o ul d give t h e reader a sense as to whether the

new ICM m e thodology will ra ise or lower the expected costs of a new regulat e d

component or system.



### Appendix A

I went t h ro ugh t h e Ap pendix and

, ot her t h a n repeati n g my s u ggestion to rem ove t h e

unhel p f u l (i n my o p i n i o n) McKi nsey case, I have no co mments: t h e reasoning as laid

out makes sense, though it do es reinforce my view that ta king a closer look at the

health care issue for the GM and Ford numbers might be valua b le.



## Part III: Conclusion

In s u mmar y , I t h i n k t h e report is methodol ogic ally sound but less so undly wr itten. To

improve the weak presentation of strong results, I suggest that the authors:o Provide dat a on t h e number and qua lifications of e n gine ers consult e d

o Show calculations f o r one of t h e final ICMs, so the reader can follow along

o Provide much more informatio n a s to contex t, m o tives, and goa l s “ u p fro n t,” i n

the Introduction and E xecutive Summary

o Clarify wha t is meant by “ d omest i c prod ucti on,” or else delete t h e phrase

o Consider having an e q uit y

a n alyst take a look at t h e a ssumptions made ar ound

the treatm ent of active vers us legacy healthcare costs

o Remove the McKinsey results, as unhel p f u l a n d possi bly conf using

o Be vigila nt in not confusin g direct and indirect costs

o Clarify the reasoning behind the decision to leave out profits

o Include at t h e end of t h e report a nume rical illustrat i on of how t h e improved

method would yiel d dynami c and complexity-different iat e d ICMs of different

magnitude s than static and undifferentiat ed RPEs; make sure to include in this

example direct costs as well, so the reader can see the impact of the new

methodology (which acts onl y on i n di rect costs) on th e total costs of a

technol o gy (e.g. a new airba g t y pe)

I congrat u l ate the a u t h ors on the impr ove d ICM meth odolog y, and h o p e th at my

remarks as to the clarity of the re port will be taken in the same spir it of good faith in

wh ich I offer th em.Review er Bio:

May 14, 2009

364 Julianna Circl e

Franklin TN 37064

Dr. Gloria H e lfand

U.S. Environm ental Protection Agency

Assessm ent and Standards Division

Office of Transportation and Air Quality

2000 Traverwood Drive

Ann Arbor, MI 48105

Dear Dr. Helfand;

I provide herewith another copy of my comm ents on the draft re port Estimating

Indirect Co st Multipliers for Individual Domestic and Foreign Automobil e

Manufacturers, previously e

‐ mail ed to you, Byron Bunker, William Ch armley and

Kathryn Sa rge a nt on January 20, 2009. I also include a list i ng of my q u alifications to

provide a review, and a discussion of conflicts of interest. I provide my comments as

a private citizen and not as a rep r esentative of my empl oyer, Argon ne National

Laboratory. Nevertheless, I enclose a discussio n of rel e van t education, exp e ri ence

at Argonne, and other services to transportation research tha t qualify me to provide

this review. The address provided is my home address.

Qualificat ions:

Danilo J. Santini obtained his Ph.D. in Urban Sys t ems Engineering and P o licy Anal ysi s

from Northwestern University in 1976. He al so holds a Bachelor of Architecture

from the Massachusetts Institute of Technology (1968) and a Masters in Business

and Economics from the Illinois Insti t ute of Technology (1972). From 1992

‐ 2004 Dr.

Santini was section lead er of the Technology Assessments Section within the Center

for Transpor tation Resea rch at Argon ne National Laboratory, and until October 2008

was leader of the Tech nology Analysis section. These sec tions specialized in the

comparative assessments of transportation t e chnologies, considering technical

attributes, vehicle and operations costs, emissions and oil use, and market

prefer enc e s. In 2003 he was awarded the title senior economist. In the late 1990s

he supervised and/or participat ed in several studies of comparati v e costs of

conventional vehicles ve r s u s hybrids and plug

‐ in hybrids. A study of lithium ion

battery cost s was conducted by membe r s of his section at tha t time. He is currently

participatin g in a study of battery costs for fou r other lithium ion chemistries. He

served as chair of the Alternativ e Fuels Co mmittee of the National Research

Council’s Transportation Resea rch Board from 1996

‐ 2002. Since May of 2001 he has

been the Department of Energy’s technical r e present a tive for the U.S. to theInternational Energy Age n c y Implementing A g reem ent on Elect ric and Hy brid

Vehicles. From 2003 to 2006 he was a member of the Ameri c an Transportation

Resea rch Institute’s Research Advi sory Commi ttee. At th e present tim e he is a

member of the Transportation Research Board’ s Committee on Land Use, Vehicle

Miles of Travel, and En ergy. Dr. Sa ntini has authored, co

‐ authored or edited over

150 articles, reports, and conferenc e papers.

Concerning conflicts of interest –

The study of costs of light duty m o tor vehicl es docum ented in the 2000 study “Comparison of

Indire ct Cost Multip lie rs f o r Manufacturing” by Vyas, Sa ntini and Cuenca, c ited in Estimating

Indirect Cost Multipliers for Individual Do mestic and Foreign Automobile Manufacturers, was

done in support of a subsequent 2001 study, Hybrid E l ectric Vehicle T echnology Assessment:

Methodology, Analytical Issu es, and Interim R e sults, by Plotkin, Santini, Vyas, and others.

