CHAPTER 5. MARKUPS FOR PRODUCT PRICE DETERMINATION

TABLE OF CONTENTS 

5.1 INTRODUCTION ........................................................................................................... 5-1

5.1.1 Distribution Channels .......................................................................................... 5-2

5.2 MARKUP CALCULATION METHODOLOGY ........................................................... 5-3

5.3 APPROACH FOR CALCULATING OVERALL MARKUP ........................................ 5-4

5.3.1 Baseline Markup .................................................................................................. 5-4

5.3.2 Incremental Markups ........................................................................................... 5-5

5.4 APPROACH FOR CALUCLATING MANUFACTURER MARKUP .......................... 5-6

5.5 APPROACH FOR CALCULATING WHOLESALER AND CONTRACTOR 

MARKUPS ...................................................................................................................... 5-6

5.5.1 Key Data and Assumptions of the Markups Methodology .................................. 5-7

5.5.2 Approach for Wholesaler Markup ....................................................................... 5-8

5.5.3 Approach for Mechanical and General Contractor Markup ................................ 5-9

5.6 DERIVATION OF MARKUPS .................................................................................... 5-10

5.6.1 Manufacturer Markups....................................................................................... 5-10

5.6.2 Wholesaler Markups .......................................................................................... 5-10

5.6.3 Mechanical Contractor Markups........................................................................ 5-12

5.6.3.1 Aggregate Baseline Markups for Mechanical Contractors ...................... 5-12

5.6.3.2 Baseline Markups for Mechanical Contractors in the Replacement 

and New Construction Markets ................................................................ 5-13

5.6.3.3 Baseline Markups for Small and Large Mechanical Contractors............. 5-13

5.6.3.4 Baseline Markups by Disaggregated Mechanical Contractor Type ......... 5-14

5.6.3.5 Incremental Markups by Mechanical Contractor Type ............................ 5-15

5.6.4 Estimation of General Contractor Markups ....................................................... 5-16

5.7 SALES TAX .................................................................................................................. 5-18

5.8 OVERALL MARKUPS................................................................................................. 5-18

REFERENCES .......................................................................................................................... 5-20

LIST OF TABLES 

Table 5.1.1 Shares of Market by Distribution Channel .................................................... 5-3

Table 5.6.1 Wholesaler Expenses and Markups ............................................................. 5-11

Table 5.6.2 Baseline Markup, All Mechanical Contractors ............................................ 5-12

Table 5.6.3 Baseline Markups for the Replacement and New Construction 

Markets, All Mechanical Contractors .......................................................... 5-13

Table 5.6.4 Baseline Markups for Small and Large Mechanical Contractors ................ 5-14

Table 5.6.5 Baseline Markups by Mechanical Contractor Type ..................................... 5-15

Table 5.6.6 Mechanical Contractor Disaggregated Expenses and Markups Based 

on 2007 U.S. Census Bureau Data ............................................................... 5-15

Table 5.6.7 Incremental Markups by Mechanical Contractor Type ............................... 5-16

5-i 
Table 5.6.8 General Contractor Expenses and Markups ................................................. 5-17

Table 5.7.1 Average Sales Tax Rates by Census Division and Large State ................... 5-18

Table 5.8.1 Summary of Overall Markups (3-phase, air cooled, air conditioning 

and heat pumps <65,000 Btu/h and water source heat pumps) ................... 5-19

LIST OF FIGURES 

Figure 5.1.1 Distribution Channels for New Construction Applications ........................... 5-2

Figure 5.1.2 Distribution Channels for Replacement Applications ................................... 5-3

5-ii
CHAPTER 5. MARKUPS FOR PRODUCT PRICE DETERMINATION

5.1 INTRODUCTION

To carry out the life-cycle cost (LCC) calculations described in Chapter 6, DOE needed 

to determine the cost to the commercial consumer of baseline air-cooled, air-conditioners and

heat pumps, and water source heat pumps, along with the cost of the more-efficient units the 

consumer would purchase under potential standards. However, the commercial consumer price 

of such units is not generally known. By applying a multiplier called a “markup” to the known 

manufacturer’s price, DOE was able to estimate the commercial consumer’s price. DOE based 

the markups for small commercial air-cooled air-conditioning and heating equipment and watersource heat pumps on the analysis conducted for commercial unitary air conditioners and heat 

pumps (CUAC/CUHP). This chapter describes how DOE derived those markups and the 

modifications made for today's NOPR.

The equipment price to the commercial consumer depends on how the consumer

purchases the equipment. DOE defines two primary types of distribution channels to describe 

how air-conditioners and heat pumps generally pass from the manufacturer to the consumer: (1) 

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

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

sells it to the consumer; (2) in the second distribution channel, the manufacturer sells the 

equipment directly to the consumer through a national account. DOE has further subdivided the 

first distribution channel by mechanical contractor size (as measured in annual revenues). 

