CHAPTER 6. MARKUPS TO DETERMINE EQUIPMENT PRICE

TABLE OF CONTENTS

**6.1 INTRODUCTION** 

**.............................................................................................................. 6­1** 

**6.2 MARKUP**  **CALCULATION PROCEDURE** 

**..................................................................... 6­2** 

**6.2.1 Baseline**  **Markups................................................................................................. 6­3** 

**6.2.2 Incremental**  **Markups**

**........................................................................................... 6­4** 

**6.2.3 Overall**  **Markups**

**.................................................................................................. 6­5** 

**6.3 ASSUMPTIONS**  **USED TO**  **ESTIMATE WHOLESALER**  **AND CONTRACTOR** 

**MARKUPS**

**......................................................................................................................... 6­6** 

**6.4 ESTIMATION**  **OF WHOLESALER**  **MARKUPS**

**............................................................. 6­8** 

**6.4.1 Estimation of Wholesaler Markup Probability Distribution................................ 6­9** 

**6.5 ESTIMATION OF MECHANICAL CONTRACTOR MARKUPS.................................. 6­9** 

**6.5.1 Markups**  **for Mechanical**  **Contractors in**  **the Replacement**  **and New** 

**Construction Markets.........................................................................................**  **6­10**

**6.5.2 Estimation**  **of Mechanical**  **Contractor Markup**  **Probability Distribution** 

**........... 6­12** 

**6.6 ESTIMATION OF GENERAL CONTRACTOR MARKUPS........................................ 6­13** 

**6.6.1 Estimation**  **of General**  **Contractor Markup**  **Probability Distribution** 

**................. 6­14** 

**6.7 SALES**  **TAX**

**..................................................................................................................... 6­15** 

**6.8 NATIONAL**  **ACCOUNTS**

**............................................................................................... 6­16** 

**6.9 OVERALL**  **MARKUPS.................................................................................................... 6­17** 

LIST OF TABLES

**Table 6.1.1**  **Market Shares**  **of PTAC**  **and PTHP**  **through Each**  **Distribution Channel** 

**............ 6­2** 

**Table 6.4.1**  **Wholesaler Expenses**  **and Markups** 

**..................................................................... 6­8** 

**Table 6.5.1**  **Baseline Markup,**  **All Mechanical**  **Contractors.................................................... 6­9** 

**Table 6.5.2**  **Baseline Markups**  **for the**  **Replacement and**  **New Construction**  **Markets,**

**All Mechanical**  **Contractors**

**............................................................................... 6­11** 

**Table 6.5.3**  **Mechanical Contractor**  **Expenses and**  **Baseline Markup,**  **Residential and** 

**Light Commercial** 

**.............................................................................................. 6­11** 

**Table 6.5.4**  **Mechanical Contractor**  **Expenses and**  **Markups Based**  **on Census**  **Bureau**

**Data.................................................................................................................... 6­12** 

**Table 6.6.1**  **General Contractor**  **Expenses and**  **Markups....................................................... 6­13** 

**Table 6.7.1**  **State Sales**  **Tax Rates.........................................................................................**  **6­15**

**Table 6.8.1**  **National Account**  **Markups................................................................................ 6­16**

**Table 6.9.1**  **Overall Baseline**  **Markups.................................................................................. 6­18** 

**Table 6.9.2**  **Overall Incremental**  **Markups**

**............................................................................ 6­18** 

LIST OF FIGURES

**Figure 6.1.1**  **Distribution Channels**  **for PTAC**  **and PTHP**  **Equipment**

**..................................... 6­1** 

**Figure 6.4.1**  **Wholesaler Baseline**  **Markup Probability**  **Distribution........................................ 6­9** 

**Figure 6.4.2**  **Wholesaler Incremental**  **Markup Probability**  **Distribution**

**.................................. 6­9** 

**6­i Figure**  **6.5.1 Mechanical**  **Contractor Baseline**  **Markup Probability**  **Distribution**

**................... 6­13** 

**Figure 6.5.2 Mechanical Contractor Incremental Markup Probability Distribution.............. 6­13** 

**Figure 6.6.1**  **General Contractor**  **Baseline Markup**  **Probability Distribution** 

**......................... 6­15** 

**Figure 6.6.2 General Contractor Incremental Markup Probability Distribution.................... 6­15** 

**6­ii**CHAPTER 6. MARKUPS TO DETERMINE EQUIPMENT PRICE

6.1 INTRODUCTION

**To carry**  **out the**  **life­cycle cost**  **(LCC) calculations**  **described in**  **Chapter 8,**  **the U.S.** 

**Department of**  **Energy (DOE)**  **needed to**  **determine the**  **cost to**  **the customer**  **of a**  **packaged**

