18-i

CHAPTER 18. REGIONAL STANDARDS IMPACTS ON MARKET PARTICIPANTS

TABLE OF CONTENTS

18.1 Introduction..................................................................................................................... 18-1

18.1.1 Regional Standards Overview............................................................................. 18-1

18.1.1.1Regional Standards vs. National Standard............................................. 18-4

18.1.2 Discussion of Non Enforcement vs. Enforcement Issues.................................... 18-6

18.2 Market Participants......................................................................................................... 18-7

18.2.1 Definition of Terms............................................................................................. 18-7

18.2.1.1Distributors ............................................................................................ 18-7

18.2.1.2Contractors............................................................................................. 18-7

18.2.1.3Dealers ................................................................................................... 18-7

18.2.1.4Installers................................................................................................. 18-8

18.2.1.5Builders.................................................................................................. 18-8

18.2.1.6Market Participant Nomenclature .......................................................... 18-8

18.3 Distribution Chain........................................................................................................... 18-8

18.3.1 Overview ............................................................................................................. 18-8

18.3.2 Vertical Integration.............................................................................................. 18-9

18.3.3 Distributors........................................................................................................ 18-10

18.3.3.1Market Overview ................................................................................. 18-10

18.3.3.2Distributor Business Model ................................................................. 18-10

18.3.4 Contractors ........................................................................................................ 18-13

18.3.4.1Market Overview ................................................................................. 18-13

18.3.4.2Business Model.................................................................................... 18-13

18.3.5 General Contractor ............................................................................................ 18-14

18.3.5.1Market Overview ................................................................................. 18-14

18.3.5.2Business Model.................................................................................... 18-14

18.3.6 Retailers............................................................................................................. 18-15

18.4 Discussion of Regional Standard Impacts .................................................................... 18-16

18.4.1 Distributor Impacts............................................................................................ 18-16

Non-enforcement Issues for Distributors.......................................................... 18-16

Enforcement Issues for Distributors.................................................................. 18-17

18.4.2 Contractor Impacts............................................................................................ 18-17

Non-enforcement Issues for Contractors........................................................... 18-17

Enforcement Issues for Contractors.................................................................. 18-17

18.4.3 General Contractor Impacts............................................................................... 18-18

Non-enforcement Issues for General Contractors............................................. 18-18

Enforcement Issues for General Contractors..................................................... 18-18

18.5 Analysis of Regional Standard Impacts........................................................................ 18-18

18.5.1.1Data Sources ........................................................................................ 18-19

18.5.1.2Sample Inventory Calculation for Southeastern Border CACHP 

Wholesaler......................................................................................................... 18-22

18.5.2 Profitability Analysis of Regional Standard Impacts........................................ 18-24

18.6 Conclusions................................................................................................................... 18-26
18-ii

LIST OF TABLES

Table 18.1.1 Regions for DFR Analysis of Furnace Standards................................................. 18-2

Table 18.1.2 Regions for DFR Analysis of Central Air Conditioner and Heat Pump Standards 18-

3

Table 18.1.3: Border States by Region for the Central Air Conditioners and Heat Pumps 

Rulemaking................................................................................................................................ 18-5

Table 18.1.4: Border States by Region for the Furnaces Rulemaking....................................... 18-5

Table 18.5.1 Typical Southeastern Wholesaler Assets, Liabilities, and Profitability.............. 18-21

Table 18.5.2 Border Wholesaler Required Inventory.............................................................. 18-24

Table 18.5.3 Profitability Impacts of Inventory Cost Increases .............................................. 18-25

Table 18.5.4 Return on Net Worth Impacts of Inventory Cost Increases................................ 18-25

LIST OF FIGURES

Figure 18.1.1 Map of the Regions for the DFR Analysis of Furnace Standards...................... 18-4

Figure 18.1.2 Map of Preliminary Analysis Proposed Regions for Central Air Conditioner and 

Heat Pump Standards................................................................................................................. 18-4

Figure 18.3.1 Distribution Chain in Replacement Market......................................................... 18-9

Figure 18.3.2 Distribution Chain in New Construction Market ................................................ 18-9
18-1

CHAPTER 18. REGIONAL STANDARDS IMPACTS ON MARKET PARTICIPANTS

18.1 INTRODUCTION

The Energy Policy and Conservation Act (EPCA), as amended by the Energy 

Independence and Security Act of 2007 (EISA; Pub. L. 110-140), directs the U.S. Department of 

Energy (DOE) to “consider the impact of additional regional standards on consumers, 

manufacturers, and other market participants, including distributors, dealers, contractors, and 

installers,” before establishing additional regional standards. (42 U.S.C. 6295(o)(6)(D)(ii))

Specifically, the language of EPCA affects the current energy conservation standards 

rulemakings for residential furnaces and central air conditioners and heat pumps. 

This technical support document (TSD) chapter establishes a framework for 

understanding the HVAC distribution chain and market dynamics. Based on the established 

framework, DOE provides analysis of the impacts of regional standards on market participants.

The chapter is structured as follows: First, DOE provides an overview of the adopted 

regional standards as they relate to the market participants specified in EPCA. Second, DOE 

defines the market participants and the interaction of those participants in the distribution chain. 

Third, DOE investigates how regional standards could affect those market participants based on 

industry research, discussions with manufacturers, distributors and contractors, and the 

comments received during the rulemaking process for residential furnace and central air 

conditioner and heat pump products. Fourth, when possible given data availability, DOE 

quantitatively assesses the impacts of regional standards on the analyzed market participants. 

Two quantitative analyses are the result of this effort: (1) an investigation of the impact of 

regional standards on distributor inventory holdings and (2) a modeling of changes in distributor 

profitability due to changes in inventory.

Additionally, chapter 6 of the TSD presents information on the impacts of regional standards on 

market participant markups. The chapter includes an analysis of regional standards’ impact on 

markups for the distribution chain, including distributors, contractors and general contractors. 

18.1.1 Regional Standards Overview

DOE is establishing regional standards for residential furnaces, air conditioners and heat 

pumps. EPCA, as amended by EISA, enables DOE to define one additional standard region for 

furnaces and one or two additional standard regions for central air conditioners and heat pumps. 

(42 U.S.C. 6295(o)(6)(B)(ii)) By statute, the regions must include whole, contiguous states. (42 

U.S.C. 6295(o)(6)(C))

For residential furnace products, DOE establishes one multi-state region in addition to a 

base national standard that would prevail in states throughout the rest of the country. For the 

purposes of analysis, the geographic region and the rest of country are treated as two analysis 

regions referred to as the “North” and the “South”. The regions are generally based on the 

population-weighted number of heating degree days (HDD) of each State. States with 5,000 

HDD or more are mostly considered as part of the northern region, while States with less than 
18-2

5,000 HDD are mostly considered part of the southern region. A complete list of States in each 

region is show in Table 18.1.1. 