DOE did not use the national accounts distribution channel in this rulemaking. National 

accounts are used by large commercial consumers of HVAC equipment, such as national retail 

chains. Due to the large volume of equipment purchased, the large commercial consumers can 

buy directly from the manufacturer at lower prices than would be obtained in the typical 

distribution chain. Small, air-cooled, 3-phase air-conditioning and heat pump equipment less 

than 65,000 Btu/h and water source heat pumps with cooling capacities less than 135,000 Btu/h 

do not fit the profile of equipment which would be used by a large, national chain. Therefore, 

DOE assumed all equipment uses a small or large mechanical contractor distribution channel to 

determine the markups in this rulemaking. 

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

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

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

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

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

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

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

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

5.1.1. 

5-1 
5.1.1 Distribution Channels

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

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

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

business costs and profit margin. In this analysis, DOE considered a primary distribution 

channel involving distributors and contractors. Within this primary channel, DOE distinguishes 

between new and replacement applications, as only new construction applications are expected 

to include a general contractor. DOE also distinguishes between small and large mechanical 

contractors. 

The distribution channel for new construction applications is shown in Figure 5.1.1. In 

the new construction distribution channel, the manufacturer sells the equipment to a wholesaler, 

who in turn sells it to either a small or large mechanical contractor, who in turn sells it to a 

general contractor, who in turns sells it to the consumer and performs the installation. 

 

Figure 5.1.1 Distribution Channels for New Construction Applications

Distribution channels for replacement applications are shown in Figure 5.1.2. In the 

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

turn sells it to either a small or large mechanical contractor, who in turns sells it to the consumer 

and performs the installation. 

Wholesaler

Small 

Mechanical 

Contractor

General 

Contractor

Consumer

Manufacturer

Large

Mechanical 

Contractor

General 

Contractor

Consumer

5-2 
Figure 5.1.2 Distribution Channels for Replacement Applications

 Based on information that equipment manufacturers provided in the commercial unitary 

air conditioner and heat pump rulemaking, end-use commercial consumers purchase 50 percent 

of equipment through small mechanical contractors, 32.5 percent through large mechanical 

contractors, and the remaining 17.5 percent through national accounts. DOE excluded national 

accounts from this analysis, therefore of the contractor distribution channel, small contractors 

represent 61 percent of sales and large contractors represent 39 percent of sales. In addition, 20 

percent of commercial air-conditioning equipment is purchased for the new construction market 

while the remaining 80 percent is assumed to serve the replacement market. DOE used this same 

distribution for the equipment in today's NOPR. Table 5.1.1 lists each distribution channel’s 

share of the full commercial air conditioner market for the original CUAC/CUHP analysis and 

today's analysis.

Table 5.1.1 Shares of Market by Distribution Channel

Distribution Channel

CUAC/CUHP 

Share of 

Market

Small 3-Phase 

AC/HP and 

WSHP Share of 

Market

New Construction, Small Mechanical Contractor 10.0% 12.2%

New Construction, Large Mechanical Contractor 6.5% 7.8%

New Construction, National Account 3.5% N/A

Replacement, Small Mechanical Contractor 40.0% 48.8%

Replacement, Large Mechanical Contractor 26.0% 31.2%

Replacement, National Account 14.0% N/A

5.2 MARKUP CALCULATION METHODOLOGY

At each point in the distribution channel, companies mark up the price of the equipment 

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

difference between the company revenue and the company cost of sales or cost of goods sold 

Wholesaler

Small 

Mechanical 

Contractor

Consumer

Manufacturer

Large

Mechanical 

Contractor

Consumer

5-3 
(CGS). The gross margin includes the expenses of companies in the distribution channel—

including overhead costs (sales, general, and administration); research and development (R&D) 

and interest expenses; depreciation and taxes—and company profits. In order for sales of a 

product to contribute positively to company cash flow, the product’s markup must be greater 

than the corporate gross margin. Products command lower or higher markups, depending on 

company expenses associated with the product and the degree of market competition. 

Equipment manufacturers sell most of their products directly to wholesalers. 

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

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

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

Most contractors compete at the local level. Many carry more than one brand of air conditioner, 

and most install the products they sell. 

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

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

cost. 

5.3 APPROACH FOR CALCULATING OVERALL MARKUP

5.3.1 Baseline Markup

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

models, given the manufacturer cost of the baseline models. DOE considers baseline models to 

be product sold under existing market conditions (i.e., without new energy conservation 

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

determine the product price for baseline models in the first new construction distribution 

channel.

