CHAPTER 6. MARKUPS TO DETERMINE PRODUCT COST 

TABLE OF CONTENTS 

6.1 INTRODUCTION ........................................................................................................... 6-1 


6.1.1 Distribution Channels ...................................................................................................... 6-1 


6.2 MARKUP CALCULATION PROCEDURE .................................................................. 6-1 


6.2.1.1 Manufacturer Markups...................................................................................6-2 


6.2.1.2 Retailer Markups............................................................................................ 6-2 


6.2.1.3 Overall Markup.............................................................................................. 6-4 


6.3 MANUFACTURER MARKUPS .................................................................................... 6-5 


6.4 RETAILER MARKUP .................................................................................................... 6-6 


6.5 SALES TAXES ............................................................................................................... 6-7 


6.6 SUMMARY OF MARKUPS .......................................................................................... 6-7 


LIST OF TABLES 

Table 6.3.1 Major Appliance Manufacturer Gross Margins and Markups............................. 6-5 


Table 6.4.1 Data Used to Calculate Retailer Markups............................................................ 6-6 


Table 6.5.1 Average Sales Tax Rates by Census Division and Large State ........................... 6-7 


Table 6.5.2 Average Sales Tax Rates by Product................................................................... 6-7 


Table 6.6.1 Summary of Markups .......................................................................................... 6-8 


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CHAPTER 6. MARKUPS TO DETERMINE PRODUCT COST 


6.1 INTRODUCTION
 

To carry out the engineering and life-cycle cost (LCC) analyses, DOE needed to 

determine the cost to the consumer of a baseline product and the cost of more-efficient units that 

might meet a revised standard. By applying a multiplier called a “markup” to the manufacturers’ 

product costs estimated in the engineering analysis, DOE estimated the consumer costs for 

baseline models and more efficient products. 

6.1.1 Distribution Channels 

The appropriate markups for determining the consumer product cost depend on the type 

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

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

business costs and profit margin. 

DOE based the distribution channels for room air conditioners and clothes dryers on data 

from the Association of Home Appliance Manufacturers (AHAM).1

 Because an overwhelming 

majority of products are sold through retail outlets, DOE estimated that all of the considered 

products are purchased by consumers from retail outlets. 

6.2 MARKUP CALCULATION PROCEDURE 

In financial statements, gross margin is the difference between the company revenue and 

the company cost of sales or cost of goods sold (CGS). Inputs for calculating the gross margin 

are all corporate costs—including overhead costs (sales, general, and administration); research 

and development (R&D) and interest expenses; depreciation, and taxes—and profits. In order 

for sales of a product to contribute positively to company cash flow, the product’s markup must 

be greater than the corporate gross margin. Individual products may command a lower or higher 

markup, depending on their perceived added value and the competition they face from similar 

products in the market. 

In developing markups for manufacturers, retailers, and distributors, DOE obtained data 

about the revenue, CGS, and expenses of firms that produce and sell the products of interest. 

DOE’s approach categorizes the expenses into two categories: labor-scaling costs (LSC), which 

are fixed labor and occupancy expenses that increase in proportion to the amount of labor 

required to produce or sell the product, and non-labor-scaling costs (NLSC), which are variable 

operating costs that do not scale with labor and vary in proportion to CGS. Together, LSC and 

NLSC represent the gross margin. 

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6.2.1.1 Manufacturer Markups 

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

manufacturer sales price. Using the CGS and gross margin, DOE calculated the manufacturer 

markup (MUMFG) with the following equation: 

CGS MFG + GMMFG MU MFG = 

CGS MFG

Where: 

MUMFG = Manufacturer markup, 

CGSMFG = Manufacturer’s cost of goods sold, and 

GMMFG = Manufacturer’s gross margin. 

6.2.1.2 Retailer Markups 

DOE based the retailer markups on financial data from the U.S. Census Business 

Expenditure Survey. DOE organized the financial data into balance sheets that break down cost 

components incurred by firms that sell the products.a

 The key assumptions that DOE used to 

estimate the retailer markups using these financial data were: 

1.	 The balance sheets faithfully represent the various average costs incurred by firms selling 

clothes dryers and room air conditioners. 

2.	 These costs can be divided into two categories: 

a.	 Costs that vary in proportion to the manufacturer sales price (variable costs); and 

b.	 Costs that do not vary with the manufacturer sales price (fixed costs). 

3.	 Retailer sales prices vary in proportion to retailer and distributor costs that are included in 

the balance sheets. 