Analytical techniques u sed in the la tte r two s t u d ies were also used in o n e of f

our cost es tim ate

cases in the 2001 Electric Powe r R e search Institute study Comparing the Benefits and Impacts of Hybri d

Ele c tric Vehi cl e Options

. Funding for the f i rst two studies, and Argonne staff participation in the thir d, came from the U.S.

Department of Energ y

. Since co mpletion of those studies , Dr. Sa ntini’s an al ysis ofte n invo lved evaluation and/or manipulation

of other studies of advan ced and alterna tively fu eled vehicles , in cluding cost estima tes. Howev e r

, since th e 2001 studies, h e has

not participated in, nor supervised an y or igin al whole vehicle cos t modeling and anal y s is. He is not presently co nducting an y

such analy s is, aside from th e b a tt er y cost modelin g mentioned abo v e. However

, a stud y that he leads, being done jointly with t he

Ele c tri c Power Research Institu t e , prob abl y wi ll m a ke use of a v e hic l e cost m odel d e velop e d b y a staff m e m b er of the El ectr i c

Power Resear ch Institute

. Im plem enting pl ans to phase into retir em ent over a coupl e of y e ar s after com p letin g existing com mitm ents, Dr. San t ini m oved to

Franklin TN in October of 2008 , resigned his section l eader position (consisten t w ith Argonne Nation a l Labor ato r y pol icy )

, and

began working part-t im e as a project m a nager/pr incip a l invest ig ator on rem a ining projects for whi c h he has such responsibilit y

. Given his part-time status , he was easily able to complete this rev i ew w ithout interference with his remaining Argonne resear ch

responsibilit ies.

Best regards;

Danilo J. Sa ntini, Ph.D.January 20

, 2 009 Commen t s by Dr. Danil o John Santini on:

Updating EPA's Methodolog y for Accounting for Indirect Costs Associa t ed with Changes in Direct

Manufacturin g Costs, by A. Rogozhin, M. Gallaher, and W. McManus.

There are ma ny positive things to say about the Rogozhin et al report draft. However, the primar y purpose of

the review is to make constr uctive suggest ions about possible error s and or ambigui t ies of

interpretation s/exposition. I have some major issues I would like to see addressed

.

First, I would prefer that th e authors cite d the Vyas et al report, rath er than the AN L report. For example

Table 2

‐ 1 title would read "Contributors in the Vyas et al Methodology "

. Individual scientists are responsible

for their work. However, if you prefer tha t we refer to the Rogozhin et al as the "EPA report" in ou r future

work, feel free to stick with the "ANL rep o rt".

(1) The au tho r s fail to mention that the Vy a s et al repor t includes results from thre e different methodologie s,

demonstrating a fair degree of consistenc y as of the mi d 199 0s.

(2) The dates of the work in the Vyas et al report (mid 1 990s) vs. the Rogozhin et al report (more than a

decade later) are quite important. No te that the auto industry aggressivel y outsou rced over that period.

Visteon was spun

‐ off by Ford in 19 97 and Delphi by GM in 199 9. Possibly this was a trend across the board,

but is just more obvious and dramatic in the case of Ford and GM (I did not look any further).

The Vyas et al report contai ns two multipl i ers, a point not acknowled g ed in the Rog o zhin et al rep o rt draft.

The outsourced components multiplier in Vyas et al is 1. 50, much the same as estimated over a de cade later

in the Rogozhin et al report draft, after a period where major automa kers made a con c e r t e d effo rt to shift to

outsourcing of component manufacture and focus primarily on final assembly. It seems to me this must be

discussed

.

(3) There app e ars to be a bi g difference in the are a of fraction of selli ng costs. The McKinsey passenger car

report (Table A

‐ 2) results appear to be c o nsistent with the three studies cited by Vyas et al in the mid 1 990s

(percentages in the low 20s). The big question is whethe r the cited au to companies have driven selling costs

down sharply (Table 2

‐ 3), or there is an er ror in the Rog o zhin et al methodology. My hypothesis is that it is

the latter. What I think is missing is dealer costs. The auto industry financial reports cited should have

reported the f i nances of the auto compani e s themselves, but not the dea l er s. What I think the Ro gozhin et al

numbers represent are what I would call cor p or a t e revenue equivalents (CREs), not retail price eq uivalents

(RPEs)

. In order to get from CREs to RPEs using financial records of the corporations involved in selling

vehicles, one would have to pore over the annual reports of at least a few mega dealers to get an id e a of the

cost per vehicle sold, and add tha t estim ate to the CRE

. I suspect th a t if tha t were done, it woul d be possible

to reconcile the big differences in selling fractions under the me thods cited in Vy as et al, and in the McKinsey

report, with the Rogozhin et al estima tes.

I note in several cases that va lu e s from the McKinsey report are used when similar data is not av ailable. This

implies a degree of respect for the numbe rs in the McKinsey et al rep o rt. However, the lack of discussion of

why the selling costs from the McKinsey re p o r t are high er than for th e selling costs used in the Ro gazin et al

estimates is inconsistent with a respect for the nu mbers in tha t report.