CCCCCCBBBBBBBB = CCCCCCCCMMMMMM

× �MMMMMMMMMM × MMMMWWWWWWWW _BBBBBBBB × MMMMMMMM MMMMMM MMMM_BBBBBBBB × MMMM _BBBBBBBB�

= CCCCCCCCMMMMMM × MMMM OO _BBBBBBBB

Where:

CPPBASE = Consumer product price for baseline models, 

COSTMFG = Manufacturer cost for baseline models, 

MUMFG = Manufacturer markup, 

MUWHOLE_BASE = Baseline wholesaler markup,

MUMCONTRACT_BASE = Baseline mechanical contractor markup,

MUMGENERAL_BASE = Baseline general contractor markup, and

MUOVERALL_BASE = Baseline overall markup.

 The following equation shows how DOE used the overall baseline markup to determine 

the product price for baseline models in the first replacement distribution channel. 

5-4 
CCCCCCBBBBBBBB = CCCCCCCCMMMMMM × �MMMMMMMMMM × MMMMWWWWWWWW _BBBBBBBB × MMMMMMMM MMMMMM MMMM_BBBBBBBB × TTTT �

= CCCCCCCCMMMMMM × MMMM OO _BBBBBBBB

Where:

CPPBASE = Consumer product price for baseline models,

COSTMFG = Manufacturer cost for baseline models, 

MUMFG = Manufacturer markup, 

MUWHOLE_BASE = Baseline wholesaler markup,

MUMCONTRACT_BASE = Baseline mechanical contractor markup,

TAXSALES = Sales tax, and

MUOVERALL_BASE = Baseline overall markup.

5.3.2 Incremental Markups

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

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

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

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

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

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

equation shows how DOE used the overall incremental markup to determine the product price 

for more energy-efficient models in the first new construction distribution channel. 

CCCCCC = CCCCCCBBBBBBBB + CCCCCCCCMMMM _II _

× �MMMMMMMMMM × MMMMWWWWWWWW _II × MMMMMMMM MMMMMM MMMM_II × MMMM _II �

= CCCCCCBBBBBBBB + CCCCCCCCMMMMMM_II × MMMM OO _II

Where:

CPPEFF = Consumer product price for more-efficient models, 

CPPBASE = Consumer equipment price for baseline models,

COSTMFG_INCR = Incremental manufacturer cost, 

MUMFG = Manufacturer markup, 

MUWHOLE_INCR = Incremental wholesaler markup,

MUMCONTRACT_INCR = Incremental mechanical contractor markup,

MUMGENERAL_INCR = Incremental general contractor markup, and

MUOVERALL_INCR= Incremental overall markup.

 The following equation shows how DOE used the overall incremental markup to 

determine the product price for more energy-efficient models in the first replacement distribution 

channel.

5-5 
CCCCCC = CCCCCCBBBBBBBB + CCCCCCCCMMMMMM_II

× �MMMMMMMMMM × MMMMWW _II × MMMMMMMM MMMMMM MMMM_II × TTTT �

= CCCCCCBBBBBBBB + CCCCCCCCMMMMMM_II × MMMM OO _II

Where:

CPPEFF = Consumer product price for more-efficient models, 

CPPBASE = Consumer equipment price for baseline models,

COSTMFG_INCR = Incremental manufacturer cost, 

MUMFG = Manufacturer markup, 

MUWHOLE_INCR = Incremental wholesaler markup,

MUMCONTRACT_INCR = Incremental mechanical contractor markup,

TAXSALES = Sales tax, and

MUOVERALL_INCR= Incremental overall markup. 

5.4 APPROACH FOR CALUCLATING MANUFACTURER MARKUP

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

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

calculated as follows:

MMMMMMMM = CCCCCCMMMMMM + MMMMMM

CCCCCCMMMMMM

Where:

MUMFG = Manufacturer markup, 

CGSMFG = Manufacturer cost of goods sold, and 

GMMFG = Manufacturer gross margin. 

5.5 APPROACH FOR CALCULATING WHOLESALER AND CONTRACTOR 

MARKUPS

DOE examined the manner in which markups change by efficiency level and other 

factors for wholesalers and contractors. DOE determined that markups are neither fixed-dollar, 

nor proportional to all direct costs, which means that the selling price of a product may not be 

strictly proportional to the purchase price of the equipment. Using the available data, DOE has 

found measurable differences between incremental markups on direct equipment costs and the 

average aggregate markup on direct business costs. Additionally, DOE discovered significant 

differences between average and incremental markups for heating, ventilation, air-conditioning 

and refrigeration (HVACR) wholesalers and for HVAC contractors. 