**terminal air**  **conditioner (PTAC)**  **or packaged**  **terminal heat**  **pump (PTHP).**  **This cost**  **was**

**determined for**  **both baseline**  **equipment and**  **more­efficient equipment**  **the customer**  **would**

**purchase following**  **the promulgation**  **of new**  **energy conservation**  **standards. However,**  **the**

**customer price**  **of baseline**  **or higher­efficiency**  **equipment is**  **not known**  **and can**  **be determined** 

**based on**  **how the**  **equipment is**  **purchased. The**  **manufacturing selling**  **price (MSP)**  **can be** 

**determined for**  **both baseline**  **equipment and**  **the more­efficient**  **equipment as**  **described in**  **the**

**engineering analysis**  **(Chapter 5).**  **Therefore, by**  **applying a**  **multiplier called**  **a “markup”**  **to the** 

**MSP, DOE**  **was able**  **to estimate**  **the customer**  **price of**  **equipment purchased**  **through various** 

**distribution channels.**  **This chapter**  **describes how**  **DOE derived**  **such markups.** 

**The cost**  **to the**  **customer depends**  **on how**  **the customer**  **purchases the**  **equipment. DOE** 

**identified four**  **distribution channels,**  **as shown**  **in Figure**  **6.1.1, to**  **describe how**  **the equipment** 

**passes from**  **the manufacturer**  **to the**  **customer for**  **both new**  **construction and**  **replacement**

**markets. In**  **the first**  **distribution channel,**  **the manufacturer**  **sells the**  **equipment to**  **the customer** 

**through a**  **national account.**  **In the**  **second channel,**  **the manufacturer**  **sells the**  **PTAC and**  **PTHP**

**equipment to**  **a wholesaler,**  **who in**  **turn sells**  **it directly**  **to the**  **customer. In**  **the third**  **and fourth** 

**channel, the**  **manufacturer sells**  **the equipment**  **to a**  **wholesaler, who**  **in turn**  **sells it**  **to a** 

**mechanical contractor,**  **who in**  **turn may**  **sell it**  **directly to**  **the customer**  **or through**  **a general** 

**contractor who**  **may sell**  **it and**  **its installation**  **to the**  **customer.**

**M a**  **n u**  **f a**  **c t**  **u r**  **e r** 

**N a**  **t i**  **o n**  **a l**  **A c**  **c o**  **u n**  **t**

**C u**  **s t**  **o m**  **e r**  **W h**  **o l**  **e s**  **a l**  **e r** 

**Mechanical Contractor** 

**(New Construction**  **or Replacement)** 

**C u**  **s t**  **o m**  **e r**  **General**

**Contractor**

**C u**  **s t**  **o m**  **e r**  **C u**  **s t**  **o m**  **e r** 

**Channel 1**  **Channel 2**  **Channel 3**  **Channel 4** 

Figure 6.1.1 Distribution Channels for PTAC and PTHP Equipment

**6­1 According**  **to Ducker**  **Worldwide analysis,**  **DOE estimated**  **the distribution**  **channel shares** 

**(in percentage**  **of total**  **sales) through**  **each of**  **the four**  **distribution channels**  **for both**  **new**

**construction and**  **the replacement**  **market, as**  **shown in**  **Table 6.1.1.**  **1 The**  **entire market**  **of PTAC** 

**and PTHP**  **equipment consists**  **of standard**  **size equipment**  **(85 percent**  **of shipment**  **volume) and** 

**non­standard size**  **equipment (15**  **percent of**  **shipment volume).**  **Of the**  **standard size**  **equipment,**

**80 percent**  **are sold**  **for the**  **replacement market**  **and 20**  **percent are**  **for the**  **new construction** 

**market. Non­standard**  **size equipment**  **is only**  **used in**  **the replacement**  **market. This**  **results in** 

**approximately 17**  **percent of**  **PTAC and**  **PTHP equipment**  **is purchased**  **to be**  **installed in**  **the new** 

**construction, while**  **the remaining**  **83 percent**  **is assumed**  **to replace**  **existing PTAC**  **and PTHP** 

**equipment.**

Table 6.1.1 Market Shares of PTAC and PTHP through Each Distribution Channel

Channel 1 Channel 2 Channel 3 Channel 4

**Replacement Market**  **15% 25%**  **60% 0%** 

**New Construction** 

**Market 30%**  **0% 38%**  **32%**

**For the**  **replacement market**  **in this**  **distribution, 60**  **percent of**  **the packaged**  **terminal**

**equipment is**  **predominantly purchased**  **directly through**  **a mechanical**  **contractor, 15**  **percent**

**through national**  **accounts, and**  **25 percent**  **through wholesalers.**  **In the**  **case of**  **the new** 

**construction market,**  **30 percent**  **of equipment**  **is purchased**  **directly from**  **manufacturer through**  **a**