In support of the first assumption, the balance sheets itemize firm costs into a number of 

expense categories, including CGS, operating labor and occupancy costs, and other operating 

costs and profit. Although retailers tend to handle multiple commodity lines, the data provide 

the most accurate available indication of home appliance expenses. 

Information obtained from the trade literature pertaining to the heating, ventilation, and 

air-conditioning (HVAC) contracting industry tends to support the second assumption. This 

information indicates that retailer and distributor markups should vary according to the quantity 

of labor and materials used to sell or distribute the products, with markups on labor tending to be 

much larger than markups on materials.2

 This information also describes markups as varying 

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

a

 The retailers and distributors to whom these financial data refer handle multiple commodity lines. 

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efficiency. This last finding strongly suggests that labor inputs vary more with sales volume than 

with appliance cost or efficiency. In the discussion that follows in sections 6.3 and 6.4, DOE 

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

(fixed costs—labor and occupancy expenses referred to above as LSC), and those that do 

(variable costs—operating expenses and profit referred to above as NLSC). This division of 

costs led to the estimate of retailer markups described below in sections 6.3 and 6.4. 

In support of the third assumption, the retailer and distributor industries are relatively 

competitive, and consumer demand for residential home appliances is relatively inelastic, i.e. the 

demand is not expected to decrease significantly with a relatively small increase in price. The 

large number of household appliance stores and merchant wholesalers of service equipment (i.e., 

distributors of products) listed by the U.S. Census Bureau in its Statistics of U.S. Businesses 

indicates the competitive nature of the market.3 For example, there are more than 10,000 

household appliance store establishments and over 5,000 merchant wholesaler establishments of 

service equipment in the United States.b Following standard economic theory, competitive firms 

facing inelastic demand either set prices in line with costs or quickly go out of business.4 

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

transform the manufacturer sales price into a consumer product cost. DOE used the baseline 

markups, which cover all of a retailer’s costs (i.e., both LSC and NLSC), to determine the sales 

price of baseline models. The baseline markup relates the manufacturer sales price to the retailer 

sales price. DOE considers baseline models to be products sold under existing market conditions 

(i.e., without new energy efficiency standards). DOE calculated the baseline markup (MUBASE) 

for retailers using the following equation: 

CGS + GM CGS + (LSC + NLSC ) MU RTL RTL RTL RTL

BASE = = CGSRTL CGSRTL 

 Where: 

MUBASE = Baseline retailer markup, 

CGSRTL = Retailer’s cost of goods sold, 

GMRTL = Retailer’s gross margin, 

LSCRTL = Retailer’s labor-scaling costs, and 

NLSCRTL = Retailer’s non-labor-scaling costs. 

Incremental markups cover only those costs that scale with a change in the 

manufacturer’s sales price (i.e., NLSC). Incremental markups are coefficients that relate the 

change in the manufacturer sales price of higher-efficiency models to the change in the retailer or 

distributor sales price. DOE considers higher-efficiency models to be products sold under market 

b

 DOE determined the number of establishments for household appliance stores based on the following North 

American Industry Classification System (NAICS) code and description: 443111, Household Appliance Stores. 

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conditions with new efficiency standards. It calculated the incremental markup (MUINCR) for 

retailers using the following equation: 

CGSRTL + NLSCRTL MU INCR = CGSRTL 

Where: 

MUINCR = Incremental retailer markup, 


CGSRTL = Retailer’s cost of goods sold, and 


NLSCRTL = Retailer’s non-labor-scaling costs. 


6.2.1.3 Overall Markup 

The overall markup is the product of the manufacturer and retailer markups, as well as 

sales taxes. 

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

models, given the manufacturer cost of the baseline models. As stated above, DOE considers 

baseline models to be products sold under existing market conditions (i.e., without new energy 

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

to determine the product cost for baseline models. 

CPCBASE = COSTMFG x (MU MFG x MU BASE xTaxSALES ) = COSTMFG x MUOVERALL _ BASE 

 Where: 

CPCBASE = Consumer product cost for baseline models, 


COSTMFG = Manufacturer cost for baseline models, 


MUMFG = Manufacturer markup, 


MUBASE = Baseline retailer markup, 


TaxSALES = Sales tax, and 


MUOVERALL_BASE = Baseline overall markup. 