5-6 
The main reason that the selling price of a product may not be strictly proportional to the 

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

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

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

business expenses are uncorrelated with the cost of equipment or cost of goods. For example, if 

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

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

5.5.1 Key Data and Assumptions of the Markups Methodology

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

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

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

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

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

and from the Air Conditioning Contractors of America (ACCA).1 2 HARDI and ACCA are trade 

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

financial data from the 2007 US Census of Business to develop general contractor markups in 

the same form as the income statement data for wholesalers and mechanical contractors.3 4 These 

income statements break down the components of all costs incurred by firms that supply and 

install air conditioning equipment.a 

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

 

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

firms distributing and installing HVAC products including commercial air conditioners.

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

manufacturer selling price (MSP) of commercial air conditioners (variant costs); and 2) 

costs that do not vary with the MSP commercial air conditioners (invariant costs). 

• Overall, commercial air-conditioner wholesaler and contractor prices vary in proportion 

to commercial air-conditioner wholesaler and contractor costs included in the income 

statements.

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

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

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

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

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

available indication of the expenses associated with commercial air conditioners.

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

residential and commercial air-conditioners.

5-7 

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

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

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

the quantity of labor and materials used to distribute and install appliances In its analysis, DOE 

assumes a division of costs between those that do not scale with the manufacturer price (labor 

and occupancy expenses), and those that do (operating expenses and profit). This division of 

costs led to the estimate of wholesale and contractor markups described below. 

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

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

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

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

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

pumps and air-conditioning equipment,6

 more than 170,000 general residential contractors, 

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

listed in the 2007 Census.9 Additionally, the 2007 Census estimated that the four firm 

concentration ratio (FFCR) for the HVAC wholesale sector is 29.7%.10 The FFCR is the market 

share of the four largest firms in the industry; FFCR under 40% represents a competitive 

industry.11,12 Following standard economic theory, competitive firms facing inelastic demand 

either set prices in line with costs or quickly go out of business.13

5.5.2 Approach for Wholesaler Markup

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

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

Distributors International (HARDI) 2010 Profit Report (Appendix 5A.1). DOE used the baseline 

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

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

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

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

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

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

MMMMWWWWWWWW _BBBBBBBB = CCCCCCWWWWWWWW + WWWWWWWW

CCCCCCWWWWWWWW

= CCCCCCWWWWWWWW + (IIII WWWWWWWW + WWWWWWWW )

CCCCCCWWWWWWWW

Where:

MUWHOLE_BASE = Baseline wholesaler markup, 

CGSWHOLE = Wholesaler cost of goods sold, 

GMWHOLE = Wholesaler gross margin, 

IVCWHOLE = Wholesaler invariant costs, and 

VCWHOLE = Wholesaler variant costs.

5-8 
Incremental markups are coefficients that relate the change in the manufacturer sales 

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

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

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

costs, VC). DOE calculated the incremental markup for wholesalers using the following 

equation: 

MMMMWWWWWWWW _II = CCCCCCWWWWWWWW + WWWWWWWW

CCCCCCWWWWWWWW

Where:

MUWHOLE_INCR = Incremental wholesaler markup,

CGSWHOLE = Wholesaler cost of goods sold, and 

VCWHOLE= Wholesaler variant costs.

5.5.3 Approach for Mechanical and General Contractor Markup

Similar financial data to that used to estimate wholesaler markups are also available for 

mechanical contractors and general contractors from ACCA and the 2007 Economic Census.2, 9

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

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

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

contractor markups, DOE collected data from the Commercial and Institutional Building 

Construction series from the 2007 Economic Census (NAICS 236220). 

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

contractor industry; therefore, the mechanical contractor baseline markup is derived using the 

following equation: 

MMMMMMMM MMMMMM MMMM_BBBBBBBB = SSSS (%)

SSSS (%) − (%)

 The 2007 Economic Census data include the number of establishments, payroll for 

construction workers, value of construction, cost of materials, and cost of subcontracted work at 

both state and national level. DOE calculated another estimate of the baseline markup for 

mechanical contractors and general contractors using the following equation: 

MMMMBBBBBBBB = CC

PP + MM + SS

Where:

MUBASE = Baseline mechanical contractor or general contractor markup,

VCONSTRUCT = Value of construction, 

5-9 
PAY = Payroll for construction workers, 

MATCOST = Cost of materials, and

SUBCOST = Cost of subcontracted work. 

Analogously, DOE estimated the incremental mechanical contractor and general 

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

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

Section 5.5.1, DOE assumes a division of costs between those that do not scale with the 

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

and profit). Hence, DOE categorized the 2007 Economic Census cost data in each major cost 

category and estimated incremental contractor markups using the following equation: 

MM _II = CCCCCC +

CCCCCC

Where:

MUCONTRACT_INCR = Incremental contractor markup,

CGSCONTRACT = Contractor cost of goods sold, and 

VCCONTRACT= Contractor variant costs. 