Table 18.1.1 Regions for DFR Analysis of Furnace Standards 

Northern Region States (Rest of Country) Southern Region States

Alaska Pennsylvania Alabama

Colorado Rhode Island Arizona

Connecticut South Dakota Arkansas

Idaho Utah California

Illinois Vermont Delaware

Indiana Washington Dist. of Columbia

Iowa West Virginia Florida

Kansas Wisconsin Georgia

Maine Wyoming Hawaii

Massachusetts Kentucky

Michigan Louisiana

Minnesota Maryland

Missouri Mississippi

Montana Nevada

Nebraska New Mexico

New Hampshire North Carolina

New Jersey Oklahoma

New York South Carolina

North Dakota Tennessee

Ohio Texas

Oregon Virginia

For central air conditioner and heat pump products, DOE establishes two multi-state 

regions in addition to a base national standard that would prevail in states throughout the rest of 

the country. The two regional and the rest of country are treated as three analysis regions, 

referred to as Hot-Humid (Southeast), Hot-Dry region (Southwestern), and North (Rest of 

Country). A complete list of States in each region is show in Table 18.1.2.
18-3

Table 18.1.2 Regions for DFR Analysis of Central Air Conditioner and Heat Pump

Standards 

Northern Region States Hot-Humid States Hot-Dry States

(Rest of Country) (Southeast Region) (Southwest Region)

Alaska New York Alabama Arizona

Colorado North Dakota Arkansas California

Connecticut Ohio Delaware Nevada

Idaho Oregon District of Columbia New Mexico

Illinois Pennsylvania Florida

Indiana Rhode Island Georgia

Iowa South Dakota Hawaii

Kansas Utah Kentucky

Maine Vermont Louisiana

Massachusetts Washington Maryland

Michigan West Virginia Mississippi

Minnesota Wisconsin North Carolina

Missouri Wyoming Oklahoma

Montana South Carolina

Nebraska Tennessee

New Hampshire Texas

New Jersey Virginia

Figure 18.1.1 and Figure 18.1.2 illustrate the regional boundaries in the DFR. 
18-4

Figure 18.1.1 Map of the Regions for the DFR Analysis of Furnace Standards

Figure 18.1.2 Map of Regions for DFR Analysis of Central Air Conditioner and Heat 

Pump Standards

18.1.1.1 Regional Standards vs. National Standard

It is important to differentiate between the impacts of an amended national standard and the 

impact of introducing regional standards. The following sections do not assess the impact on 

market participants of more stringent energy conservation standards. The impacts of higher 

standards are evaluated in DOE’s standard analysis, as summarized in the Direct Final Rule

notice. For example, the impacts of physically larger HVAC units on distributors (due to a more 

stringent standard) are not discussed in this chapter because such an impact would occur under 

an increase in a single national standard as well. Rather, this chapter considers the impacts of 

additional

For firms located farther from the borders of the standard regions and serving only small 

areas, the impact of regional standards is expected to be very similar to the impact of a national 

energy conservation standard. However, firms located near the border between regions and 

serving more than one region are expected to be most strongly impacted because they may have 

to respond to different efficiency requirements for each region in which they operate. For 

example, distributors located near regional borders may carry more inventory or manage their 

inventory differently to meet the separate needs of customers in each region.

regional standards on these market participants, including product distributors, 

dealers, contractors, and installers. For example, the impact on a distributor of having to alter 

inventory systems to serve regions with differential efficiency levels is an impact that would be 

considered.

Table 18.1.3 and 

Table 18.1.4 display the states on the borders of the CACHP and furnaces regions, respectively. 
18-5

Table 18.1.3: Border States for the Central Air Conditioners and Heat Pumps Regions

Northern Region States 

(Rest of Country) 

Hot-Humid States 

(Southeast Region)

Hot-Dry States

(Southwest Region)

Colorado Arkansas Arizona

Idaho Delaware California

Indiana Kentucky Nevada

Illinois Maryland New Mexico

Kansas Oklahoma

Missouri Tennessee

New Jersey Texas

Pennsylvania Virginia 

Ohio

Oregon

Utah

West Virginia

Table 18.1.4: Border States for the Furnaces Regions

Northern Region States Southern Region States

Colorado Arizona

Idaho Arkansas

Illinois California

Indiana Delaware

Kansas Kentucky

Missouri Maryland

New Jersey Nevada

Ohio New Mexico

Oregon Oklahoma

Pennsylvania Tennessee

Utah Virginia

West Virginia
18-6

18.1.2 Discussion of Non Enforcement vs. Enforcement Issues

For the purposes of this chapter, DOE groups potential impacts of regional standards on 

market participants into two categories: (1) non-enforcement related issues and (2) enforcementrelated issues. Non-enforcement issues are those that arise from regional standards regardless of 

the enforcement plan eventually established by DOE. Enforcement-related issues are those 

impacts that would vary depending on the enforcement path proposed by DOE (e.g.

At this stage, while DOE is considering various enforcement plans, no mechanisms or 

requirements are adopted here. As such, DOE does not attempt to quantify enforcement-related 

impacts in this chapter. EPCA requires DOE to begin an enforcement rulemaking not later than 

90 days after the issuance of a final rule establishing regional standards and complete the 

rulemaking not later than 15 months following the issuance of the rule. (42 U.S.C. 

6295(o)(6)(G)(ii)). DOE recognizes the challenges of regional standards enforcement and 

continues to investigate the most effective means of meeting those challenges. DOE will 

incorporate all feedback from this standards rulemaking process into the enforcement

rulemaking.

, 

certification, verification, and labeling costs).
18-7

18.2 MARKET PARTICIPANTS

18.2.1 Definition of Terms 

As discussed previously, EPCA directs DOE to consider the impacts of additional 

regional standards on market participants, including “distributors, dealers, contractors, and 

installers.” (42 U.S.C. 6295(o)(6)(D)(ii)) Based on DOE’s research and comments from 

stakeholders, some of the market participants enumerated in EPCA have overlapping or identical 

functions in the HVAC marketplace. Industry often uses the various terms interchangeably to 

describe the same market participant. Therefore, it is important to clarify what market roles are 

associated with each term for the purposes of this analysis. Below is a brief description of DOE’s 

understanding of each player in the distribution chain.

18.2.1.1 Distributors

Also known as ‘wholesalers,’ distributors purchase HVAC equipment directly from the 

original equipment manufacturers (OEMs). Distributors absorb short-term imbalances in supply 

and demand and sell equipment to contractors at a markup to cover operating expenses and 

profit.

18.2.1.2 Contractors

There are two basic types of contractors of relevance to the HVAC market: (1) general 

contractors and (2) mechanical contractors.

In the new construction market, general contractors manage and oversee residential and 

commercial construction projects. General contractors often lack the necessary technical 

expertise to install and inspect HVAC systems. As a result, they hire HVAC trade specialists, or 

mechanical contractors, to install equipment. General contractors usually have no significant role 

in the residential replacement market, except for cases of major retrofits.