Another reality that needs to be considered is that the corporate reports provide information on sales of all

types of vehicles produced by the corporation. Heavy vehicles probably do not requi re the same sh a r e of

advertizing expenditures as light duty vehi cles. Is the McKinsey report really for "passenger cars" only, and

not light truc k s ? In any case

, the corporate reports, to va r y in g degrees, may not separately detai l light dutyautomotive op e r a t i o n s fro m commercial (heavy) vehicle operations. A closely related issue is the question of

retail sales vs. fleet sales. The corporate re p o r t s are like l y a mix of the two. The que stion is whether the

McKinsey report actually addresses retail sales of one v ehicle per customer, while the corporate re p o r t s fold

fleet sales and retail sales to gether, pulling the average sales price down and thus misleadingly p u lling the

estimated RPE multiplier down.

(4) The different numbers for "manufactur i ng cost" in 20 06 between tables A

‐ 3 and A

‐ 4, A

‐ 5 and A

‐ 6, A

‐ 8 and

A

‐ 9 etc are troubling, particularly for the domestic manufacturers, where the differences are large and

inconsistent in direction. Pe r h a p s the label "RPE" shoul d be dropped from the 20 02

‐ 200 7 historical trends

tables, since it appears tha t the report is not using these low estimate s. Perhaps it would be better to simply

report tha t th e bundle of costs listed (selli ng

..., operating

..., depreciation, profit, ot h e r ...) amou nts to a

certain perce ntage of total corporate costs (or is it perc entage of manufacturing cost?).

(5) In perusin g the time series tables, it appea r s to me that all of the com p a n ie s aside from Daimle rChrysler

had a downw a rd trend in the estimated "RPE multiplie r" (a term tha n should be ch a n ge d in the s e tables)

over time. This is consistent with my hyp o thesis about the existence of an outsourcing trend in the auto

industry. It is inconsistent with the clai m that the multi pliers stayed constant over time (page 2

‐ 4). One

might plot the s e values on a chart and fit trend lines to them, then co nstruct estima tes of what th e values

might have be en in the mid 1990s if these trends are b a ckcasted. Since losses by some companies pull down

values later in the period, per h a p s profit should not be included in th e bundle of non manufactu ring costs.

When large losses are booked in a single year, it seems appropriate to discuss wha t the automa ker says

caused the losses. It would make a difference if the losses are due to one

‐ time ch arges (special

circumstances), or recurring problems. The claim on p. 2

‐ 4 that it was ensured that 2007 was not an outlier

year seems to be a false clai m for the GM case (Table A

‐

. 9) The maj o r 2007 losses for GM sugge st that a

different year's report be us ed for the GM estimates.

While I like th e idea of tech nology complexity, and generally support the argumen t about it s qual i tative

effect on multipliers, I nevertheless think that the low en d multipliers are too low. My line of tho ught is that

if a component supplier does all product dev e lop m en t

, and the compo nent is a long standardized part of

vehicles, then

‐‐ as the repor t contends

‐ ‐ this would result in the lowest multiplier.

However, in my opinion, every component would have to be allocated selling and some corporate overhead

costs. This ge ts us back to the issue of whether or not s elling costs, in cluding dealer costs, have been

properly included in the Rogozhin et al methodology. If I am correct that selling costs are undere stimated

and the shares listed in Vyas et al remain roughly valid, then the lowest plausible multiplier would add profit,

selling cost, and a portion of corporate overhead. Based on the Vyas et al estima te s, this would mean tha t

the lowest multiplier I would come up with would be in the neighborhood of about 1.4 (~ 3. 0% co rporate

overhead, 23. 5% selling, 2.5 % profit

= 29 %, then 1 00% /71%

= 1.41). If you do not ch a n ge your selling costs

share, the same logic would lead to a co nsiderably lower number than 1.4

, but still would not be as low as

1.06 or 1.03.

One possible counterargument is tha t some regulations may simply force refurbish ing of existing production

lines, while others (such as hybrid components) might r equire completely new factories. This logic relates to

needed depreciation and a m ortization ch a r ge s.

Regardless, I praise the effort to ma ke th is distinction. I agree that all new powertr a ins could have a high

short

‐ term multiplier, for ma ny reasons. Supporting arguments mad e in the report, electric vehicles were

reportedly hard to sell, tak i ng a lot more of the salesman's time wi th the customer to complete the sale.

Similarly for ear l y hybrids. Parts supply at dealers to as sure reliability of low volume products should be

more costly. Anyway, it is good that the con c e p t u a l issue has been discussed in the report.I like the greater detail in th e report th an could be found in the three methodologie s cited in Vyas et al. The

Appendix A ta bles estimating the 20 07 multipliers, by corporation, seem to be the anchor of the report.

Looking at the Vyas et al rep o rt, a major qu est i on is the proportion of warranty, R& D, and deprec iation and

amortization absorbed by the final vehicle assembler (the corporations for which the multipliers are

estimated) vs. the compone nts suppliers. It is a shame that the time series values (2002

‐ 200 7) pro vide no

insight on the trend in these costs. I am not familiar with the corporate reports, bu t it seems that there are

problems in tr anslating the in for m a t i o n

. Is it possible that there are di fferent corpor ate report tab l es used

for the 200 7 e s timates and 2002

‐ 20 07 his t orical tables? Could the au thors identify the page number(s) of the

report tha t th ey used to compile the information for each table?