**national account,**  **38 percent**  **through a**  **mechanical contractor**  **directly and**  **the remaining**  **32**

**percent through**  **a general**  **contractor distribution**  **channel.**

**For each**  **of the**  **steps in**  **the distribution**  **channels presented**  **above, DOE**  **estimated a** 

**baseline markup**  **and an**  **incremental markup.**  **DOE defined**  **a baseline**  **markup as**  **a multiplier** 

**that converts**  **the MSP**  **of equipment**  **with baseline**  **efficiency to**  **the customer**  **purchase price**  **for**

**the equipment**  **at the**  **same baseline**  **efficiency level.**  **An incremental**  **markup is**  **defined as**  **the**

**multiplier to**  **convert the**  **incremental increase**  **in MSP**  **of higher**  **efficiency equipment**  **to the** 

**customer purchase**  **price for**  **the same**  **equipment. Both**  **baseline and**  **incremental markups**  **are only**  **dependent on**  **the particular**  **distribution channel**  **and are**  **independent of**  **the efficiency**  **levels**

**of the**  **PTACs and**  **PTHPs.**

6.2 MARKUP CALCULATION PROCEDURE

**For equipment**  **that the**  **customer purchases**  **directly from**  **the manufacturer**  **through a** 

**national account,**  **the following**  **equation defines**  **the equipment**  **price:**

EQP CUST **=** MSP **x** MU NATL ACCT **x (1+**  **ST)** Eq. 6.1

**where:**

EQP CUST **= equipment**  **price to**  **the customer**  **($),**

MSP

**= manufacturer**  **selling price**  **($),**

MU NATL ACCT **= national**  **account markup,** 

**6­2**ST

**= sales**  **tax ($).** 

**The following**  **equation describes**  **how DOE**  **determined the**  **equipment price**  **if a** 

**wholesaler sells**  **the equipment**  **to the**  **customer through**  **the wholesaler**  **distribution channel:** 

EQP CUST **=** MSP **x** MU WHOLE **x (1+ST)**  Eq. 6.2

**where:**

MU WHOLE **= wholesaler**  **markup**

**The following**  **equation describes**  **how DOE**  **determined the**  **equipment price**  **if a** 

**mechanical contractor**  **sells the**  **equipment directly**  **to the**  **customer through**  **the wholesaler** 

**distribution channel:** 

EQP CUST = MSP **x** MU WHOLE **x M** U MECH CONT **x (1+**  **ST)** Eq. 6.3

**where:**

MU MECH CONT **= residential**  **and light**  **commercial mechanical**  **contractor markup** 

**The following**  **equation describes**  **how DOE**  **determined the**  **equipment price**  **if a** 

**mechanical contractor**  **sells the**  **equipment to**  **the customer**  **through a**  **general contractor** 

**distribution chain:** 

EQP CUST **=** MSP **x** MU WHOLE **x** MU MECH CONT **x** MU GEN CONT **x (1+**  **ST)** Eq. 6.4

**where:**

MU GEN CONT **= general**  **contractor markup** 

**The markup**  **multiplier to**  **the equipment**  **price is**  **lessened for**  **shorter distribution**  **chains**

**by omitting**  **the applicable**  **markup(s).**

**The mechanical**  **contractor markup**  **is a**  **function of**  **whether the**  **contractor serves**  **the new** 

**or replacement**  **market (as**  **measured in**  **annual revenues).**  **The later**  **sections of**  **this chapter** 

**describe the**  **determination of**  **the residential**  **and light**  **commercial mechanical**  **contractor**

**markups and**  **market type**  **(i.e., new**  **or replacement).**  **For each**  **of the**  **markups presented**  **above,**

**DOE further**  **differentiated between**  **a baseline**  **markup and**  **an incremental**  **markup, as**  **described**

**below. The**  **overall markup**  **describes the**  **product of**  **all the**  **markups (baseline**  **and incremental)** 

**plus sales**  **tax within**  **a distribution**  **channel.**

6.2.1 Baseline Markups

**DOE defined**  **baseline markups**  **as cost**  **multipliers that**  **convert the**  **MSP of**  **equipment**

**with baseline**  **efficiency to**  **the customer**  **purchase price**  **for the**  **equipment at**  **the same**  **baseline**