Mechanical contractors are specialized contractors that install and maintain HVAC 

systems, plumbing, wiring, etc. Mechanical contractors purchase HVAC systems from 

distributors and install them for their customers. Contractors often service existing HVAC 

systems as well. Again, in the new construction market, they are usually hired by general 

contractors. In the replacement market, they are hired by homeowners and are considered 

synonymous with dealers (below).

18.2.1.3 Dealers

Much like mechanical contractors, HVAC dealers purchase systems from distributors.

Often they may have a more formal relationship with a manufacturer. Dealers resell the 

equipment to the end-user at a mark-up, nearly always installing the HVAC system as well.

Dealers also inspect, maintain, and repair existing systems.
18-8

18.2.1.4 Installers

The industry uses installers interchangeably with mechanical contractors and dealers. 

Because the HVAC market is very rarely a do-it-yourself market, DOE includes homeowners 

who install their own systems in this category. In general, the impact of regional standards on 

homeowners is assessed in the LCC analysis. 

18.2.1.5 Builders

For the purposes of this chapter, builders serve the same function in the HVAC 

marketplace as general contractors.

18.2.1.6 Market Participant Nomenclature

Given the above similarities and overlapping roles in the distribution chain, DOE 

believes that EPCA’s requirement to analyze the impacts on product distributors, dealers, 

contractors, and installers is satisfied by an analysis of the impacts of regional standards on three 

categories of market participants:

• Distributors

• Mechanical contractors

• General contractors

The category of “mechanical contractors” includes dealers, mechanical contractors, and 

installers. The category of “general contractors” comprises builders and general contractors. In 

accordance with comments received and consistent with the markups analysis, DOE believes 

such a grouping is appropriate for this analysis and allows DOE to consider the economic impact 

of regional standards on the relevant market participants as required by EPCA. Impacts on 

manufacturers are assessed in the manufacturer impact analysis (chapter 12 of the TSD), while 

impacts on consumers are assessed in the life-cycle cost analysis (chapter 8 of the TSD).

18.3 DISTRIBUTION CHAIN 

18.3.1 Overview

A single distribution channel represents the vast majority of the HVAC market. Simply, 

the OEM assembles the system and sells it to a distributor; the distributor warehouses and sells 

the unit to a contractor; and the contractor sells the unit to the final consumer and performs the 

installation. The final consumer varies in the replacement and in the new construction market. In 

the replacement market, the final consumer is usually the home or business owner, as illustrated 

in Figure 18.1.1. In the new construction market, a builder or general contractor is effectively the 

final end-user, as shown in Figure 18.3.2. 
18-9

Figure 18.3.1 Distribution Chain in Replacement Market

Figure 18.3.2 Distribution Chain in New Construction Market

After installation, mechanical contractors typically perform additional lifecycle service 

on the system, including inspection, maintenance, and repair.

18.3.2 Vertical Integration

In some cases, a single entity can perform one or more of the basic steps along the HVAC 

distribution channel. For example, most manufacturers own at least some distribution centers, 

which operate much like the independent distribution companies. In fact, all major manufacturers 

maintain at least some distribution capability in-house. In this distribution model, the OEM ships 

units to its own subsidiaries, which operate distribution centers and sell product to contractors.

Manufacturers usually employ this strategy in areas where they have limited relationships with 

distributors for a given product line.

Historically, the degree of vertical integration has ebbed and flowed with the economic 

well-being of the industry. In good times, OEMs have historically been more likely to acquire a 

distribution presence. Conversely, in bad times, they have been more likely to seek to shed the 

costs and risks associated with the distribution function. According to the U.S. Census Bureau, in 

2002, 74 percent of HVAC sales went through independent distributors.1

Lennox International Inc. (LII), a large equipment manufacturer, has one of the largest 

distribution presences in the industry. It owns several subsidiaries which operate as distributors 

and even as contractors, as is the case with LII subsidiary, Service Experts. While Service 

Experts is a wholly owned subsidiary, it operates independently from LII’s manufacturing 

operations. Service Experts carries heating and cooling equipment inventory and offers service 

for HVAC equipment from various manufacturers.

Currently, the 

percentage of the dollar value of HVACR products that go through independent distributors is 

estimated to be around 80 percent.

2
18-10

Importantly, while some entities may have a controlling interest over multiple steps in 

the distribution chain, the costs, markups, and business processes in the distribution chain 

ultimately remain relatively equivalent. That is, the distributor and contractor markups (and the 

resulting pricing) for the manufacturer-owned distributor and contractor businesses are roughly 

equivalent to the markups that occur where those businesses operate independently.

The business models of distributors, contractors, and general contractors are described in 

greater detail below.

18.3.3 Distributors

18.3.3.1 Market Overview 

The HVAC distribution market is a well-established yet fragmented industry consisting 

of approximately 1,300 distribution companies. Independent distributors are responsible for the 

majority of the business in the industry, but all major manufacturers have some type of factoryowned distribution. The vast majority of independent distributors are small, private companies. 

In 2002, there were 5,468 total distribution branches, 5,156 of which were independent 

distribution branches and 312 of which were owned by manufacturers.3

18.3.3.2 Distributor Business Model

Distributors link the handful of furnace and central air conditioning and heat pump

manufacturers to the tens of thousands of contractors. Distributors receive shipments from 

manufacturers and resell the equipment to contractors at a markup that covers distributor 

operating expenses and profit. Manufacturers rely on distributors to consolidate and forecast 

product demand at the regional and local levels. Contractors rely on distributors to hold enough 

inventory and parts to meet their day-to-day business needs. As the only player along the 

distribution chain that holds significant inventory, distributors add value by absorbing short-term 

imbalances in supply and demand while still satisfying the needs of the homeowner (and, by 

extension, the contractor) for fast deliveries.4

The distributor’s warehouse is usually the only stop for HVAC equipment on the way to 

the final installation site; however, in some markets distributors utilize regional distribution 

centers that supply secondary distribution warehouses. In either case, shipments are warehoused 

as distributor inventory until sold to contractors. Although it can vary widely, typically 60 to 70 

percent of revenue comes from unitary equipment, with the remainder coming from parts and 

other supplies.

Distribution is a highly competitive and low-margin business. The critical driver of 

profitability is the ability to manage inventory efficiently. Traditionally, distributors tended to 

receive large-volume pre-season shipments from original equipment manufacturers (OEMs).

However, the market has migrated away from that model as industry lead times (the time it takes 

to receive an order from the OEM) have fallen. Most distributors now operate in somewhat of a 

blend between just-in-time supply and the traditional model. To streamline inventory 

management, distributors often conduct extensive demand forecasting to estimate the timing and 

quantity of their orders. Key factors include historical demand, new construction, OEM lead 

times, new products and lines, and weather patterns. The typical lead time of an average 
18-11

residential HVAC system is 2-3 weeks, although different parts or components, as well as more 

intricate HVAC systems, may have different lead times. Some of the more advanced coils, for 

example, can have lead times of 6-8 weeks. 

