CHAPTER 12 PRELIMINARY MANUFACTURER IMPACT ANALYSIS

TABLE OF CONTENTS

12.1 INTRODUCTION

......................................................................................................... 12-1

12.2 METHODOLOGY

........................................................................................................ 12-1

12.2.1 Phase I: Industry Profile

..................................................................................... 12-2

12.2.2 Phase II: Industry Cash-Flow Analysis and Interview Guide

............................ 12-2

12.2.2.1 Industry Cash-Flow Analysis

........................................................... 12-2

12.2.2.2 Interview Guide

............................................................................... 12-2

12.2.3 Phase III: Subgroup Analysis

............................................................................. 12-3

12.2.3.1 Manufacturer Interviews

.................................................................. 12-3

12.2.3.2 Revised Industry Cash-Flow Analysis

............................................. 12-3

12.2.3.3 Manufacturer Subgroup Analysis

.................................................... 12-3

12.2.3.4 Competitive Impact Assessment

...................................................... 12-4

12.2.3.5 Manufacturing Capacity Impact

...................................................... 12-4

12.2.3.6 Employment Impact

......................................................................... 12-4

12.2.3.7 Cumulative Regulatory Burden

....................................................... 12-4

12.3 INDUSTRY OVERVIEW

............................................................................................. 12-4

12.3.1 Industry Cost Structure

...................................................................................... 12-5

12.3.2 Inventory Levels and Cap acity Utilization Rates

.............................................. 12-5

12.4 INTERVIEW TOPICS AND PRELIMINARY FINDINGS

......................................... 12-6

12.4.1 Market Shares and Industry Consolidation

........................................................ 12-6

12.4.1.1 Market Assessment

.......................................................................... 12-7

12.4.1.2 Impact on Small Manufacturers

....................................................... 12-7

12.4.2 Production and Pr oduct Mix

.............................................................................. 12-7

12.4.2.1 Impact on Product Mix

.................................................................... 12-7

12.4.2.2 Product Utility

.................................................................................. 12-8

12.4.3 Conversion Costs

............................................................................................... 12-8

12.4.4 Cumulative Regulatory Burden

......................................................................... 12-8

12.5 OVERALL KEY ISSUES

............................................................................................. 12-9

12.5.1 Impacts on Profitability

...................................................................................... 12-9

12.5.2 Product Conversion Costs/Diminishi ng Returns to Consumers

........................ 12-9

12.5.3 Product Innovation

............................................................................................. 12-9

LIST OF TABLES

Table 12.3.1 Fluorescent Lamp Ballast Industry Employment and Earnings

.................... 12-5

Table 12.3.2 Fluorescent Lamp Ballast Industry Material and Payroll Costs

.................... 12-5

Table 12.3.3 Fluorescent Lamp Ballast Industry End-of-Year Inventory

.......................... 12-6

Table 12.3.4 Full Production Capacity Utilization Rates

................................................... 12-6

12-iCHAPTER 12 PRELIMINARY MANUFACTURER IMPACT ANALYSIS

12.1 INTRODUCTION

The purpose of the manufacturer impact analysis (MIA) is to identify and quantify the likely impacts of amended energy conservation standards on manufacturers. The Process Rule a provides guidance for conducting this analysis with input from manufacturers and other interested parties. The U.S. Department of Energy (DOE) a pplies this methodology to its evaluation of amended energy conservation standard s for fluorescent lamp ballasts to the extent that it is appropriate for this rulemaking. The Process Rule gives guidelines for considering financial impacts and a wide ra nge of quantitative and qualitative industry impacts that might occur due to an amended energy conservation stan dard. For example, a particular standard level could require changes in manufact uring practices for fluorescent lamp ballasts. DOE identifies and analyzes these impacts through interviews with manufacturers and other interested parties during the notice of proposed rulemaking (NOPR) stage of analysis.