5.6 DERIVATION OF MARKUPS

5.6.1 Manufacturer Markups

For this rulemaking, DOE relied on the manufacturer markups developed for central air 

conditioners and heat pumps, which is a markup of 1.30.b DOE applied this markup to all 

equipment classes.

5.6.2 Wholesaler Markups

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

its members. In the survey, HARDI itemized revenues and costs into categories, including direct 

equipment expenses (cost of goods sold), labor expenses, occupancy expenses, other operating 

expenses, and profit. DOE presents these data in full in appendix 5A.1, Detailed Data for 

Equipment Price Markups. Table 5.6.1 summarizes them in terms of cost-per-dollar sales 

revenue in the first data column and in terms of cost-per-dollar of cost of goods sold in the 

second column. 

b http://www1.eere.energy.gov/buildings/appliance_standards/pdfs/cacfurn_dfr.pdf

5-10 

 
Table 5.6.1 Wholesaler Expenses and Markups

Descriptions

Per Dollar

Sales Revenue

$

Per Dollar Cost 

of Goods 

$

Direct Cost of Equipment Sales: Cost of goods sold 0.737 1.000

Labor Expenses: Salaries and benefits 0.151 0.205

Occupancy Expense: Rent, maintenance, and utilities 0.036 0.049

Other Operating Expenses: Depreciation, advertising, and 

insurance.

0.055 0.075

Operating Profit 0.020 0.027

Baseline Revenue: Baseline revenue earned per dollar cost of goods sold 1.357

Wholesaler Baseline Markup (MUWHOLE BASE) 1.357

Incremental Revenue: Increased revenue per dollar increase cost of goods 

sold

1.103

Incremental Markup (MUWHOLE INCR) 1.103

Source: Heating, Air Conditioning & Refrigeration Distributors International. 2012. 2012 Profit 

Report (2010 Data). 

In this case, direct equipment expenses (cost of goods sold) represent about $0.74 per 

dollar sales revenue, so for every $1 wholesalers take in as sales revenue, $0.74 is used to pay 

the direct equipment costs. Labor expenses represent $0.15 per dollar sales revenue, occupancy 

expenses represent $0.04, other operating expenses represent $0.06, and profit accounts for $0.02 

per dollar sales revenue.

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

by dividing each figure in the first data column by $0.74 (i.e., cost of goods sold per dollar of 

sales revenue). For every $1.00 the wholesaler spends on equipment costs, the wholesaler spends 

$0.205 to cover labor costs, $0.049 to cover occupancy expenses, $0.075 for other operating 

expenses, and $0.027 in profits. This totals to $1.357 in sales revenue earned for every $1.00 

spent on equipment costs. Therefore, the wholesaler baseline markup (MUWHOLE BASE) is 1.357 

($1.357 ÷ $1.00). 

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

incremental markup depends on which of the costs in Table 5.6.1 are variant or invariant with 

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

the MSP (i.e., all costs are variant), the increase in wholesale price will be $1.357, implying that 

the incremental markup is 1.357, or the same as the baseline markup. At the other extreme, if no 

other costs are variant, then a $1.00 increase in the MSP will lead to a $1.00 increase in the 

wholesale price, for an incremental markup of 1.0. 

As stated in section 5.5 DOE believes that the labor and occupancy costs are invariant 

with respect to MSP, while other operating costs and profit are variant. In this case, for a $1.00 

increase in the MSP, the wholesale price will increase in line with changes in the categories 

“other operating costs” and “operating profit”; these are approximately of $0.067, which when 

divided by $0.737 cents in cost of goods sold yields an increase of $0.103, giving a wholesaler 

incremental markup (MUWHOLE INCR) of 1.103. See appendix 5.A for cost details. 

5-11 
5.6.3 Mechanical Contractor Markups

5.6.3.1 Aggregate Baseline Markups for Mechanical Contractors

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

data in an ACCA financial analysis of the HVAC industry. These data are shown in Table 5.6.2

Table 5.6.2 Baseline Markup, All Mechanical Contractors

Description

Contractor Expenses or Revenue

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods 

$

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

Gross Margin: Labor, occupancy, operating expenses, 

and profit

0.27 0.37

Revenue: Baseline revenue earned per dollar cost of goods 1.37

Baseline Markup (MUMECH CONT BASE) 1.37

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

Contracting Industry.