The references do not consistently seem to be adequately documented. Typically the city and state or

country where a publisher is headquarter ed is included in a reference. A web ad dr ess should be provided if

the ma terial is available on the web, inste a d of in hard cop y from a bu siness location. Argonne, IL is our

location.

It would be ap preciated if th e rounding in the tables was consistent.

The purpose of our original report was simply to assure that when cost was evaluate d by DOE sponsors,

those evaluating such costs would be explicit with regar d to whether it was manufacturing cost or retail price

equivalent. Ou r work was not directed at regulatory questions.

I am refrainin g from commenting on the positions of the Rogozhin et al team with re ga r d to the pr op er

method of acc o unting for costs of regulation. My comments are simply directed pri m arily at the effort to

properly execute and update the RPE method as our an alytical team ca m e to under s tand it in the 1990s.Review er Bio:

ABOUT C O NSULTING, INC.

3805 Penberton Court

Ann Arbor, MI 48105-3039

January 16, 2009

Ms. Gloria Helfand

U.S. Environm ental Protection Agency

Assessm ent and Standards Division

Office of Transportation and Air Quality

2000 Traverwood Drive

Ann Arbor, MI 48105

Dear Ms. Helfand:

My comm ents on the docum e nt Estim ating Indirect Cost Multip liers for Individual Domestic and

Foreign Automobile Manufacturers is enc l osed a s an attachment to this le tte r.

My nam e is Morgan H. Edwards, doing busines s as About Consulting, In c., which is a

Subchapter S corporation incorpor ated in the S t ate of Michig an, of which I am the sole owner

and president. My address is 3805 Pe nberton Court, Ann Arbor, MI 48105-3039.

The m a terial reviewed consists of the docum ent listed in the prev ious paragraph, which also is

titled Updating EPA’s Methodology for Accounting for Indirect Costs Associated with Changes

in Direct Manufacturing Costs, as well as excerpts from th e Annual Reports cited in the

docum ent, which I hav e acces sed o n line, us ing the Referen ces list p r ovided in the d o cum e nt.

My expertis e and qualification s are s u mm arized as follows: I am a graduate of Carnegie Mellon

University, having received a Bach elor of Science degree with a m a jor in industrial managem e nt

and a Master of Science degree in in dustrial adm i nistra tion w ith a m ajor in f i nance. I was

em ployed by Ford Motor Com p any for 35 years in the financial analysis organizations ( i.e.,

controller’s offices) of aeros pace, autom otive m a nufacturi ng, and autom o tive m a rketing

division s, as well as in Ford’s finance and corpo r ate s t rategy staffs. I was not an accou n ting

m a jor nor am I a Certified Public A ccountant, although during m y years at Ford in financial

analysis and corporate strategy, I frequently worked on analyses that required the basic

understand ing and application of cost accoun ting prin ciples to a variety o f autom o tive situations,

including profit planning, budgeting, financia l reporting, vehicle and option pricing. Since

retirem e nt in 1995, I worked briefly as the fu ll-tim e chief financial officer of a sm all

m anufacturing com p any in England and subsequently as a part-tim e consultant at the Center for

Autom o tive Research an d the University of Mi ch igan Transp ortation Res earch Institu te on a

variety of autom o tive industry studies. I am pres ently engaged part-tim e in a study for the latter

organization, under the direction of Dr. W a lter McManus.

-2-As to any real or perceived conflicts of inte rest, I would point out th a t I left Ford Moto r

Com p any’s em ploym e nt fourteen years ago and have had little contact with m y for m e r

colleagues d u ring th at period. My co nsulting work has involv e d broad analyses of indu stry data

and trends relating to both original equipm ent manufacturer s and the au tom o tive sup p lie r

industry. I believe that none of these ac tivities represent a co nflict of interest.

My comm ents include an Appendix A, which is being forwarded to you as a separate file.

As we discussed by telephone, I have m a de a list of certain errata in the docum e nt, none of

which are pe rtin ent to a s ubstant ive review and th erefore are n o t included in m y comments. This

list is a tta ch ed as a sep ar ate f ile.

This review has required approxim a tely 32 hours of m y ti m e

.

I have sent an invoice for the work to RTP Finan ce, as you directed in you r letter. A copy of the

invoice is attached as a separa te file f or your inform ation.

Yours very truly,

Morgan H. Edwards

Attachm ents (as e-m ail a ttachm ent f i les):

1. Review of EPA Docum e nt – Microsoft W o rd 2003 file

2. Appendix A, an attachm e nt to m y review – Micros oft Excel 2003 file

3. Errata List – Microsoft W ord 2003 file

4. Invoice – Microsoft E x cel 2003 fileREVIEW OF EPA DOCUMENT

ESTIMATING IND I RECT COST MULTI P LIERS FOR INDIVIDUAL DOMESTIC AND FOREIGN

AUTOMOBI LE MANUFA CTURERS

Overall Approach and Methodology

The stated objective of the report is to develop methodolog ies for evaluating the eff e ct of

potential regulatory actions on indirect costs of manufacturers, recognizing differen t levels of

technical complexit y inherent in the regulatory actions and recognizing that cost effects

observed in the short

‐ run may differ from those observed in the long

‐ run. The report presents

and explores past efforts 1) to identify incremen tal indirect costs relative to regulation

‐ induced

increm ents of direct manufacturing cost and 2) to express these relationships through the use

of Retail Price Equivalent (RPE) multipliers. The report further develops its own set of weighted

industry average RPE multipliers, using data for eight global automobile manufacturers, largely

drawn from 2007 Annual Reports. As a background foundation for further discussion an d

refinement, this approach is appropriate and useful.