**efficiency level.** 

**If sold**  **to a**  **customer by**  **the manufacturer**  **through a**  **national account,**  **the following** 

**equation defines**  **the equipment**  **price:**

**6­3**EQP NATL ACCNT BASE **=** MSP BASE **x** MU NATL ACCT BASE **x (1+ST)**  Eq. 6.5

**where:**

EQP NATL ACCNT BASE **= national**  **account price**  **to the**  **customer of**  **baseline equipment**  **($),**

MSP BASE **= manufacturer**  **selling price**  **of baseline**  **equipment ($),** 

MU NATL ACCT BASE **= national**  **account markup**  **on baseline**  **equipment,**

ST

**= sales**  **tax ($).** 

**If sold**  **to a**  **customer by**  **a wholesaler­distributor:** 

EQP WHOLE BASE **=** MSP BASE **x** MU WHOLE BASE **x (1+ST)**  Eq. 6.6

**If sold**  **to a**  **customer directly**  **by a**  **mechanical contractor:** 

EQP MECH CONT BASE **=** MSP BASE **x** MU WHOLE BASE **x** MU MECH CONT BASE **x (1+ST)**  Eq. 6.7

**If sold**  **to a**  **customer by**  **a mechanical**  **contractor through**  **a general­contractor**  **distributor:**

EQP GEN CONT BASE **=** MSP BASE **x** MU WHOLE BASE **x** MU MECH CONT BASE **x** MU GEN CONT BASE **x (1+ST)**  Eq. 6.8

**where:**

EQP WHOLE BASE **= wholesaler**  **price of**  **baseline equipment**  **($),**

EQP MECH CONT BASE **= mechanical**  **contractor price**  **of baseline**  **equipment ($),** 

EQP GEN CONT BASE **= general**  **contractor price**  **of baseline**  **equipment ($),** 

MU WHOLE BASE **= wholesaler**  **markup on**  **baseline equipment,** 

MU MECH CONT BASE **= mechanical**  **contractor markup**  **on baseline**  **equipment,**

MU GEN CONT BASE **= general**  **contractor markup**  **on baseline**  **equipment.**

**The use**  **of the**  **markups results**  **in the**  **national account**  **(** EQP NATL ACCNT BASE **), wholesaler** 

**(** EQP WHOLE BASE **), mechanical**  **contractor (**  EQP MECH CONT BASE **), and**  **general contractor**  **(** EQP GEN CONT

BASE **) prices**  **of baseline**  **PTAC and**  **PTHP equipment.** 

6.2.2 Incremental Markups

**Incremental markups**  **are defined**  **as the**  **cost multipliers**  **to convert**  **the incremental** 

**increase in**  **MSP of**  **higher efficiency**  **equipment to**  **the customer**  **purchase price**  **for the**  **same**

**equipment, as**  **shown in**  **the following**  **equations:**

**If sold**  **to a**  **customer by**  **the manufacturer**  **through a**  **national account,**  **the following** 

**equation defines**  **the equipment**  **price:**

EQP NATL ACCNT INCR **=** MSP INCR **x** MU NATL ACCT INCR **x (1+ST)**  Eq. 6.9

**where:**

EQP NATL ACCNT INCR **= incremental**  **equipment price**  **to the**  **national account**  **customer**

**($),**

**6­4**MSP INCR **= change**  **in the**  **MSP of**  **higher efficiency**  **equipment brought**  **about**

**by an**  **increase in**  **efficiency due**  **to new**  **energy conservation** 

**standards ($),** 

MU NATL ACCT INCR **= national**  **account incremental**  **markup,**

ST

**= sales**  **tax ($).** 

**If sold**  **to a**  **customer by**  **a wholesaler­distributor:** 

EQP WHOLE INCR **=** MSP INCR **x** MU WHOLE INCR **x (1+ST)**  Eq. 6.10

**If sold**  **to a**  **customer directly**  **by a**  **mechanical contractor:** 

EQP MECH CONT INCR **=** MSP INCR **x** MU WHOLE INCR **x** MU MECH CONT INCR **x (1+ST)**  Eq. 6.11

**If sold**  **to a**  **customer by**  **a mechanical**  **contractor through**  **a general­contractor**  **distributor:**

EQP GEN CONT INCR **=** MSP INCR **x** MU WHOLE INCR **x** MU MECH CONT INCR **x** MU GEN CONT INCR **x (1+ST)**  Eq. 6.12

**where:**

EQP WHOLE INCR **= incremental**  **wholesaler price**  **($),**

EQP MECH CONT INCR **= incremental**  **mechanical contractor**  **price ($),** 

EQP GEN CONT INCR **= incremental**  **general contractor**  **price ($),** 

MU WHOLE INCR **= incremental**  **wholesaler markup,** 

MU MECH CONT INCR **= incremental**  **mechanical contractor**  **markup,**

MU GEN CONT INCR **= incremental**  **general contractor**  **markup.**

**In these**  **equations,** MSP INCR **refers to**  **a change**  **in the**  **MSP (e.g.,**  **brought about**  **by an** 