Data reported in this analysis are not as detailed as those provided by HARDI and the 

U.S. Census, containing only cost of goods sold and gross margin. Since the gross margin is the 

sum of labor, occupancy expenses, operating expenses, and profit, the data are sufficient to 

estimate the baseline markup. The first data column in Table 5.6.2 provides the cost of goods 

sold and gross margin, expressed as dollars per dollar of sales revenue. The only important 

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

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

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

DOE converted these expenses per dollar sales into revenue per dollar cost of goods sold 

by dividing each figure in the first data column by $0.73. For every $1.00 the mechanical 

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

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

sales revenue earned for every $1.00 spent on equipment costs, for a baseline markup (MUMECH 

CONT BASE) of 1.37 for mechanical contractors. This is the beginning point for the determination 

of mechanical contractor markups. 

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

all contractors, including large and small contractors serving the replacement and new 

construction markets. The following sections describe how DOE further derived the baseline and 

incremental markups for four distinct categories of mechanical contractors: (1) small contractors 

in the replacement market; (2) small contractors in the new construction market; (3) large 

contractors in the replacement market; and (4) large contractors in the new construction market. 

5-12 
5.6.3.2 Baseline Markups for Mechanical Contractors in the Replacement and 

New Construction Markets

As presented above for all mechanical contractors in aggregate , the ACCA financial data 

provided only gross margin data, which allows for the determination of only the baseline markup 

for the four types of contractor, since the gross margin is the sum of all contractor labor and 

operating expenses plus profit. 

Table 5.6.3 summarizes the gross margin and resulting baseline markup data for all 

mechanical contractors that serve the replacement and new construction markets. Note that while 

this data is disaggregated by the market served, it aggregates mechanical contractors of all sizes.

Table 5.6.3 Baseline Markups for the Replacement and New Construction Markets, All 

Mechanical Contractors 

Description

Contractor Expenses or Revenue by Market Type

Replacement New Construction

Per Dollar

Sales 

Revenue

$

Per Dollar 

Cost of 

Goods 

$

Per Dollar

Sales 

Revenue

$

Per Dollar 

Cost of 

Goods 

$

Direct Cost of Equipment Sales: 

Cost of goods sold 0.703 1.000 0.745 1.000 

Gross Margin: Labor, occupancy, 

operating expenses, and profit 0.297 0.422 0.255 0.342 

Baseline Markup (MUMECH CONT 

BASE): Revenue per dollar cost of 

goods

NA 1.42 NA 1.34 

% Difference from Aggregate 

Mechanical Contractor Baseline 

MU

NA 3.6% NA -2.2% 

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

Contracting Industry.

Using the baseline markup data for replacement and new construction contractors from 

Table 5.6.3, DOE calculated that the baseline markups for the replacement and new markets are 

3.6 percent higher and 2.2 percent lower, respectively, than that for all mechanical contractors 

serving all markets shown in Table 5.6.2. These percentage differences are later used, along 

with those defined in section 5.6.3.3 to estimate separate markups for the four categories of 

mechanical contractor of interest.

5.6.3.3 Baseline Markups for Small and Large Mechanical Contractors

ACCA provides data for contracting businesses earning annual revenues in each of the 

four following categories: (1) below one million dollars; (2) from one to two million dollars; (3) 

from two to five million dollars; and (4) over five million dollars. DOE aggregated the data into 

two categories: contractors earning annual revenue below two million dollars and contractors 

5-13 
earning annual revenue above two million dollars. The values reported for small contractors are 

the average of the categories: (1) below one million dollars, and (2) from one to two million 

dollars. The values reported for large contractors are the average of the categories: (3) from two 

to five million dollars, and (4) over five million dollars. 

Table 5.6.4 Baseline Markups for Small and Large Mechanical Contractors

Description

Contractor Expenses or Revenue by Market Type

Small ( < $2 million) Large ( > $2 million)

Per Dollar

Sales 

Revenue

$

Per Dollar 

Cost of 

Goods 

$

Per Dollar

Sales 

Revenue

$

Per Dollar 

Cost of 

Goods 

$

Direct Cost of Equipment Sales: 

Cost of goods sold 0.653 1.000 0.753 1.000 

Gross Margin: Labor, occupancy, 

operating expenses, and profit 0.347 0.532 0.247 0.328 

Baseline Markup (MUMECH CONT 

BASE): Revenue per dollar cost of 

goods

NA 1.53 NA 1.33 

% Difference from Aggregate 

Mechanical Contractor Baseline 

MU

NA 11.6% NA -3.2% 

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

Contracting Industry.

Using the baseline markup data for small and large contractors from Table 5.6.4, DOE 

calculated that the baseline markups for small and large are 11.6 percent higher and 3.2 percent 

lower, respectively, than that for all mechanical contractors serving all markets shown in Table 

5.6.2. 