DOE announced changes to the MIA format through a report issued to Congress on January 31, 2006 (as required by section 141 of the Energy Policy Act of 2005 (EPACT 2005)), entitled “Energy Conservation Standards Activities.” b Previously, DOE did not report any MIA results before the NOPR phase; however, under this new format, DOE collects, evaluates, and reports preliminary information and data in the Preliminary Analysis. Such information includes market data, key issues, produc t mixes, conversion costs, foreign competition, market shares, industry consolidation, and cumulative regulatory burden information. DOE solicits this information during the preliminary manufacturer interviews and reports the results in this chapter. Appendix 12A includes a copy of th e interview guide that DOE distributed to

manufacturers.

12.2 METHODOLOGY

DOE conducts the MIA in three phases. In Phase I, DOE creates an industry profile to characterize the industry and conducts preliminary MIA interviews to identify important issues that require consideration. Sec tion 12.3 of this chapter presents initial findings of the Phase I analysis. In Phase II, DOE prepares an industr y cash flow model and an interview questionnaire to guide subsequent discussions with manufactur ers. In Phase III, DOE interviews manufacturers and assesses the impacts of amended energy conservation standards both quantitatively and qualitatively. DOE assesses industry and subgroup cash flow impacts and the industry net present value (INPV) using the Government Regulatory Impact Model (GRIM). DOE then

a On July 15, 1996, the Department published a Process Improvement Rule establishing procedures, interpretations and policies to guide the Department in the consideration of new or revised appliance efficiency standards (Procedures for Consideration of New or Revised Energy Conservation Standards for Consumer Products). 61 FR

36974.

b This report is available on the DOE website at www.eere.energy.gov/buildings/appliance_standards/2006_schedule_setting.html

.

12-1assesses impacts on competition, ma nufacturing capacity, employment, and regulatory burden

based on manufacturer interv iews and discussions. The Federal Register NOPR and technical support document (TSD) will both present results of the Phase II and III analyses.

12.2.1 Phase I: Industry Profile

In Phase I of the MIA, DOE collects pertinent qualitative and quantitative financial and market information. This includes wages, empl oyment, and industry costs for fluorescent lamp

ballasts. Sources of information include reports published by indus try groups, trade journals, the

U.S. Census Bureau, and Securities Exchange Commission (SEC) 10-K filings. In addition, DOE

relies on information from its mark et and technology assessment, engineering analysis, life-cycle cost analysis, and consumer price analysis to characterize the fluorescent lamp ballast manufacturing industry.

12.2.2 Phase II: Industry Cash-Flow Analysis and Interview Guide

In Phase II, DOE performs a preliminary industry cash-flow analysis and prepares a questionnaire, or interview guide, for interviewing manufacturers.

12.2.2.1 Industry Cash-Flow Analysis

DOE uses the GRIM to analyze the financia l impacts of amended energy conservation standards. Amended energy conservation standa rds may require additi onal investment, raise production costs, and/or affect re venue through higher prices and possibly lower shipments. The

GRIM uses several factors to determine a series of annual cash flows for the year that amended energy conservation standards become effectiv e and for several years after implementation. These factors include annual expected revenues, costs of sales, selling and general administration costs, taxes, and capital expenditures. Inputs to the GRIM include financial information, manufacturing costs, shipment forecasts, and price forecasts developed in other analyses. Financial information is developed based on publicly available data and confidentially submitted manufacturer information. DOE compares the GRIM results for standards case at each trial standard level against the results for the base case in which no amended energy conservation standards are in place. The financial impact of amended energy conservation standards is the

difference between the two sets of discounted annual cash flows.

12.2.2.2 Interview Guide

DOE conducts interviews with manufacturers to gather in formation on the effects of amended energy conservation standards on revenu es and finances, direct employment, capital assets, and industry competitiveness. These interv iews take place during Phase III of the MIA. Before the interviews, DOE distributes an interview guide that will help identify the impacts of amended energy conservation standards on individual manufacturers or subgroups of manufacturers. The interview guide covers produc tion costs; shipment projections and market share; product mix; conversion co sts; markups and profitability; assessment of the impact on competition, manufacturing capacity; and other topics that are relevant to assessing the impacts of amended energy conservation standards on the fluorescent lamp ballast industry.