The report then advocates development of a range of Indir e ct Cost Multipliers (ICM s) to reflect

1) differences in technical complexit y and 2) changes in indirect costs ov er time as regulatory

actions are adopted and integrated into produc tion. The result is six ICMs representi ng the

intersection of three lev e ls of technical complexi ty (low, med i um, and high) and two lev els of

time passage (short

‐ run and long

‐ run). This is a lo g i cal and reasonable approach. Th e report

purports to base the new ICMs on th e previously developed RPE multipliers, and it describes

the ICMs as scalar factors to be multiplied by the baseline RP Es. In concept, this again appears a

reasonable approach, but the methodology for evaluating the magnitude of the scalar

multipliers and their combination into overall ICMs are inadequately explained an d must be

questioned in terms of concept, met hod of development, and the mecha n ics of combination

and applicat ion.

In a final section, the report enters into a discussi on of supply and demand curves as a means of

comparing the validity of RPE multipliers and ICMs. The approach is promising, but the principle

conclusion do es not follow from the analysis (more on this in the section of Appropriateness of

Conclusions).

Appropriate n ess of the Datasets and Other Inputs

The data used in the report consist of three principal data sets:

1. Inco me statement data from the 2007 Annual Reports of eight principal automotive

manufacturers with worldwide man u facturing operations: General Motors, Ford,

DaimlerChrysler, VW, Toyota, Honda, Nissan, and Hyundai.

2. Annual dollar sales data for the eight companies is used to compute a weighted industry

average of the eight separately cal c ulated RPEs.3. A set of scalar factors for the short

‐ term and long

‐ term effects of technical complexity, based

on the subjective evaluations of a “team of engineers.”

In the first data set, Ann u al Report data have the virtue of being published public numbers

presented a ccording to standards of the Financi al Accountin g Standard Board (FASB )

. On the

other hand, within the FASB standards there is considerable leewa y on aggregation of indirect

cost categories and amount of detail provided. Further, the adherence to FASB standards

differs among U.S

., German, Japanese, and Korean companies. As a result, numerous

adjustments must be made to the data, introducing many possibilities for errors in

interpretation and calculation.

2006 Annual Report data from Daimler

‐ Chr y sler are used because with the 2007 sale of

Chrysler to Cerb erus, published statements are no longer available for Chrysler. Although fiscal

year 2007 is defined diff erentl y amo n g the companies (year ended 12/31/2007 fo r GM, Ford,

VW, and Hyundai; year ended 12/31/2006 fo r DaimlerChrysler; year en ded 3/31/ 07 for Toyota

and Nissan; year ended 3/31/2008 fo r Honda), all data span a full twelve

‐ month year and may

be assumed to represent comparable operating conditions ac ross the eight companies.

For the second data set, not all the annual sales data covered the same scope of op erations.

The appropriate weighting factor would be global automotive sales. Insp ection of the Annual

Reports rev e als that sales data for Ford, GM Honda, and VW are for the automotive sector only.

Sales data for DaimlerChrysler, Hyundai, Nissan, and Toyota are world

‐ wide consolidated

corporate sales, including revenue from financial services an d other busi nesses. This gives

excessive weight to these companies in the weighted industry averag e. As a result, Toyota is

given a weight 70% greater than General Motors, which is out of prop or tion to their respect ive

sizes. Despite the report ’s reliance on global sales and costs t hroughout, it is curious th at the

text (pag e 2

‐ 1) states that domestic automotive production is reflect e d in the analys is.

For the third data set, the report gives only the sketchiest explanation for the rationale for the

subjective s c alar factors, and no objective data are provided in support of the assu mptions.

Data Analysis Conducted

While it would be desirable to mea s ure indirect costs against a common set of consistent

accounting definitions, it is unlikely that any of the compani e s would consent to sup ply data in

conformity with an EPA

‐ specified set of accounting categories, given the competitive nature of

the industry. Accordingly, the report makes adju stments to fill in certain indirect cost categories

not explicitly revea l ed in the Annual Reports, using information in Notes to Financial

Statem ents where appropriate. In concept, this is not objectionable, but the adjustments

should be handled more consistently across indirect cost categories. For exampl e, none of the

companies separately id entified plant maintenance, re pairs, and operating costs, but buried

this category in larger aggregations. The McKinsey study, however, stated that this cost

category r e presents 14.1% of direct manufacturing cost; so th e report assigns 14.1% to all

companies for these costs (except VW, for an unexplained reason). In the case of transportation

cost and dealer support and markup costs, a sim ilar adjustment was not made for missing data,with “NA” being assigned to the empty cells. Further, where assumed costs are added in one

category, it is assumed that the same magnitude of cost is su btracted fro m another category, so

that total costs remain valid, but the compensating entry is seldom explained in the re port,

depriving the read er of the opportunity to test the validity of the adjustment.