Financing and credit, closely related to inventory, play a critical role in the distribution 

business model. With the high working capital requirements due to inventory needs, short-term 

credit availability is the lifeblood of many small wholesalers. Distributors typically purchase 

equipment from manufacturers on credit, with the balance being paid within 30 days, often with 

discounts for early payment. Historically, OEMs have offered financing to their distributor 

clients, but have generally exited that business. Instead, most distributors now are financed 

through local banks. In turn, distributors often extend lines of credit to certain contractors based 

on the amount of business volume, profitability of the relationship, and previous experience with 

the contractor. As a result, distributors incur the carrying costs associated with the difference 

between the financing terms that they receive from their creditors and the terms they extend to 

their contractor customers. Effectively, the distributor incurs as a cost the difference between 

these two rates over the period of time after the distributor pays the OEM for the unit and before

it receives payment from the contractor.

Because of this dynamic, a key financial metric driving profitability is days sales 

outstanding (DSOs), a measure of the number of days it takes a company to collect revenue after 

a sale has been made. DSOs in the industry average between 40-45 days; if they grow higher, the 

increased carrying costs can threaten the thin margins under which distributors operate. In 

extending credit to their customers, distributors also assume the risks involved with floating the 

receivables (i.e., the contractor goes out of business or otherwise fails to pay).

Changes in market dynamics, which can lead to changes in the quantity and type of 

product demanded, may cause distributors to incur one-time costs associated with temporary 

increases in inventory, inventory obsolescence, or the opportunity costs represented by the 

failure to meet customer needs. Increased market uncertainty forces distributors to hold greaterthan-usual inventory to reduce the risk of not meeting customer needs.5 Failure to do so could 

mean losing customers to competition.6 However, if certain products do not sell, distributors 

absorb the costs of unsold inventory.7 Typically, following an initial learning curve associated 

with these market changes, distributors adjust to their customers’ demands and are able to adjust 

inventory levels accordingly.8

The increasing use of information technology in distribution has helped wholesalers 

adapt to market transitions. Sales and orders are usually made electronically at each step along 

the distribution chain. IT systems exist that allow distributors to forecast demand, source and 

purchase supplies, manage and track inventory, streamline the supply chain, and manage various 

sales channels.9 Many distributors give contractors the ability to place orders online after-hours 

so that the orders are ready for pickup the following morning, while others give some customers 

a direct link into a computer system for automatic inventory replenishment.10

At the distribution center, inventory is generally organized by model and 

SEER/HSPF/AFUE rating. Units are stacked vertically and, depending on their size, may be 

transported with forklifts. The layout of warehouses and placement of products affect order 

processing and inventory efficiency.11 It is important for distributors to organize inventory in a 
18-12

manner that minimizes the order cost and minimizes mistakes that lead to costly reprocessing.

The average cost of processing an order, from receipt of the order until payment is received, is 

$35-$45.12

For distributors, the largest cost considerations aside from the costs of goods sold are 

those that impact inventory and transportation costs. The size of an HVAC system impacts both.

Larger, more efficient units require more warehouse space to inventory. The switch from 10 

SEER to 13 SEER in 2006, for example, required 35-40% more floor space for every condensing 

unit.

Cycle counts are performed frequently to minimize and document inventory 

shrinkage. 

13 Fewer units can fit on trucks and forklifts, requiring more time per unit for transportation 

and handling, absent new and upgraded equipment.14 The larger units can require two people to 

offload them instead of one.15

Manufacturer-to-Distributor Interactions

The relationships between manufacturers and distributors are generally well-established, 

long-term relationships. In most markets, distributors are the exclusive carrier of a given 

manufacturer’s product. Distributors will often carry a second brand from the same 

manufacturer, which has a different price point targeting a second market segment.

Most manufacturers will not allow distributors to carry products from a competitor, 

unless the manufacturer does not offer a product applicable to the market. In that case, 

distributors may partner with a second manufacturer. The terms of agreements can vary 

significantly depending on a wide range of factors, including sales volume, the extent of 

contractor relationships, strength of the brand in the area, and projected market growth. If a 

distributor carries a product line, it also has the parts business associated with that line.

Manufacturers are generally responsible for getting the equipment to distributors’ 

warehouses and incur the associated costs, which they embed in their prices. Manufacturers 

usually hire a shipping company to transport the equipment and pass on these costs to the 

distributors in the sales price. Almost all inbound freight shipped to distributors is shipped FOB 

Origin Freight Prepaid, which means that once the manufacturer ships the freight, the distributor 

owns it.16 This can lead to problems when items are damaged or broken upon arrival, 

representing another risk in the distributor business model.

17

Distributor-to-Contractor Interactions

Because there is relatively low manufacturer brand loyalty among consumer end-users, 

distributors compete actively over contractor customers. While OEMs focus on general brand 

awareness and product demand, distributors are frequently involved in providing multifunctional support to their contractors. To increase competitiveness and revenues, distributors are 

increasingly offering value-added services, such as business planning help, financial 

management classes, and support for advertising, to their contractor customers beyond their 

supply function. This is also a strategy for increasing profitability—a contractor that is 

unprofitable cannot pay the distributor in a timely fashion, if at all. Thus, successful distributors 

are heavily invested in their contractors’ success.18
18-13

In the vast majority of cases, contractors purchase the unit over the counter at the 

distributor’s warehouse. Because most contractors do not carry much or any inventory, the 

transaction will include a specific unit needed for a single job. The contractor can generally callin, order online, or fax in an order and go pick up the needed unit on the same day. At the 

warehouse, the distributor loads the unit onto the contractor’s truck (some distributors have 

“drive through” warehouses) and contractor can be on the way to the job site in minutes. While 

business is primarily done in this over-the-counter model, distributors also make onsite deliveries 

for their customers.

18.3.4 Contractors

18.3.4.1 Market Overview

The HVAC contractor market is even more fragmented than the distribution industry.

There are 36,345 HVAC branches that specialize 51 percent or more in HVAC, 25,496 of which 

specialize entirely in the industry.19

The large majority of contractors operate as small businesses, as defined by the U.S. 

Small Business Association. The SBA size limit for residential construction (NACIS codes 

236115 through 236118) is $33.5 million in sales and the limit for heating and air conditioning 

contractors is $14 million in sales (NAICS code 238220). The 2002 Census Bureau figures 

break out general contractors that focus on residential construction. Only 3,648 out of the total of 

171,652, or 2.1%, of residential construction general contractors had more than $10 million in 

sales. Residential builders are overwhelmingly small businesses. Of mechanical contractors in 

2002, only 1,832 out of 87,501, or 2.1%, of mechanical contractors had sales of at least $10 

million. As with general contractors, it is clear from the national-level data that the mechanical 

contractor sector is overwhelmingly composed of small businesses. 

The contactor industry primarily consists of small businesses and is extremely 

fragmented. Approximately 60 percent of branches in the industry generate less than $500,000 in 

revenue annually and 76 percent generate less than $1,000,000 annually.20 Comfort Systems 

USA is the larger of two public HVAC contractor companies that DOE identified. Its 2008 

revenues ($1,328,465,00021) accounted for approximately 3 percent of the $49,425,445,00022

HVAC contractor industry (although the company does provide ancillary services).23 Most 

independent contractors work with a variety of HVAC brands, although some specialize in one 

particular brand, or have a relationship as a licensed dealer of a specific manufacturer.