12-212.2.3 Phase III: Subgroup Analysis

Phase III activities occur after publication of the preliminary analysis. These activities

include manufacturer interviews ; revision of the industry cash-flow analysis; a manufacturer subgroup analysis; an assessment of the impacts on industry competition, manufacturing capacity, direct employment, and the cumulative regulatory burden; and other qualitative impacts.

12.2.3.1 Manufacturer Interviews

DOE supplements the information gathered in Phase I and the cash-flow analysis performed in Phase II with information gather ed through interviews with manufacturers during Phase III. The interview process has a key role in the MIA because it provides an opportunity for interested parties to express their views privately on important issues.

DOE conducts detailed interviews with manufacturers to gain insight into the potential impacts of amended energy conservation standard s on sales, direct empl oyment, capital assets, and industry competitiveness. Interviews are scheduled well in advance to provide every opportunity for key individuals to be availabl e for comment. Although a written response to the questionnaire is acceptable, DOE prefers interactiv e interviews, which help clarify responses and provide the opportunity to identify additional issues.

A non-disclosure agreement allows DOE to consider confidential or sensitive information in the decision-making process. Ho wever, confidential information is not made available in the public record. At most, sensitive or confidential information may be aggregated and presented in industry-wide representations.

12.2.3.2 Revised Industry Cash-Flow Analysis

During the interviews, DOE requests inform ation about profitabilit y impacts, necessary plant changes, and other manufacturing impacts. Following the interviews, DOE revises the preliminary GRIM prepared in Phase II based on the feedback it receives.

12.2.3.3 Manufacturer Subgroup Analysis

Using average cost assumptions to devel op an industry cash-flow estimate does not adequately assess differential impacts among ma nufacturer subgroups. Smaller manufacturers, niche players, and manufacturers exhibiting a cost structure that differs largely from the industry average could be more negatively affected. Id eally, DOE would consider the impact on every firm individually; however, it typically uses the results of the industry characterization to group manufacturers with similar characteristics. During the interviews, DOE discusses the potential subgroups that have been identified for th e analysis. DOE asks manufacturers and other interested parties to suggest what subgroups or characteristics are most appropriate for the analysis.

12-312.2.3.4 Competitive Impact Assessment

Section 342 (6)(B)(i)(V) of the Energy Policy Act of 1992 (EPCA) directs DOE to consider any lessening of competition likely to result from imposition of standards. EPCA further directs the U.S. Attorney General to determine the impacts, if any, of any decrease in competition. DOE makes a determined effort to gather firm-speci fic financial information and impacts and report the results in the competitive impact assessment. The competitive impact

assessment is based on manufacturer cost data and information collected from the manufacturer interviews. The interviews focus on assessing asymmetrical cost increases to some manufacturers, the potential increase in busine ss risks from an increased proportion of fixed costs, and potential barriers to market entry ( e.g ., proprietary technolog ies). The competitive impact analysis also focuses on assessing any differential impacts to smaller manufacturers.

12.2.3.5 Manufacturing Capacity Impact

One of the significant outcomes of amended energy conservation standards can be the obsolescence of existing manufacturing assets, in cluding tooling and other investments. The manufacturer interview guide has a series of que stions to help identify impacts on manufacturing capacity, specifically capacity utilization and plant location decisions in North America with and without an amended energy conservation standard; the ability of manufacturers to upgrade or remodel existing facilities to acco mmodate the new requirements; the nature and value of stranded assets, if any; and estimates for any one-time restructuring or other charges, where applicable.