5.6.3.4 Baseline Markups by Disaggregated Mechanical Contractor Type 

Using the percentage difference from the aggregate mechanical contractor baseline 

markup (Table 5.6.2), DOE then estimated the baseline markup for each of the four mechanical 

contractor types: (1) small contractors in the replacement market; (2) small contractors in the 

new construction market; (3) large contractors in the replacement market; and (4) large 

contractors in the new construction market. The baseline markup for each mechanical contractor 

type is estimated using the following equation:

MMMMMMMM MMMMMM MMMM_BBBBBBBB = MMMM + MMMM × μμ SS + MMMM × μμMM MMMM MM

 

Where:

MUAGGREGATE = Baseline markup for aggregate of all mechanical contractors,

μSIZE = Size modifier (small or large contractor percentage difference from 

aggregate of all contractors’ markup), 

5-14 
μMARKET = Market modifier (replacement or new construction contractor percentage 

difference from aggregate of all contractors’ markup), and, 

MUMCONTRACT_BASE = Baseline markup for specific mechanical contractor type.

Table 5.6.5 Baseline Markups by Mechanical Contractor Type

Mechanical Contractor Type Size 

Modifier

Market 

Modifier

Baseline 

Size Market Markup

Small Replacement 11.6% 3.6% 1.58

New Construction 11.6% -2.2% 1.50

Large Replacement -3.2% 3.6% 1.38

New Construction -3.2% -2.2% 1.30

5.6.3.5 Incremental Markups by Mechanical Contractor Type

Calculation of the incremental markups for each mechanical contractor type required 

separation of the invariant and variant costs. Since this was not possible using the ACCA data, 

DOE used more detailed 2007 U.S. Census Bureau data for all plumbing, heating, and airconditioning contractors. The U.S. Census Bureau data were used to calculate the baseline and 

incremental markups as shown in Table 5.6.6 . Appendix 5A.2 contains the full set of data used 

in this calculation.

Table 5.6.6 Mechanical Contractor Disaggregated Expenses and Markups Based on 2007 

U.S. Census Bureau Data

Description

Contractor Expenses or Revenue

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods 

$

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

Labor Expenses: Salaries (indirect) and benefits 0.17 0.26

Occupancy Expense: Rent, maintenance, and utilities 0.02 0.03

Other Operating Expenses: Depreciation, advertising, and 

insurance.

0.04 0.06

Net Profit Before Taxes 0.09 0.13

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

Incremental Markup (MUMECH INCR): Increased revenue per dollar increase cost 

of goods sold

1.18

Percent difference between Baseline and Incremental Markup 20.0%

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

Sector 23: 238220. Construction: Industry Series, Preliminary Detailed Statistics for 

Establishments, 2007. 

5-15 
Using the data in Table 5.6.6, the incremental markup is 20 percent lower than the 

baseline markup. By applying this 20 percent differential between baseline and incremental 

markup to the baseline markups estimated for the four specific mechanical contractor types, 

DOE estimates the incremental markup for each type (Table 5.6.7).

Table 5.6.7 Incremental Markups by Mechanical Contractor Type

Mechanical Contractor Type Incremental 

Size Market Markup

Small Replacement 1.26

New Construction 1.20

Large Replacement 1.10

New Construction 1.04

5.6.4 Estimation of General Contractor Markups

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

commercial building construction sector. The commercial construction sector includes 

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

additions, alterations, and repairs. 

The U.S. Census Bureau data for the construction sector include detailed statistics for 

establishments with payrolls, similar to the data reported by HARDI for wholesalers. The 

primary difference is that the U.S. Census Bureau reports itemized revenues and expenses in 

total dollars for the construction industry as a whole, rather than in typical values for an average 

or representative business. Because of this, DOE assumed that the total dollar values that the 

U.S. Census Bureau reported, once converted to a percentage basis, represented revenues and 

expenses for an average or typical contracting business. Similar to the data for wholesalers, 

Table 5.6.8 summarizes the expenses for general contractors as expenses per dollar sales revenue 

in the first data column (Appendix 5A.3 contains the full set of data). 

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Table 5.6.8 General Contractor Expenses and Markups

Description

Wholesale Firm Expenses or 

Revenue

Per Dollar

Sales Revenue

$

Per Dollar 

Cost of Goods 

$

Direct Cost of Equipment Sales: Cost of goods sold 0.76 1

Labor Expenses: Salaries (indirect) and benefits 0.08 0.10

Occupancy Expense: Rent, maintenance, and utilities 0.01 0.01

Other Operating Expenses: Depreciation, advertising, and 

insurance.