**increase in**  **equipment efficiency**  **due to**  **amended energy**  **conservation standards)**  **and** MU NATL ACCT

INCR , MU WHOLE INCR

**,** MU MECH CONT INCR

, **and** MU GEN CONT INCR **refer to**  **the incremental**  **national account,** 

**incremental wholesaler,**  **incremental mechanical**  **contractor, and**  **incremental general**  **contractor**

**markups, respectively.**  **The use**  **of the**  **incremental markups**  **results in**  **incremental equipment** 

**price to**  **the national**  **account customer**  **(** EQP NATL ACCNT INCR **), incremental**  **wholesaler (**  EQP WHOLE

INCR **), incremental**  **mechanical contractor**  **(** EQP MECH CONT INCR **), and**  **incremental general**  **contractor**

**(** EQP GEN CONT INCR **) prices.** 

6.2.3 Overall Markups

**The overall**  **markup is**  **the product**  **of all**  **the markups,**  **including both**  **overall baseline**  **and**

**overall incremental**  **markups, for**  **the different**  **steps within**  **a distribution**  **channel plus**  **sales tax,** 

**as indicated**  **by the**  **following equations:** 

EQP CUST BASE **=** MSP BASE **x (** WT NATL ACCNT BASE **x** MU NATL ACCT BASE + WT WHOLE BASE **x** MU WHOLE

BASE + WT MECH CONT BASE **x** MU WHOLE BASE **x** MU MECH CONT BASE **+** WT GEN CONT BASE **x** MU WHOLE BASE **x**

MU MECH CONT BASE **x** MU GEN CONT BASE **) x**  **(1+** ST **)**

**=** MSP BASE **x** MU OVERALL BASE **)** Eq. 6.13

**6­5**EQP CUST INCR **=** MSP INCR **x (** WT NATL ACCNT INCR **x** MU NATL ACCT INCR + WT WHOLE INCR **x** MU WHOLE

INCR + WT MECH CONT INCR **x** MU WHOLE INCR **x** MU MECH CONT INCR **+** WT GEN CONT INCR **x** MU WHOLE INCR **x** MU MECH

CONT INCR **x** MU GEN CONT INCR **) x**  **(1+** ST **)**

**=** MSP INCR **x** MU OVERALL INCR Eq. 6.14

EQP CUST = EQP CUST BASE + EQP CUST INCR Eq. 6.15

**where:**

EQP CUST BASE **= baseline**  **customer price**  **($),**

EQP CUST INCR **= incremental**  **customer price**  **($),**

EQP CUST **= total**  **customer price**  **($),**

MU OVERALL BASE **= overall**  **weighted baseline**  **markup that**  **is the**  **product of**  **all the** 

**weights and**  **baseline markups**  **for each**  **step of**  **the distribution** 

**channel,**

MU OVERALL INCR **= overall**  **weighted incremental**  **markup that**  **is the**  **product of**  **all**

**the weights**  **and incremental**  **markups for**  **each step**  **of the** 

**distribution channel,** 

WT NATL ACCNT BASE **= weight**  **(percent) of**  **baseline equipment**  **sales through**  **national**

**accounts,**

WT WHOLE BASE **= weight**  **(percent) of**  **baseline equipment**  **sales through** 

**wholesalers,**

WT MECH CONT BASE **= weight**  **(percent) of**  **baseline equipment**  **sales through**  **mechanical**

**contractors,**

WT GEN CONT BASE **= weight**  **(percent) of**  **baseline equipment**  **sales through**  **general**

**contractors,**

WT NATL ACCNT INCR **= weight**  **(percent) of**  **higher efficiency**  **equipment sales**  **through**

**national accounts,** 

WT WHOLE INCR **= weight**  **(percent) of**  **higher efficiency**  **equipment sales**  **through**

**wholesalers,**

WT MECH CONT INCR **= weight**  **(percent) of**  **higher efficiency**  **equipment sales**  **through**

**mechanical contractors,** 

WT GEN CONT INCR **= weight**  **(percent) of**  **higher efficiency**  **equipment sales**  **through**

**general contractors.** 

**The use**  **of the**  **overall baseline**  **and overall**  **incremental markups**  **results in**  **the baseline** 

**customer price**  **(** EQP CUST BASE **) and**  **the incremental**  **customer price**  **(** EQP CUST INCR **). For**  **a particular** 