18.3.4.2 Business Model

HVAC contractors primarily install and service HVAC systems. Contractors are the 

interface with the end-users, installing new HVAC systems to end user specifications as well as 

inspecting, servicing, or repairing existing systems. Contractors must balance two very different 

aspects of their business to be successful. First, contractors must fulfill the technical role of 

installing and servicing the HVAC systems. This requires a staff that is knowledgeable about 

HVAC principles in general and adept at installation and service on many different HVAC units.

Second, contractors must also operate the commercial aspects of their business. Because of the 
18-14

high level of competition, advertising, customer service, and sales skills are integral aspects of 

the contractor’s business. Rarely do HVAC companies achieve sufficient scale to have staff 

specialize in a single business practice.

Contractors have the largest influence on which system a consumer will purchase.24 For 

their part, contractors tend to gravitate toward the products with which they are familiar.25

Contractors often employ a good-better-best selling philosophy to up-sell consumers on premium 

products.26 The minimum SEER model is a “good” system; there is a “better” system that is 

rated a few SEER points higher; and finally, there is a “best” system which has a very high 

SEER rating.27 A sample good-better-best set of systems might be 13 SEER-16 SEER-20 SEER; 

however, this is dependent on minimum efficiency requirements.28 Customers are more likely 

than they used to be to purchase energy-efficient and environmentally friendly products, in spite 

of the higher cost associated with them, because they have become more sensitive to the 

environment and the cost of energy.29

While some contractors have exclusive relationships with manufacturers, most 

contractors compete by offering a large variety of product offerings and by being trained to 

install, inspect, service, and repair those offerings. As with distributors, the size and weight of 

HVAC systems affect the business of contractors. While the vast majority of inventory is held by 

distributors, some contractors do carry a small amount of inventory and could be likewise 

affected by larger units. Larger systems are also more difficult to transport from the distributor to 

the job site, possibly even requiring special precautions or equipment to load or unload the unit 

in extreme cases.

Increasing tax credits and utility rebates can defray some 

of the higher incremental first cost as well.

A contractor’s labor costs related to the installation and service of HVAC systems remain 

relatively constant regardless of the HVAC systems that the company installs and services. 30

Once the technicians are trained, the time spent installing an HVAC unit does not vary greatly 

from system to system.31

18.3.5 General Contractor 

18.3.5.1 Market Overview

As discussed above, for the purposes of this chapter and consistent with comments 

received, DOE considers general contractors and homebuilders to have essentially the same role 

in the distribution chain. Thus, DOE believes the two will have similar concerns and face similar 

potential impacts from regional standards. As with mechanical contractors, the general contractor 

and builder market is highly fragmented and localized. According to the U.S. Census, there were 

more than 200,000 general contractor establishments in 2002.32

18.3.5.2 Business Model

General contractors manage new construction and significant renovation projects. When 

supervising a project, the general contractor hires a mechanical contractor to perform the 

installation. In this situation, the general contractor functions as the final step in the distribution 

chain. The general contractor may purchase the HVAC system from the distributor and hire the 

mechanical contractor or purchase the system from the installing mechanical contractor. When 
18-15

projects are larger—a townhouse development, for example—a distributor may seek to establish 

a supplying relationship with the general contractor and deliver the units in bulk. The general 

contractor would then hire a mechanical contractor to perform the installation. For a custombuilt home or renovation, the mechanical contractor may purchase the unit to the specifications 

requested by the general contractor.

18.3.6 Retailers

Retailers such as Home Depot, Lowe’s and Sears can also be involved in the distribution 

process. However, DOE’s understanding of these retailers is that they function mostly as a leadgenerating system for contractors, as the HVAC market is very rarely a do-it-yourself market.

When the so-called “Big Box” retailers are involved, customers go to a retailer and ask to be put 

into contact with a contractor. A distributor usually still supplies a contractor, who still performs 

the installation. In the end, the costs and markups reflect those in the standard distribution model.

Furthermore, DOE believes this reflects a small portion of overall unit sales. Therefore, for the 

purposes of this analysis, DOE does not consider the role of retailers in this analysis.
18-16

18.4 DISCUSSION OF REGIONAL STANDARD IMPACTS

Through public notices, public meetings, and interviews with industry trade groups, DOE 

has solicited comments on the impact of regional standards on CACHP and Furnace industry 

participants. This chapter discusses DOE’s understanding of the potential impacts on key players 

in the distribution chain.

As noted in Section 18.1.1.1, it is important to differentiate between the impacts of a 

higher base national standard and of regional standards. The following sections do not assess the 

impact on market participants of an increase in the efficiency standard. Rather, this chapter 

focuses on the impacts of having different standards affecting different geographic markets.

The impacts of regional standards are separated here into two categories: nonenforcement issues and enforcement issues. Non-enforcement issues are those issues that arise 

irrespective of the actions taken to enforce the regional standards. Enforcement issues are those 

impacts and costs that are directly related to ensuring compliance or that arise from noncompliance. Because DOE has not established an enforcement plan for regional standards, DOE 

is not able to capture any enforcement impacts in this analysis. 

18.4.1 Distributor Impacts

Non-enforcement Issues for Distributors

Based on its analysis and research, DOE believes that distributors that serve multiple 

regions will be impacted by additional (i.e.

DOE understands there to be two types of distributors that will serve multiple standard 

regions and could be affected by the differentiated regional standards: (1) central distributors 

shipping to local distributors in multiple regions and (2) local distributors selling to contractors 

in multiple regions. In general, distributors located near regional standard borders are more likely 

to serve multiple standard regions

, differentiated) regional standards. DOE also believes 

that distributors serving markets entirely within a single region will not experience any nonenforcement impacts distinguishable from a national amended energy conservation standard. As 

a result, DOE’s investigation of non-enforcement issues focuses on distributors that serve 

multiple regions.

DOE expects that distributors serving multiple standard regions may need to manage 

more variation in demand. Under a national standard, distributors could expect the bulk of 

demand to be at the base national level (e.g., 13 SEER for CACHP). Under regional standards, 

however, distributors near boundaries may experience bimodal demand, with the one large 

portion of shipments at the national standard efficiency level (e.g., 13 SEER) and a second large 

portion at a different regional efficiency level (e.g., 14 SEER). DOE believes that this bimodal 

demand does not signify a doubling of necessary inventory, but rather a more diverse inventory.

The resulting change in product mix for distributors serving multiple regions could increase 

inventory investment and inventory management costs because more product models of 

equipment are required to meet demand.
18-17

In Section 18.5, DOE performs a sensitivity analysis that investigates the impact of 

regional standards on inventory holdings and profitability. The analysis estimates a reasonable 

range of inventory increases based on industry data and then calculates the impact of those 

inventory changes on distributor profitability based on sample distributor financials. In general, 

the analysis finds that only small inventory changes would be required for distributors to meet 

product demand for multiple regions. Additionally, the sensitivity analysis finds the potential 

changes in inventory to have only small impacts on distributor profitability.