12.2.3.6 Employment Impact

The impact of amended energy conservation standards on employment is an important consideration in the rulemaking process. To as sess how domestic employ ment patterns might be affected, the manufacturer interviews explore curre nt employment trends in the fluorescent lamp ballast industry and solicits manuf acturer views on changes in employment patterns that may result from increased standard levels. The employment impacts section of the interview guide focuses on current employment levels at production facilities, expected future employment levels with and without an amended energy conservati on standard, differences in workforce skills, and employee retraining.

12.2.3.7 Cumulative Regu latory Burden

DOE seeks to mitigate the overlapping effects on manufacturers of energy conservation standards and other regulatory actions affecting the same products or companies. DOE analyzes and considers the impact on manufacturers of multiple, product-specific regulatory actions.

12.3 INDUSTRY OVERVIEW

The following section summarizes publicly available industry data.

12-412.3.1 Industry Cost Structure DOE developed the fluorescent lamp ballast i ndustry cost structure from the U.S. Census
Bureau, Annual Survey of Manufacturers

, Statistics for Industry Groups and Industries from 2003 to 2006. Fluorescent lamp ballast manufacturin g is classified under the North American Industry Classification System (NAICS) code 335311 ( Power, Distribution, and Specialty Transformer Manufacturing ).

Table 12.3.1 presents the fluorescent lamp balla st employment levels and earnings from 2003 to 2006. The statistics illustrate a 3-percen t increase in the number of production workers from 2003 to 2006; however, there was no major cha nge in the overall number of employees in the industry.

Table 12.3.1 Fluorescent Lamp Ballast Industry Employment and Earnings

Year Production Workers All Employees Payroll for All Employees thousand

2006 dollars

2003 14,966 20,546 755,635

2004 13,635 18,692 720,767

2005 14,471 19,427 779,246

2006 15,438 20,642 863,266

U.S. Census Bureau. 2006 Annual Survey of Manufacturers: 2006 and Earlier Years . December 2006.

Table 12.3.2 presents the costs of materials and industry payroll as a percentage of shipment value from 2003 to 2006. The cost of materials has increased slightly from 2003 to 2006. The cost of payroll for production workers a nd the cost of total payroll declined by 5.4 percent and 8.5, percent respectively.

Table 12.3.2 Fluorescent Lamp Ballast Industry Material and Payroll Costs

Year Cost of Materials percent of shipment value Cost of Payroll

for Production Workers percent of shipment value Cost of Total Payroll:

Production + Administration

percent of shipment value

2003 49.5 11.0 18.8

2004 51.1 11.8 19.4

2005 51.7 11.1 18.2

2006 51.8 10.4 17.2

U.S. Census Bureau. 2006 Annual Survey of Manufacturers: 2006 and Earlier Years . December 2006.

12.3.2 Inventory Levels and Capacity Utilization Rates

Table 12.3.3 shows the year-end inventory fo r the fluorescent lamp ballast industry obtained from the U.S. Census Bureau, Annual Survey of Manufacturers

, Statistics for Industry Groups and Industries from 2003 to 2006. The industry’s end-of-year inventory from 2002 to 2005 experienced an overall increase when expre ssed both in dollars and as a percentage of shipment value.

12-5Table 12.3.3 Fluorescent Lamp Ballast Industry End-of-Year Inventory

Year End-of-Year Inventory

million 2006 dollars End-of-Year Inventory percent of shipment value

2003 502,089 12.5

2004 427,802 11.5

2005 511,504 12.0

2006 637,235 12.7

U.S. Census Bureau. 2006 Annual Survey of Manufacturers: 2006 and Earlier Years . December 2006.

DOE obtained full production capacity utilization rates from the U.S. Census Bureau, “Current Industrial Reports,” Survey of Plant Capacity from 2002 to 2006. Table 12.3.4 presents production capacity utilization rates for NAICS code 335311. Full production capacity is defined as the maximum level of produc tion an establishment could attain under normal operating

conditions. In the Survey of Plant Capacity report, the full production utiliz ation rate is a ratio of the actual level of operations to the full production level.