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

product cost, given changes in the manufacturer cost above the baseline model cost resulting 

from a standard to raise product efficiency. The total consumer product cost for higherefficiency models is composed of two components: the consumer product cost of the baseline 

model and the change in consumer product cost associated with the increase in manufacturer cost 

to meet the new efficiency standard. The following equation shows how DOE used the overall 

incremental markup to determine the consumer product cost for higher-efficiency models (i.e., 

models meeting new efficiency standards). 

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CPC = COST x MU + ICOST x (MU x MU xTax ) STD MFG OVERALL _ BASE MFG MFG INCR SALES 

= CPC BASE + ICOST MFG OVERALL x MU _ INCR 

Where: 

CPCSTD = Consumer product cost for models meeting new efficiency standards, 

CPCBASE = Consumer product cost for baseline models, 

COSTMFG = Manufacturer cost for baseline models, 

1COSTMFG = Change in manufacturer cost for higher-efficiency models, 

MUMFG = Manufacturer markup, 

MUINCR = Incremental retailer or distributor markup, 

TaxSALES = Sales tax, 

MUOVERALL_BASE = Baseline overall markup, and 

MUOVERALL_INCR = Incremental overall markup. 

6.3 MANUFACTURER MARKUPS 

DOE developed an average manufacturer markup by examining the annual Securities and 

Exchange Commission (SEC) 10-K reports filed by four publicly-traded manufacturers primarily 

engaged in appliance manufacturing and whose combined product range includes room air 

conditioners and clothes dryers.5

 The four manufacturers represent a nearly 50 percent market 

share for core appliances. Because these companies are typically diversified, producing a range 

of different appliances, an industry average markup was assumed by DOE to be representative 

for the manufacture of each type of appliance. DOE evaluated markups for the years between 

2002 and 2005, inclusive. Table 6.3.1 lists the average corporate gross margin during the years 

from 2002 to 2005, and corresponding markups, for each of the four manufacturers. The average 

markup value based on these four companies is 1.26. 

Table 6.3.1 Major Appliance Manufacturer Gross Margins and Markups 

Mfr A Mfr B Mfr C Mfr D 

Average Net Revenues (Million) $372 $280 $4770 $12,682 

Corporate Gross Margin 15% 28% 16% 22% 

Markup 1.18 1.39 1.19 1.28 

Source: SEC 10-K reports (2002-2005) 

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6.4 RETAILER MARKUP 

DOE used financial data from the U.S. Census Business Expenditure Survey (BES), in 

the “Household Appliance Stores” category, to calculate markups used by retailers that apply to 

room air conditioners and clothes dryers.c,6 Table 6.4.1 shows the BES data that DOE used and 

the retail markups for these appliances that DOE estimated following the procedures described 

above. 

Table 6.4.1 Data Used to Calculate Retailer Markups 

Item Million 1997 Dollars 

Sales (revenue) 10,343 

Cost of Goods Sold (CGS) 7,151 

Gross Margin (GM) 3,193 

Labor-Scaling Costs (LSC)

 Payroll 1,366 

Fringe Benefits 208 

Contract Labor 69 

Taxes and License Fees 53 

 Lease and Rental Payments 238 

 Telephone and Communications 58 

Utilities 70 

Repair and Maintenance 36 

 LCS Subtotal: 2,098 

Non-Labor-Scaling Costs (NLSC)

 Depreciation and Amortization 94 

Office Supplies 37 

 Packaging and Other Materials 0 

Advertising Services 274 

Legal Services 8 

Accounting, Auditing, and Bookkeeping 19 

 Computer Related Services 10 

 Other Operating Expenses 389 

 Net Profit Before Taxes 263 

NLCS Subtotal: 1,094 

Baseline Markup (MUBASE) = (CGS+GM)/CGS 1.45 

Incremental Markup (MUINCR) = (CGS+NLSC)/CGS 1.15 

c

 DOE used the 1997 BES because the 2002 BES did not contain sufficient data for the calculation of gross margin 

or cost of goods sold. 

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6.5 SALES TAXES 

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

product cost of the product. The sales tax is a multiplicative factor similar to a markup. 

DOE derived state and local taxes from data provided by the Sales Tax Clearinghouse.7 

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

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

Table 6.5.1 below. 