**higher efficiency**  **level that**  **increases MSP,**  **the total**  **equipment price**  **(** EQP CUST **) to**  **the customer** 

**is the**  **sum of**  **the baseline**  **customer price**  **(** EQP CUST BASE **) and**  **the incremental**  **customer price** 

**(** EQP CUST INCR **).**

6.3 ASSUMPTIONS USED TO ESTIMATE WHOLESALER AND CONTRACTOR

MARKUPS

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

**PTAC and**  **PTHP costs.**  **DOE based**  **the wholesaler**  **and mechanical**  **contractor markups**  **on firm** 

**balance­sheet data,**  **while it**  **based the**  **general contractor**  **markups on**  **U.S. Census**  **Bureau data**  **for**

**6­6 the**  **commercial and**  **institutional building**  **construction industry.**  **DOE obtained**  **the firm**  **balance**

**sheets from**  **the Heating,**  **Air­conditioning &**  **Refrigeration Distributors**  **International (HARDI)** 

**2005 Profit**  **Planning Report**  **and from**  **the Air**  **Conditioning Contractors**  **of America**  **(ACCA). 2,3** 

**HARDI and**  **ACCA are**  **trade associations**  **representing wholesalers**  **and mechanical**  **contractors,**

**respectively. DOE**  **used the**  **financial data**  **from the**  **2002 US**  **Census Bureau**  **for developing** 

**general contractor**  **markups in**  **the same**  **form as**  **the balance**  **sheet data**  **for wholesalers**  **and**

**mechanical contractors.**  **4 These**  **balance sheets**  **break out**  **the components**  **of all**  **costs incurred**  **by**

**firms that**  **supply and**  **install air**  **conditioning equipment.**  **a The**  **key assumptions**  **used to**  **estimate**

**markups using**  **these financial**  **data are:** 

• **The firm**  **balance sheets**  **accurately represent**  **the various**  **average costs**  **incurred by**  **firms**

**distributing and**  **installing commercial**  **air conditioning**  **and heating**  **equipment.**

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

**of commercial**  **air conditioning**  **and heating**  **equipment (variable**  **costs); and**  **(2) costs**  **do not** 

**vary with**  **the MSP**  **of commercial**  **air conditioning**  **and heating**  **equipment (fixed**  **costs).**

• **Wholesaler and**  **contractor prices**  **vary in**  **proportion to**  **PTAC and**  **PTHP wholesaler**  **and**

**contractor costs**  **included in**  **the balance**  **sheets.**

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

**expense categories,**  **including direct**  **costs to**  **purchase or**  **install the**  **equipment, operating**  **labor**

**and occupancy**  **costs, and**  **other operating**  **costs and**  **profit. Although**  **wholesalers and**  **contractors**

**tend to**  **handle multiple**  **commodity lines**  **(including air**  **conditioners, furnaces,**  **and boilers),**  **the**

**data provide**  **the most**  **accurate available**  **indication of**  **PTAC and**  **PTHP expenses.** 

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

**conditioning (HVAC)**  **wholesalers, contractors,**  **and consultants**  **support the**  **second assumption.** 

**This information**  **indicated that**  **wholesaler and**  **contractor markups**  **vary according**  **to the**  **quantity**

**of labor**  **and materials**  **used to**  **distribute and**  **install appliances,**  **with markups**  **on labor**  **tending to** 

**be much**  **higher than**  **markups on**  **materials. The**  **obtained information**  **described markups**  **as**

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

**appliance efficiency.**  **This last**  **finding strongly**  **suggested that**  **labor inputs**  **vary more**  **with sales** 

**volume than**  **with appliance**  **cost or**  **efficiency. DOE**  **assumed a**  **division of**  **costs between**  **those**

**costs that**  **do not**  **scale with**  **the MSP**  **(labor and**  **occupancy expenses),**  **and those**  **costs that**  **do**

**(operating expenses**  **and profit).**  **This division**  **of costs**  **led to**  **the estimate**  **of wholesaler**  **and**

**contractor markups**  **described below.** 

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

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

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

**large number**  **of HVAC**  **firms listed**  **in the**  **2002 Census**  **indicates the**  **competitive nature**  **of the** 

**market. For**  **example, there**  **are more**  **than 700**  **HVAC manufacturers,**  **5 6,000**  **wholesalers of**  **heat**

**pumps and**  **air­conditioning equipment,**  **6 more**  **than 37,000**  **general contractors,**  **7 and**  **87,000**

**HVAC contractors**  **8 listed**  **in the**  **2002 Census.**  **Following standard**  **economic theory,**  **competitive**

**firms facing**  **inelastic demand**  **either set**  **prices in**  **line with**  **costs or**  **quickly go**  **out of**  **business. 9** 