In the development of ICMs in Section 3, a scala r value of “1” is assigned to indirect cost

categories where “th e average le ve l is expected,” causing the indirect cost RPE level previously

determined to be retain ed, while a s c alar value of “0” is assi gned when “ther e is no expected

change,” th ereb y wipin g out the indirect cost i n crem ent entirely. Of the total of th irty cells in

Tables 3

‐ 3 (short

‐ term ef fects), twelve are assigned a scalar of “0,” meani n g that in the short

‐

term no incr emental indirect costs would be incurred in their respect ive cost categories for an

increas e in manufacturing cost of any magnitude. Of the thi r ty cells in Table 3

‐ 4 (long

‐ term

effects )

, nineteen ar e as signed a subjective scalar of “0,” implying that the cumulativ e effect of

numerous regulatory ch anges will be a witherin g away of indirect costs.

Increment al cost analysis is often tri c ky. As a general principle, transient aberrations from

steady state costs (the on

‐ going actual indirect costs) may occur (up or down) with any change

in production, but the transient aberrations generally conver ge over time to a new st eady state.

The report’s analysis of th e long

‐ term effects of regulatory change s does not appear to

acknowledg e this principle.

Appropriate n ess of the Conclusions

There is a serious argument to be made concerning the appropriateness and validity of the

long

‐ term portion of the ICM analysis. In the Appendix, the report shows that the RPEs for the

eight compa n ies have been rema rka b ly stable over the last six yea rs, a period in which

numerous regulatory requirements in safety, emissions, and fuel consumption have been

implem ented. If the lo ng

‐ term effects of regulation on indir e ct costs rel a tive to direct

manufacturing costs were disproportionately lower than the earli e r cost levels, as arg u ed in the

report, why are not the historical RPEs dropping year by year

. Indeed, it may be argu ed that the

RPE values are the long

‐ term values. After all, th e RPEs incorporate for the long

‐ term all the

various actions and changes made by the comp anies, whet her from regulation or market

forces. In ot her words, in the long

‐ r un, the total costs are the only relev ant costs. On the other

hand, in the short

‐ term, when regula tory change produces dislocations an d a steep learning

curve, it ma y be argued that ICMs substantially great than “1 ” should be applied for several

years, and t h erefore that most of the twelve “0” scalars in Table 3

‐ 3 should be at least “1.”

In Section 4, an argumen t is advanced that RPE multipliers ar e defective because 1) the y do not

recognize th at indirect cost effects or regulatory changes ma y vary according to the t e chnical

complexit y of the changes, 2) they include profits in the multiplier, and 3) they do not recognize

that the increased cost of regulatory changes ma y affect both the price tha t may be charged in

the mark et place and th e quantity sold, depending on the elasticity of the demand curve

. It is

stated that the ICM approach does no t suffer from these defects.The ICM approach solves the first defect by applying scalar adjustments to certain indirect cost

categories in certain ci r c umstances. It sol v es the second defect by arbit r arily excluding the

manufacturer’s (assembler’s) profit. (But note that it does not exclud e the dealer’s profit

(discount/markup) nor the parts suppliers’ profits, all of which ultimately factor into an

economic supply and demand analys is).

The ICM approach, however, does not sol ve

– or even address

– the third defect. ICMs would

be used the same as RPE multipliers are used, as point estimates of indirect cost effects without

reference to ultimate selling price or quantity. Th e assumed shape and slope of the demand

and supply “curves” in Figure 4

‐ 1 are arbitrary and independent of whether RPEs or “ICMs are

used to estimate Point B on the sup ply curve. Therefore, the final concl usion (“The ICM is

prefer red be c a use it mode ls the direct and indirect costs as a shift in the supply curve, which

then leads to a new equilibrium price and quantity.”) is not valid. Neither the RPE multipliers

nor the ICMs by themsel v es do that.

Recommen d ations for Any Alterna t e Data and/or Analysis

As mentioned previously, obtaining direct and in direct cost da t a from all the automotive

manufacturers in consistent and comparable cost categories would be desirable, but is unlikely

to be achieved. It is possible that company Form 10K filings with the SEC might contain more

detail on direct and indirect costs in more comparable format, but that has not been explored

as part of this review It may be noted that when the automobile industry or a company within

the industry brings suit with the Fed e ral Trade Commission in an anti

‐ dumping action, the

Federal Trade Commission is able to specify con s istent data formats across companies as well

as rigorous adherence to specified classifications, and the suing and su ed compani e s must

comply. Of course, in this instance, the compani e s are the s upplicants, giving the FTC the upper

hand in demanding compliance; the EPA may not enjoy such authority. Further, one could

speculate whe t he r

, in th e present financial crisi s

, an “auto czar” could achieve greater

uniformity in automotive cost accounting as part of his mandate, as well as whether tha t would

be useful in achieving improved understanding of regulatory costs.

Clarity of th e Presentation

Clarit y of presentation in the report presents some chall e ng es. In general, the background

materi al on Retail Price Equivalent (R PE) multipliers in Sections 1 and 2 is adequate in detail and

clarit y, but information on the step

‐ by

‐ step development Indirect Cost Multipliers (ICMs) in

Section 3 leaves gaps in clarity, and as a result, the Executiv e Summary and Introduction

sections, in so far as they deal with ICMs, also lack clarit y.