Table 12.3.4 Full Production Ca pacity Utilization Rates

Year Power, Distribution, and Specialty Transformer Manufacturing

Percent

2002 63

2003 61

2004 63

2005 66

2006 69

U.S. Census Bureau. 2007 Current Industrial Reports: Table 1a – Full Production Capacity Utilization Rates by Industry: Fourth Quarters 2002 through 2006 . November 2007.

12.4 INTERVIEW TOPICS AND PRELIMINARY FINDINGS

The following section summarizes information gathered during interviews held during the last quarter of 2008 for the preliminary MIA.

12.4.1 Market Shares and Industry Consolidation

Amended energy conservation standards can alter the competitive dynamics of the marketplace, prompting companies to enter the market, exit the market, or merge with other companies. The preliminary MIA interview questions asked manufacturers to share their perspectives on industry consolidation both in the absence of amended energy conservation standards and assuming amended st andards at various efficiency levels. The interview questions focused on gathering info rmation that assessed:

 disproportionate cost increases to some manufacturers;

 increased proportion of fixed costs potentially increasing business risks; and

 potential barriers to market entry ( e.g ., proprietary technologies).

The need to assess anti-competitive effects of proposed amended energy conservation standards comes from the need to protect cons umer interests. During the interviews, DOE

solicited information to determine whether amen ded energy conservation standards could result in disproportionate economic or performance penalties for par ticular consumer or user

12-6subgroups. Manufacturers were also asked if amended energy conservation standards could result in products that will be more or less desirable to consumers due to changes in product functionality, utility, or other features.

12.4.1.1 Market Assessment
As described in preliminary TSD chapter 3, four manufacturers hold the majority of the domestic market share of fluorescent lamp ballasts:

• GE Consumer and Industrial of General Electric, Inc.

• OSRAM Sylvania of Siemens AG

• Advance Transformer of Philips Lighting

• Universal Lighting Technologies

The lighting divisions of some of thes e companies manufacture products other than fluorescent lamp ballasts, such as fluorescent lamps, high intensity discharge lamps, light emitting diode (LED) lighting, and compact fluorescent lamps (CFL). During interviews, manufacturers stated that the vast majority of ballast production takes place abroad.

12.4.1.2 Impact on Small Manufacturers
The Small Business Administration (SBA) defines small business manufacturing enterprises for fluorescent lamp ballast as havi ng 750 employees or fewer. SBA lists small business size standards that are matched to industries as they are described in the NAICS. A size standard is the largest that a for-profit entity can be and still qualify as a small business for Federal programs. These size standards are gene rally the average annual receipts or the average employment of a firm. For fluorescent lamp ballasts, the size standard is matched to NAICS code

33511 , Power, Distribution, and Specialty Transformer Manufacturing , which has a size standard of 750 employees. DOE will study th e potential impacts on these small businesses in detail as part of the NOPR analysis.

12.4.2 Production and Product Mix

DOE requested manufacturers’ feedback on wh at they perceived to be the possible impact of amended energy conservation standards on cash flow and profitability. For instance, the capital and product conversion outlays needed to upgrade or redesign products before they have reached the end of their useful life may cr eate significant conversion costs, resulting in reduced cash flow and stranded investments. Higher energy conservation standards could also result in higher per-unit costs that could cause consumers to shift to less expensive products.

12.4.2.1 Impact on Product Mix
Manufacturers believed that amended energy conservation standards would affect the product mix of fluorescent lamp ballasts. Some manufacturers commented that changes in energy conservation standards could consolidate product offerings and lower profits by eradicating up-selling opportunities. Certain manufacturers commented that if the rulemaking increases efficiency levels significantly, they might exit the fluorescent lamp ballast market, citing an unwillingness to put resources into fixed output ballasts. Additionally, because

12-7residential ballasts are extremely price sensitive, an amended energy conservation standard could encourage consumers to switch to low-efficien cy products such as incandescent lighting.