Table 6.5.1 Average Sales Tax Rates by Census Division and Large State 

Census Division/State Tax Rate 

New England 4.98% 

Mid Atlantic 6.07% 

East North Central 6.56% 

West North Central 6.65% 

South Atlantic 5.95% 

East South Central 7.85% 

West South Central 8.30% 

Mountain 6.46% 

Pacific 4.97% 

New York State 8.25% 

California 7.95% 

Texas 7.95% 

Florida 6.70% 

DOE then derived U.S.-average tax values for each product (as shown in Table 6.5.2 

below) based on the product’s saturation within each Census division and large state. It 

determined the saturations from the DOE Energy Information Administration’s 2005 Residential 

Energy Consumption Survey.8 

Table 6.5.2 Average Sales Tax Rates by Product 

Product Tax Rate 

Room air conditioners 6.75% 

Clothes dryers 6.78% 

6.6 SUMMARY OF MARKUPS 

Table 6.6.1 summarizes the markups at each stage in the distribution channel and the 

overall baseline and incremental markups, as well as sales taxes, for each product. 

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Table 6.6.1 Summary of Markups 

Room Air Conditioners Clothes Dryers 

Markup Baseline Incremental Baseline Incremental 

Manufacturer 1.26 1.26 

Retailer 1.45 1.15 1.45 1.15 

Sales Tax 1.068 1.068 

Overall 1.95 1.55 1.95 1.55 

The example for room air conditioners, provided below, illustrates how DOE used the 

baseline and incremental markups to derive a consumer product cost. Assuming the baseline 

manufacturer cost is $225 and the change in manufacturer cost to meet a given energy efficiency 

standard is $10, the resulting baseline consumer product cost (CPCBASE) and higher-efficiency 

product cost (CPCSTD) are: 

CPC = COST x (MU x MU xTax ) BASE MFG MFG BASE SALES 

= $225x1.26 x1.45x1.068 = $439 

CPC = CPC + ICOST x (MU x MU xTax ) STD BASE MFG MFG INCR SALES 

= $225 + ($10 x1.26 x1.15x1.068) = $439 + $15 = $464 

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6.6.1 Validation of Estimated Markups 

As part of its market data collection, DOE assembled a data base with retail Internet 

prices for a large number of clothes dryer models at baseline efficiency. Additionally, DOE used 

detailed sales data from NPD Group, a market research firm, to estimate room air conditioner 

retail prices at baseline efficiency for three of the product classes.d

 For each model, DOE divided 

the retail price by the estimated manufacturer cost for the appropriately-sized clothes dryer or 

room air conditioner (estimated as described in chapter 5) to derive an implicit markup. This 

markup would include the manufacturer markup and the retail markup. To be comparable with 

the overall markups shown in Table 6.6.1, DOE added U.S.-average sales tax values for each 

product. See appendix 6-A, Detailed Data for Product Cost Markups, for the derivation of the 

implicit markups. 

For electric clothes dryers, the implicit markups for standard and compact models 

average 2.08, which is slightly higher than the calculated overall markup (1.95). For room air 

conditioners, the implicit markups average 1.91, close to the calculated overall markup (1.95). 

Exact agreement should not be expected, since the actual manufacturing costs may be different 

from the costs estimated by DOE and the price data from the NPD dataset does not cover all 

retail sales. 

d

 For the other product classes, there was an imperfect match between efficiency levels of retail data and those used 

to estimate manufacturing cost. 

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REFERENCES 

1. 	Association of Home Appliance Manufacturers, AHAM 2003 Fact Book. 2003. 

Washington, DC. 

2. 	 Skaer, M., What should you charge? Try These Tested Formulas. The Air Conditioning, 

Heating, and Refrigeration News, 

2001<http://www.achrnews.com/CDA/ArticleInformation/features/BNP__Features__Ite 

m/0,1338,23113,00.html> 

3. 	 U. S. Department of Commerce - Bureau of the Census, Statistics of U.S. Businesses., 

2004. Washington, DC. 

4. 	 Pindyck, R. S. and D. L. Rubinfeld, Microeconomics. 5th ed. 2000. Prentice Hall: New 

Jersey. 

5. 	 Security Exchange Commission, SEC 10-K Reports, Various dates, 2002-2005. Security 

Exchange Commission. <http://www.sec.gov/> 

6. 	 U.S. Census Bureau, 1997 Economic Census, Business Expenses Survey, Retail Trade, 

Electronics and Appliance Stores., 1997. Washington, DC 

7. 	 Sales Tax Clearinghouse Inc., State Sales Tax Rates Along with Combined Average City 

and County Rates, 2006. <http://thestc.com/STrates.stm> 

8. 	 U.S. Department of Energy - Energy Information Administration, Residential Energy 

Consumption Survey: 2005 Public Use Data Files, 2005. 

<http://www.eia.doe.gov/emeu/recs/recspubuse05/pubuse05.html> 

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