Enforcement Issues for Distributors

DOE understands that many distributors do business in more than one region.

Furthermore, the contractors to whom these distributors sell often do business in more than one 

region. At this time, however, DOE is not able to accurately assess impacts of enforcement

requirements on market participants.

DOE recognizes the challenges of regional standards enforcement and continues to 

investigate the most effective means of meeting those challenges. DOE will incorporate all 

feedback submitted during the standards rulemaking into the enforcement rulemaking. If regional 

standards are adopted, the enforcement rulemaking will begin within 90 days of the issuance of a 

final rule, as required by 42 U.S.C. 6295(o)(6)(G)(ii).

18.4.2 Contractor Impacts

Non-enforcement Issues for Contractors

During the preliminary analysis phase, the Air-Conditioning Contractors of America 

(ACCA) commented that larger units would cause higher transport and handling costs and, in 

many cases, would not fit in the residential space that housed the previous unit. (ACCA, Public 

Meeting Transcript, No. 23 at p. 252)

DOE notes that this issue is a function of higher standards, not differential regional 

standards. Problems with larger units which result from a higher standard are not directly 

considered in this chapter. To the extent that regional standards affect cost of goods sold above 

and beyond a national standard, DOE incorporates the effect in its markups analysis discussed in 

chapter 6 of the TSD. DOE is unaware of any other contractor concerns with regional standards 

that do not involve enforcement issues.

Enforcement Issues for Contractors

As with distributors, in general DOE believes that contractors near regional borders could 

potentially be impacted by enforcement-related competitive issues surrounding differential 

regions. DOE recognizes that non-compliance can be a problem for contractors as there is an 

incentive for non-compliance in the form of being able to offer unknowing homeowners a lower 

price point for products and HVAC service. DOE recognizes that along border regions, 

differential standards could exacerbate this disadvantage for complying contractors, particularly 

if the price difference between the regional-compliant products is significant. 
18-18

DOE acknowledges that depending on the enforcement mechanisms put in place 

following a DOE rulemaking, contractors may incur additional administrative compliance costs 

associated with regional standards, including recording keeping or verification costs. However, 

as noted above, at this point DOE cannot accurately assess any impacts of compliance due to 

regional standards because no enforcement mechanisms and compliance requirements have yet 

been established.

18.4.3 General Contractor Impacts

Non-enforcement Issues for General Contractors

DOE received no comments on any non-enforcement related regional standard impacts 

on builders and general contractors, and is not aware of any impacts. 

Enforcement Issues for General Contractors

In the preliminary analysis phase, the National Association of Home Builders (NAHB) 

commented that a general contractor usually will not have any special HVAC expertise.

Therefore, if regional standards are implemented, a builder is likely to use more time and effort 

double-checking that units are compliant. The extra cost of this effort should be included in the 

payback analysis, the cumulative regulatory burden, the employment impact analysis, and the 

regulatory impact analysis. NAHB also commented that regional standards would affect home 

builders, most of which are small businesses; as such, a regulatory flexibility analysis would be 

necessary. (NAHB, No. 21 at pp. 1, 2)

DOE recognizes that there may be impacts on general contractors operating in two 

different regions. For instance, DOE believes general contractors working on projects near 

regional standard borders may experience greater risk of mistakenly installing non-compliant 

systems—or hiring contractors who do so—and consequently incur greater cost under regional 

standards than they would under a single national standard. DOE expects this impact to be short 

run in nature as contractors adjust to the new standards.

18.5 ANALYSIS OF REGIONAL STANDARD IMPACTS

The focus of this section is the impact of regional standards on distributors, particularly 

those operating near regional boundaries. DOE attempts to quantify the financial implications of 

imposing different efficiency standards in multiple geographic regions. As previously noted, 

until DOE has further developed the enforcement plan for regional standards, it is not possible to 

provide detailed analysis of enforcement impacts. To understand non-enforcement impacts, two 

analyses are presented here: (1) an analysis of inventory impacts under regional standards and (2) 

an analysis of profitability sensitivity to inventory changes.

The first analysis provides a framework for understanding the magnitude of inventory 

changes that may result from regional standards. The second analysis anticipates how inventory 

changes due to regional standards may impact distributor profitability. As discussed in 18.3.3, 

DOE believes the key driver of distributor profitability is inventory. Therefore, these quantitative 

analyses only address changes in inventory costs.
18-19

Most HVAC distributors carry both residential furnace and central air conditioner and 

heat pump products. Though the analysis models central air conditioner and heat pump 

inventory, DOE anticipates the results also apply to furnace products. The analysis is not 

dependent on equipment or product class.

Additional analysis on the impact of regional standards on markups and costs passed 

down the distribution chain (including distributors and mechanical contractors) can be found in 

chapter 6 of the TSD.

18.5.1.1 Data Sources

The analyses of inventory impact and profitability impacts of distributors relies on three 

sources of information: Heating, Air conditioning and Refrigeration Distributors International 

2009 Profit Report (2008 Data), 2002 Economic Census, and 2007 County Business Patterns.

The following information can be obtained from these sources:

• Number of firms; total and population-weighted average sales; total and average 

employment; and firm size distribution by revenue (2002 Economic Census and 2007 

County Business Patterns). 

These values are reported for the nation and by state. It is possible to calculate these 

values for each of the regions affected by the standard (Hot-Humid, Hot-dry, and Rest of 

Country) and for each of the 24 states that borders these regions.

• Number of small businesses as defined by the Small Business Administration (SBA).

The SBA maximum threshold to qualify as a “small business” for NAICS 42373, warm 

air heating & AC equip merchant wholesalers, is 100 employees. In 2002, out of 2,773 

firms with 5,942 individual establishments nation-wide, only five firms (0.2%) had 100

or more employees. The national-level data shows that the distributors are 

overwhelmingly small businesses. Data is not available at the regional level, but regional 

analysis would be unlikely to show a different result.

• Typical cost structure and profitability (HARDI Profit Report 2009, 2002 Census). 

Variation among firm sizes and types (HARDI data).

The annual HARDI profit reports have detailed cost structure data for typical firms, 

including pro-forma income statements and balance sheets (see sample data in Table 18.5.1).

Data related to costs and potential markups are available at the national level and for seven 

geographic regions. The HARDI geographic regions do not match with the rulemaking regions.

However, it is possible to assign the typical income statements to firms in each state in the 

HARDI regions and then develop weighted-average balance sheets for each rulemaking region.