12.4.2.2 Product Utility
Certain manufacturers expressed concern th at amended energy conservation standards might require changes in product functionality, utility, and othe r features that would make products less desirable to consumer s. The major area of concern related to ballasts used in harsh environments and in applications where complete reliability is required. For example, specialty applications, like critical healthcare areas and airport runways, may be better served by magnetic

ballasts.

12.4.3 Conversion Costs

In some instances, manufacturers may be able to meet proposed standard levels by modifying existing products. In other cases, the necessary changes may entail a complete product-line redesign. In these situations, a high er amended energy conservation standard would cause manufacturers to incur one-time capital an d product conversion cost s. Capital conversion

costs are one-time investments in property, plant and equipm ent. Product conversion costs include one-time investments in research, product development, testing and marketing. DOE will study the potential impact of conversion costs in more detail as part of the NOPR analysis.

12.4.4 Cumulative Regu latory Burden

While any one regulation may not impose a significant burden on manufacturers, the combined effects of several impending regulations may have serious consequences for individual manufacturers, groups of manufacturers, or entire industries. Assessing the impact of a single regulation may overlook this cumulative regulatory burden.

Expenditures associated with meeting other re gulations are an important aspect of DOE’s consideration of the cumulative regulatory bur den the industry faces. The interviews helped DOE identify the level and timing of investments manufacturers are expecting to incur because of these regulations. Manufacturers were also asked under what circumstances they might be able to make expenditures related to regula tions and energy conservation standards.

Several Federal and international regulatory programs may affect the markets for fluorescent lamp ballasts. The market and technol ogy assessment discusses some of the notable initiatives that characterize recent developments in the lighting market. See chapter 3 for a list and description of the regulat ory requirements DOE identified.

Specifically, certain ma nufacturers expressed concern about regulations on 4- and 8-foot residential fluorescent lamps because those standards may drive price-sensitive consumers to other, less-efficient technologies, which would affect ballast sales. At the same time, manufacturers also expressed concer n that failure to regulate residential ballasts would create a loophole for inefficient ballasts to enter the mark et from offshore. Manufacturers noted that they would prefer that DOE set a final date for ballast produc tion rather than one for final sell because it would mitigate the negative effect of obsolescent inventory. Manufacturers are also concerned about system interconnect issues , implementation of hazardous material regulations, and how

12-8these issues may lead to ballast requirements th at could lower ballast efficiency and affect payback calculations. Manufacturers also mentio ned the impact of international standards on ballast redesign.

12.5 OVERALL KEY ISSUES

Perhaps the most important aspect of the pr eliminary MIA is the opportunity it creates for DOE to identify key manufacturer issues early in the development of amended energy conservation standards. During preliminary interviews manufacturers identified three major areas of concern: (1) impacts on profitability, (2 ) conversion costs, and (3) product innovation.

12.5.1 Impacts on Profitability Some manufacturers commented that pr ofit margins would decrease with the implementation of amended energy conservation standards, especial ly for the original equipment manufacturer (OEM) distribution channels. For example, a higher standard could cause consumers to switch from residential ballasts, which are more price sensitive, to less efficient products. According to the manufacturers interv iewed, consistent profita bility is not common across all types of fluorescent lamp ballasts. Manufacturers also ex pressed concern th at pricing is extremely variable depending on the applica tion (commodities, old products, new products, niche, etc). Some products are sold at a loss, some are sold at cost, and some are sold for a profit.

12.5.2 Product Conversion Costs/Diminishing Returns to Consumers

Certain manufacturers commented that am ended energy conservation standards would force them to invest in more expensive and energy efficient components, improve existing product lines, and design new pr oduct lines. The majority of these product conversion costs would be attributed to engineering and consumer education. Those manufacturers that expected significant product conversion costs commented th at the large investment could result in more expensive products for consumers. However, ot her manufacturers did not expect substantial product conversion costs.

12.5.3 Product Innovation

Manufacturers also expressed concern over the impact of amended energy conservation standards on product innovation. Because employees may need to spend more time redesigning products to comply with standards, the resource s available for the development of new products would significantly decrease.

12-9