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

**residential and**  **commercial air­conditioners**  **and warm­air**  **furnaces.**

**6­7**6.4 ESTIMATION OF WHOLESALER MARKUPS

**Wholesalers reported**  **median data**  **in a**  **confidential survey**  **that HARDI**  **conducted of** 

**member firms.**  **2 In**  **the survey,**  **HARDI itemized**  **revenues and**  **costs into**  **cost categories,** 

**including direct**  **equipment expenses**  **(cost of**  **goods sold),**  **labor expenses,**  **occupancy expenses,** 

**other operating**  **expenses, and**  **profit. DOE**  **presents these**  **data in**  **full in**  **appendix A,**  **Detailed**

**Data for**  **Equipment Price**  **Markups. Table**  **6.4.1 summarizes**  **them as**  **cost­per­dollar sales** 

**revenue in**  **the first**  **data column.** 

Table 6.4.1 Wholesaler Expenses and Markups

Descriptions Per Dollar

Sales Revenue Per Dollar Cost of

Goods

Direct Cost of Equipment Sales: **Cost of**  **goods sold**  **$0.70 $1.00** 

Labor Expenses: **Salaries and**  **benefits $0.20**  **$0.28**

Occupancy Expense: **Rent, maintenance,**  **and utilities**  **$0.03 $0.05** 

Other Operating Expenses: **Depreciation, advertising,**  **and insurance.**  **$0.04 $0.06** 

Profit **$0.03 $0.04** 

Baseline Revenue: **Baseline revenue**  **earned per**  **dollar cost**  **of goods**  **sold** $1.43

Wholesaler Baseline Markup ( MU WHOLE BASE ) 1.43

Incremental Revenue: **Increased revenue**  **per dollar**  **increase cost**  **of goods**  **sold** $1.10

Incremental Markup ( MU WHOLE INCR ) 1.10

**Source: Heating,**  **Air Conditioning**  **& Refrigeration**  **Distributors International.**  **2005. 2005**  **Profit Report**  **(2004 Data).**  **2**

**In this**  **case, direct**  **equipment expenses**  **(cost of**  **goods sold)**  **represent about**  **$0.70 per** 

**dollar sales**  **revenue, so**  **for every**  **$1 wholesalers**  **take in**  **as sales**  **revenue, $0.70**  **is used**  **to pay** 

**the direct**  **equipment costs.**  **Labor expenses**  **represent $0.20**  **per dollar**  **sales revenue,**  **occupancy**

**expenses represent**  **$0.03, other**  **operating expenses**  **represent $0.04,**  **and profit**  **accounts for**  **$0.03**

**per dollar**  **sales revenue.** 

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

**by dividing**  **each figure**  **in the**  **first data**  **column by**  **$0.70 (i.e.**  **cost of**  **goods sold**  **per dollar**  **of**

**sales revenue).**  **The data**  **in column**  **two show**  **that, for**  **every $1.00**  **the wholesaler**  **spends on** 

**equipment costs,**  **the wholesaler**  **earns $1.00**  **in sales**  **revenue to**  **cover the**  **equipment cost,**  **$0.28**

**to cover**  **labor costs,**  **$0.05 to**  **cover occupancy**  **expenses, $0.06**  **for other**  **operating expenses,**  **and**

**$0.04 in**  **profits. This**  **totals to**  **$1.43 in**  **sales revenue**  **earned for**  **every $1.00**  **spent on**  **equipment**

**costs. Therefore,**  **the wholesaler**  **baseline markup**  **(** MU WHOLE BASE **) is**  **1.43 ($1.43**  **÷ $1.00).** 

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

**incremental markup**  **depends on**  **which of**  **the costs**  **in Table**  **6.4.1 are**  **variable and**  **which are** 

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

**(i.e., all**  **costs are**  **variable), the**  **increase in**  **wholesaler price**  **will be**  **$1.43, implying**  **that the** 

**incremental markup**  **is 1.43,**  **or the**  **same as**  **the baseline**  **markup. At**  **the other**  **extreme, if**  **none of** 

**the other**  **costs is**  **variable, then**  **a $1.00**  **increase in**  **the MSP**  **will lead**  **to a**  **$1.00 increase**  **in the** 

**wholesaler price,**  **for an**  **incremental markup**  **of 1.0.**  **Actually, DOE**  **believes that**  **the labor**  **and**

**occupancy costs**  **will be**  **fixed and**  **that the**  **other operating**  **costs and**  **profit will**  **scale with**  **the**

**6­8 MSP**  **(i.e., be**  **variable). In**  **this case,**  **for a**  **$1.00 increase**  **in the**  **MSP, the**  **wholesaler price**  **will**