Economic Census data is not as financially detailed but has greater geographic 

specificity. It is used to indicate variation of profitability around the regional averages, and 

whether border state establishments are significantly different than the regional average.
18-20

To see how the impact of additional standards is calculated with an estimate of additional 

inventories, consider the model of a “typical” distributor in the Southeastern United States shown 

in Table 18.5.1.
18-21

Table 18.5.1 Typical Southeastern Wholesaler Assets, Liabilities, and Profitability 

Profit Margin Asset Turnover

Profit before Taxes $457,467 Total Assets $9,842,389 

Net Sales $24,077,230 Net Sales $24,077,230 

Ratio 1.9% 2.45

Income Statement Profit Before Taxes Assets Breakdown

Net Sales $24,077,230 

Cash and Marketable 

Securities $125,202 

Cost of Goods Sold $17,793,073 Accounts Receivable $2,783,329 

Gross Margin $6,284,157 Inventory $5,287,361 

Operating Expenses $5,874,844 Other $1,435,003 

Operating Profit $409,313 Total $9,630,895 

Other 

Income/Expenses $48,154 

Profit Before Taxes $457,467 

Financial Leverage

Return on Net 

Worth

Total Assets $9,630,895 

Total Net Worth $5,065,851 

Ratio 1.90 9.0%

Original % of Asset 

Value Original Liabilities Modified Liabilities

Accounts Payable 23.1% $2,224,737 $2,224,736.75 

Notes Payable 6.1% $587,485 $587,485 

Other Current 

Liabilities 7.9% $760,841 $760,841 

Total Current 

Liabilities 37.1% $3,573,062 $3,573,062 

Long-Term 

Liabilities 10.3% $991,982 $991,982 

Total Liabilities 47.4% $4,565,044 $4,565,044 

Net Worth 52.6% $5,065,851 $5,065,851 

SOURCE: HARDI Profit Report 2009
18-22

The values in the shaded cells in Table 18.5.1 can be changed in percentage terms to estimate the 

sensitivity of profitability, as defined by return on net worth. Data are not currently available to 

perform comparable calculations on the costs of record-keeping and reporting activities (changes 

in operating expenses). 

18.5.1.2 Sample Inventory Calculation for Southeastern Border CACHP Wholesaler

In general, DOE believes distributors operating in a single standard region will not see 

any inventory impacts that are different from the impacts resulting from a change in the national 

standard. However, distributors operating in multiple regions may have to adjust to business 

impacts that are unique to the introduction of multiple standard regions.

The following analysis provides guidance on the potential impacts of regional standards 

on inventory for distributors serving more than one standard region. The model assumes that a 

Southeastern border wholesaler would have financials similar to the typical firm in Table 18.5.1. 

The wholesaler makes half of its sales in its home region (Hot-Humid Region) and half in a 

different region (Rest of Country). The example border wholesaler is assumed to have the 

following characteristics:

• Sales to dealers and contractors average 200 units a week, 100 in each region.

• Sales of different efficiency products have the same approximate distribution as the 

national sales of split-system air conditioners and heat pumps.

• Sales at each efficiency level follow a Poisson statistical distribution.

• The wholesaler orders monthly from the manufacturer and keeps enough inventories on 

hand to meet quarterly sales forecasts.

Based on Table 18.5.1, known manufacturer costs, and wholesale markups for central air 

conditioner and heat pump equipment, the assumed 200 units per week is close to the sales of a 

“typical” HARDI wholesaler in the southeastern United States in 2008. Based on HARDI 

information, an average order cycle of 4 weeks and forecast period of 14 weeks are reasonable.

The average lead time from placement of order to receiving units for inventory is about 5.1 

weeks. Wholesale markup factors are 1.37 and estimated delivered cost of a unit of inventory is 

$1,200. These values are consistent with the values of sales and inventories in Table 18.5.1 and 

with observations that complete units constitute 70% of sales and average stock turnover is 3.6 

times per year.

Sales are distributed as follows by efficiency level based on approximate national sales of 

split-system air conditioners (numerical results are somewhat affected by the percentages, but the 

general takeaway does not change with a different efficiency mix): 

• SEER 13: 50.1%

• SEER 14: 17.3%

• SEER 15: 15.1%

• SEER 16: 15.4%

• SEER 18 (above 16): 2.2%

Sales at each efficiency level follow a Poisson statistical distribution. This distribution is 

commonly used in applied statistics to characterize the probability and number of comparatively 
18-23

rare observed events (for example, purchase of air conditioning units by a household) that occur 

in repeated samples (for example, weekly totals of sales). It is used frequently in studies of 

inventory and other logistics problems. A convenient attribute of a Poisson distribution is that the 

variance of the distribution equals its mean and therefore its standard deviation equals the square 

root of the mean.

The wholesaler orders monthly from the manufacturer and keeps enough inventories on 

hand to meet quarterly sales forecasts. Because sales vary week to-week, the wholesaler’s 

“standard of service” is that it always carries enough inventory to meet a level of quarterly sales 

of any of its offered products at least two standard deviations above the mean, plus 1 unit. This 

gives the wholesaler a 98% chance of meeting any order.

Four cases showing different shifts in demand for CACHP equipment are considered, 

driven by a SEER 14 minimum efficiency standard.

• Case 1: SEER 14 is imposed in both regions. The result is a “rollup” of demand, which 

shifts all SEER 13 demand to SEER 14 without affecting weekly demand for SEER 15, 

16, or 18. SEER 14 sales change from 5 percent to 86 percent of sales in both regions 

after the shift. SEER 15, 16, and 18 sales are unaffected

• Case 2: SEER 14 is imposed only in the Hot-Humid Region, while SEER 13 remains the 

standard in the Rest of Country region. The impact on demand is a “rollup” but only in 

the Hot-Humid region.

• Case 3: SEER 14 is imposed in both regions, but the percentages of sales at levels above 

SEER 14 are significantly affected (efficiency distribution shift). The average distribution 

in both regions after the SEER 14 standard is imposed are:

o SEER 13: 0.0%

o SEER 14: 37.20%

o SEER 15: 25.2%

o SEER 16: 25.4%

o SEER 18: 12.2%

• Case 4: SEER 14 is imposed only in the Hot-Humid Region, but the percentages of sales 

at levels above SEER 14 are significantly affected (efficiency distribution shift). The 

average distribution described in Case 3 is applied to the Hot-Humid region.

The results of this analysis for these four cases are shown in Table 18.5.2.
18-24

Table 18.5.2 Border Wholesaler Required Inventory 

Scenario No. Units in Inventory 

Base Case 3117

Case 1 3084

Case 2 3120

Case 3 3110

Case 4 3132

Impact of Regional Standards on Value of Inventories

Rollup (Case 2 / Case 1) 1.2 % Increase

Shift (Case 4 / Case 3) 0.7 % Increase

The base case scenario shows the inventory holdings required if there are no changes in 

the efficiency standard. The wholesaler must hold 3117 units in inventory in order to meet the 

“standard of service” conditions of the model.

Case 1 shows the impact of a single national standard with a rollup scenario. In this case, 

SEER 13 units are no longer sold, and it is no longer necessary to stock them. There is some 

compensating increase in inventory for SEER 14 units, but the overall inventory service is 

simpler and the inventory stock drops.