In the Execu t ive summary, becaus e of inadequate definition of ICMs (a new concept), the

reader is left to wonder why the RPE s are expr es sed as percentages of direct manufacturing

costs and the ICMs are expressed as absolute multipliers of some undefined base. The

appearan ce is given that the ICMs are but minor adjustments of the RPEs, when a full

understanding of the concept rev e al s they are a major modification of the RPEs. The clarit y of

the Executiv e Summary (and the rep o rt as a whole) would be improved by converting the ICMs

to percentages, for direct comparis on with the RPEs in the adjoining table on page E

‐ 2, and byspecifying tha t the percentages are to be applied to the sam e base of increm ental direct

manufacturing cost, not to the RPEs themselves. It would the n be evident to the reader that the

ICMs drastically discount the increm ental indirect costs to be associated with increm ental direct

manufacturing costs fo r changes of low or medium technical complexit y

. For example, in the

case of the long

‐ term effect of regul a tory chang e s of medium technical complexit y

, $4 of

increm ental indirect cost for each $100 of incremental direct manufacturing cost would be

imputed under the ICM method, compared wit h $49.40 under the RPE method.

The same cl arity problem occurs in the next to last paragraph of the Intr oduction, wh ere the

exposition glides seamlessly from “(we) cal c ulat e an industry average RPE multiplier

. We then

calculat ed the share of that multiplier

, which should be used as a multiplicative adj ustment

factor ...” to “... this multiplier is called an indirect cost multiplier or ICM” (my added emphasis)

without revealing the shift in the underlying base for the multiplier fro m historical indirect cost

to incremen tal direct manufacturing cost. A restatement of the last sentence in the paragraph

to “We estimated that the values of the ICMs range from 103% to 153% of incremen tal direct

manufacturing cost for r e gulations with different levels of t e chnical complexit y ” woul d greatly

clarif y the re port.

The confusi o n engendered by the poorly defined concept of ICMs can be seen dramaticall y in a

table that I developed while attempting to understand the concept. The table is included in

Appendix A of this review. My initial interpret a ti on of th e meaning of the ICMs (Interpretation

A), derived fr om a caref u l reading of the text, was untenable. Interpretation B, derived after

much wrestling with the subject, turns out to ma p closely to the result presented in the report.

My point in mentioning this is that clarity demands that the average re ade r not be subjected to

the same struggle. An explanatory bridge between the scalar factors in Tables 3

‐ 3 and 3

‐ 4 and

the ICMs in Table 3

‐ 5 is needed. Consideration might be given to including in the report a table

similar to my Appendix A (but abbreviated) to illustrate the differen c es in deriving RPEs and

ICMs.

Several other less significant points needing clarif iciation should be mentioned. One is the

omission of the McKinsey study in the review of past studies in the second paragraph of the

Introduction, in spite of th e prominence given it as a source of data later in the both Section 2

and the Appendix. The first mention of “a McKinsey study” occurs parenthetically in the last

paragraph of the Introduction, but it deserves a more prominent place as well as a description

of its origin (d a t e and sponsorship) an d significance.

Additional clarity is need ed in the Executive summary and th e Introduction about the scope of

the data. Th e read er only later le a r ns indirectly tha t the scope includes global operations, sales,

and costs, no t just No rth Ameri c an or U.S

. oper ations.

In Section 2, confusion ex i s t s concerning health care be ne f i ts, retiremen t benefits, and legacy

costs. Legacy costs include more than health car e benefits. They also include supplemental

pension (“buy

‐ out”) costs for early re tiree s (whi ch GM, Ford, and Chrysl er have incu rred in

major downsizing actions over the last 10

‐ 15 years) and life insur a nc e premiums for salariedretir ees. It also is confusing to state that “foreign manufact u rers’ health care benefits for

retired workers are largely covered by the government of the country in which they are

headquartered.” National health plans in the “headquarters ” country cover only em ployees in

that country, not the rest of the worl d. The state m ent about GM phasing out legacy costs by

2010 is questionable because the costs continue beyond 2010 and the UAW fund that will pay

them is being underwritten by GM.

Morgan H. Edwards

January 16, 2009ERRATA LIST FOR EPA DOCUMENT

Estimating Indirect Cost Multipliers fo r Individual Domestic and Foreign Auto mo bile

Manufacturers

Page 1

‐ 2: “Ch r ys l e r ” should be “DaimlerCh rysl er.”

Pages 2

‐ 1 an d 2

‐ 2: In th e context of MSRP, dealer discount and dealer markup are two names

for the same thing and therefore are redundant.

Page 2

‐ 1, foo t n o te 6: In accepted economic and automotive terminology, the definition sh ould

read “...the differen c e b e tween the total of all th e vehicle revenue and the total of al l the

vehicle expenditures ...” “ R evenue in come” is redundant and “revenu e expenditures” is

contradictory.

Page 3

‐ 1: The referen c e to Table 2

‐ 1 should be to Table 2

‐ 3.

Page 3

‐ 6: The first paragraph shoul d end with “are described in more detail in Section 3.3.1,

3.3.2, and 3.3.3.”

Page 3

‐ 6, Section 3.3.2: The second sentence would more accurat e ly read “...combines the high

mechani c al effici ency of a manual transmission with the shift control of an automatic

transmission.”