0.03 0.04

Net Profit Before Taxes 0.12 0.15

Baseline Markup (MUGEN CONT BASE): Revenue per dollar cost of goods 1.31

Incremental Markup (MUGEN CONT INCR): Increased revenue per dollar increase 

cost of goods sold

1.19

Source: U.S. Census Bureau. 2007. Sector 236220 (Commercial Building Construction). 

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

As shown in the first column, the direct cost of sales represents about $0.76 per dollar 

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

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

$0.03, and profit makes up $0.12 per dollar sales revenue.

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

by dividing each figure in the first data column by $0.76. The data in column two show that, for 

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

in sales revenue to cover the equipment cost, $0.10 to cover labor costs, $0.01 to cover 

occupancy expenses, $0.04 for other operating expenses, and $0.15 in profits. This totals to 

$1.31 in sales revenue earned for every $1.00 spent on equipment costs. Thus, the general 

contractor baseline markup (MUGCONTRACT_ BASE) is 1.31. 

DOE was also able to use the data in column two of Table 5.6.8 to estimate the 

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

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

general contractor price will be $1.48, implying that the incremental markup is 1.48, or the same 

as the baseline markup. At the other extreme, if none of the other costs are variant, then a $1.00 

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

an incremental markup of 1.0. DOE believes the labor and occupancy costs are invariant, while 

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

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

$1.19, giving a general contractor incremental markup (MUGCONTRACT_INCR) of 1.19. 

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5.7 SALES TAX

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

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

price.

DOE derived state and local taxes from data provided by the Sales Tax Clearinghouse.14

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

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

Table 5.7.1 below. The average sales tax presented in the bottom row of the table is the weighted 

average accounting for commercial building floor space with packaged cooling by Census 

division, calculated using CBECS 2003. Detailed sales tax data by each state can be found in 

Appendix 5A.4. 

Table 5.7.1 Average Sales Tax Rates by Census Division and Large State 

Census Division/State Tax Rate

New England 6.91%

Mid Atlantic 8.01%

East North Central 7.47%

West North Central 6.44%

South Atlantic 5.68%

East South Central 7.65%

West South Central 6.50%

Mountain 7.09%

Pacific 8.13%

New York 8.40%

California 8.45%

Texas 7.90%

Florida 6.65%

Average 7.16%

Source: The Sales Tax Clearinghouse at https://thestc.com/STRates.stm (Accessed March, 2014) 

5.8 OVERALL MARKUPS

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

markups, as well as sales tax in the case of replacement applications. These values are provided 

in Table 5.8.1. 

5-18 
Table 5.8.1 Summary of Overall Markups (3-phase, air cooled, air conditioning and heat 

pumps <65,000 Btu/h and water source heat pumps)

Distribution Channel 

Segment

Replacement New Construction

Baseline 

Markup

Incremental 

Markup

Baseline 

Markup

Incremental 

Markup

Manufacturer 1.30 1.30 1.30 1.30

Wholesaler 1.36 1.10 1.36 1.10

Mechanical Contractor 

(large/small) 1.38 / 1.58 1.10 / 1.26 1.30 / 1.50 1.04 / 1.20 

General Contractor 

(new construction only) -- -- 1.31 1.20 

Sales tax 

(replacements only) 1.07 1.07 -- --

Overall Markup

(large/small contractor) 2.60 / 2.99 1.70 / 1.94 3.00 / 3.47 1.78 / 2.06 

5-19 
REFERENCES

1

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

2

 Air Conditioning Contractors of America, 2005 Financial Analysis for the HVACR Contracting 

Industry, 2005. 

3

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

Detailed Statistics for Establishments, 2007. 

4

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

Preliminary Detailed Statistics for Establishments: 2007. 2007.

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

2007. Air-Conditioning and Warm Air Heating Equipment and Commercial and Industrial 

Refrigeration Equipment Manufacturing. Data set for Sector 31: EC073111 2007. 

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

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

EC0742111, 2007. 

7

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

Establishments: 2007. Commercial and Institutional Building Construction. , 2007. 

8

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

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

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

2007. 

9

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

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

2007., 2007. 

10 U.S. Census Bureau, Wholesale Trade: Subject Series: Estab and Firm Size: Summary 

Statistics by Concentration of Largest Firms for the United States: 2007. Data set for Sector 

42: EC074373. 2007. 

11 University of Maryland University College, Note on Industry Structure, 2002. (Last accessed 

February, 2013.) <http://info.umuc.edu/mba/public/AMBA607/IndustryStructure.html

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

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

13 Pindyck, R. and D. Rubinfeld, Microeconomics. 2000. Prentice Hall. 

14 The Sales Tax Clearinghouse, <https://thestc.com/STRates.stm> 

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