Case 2 corresponds to a regional standard with a rollup scenario. It is still necessary for 

the border wholesaler to stock slightly more than half as many SEER 13 units as before to serve 

the Rest of Country, although these units can no longer be sold in the Hot-Humid region. In 

addition, more SEER 14 inventory must be carried to serve both regions. The difference in 

inventory between Case 1 and the Base Case is 0.1 percent; however, Case 2 (regional standard) 

requires about 1.2 percent more inventory than Case 1 (national standard).

Case 3 corresponds to a single national standard with a market shift scenario. Once again, 

the elimination of 13 SEER units reduces the overall inventory that must be held. There is some 

compensating increase in inventory as sales of efficient equipment over several higher efficiency 

levels increase. Overall required inventories go down by 0.2 percent compared with the Base 

Case.

Case 4 corresponds to a regional standard with a market shift scenario. This case requires 

0.7 percent more inventory than Case 3. 

18.5.2 Profitability Analysis of Regional Standard Impacts

The increases in required physical units of inventory range from 0.7 percent to 1.2 

percent higher for a regional standard than with a national standard for distributors serving two 

regions. Thus, the impacts appear to be on the order of 1 percent. Table 18.5.3 and Table 18.5.4

present the modeled impacts of these inventory changes on ‘profit as a percentage of total sales’ 
18-25

and on ‘return on net worth,’ respectively. The tables also present the impacts of changes in 

inventory changes that are twice as large (2 percent increase) and ten times as large (10 percent 

increase) to demonstrate the sensitivity of profitability to such changes.

The values in Table 18.5.3 and Table 18.5.4 are derived from the model in Table 18.5.1

by assuming increases to inventory and the associated increase in interest expense necessary to 

finance that additional working capital. Additionally, for illustrative purposes, DOE applied a 

range of interest rates for the capital required to finance the additional inventory. 

Table 18.5.3 Profitability Impacts of Inventory Cost Increases

Profit before Taxes (% of Sales)

% Change in Inventory

Interest Rate for Inventory 0% 1% 2% 4% 10%

6% 1.9% 1.9% 1.9% 1.8% 1.8%

8% 1.9% 1.9% 1.9% 1.8% 1.7%

10% 1.9% 1.9% 1.9% 1.8% 1.7%

12% 1.9% 1.9% 1.8% 1.8% 1.7%

Table 18.5.3 indicates that the impacts of additional inventory on profitability are not 

observable at one percent and two percent inventory changes, except at the highest modeled 

interest rates. Table 18.5.3 also indicates that an inventory increase of 10 percent financed at 12 

percent interest could reduce pretax margins by approximately 20 basis points, a decline of 

approximately 10 percent.

Table 18.5.4 Return on Net Worth Impacts of Inventory Cost Increases

Return on Net Worth

% Change in Inventory

Interest Rate for Inventory 0% 1% 2% 4% 10%

6% 9.0% 9.0% 8.9% 8.8% 8.4%

8% 9.0% 8.9% 8.9% 8.7% 8.2%

10% 9.0% 8.9% 8.8% 8.6% 8.0%

12% 9.0% 8.9% 8.8% 8.5% 7.5%

Table 18.5.4 shows the impact of inventory changes on distributor Return on Net Worth, 

which is calculated as pretax profit divided by net worth, where net worth equals assets less 

liabilities. At the expected one to two percent inventory change, impacts on return on net worth
18-26

are again small. However, the impacts could be significant for distributors with high borrowing 

costs and where there are significantly higher inventory requirements.

18.6 CONCLUSIONS

EISA instructs DOE to “consider the impacts of the additional regional standard on 

consumers, manufacturers, and other market participants” before proposing regional standards. 

(42 U.S.C. 6295(o)(6)(D)(ii)) The impacts on consumers are presented in the LCC described in 

chapter 8 of the TSD; the impacts on manufacturers are presented in the MIA described in 

chapter 12 of the TSD; and the impact on market participants is analyzed in this chapter. 

DOE understands the term market participants to consist of distributors, mechanical 

contractors and general contractors. The participants termed dealers, contractors, and installers 

have overlapping or identical functions to distributors, mechanical contractors and general 

contractors.

In determining the effects of regional standards on distributors, mechanical contractors 

and general contractors, DOE differentiates between enforcement and non-enforcement impacts. 

Enforcement-related impacts vary depending on the enforcement path proposed by DOE. 

Examples include the additional cost and complexity of potential reporting, compliance, and 

labeling requirements. Non-enforcement impacts are not dependent on the choice of enforcement 

mechanisms. Examples for distributors include the expense of carrying additional inventory to 

manage greater diversity in demand and the overhead of educating contractors about regional 

boundaries. At this stage, no enforcement plans or requirements have been proposed. As such, 

DOE does not attempt to quantify enforcement-related impacts in this chapter. This chapter 

focuses on the non-enforcement impacts of regional standards on distributors, mechanical 

contractors and general contractors.

Additionally, in this chapter, DOE differentiates between the impacts of higher standards 

and the impacts of introducing regional standards. This chapter focuses on the impacts of 

“establishing separate standards by geographic region”. Impacts that are the result of higher 

standards, which would occur under an amended energy conservation standard that did not 

specify regions, are not considered in this chapter. 

Based on DOE’s research and industry feedback, the Department has not identified any 

non-enforcement impacts from regional standards on mechanical and general contractors. Most 

contractor issues identified in public meetings, written comments, and interviews have been 

related to the increase in size and the additional complexity of products. These issues are the 

result of higher standards rather than regional standards and are beyond the scope of this chapter. 

(Discussion of the impacts of a higher standard on installation costs and on contractor labor 

requirements are included in the discussion of markups in chapter 6 of the TSD.) Additional 

concerns raised were related to the burdens of enforcement and the competitive impacts of 

insufficient enforcement. Enforcement impacts will be evaluated as part of the enforcement 

rulemaking, which is required if regional standards are adopted.

For distributors, DOE separately considered those that operate within the bounds of a 

single region and those that operate within multiple regions. For distributors that service a single 
18-27

region and are far from regional borders, DOE expects regional standards to have impacts that 

are similar to a single national standard. Those distributors are not expected to incur additional 

costs or complications due to the implementation of multiple regional standards. However, 

distributors that serve multiple regions or are near border regions may have non-enforcement 

impacts directly tied to the introduction of regional standards.

DOE identified the most significant non-enforcement impacts on distributors serving 

multiple regions to result from changes in inventory. DOE expects that distributors serving 

multiple standard regions will need to manage more variation in demand. The resulting change in 

product mix for distributors serving multiple regions could increase inventory investment and 

inventory management costs because more product models of equipment are required to meet 

standards. Using HARDI data for a typical distributor’s financials, DOE estimates that a 

Southeast distributor serving two regions would need a 1 to 2 percent increase in inventory to 

meet changes in demand due to regional standards. A 2 percent change in inventory would 

reduce distributor profits by as much as 5.3 percent annually. DOE also models the impacts of 

larger inventory changes and different costs of capital in section 18.5.
18-28

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