Pages 3

‐ 7, 3

‐ 8, and 3

‐ 9: The tables on each page contain apparently rand om horizont al lines

where they do not belong. They should be removed for clari t y.

Page 3

‐ 10: The last sentence re ferenc e s “Table 2

‐ 7.” There is no Table 2

‐ 7 in the report.

Page 3

‐ 10: The first sentence in Se ction 3.5 cites a “range from 1.06 to 1.52,” whereas Table 3

‐

5 immediat ely above it shows 1.06 and 1.53.

Page R

‐ 1 and R

‐ 2: The references contain much duplication that shoul d be eliminated.

(Duplicat e re fe re nce s occur in the For d

, Honda, Hyundai, Nis s an, and Toy ota citations.) Each

citation should contain one document only. In addition, the GM citation should read “Gener al

Motors Corporation 2008. Annual Repo rt 2007... ” The Volk swagen citat i on should read “Annual

Repo rt 2007,” not 2003.

Page A

‐ 5, table A

‐ 5: In the left colu mn containing Cost Contributors, the alignment of “Sum of

Indirect Costs” and “Net Income” does not agree with the corresponding values in the other

columns, and “Other Expense (not included in RPE multiplier)” is missing altogether. The

intended order and spacing are cl ea rly seen in Tables A

‐ 3, A

‐ 6, A

‐ 8, etc. Also, the “value” shown

for Distribution on page A

‐ 5 should read “Incl. in G&A,” not “Incl. in R&D.”Pages A

‐ 6, A

‐ 7, A

‐ 8, and A

‐ 9: At several points, the text is written as if General Motors were the

first company to appear in the Appendix instead of the third. The general descriptions that

pertain to all companies (for exampl e, “... in the remaind e r of this appendix...” on page A

‐ 8)

should be mo v e d to Section A.2 DaimlerCh rysl e r, the first company discussed.

Page A

‐ 11, Sect io n A.6: “Table A

‐ 12 presents rel e vant RPE cost contributors...”----------Appendix AAPPLICATIOIN OF RPE MULTIPLIERS AND INDIRECT COST MULTIPLIERS (ICM)An Example Highlighting Conflicting Results from ICMsIndirectCostsExample Illustrating Application of RPE Multipliers and Indirect Cost Multiplierss ICMs)Ralative toRPE ApproachICM Approach- Incremental Indirect Costs Incurred forManuf. CostIncrem. IndirectIncremental $100 in Direct Manufacturing Cost Using ICM Scale Factors(WeightedCosts forShort -Term EffectsLong-Term EffectsIndustryIncrementalLow Tech.Medium Tech.High Tech.Low Tech.Medium Tech.High Tech.Average -$100 DirectComplexityComplexityComplexityComplexityComplexityComplexityCost ContributorTable 2-3)Manuf. CostICMCostICMCostICMCostICMCostICMCostICMCostManufacturingManufacturing Cost100.0%$100.00$100.00$100.00$100.00$100.00$100.00$100.00Production OverheadWarranty2.6%$2.601.2$3.121.4$3.641.6$4.161$2.601$2.601$2.60R&D (Product Development)5.3%$5.300.2$1.061.1$5.832$10.600$0.000$0.000.3$1.59Depreciation & Amortization7.0%$7.000$0.000$0.001$7.000$0.000$0.001$7.00Maint, Repair, Operating Costs15.2%$15.200$0.000$0.001$15.200$0.000$0.001$15.20Total Production Overhead29.1%$29.10$4.18$9.47$36.96$2.60$2.60$26.39(non-additive)Corporate OverheadGeneral & Administrative10.0%$10.010$0.000$0.000.5$5.010$0.000$0.000.5$5.01Retirement0.4%$0.400$0.000$0.000.5$0.200$0.000$0.000.5$0.20Health Care0.3%$0.300$0.000$0.000.5$0.150$0.000$0.000.5$0.15Total Corporate Overhead10.6%$10.60$0.00$0.00$5.36$0.00$0.00$5.36(non-additive)SellingTransportation (Distribution)3.7%$3.700$0.000$0.000.3$1.110$0.000$0.000$0.00Marketing3.7%$3.700.5$1.851$3.701.5$5.550$0.000$0.000$0.00Dealer Support & Discount2.5%$2.500.1$0.251$2.501.5$3.750$0.000.3$0.751$2.50Total Selling Cost (non-additive)6.1%$6.10$2.10$6.20$10.41$0.00$0.75$2.50Total Indirect Costs Before Profit45.4%$45.40$6.28$15.67$52.73$2.60$3.35$34.25Corporate Profit4.1%$4.10Total Retail Price Equivalent149.4%$149.40Interpretation A- Apply the ICMs from Table 3-5 to the RPE-developed Indirect Costs*Total Indirect Cost Before Profit$45.401.06$48.121.16$52.661.53$69.461.03$46.761.04$47.221.34$60.84Interpretation B- Apply the decimal part of ICMs from Table 3-5 to the Manufacturing Cost BaseTotal Indirect Cost Before Profit$100.000.06$6.000.16$16.000.53$53.000.03$3.000.04$4.000.34$34.00*In the same way that the scalar multipliers (which are presented as ICMs) were applied to indirect cost categories in Tables 3-3 and 3-4 and in the body of the table above.