**increase by**  **$1.10, giving**  **a wholesaler**  **incremental markup**  **(** MU WHOLE INCR **) of**  **1.10.**

6.4.1 Estimation of Wholesaler Markup Probability Distribution

**DOE characterized**  **the markups**  **developed from**  **the above**  **financial data**  **with probability** 

**distributions from**  **statistics published**  **by the**  **U.S. Census**  **Bureau for**  **wholesalers (see**  **appendix**

**A). The**  **analysis provided**  **a standard**  **deviation on**  **the markups**  **of wholesaler**  **firms in**  **the U.S.** 

**DOE then**  **applied the**  **standard deviation**  **to the**  **single­point baseline**  **and incremental**  **markups**

**calculated above**  **to create**  **normal probability**  **distributions for**  **these markups.** 

**Based on**  **the analysis**  **of U.S.**  **Census data**  **for wholesalers,**  **DOE calculated**  **a standard** 

**deviation of**  **8.6 percent**  **for the**  **baseline markup**  **as described**  **in appendix**  **A. DOE**  **assumed that** 

**the variation**  **determined for**  **the baseline**  **markup applied**  **to the**  **incremental markup**  **as well.**  **For**

**the baseline**  **markup of**  **1.43, a**  **standard deviation**  **of 8.6**  **percent translates**  **into an**  **absolute value** 

**of 0.123.**  **For the**  **incremental markup**  **of 1.10,**  **a standard**  **deviation of**  **8.6 percent**  **translates into** 

**an absolute**  **value of**  **0.095.**

**Figure 6.4.1**  **and Figure**  **6.4.2 show**  **the probability**  **distributions that**  **DOE used**  **to**

**characterize the**  **wholesaler baseline**  **and incremental**  **markups.**

Figure 6.4.1 Wholesaler Baseline

Markup Probability Distribution Figure 6.4.2 Wholesaler Incremental

Markup Probability Distribution

**Note that**  **for the**  **incremental markup,**  **the standard**  **deviation of**  **8.6 percent**  **results in** 

**markup values**  **that are**  **less than**  **1.0. Since**  **a markup**  **value of**  **less than**  **1.0 would**  **not allow**  **the**

**wholesaler to**  **recover its**  **costs, DOE**  **truncated all**  **values less**  **than 1.0**  **from the**  **normal**

**distribution as**  **shown in**  **Figure 6.4.2.** 

6.5 ESTIMATION OF MECHANICAL CONTRACTOR MARKUPS

**The HVAC**  **contractors, defined**  **here as**  **mechanical contractors,**  **reported median**  **cost**

**data in**  **an ACCA**  **financial analysis**  **of the**  **HVAC industry.**  **3 This**  **data is**  **shown in**  **Table 6.5.1.** 

Table 6.5.1 Baseline Markup, All Mechanical Contractors

Contractor Expenses or Revenue

Description Per Dollar Per Dollar Cost of

**6­9**Sales Revenue Goods

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

Gross Margin: **Labor, occupancy,**  **operating expenses,**  **and profit**  **$0.27 $0.37** 

Revenue: **Baseline revenue**  **earned per**  **dollar cost**  **of goods**  $1.37

Baseline Markup ( MU MECH CONT BASE ) 1.37

**Source: Air**  **Conditioning Contractors**  **of America.**  **2005. Financial**  **Analysis for**  **the HVACR**  **Contracting Industry.**  **3**

**Data reported**  **in this**  **analysis are**  **not as**  **detailed as**  **that provided**  **by the**  **other sources,** 

**containing only**  **cost of**  **goods sold**  **and gross**  **margin. Since**  **the gross**  **margin is**  **the sum**  **of labor,** 

**occupancy expenses,**  **operating expenses,**  **and profit,**  **the gross**  **margin allows**  **for the** 

**determination of**  **the baseline**  **markup. The**  **first data**  **column in**  **Table 6.5.1**  **provides the**  **cost of** 

**goods sold**  **and gross**  **margin as**  **expenses per**  **dollar sales**  **revenue. The**  **only important**  **difference**

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

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

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

**mechanical contractor**  **expenditures per**  **dollar sales**  **revenue in**  **Table 6.5.1**  **are quite**  **similar to**  **the**

**wholesaler expenditures**  **per dollar**  **sales revenue**  **reported in**  **Table 6.4.1.** 

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

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

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

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

**earned for**  **every $1.00**  **spent on**  **equipment costs,**  **for a**  **baseline markup**  **(** MU MECH CONT BASE **) of**  **1.37**

**for mechanical**  **contractors, since**  **the contractor**  **earns $1.37**  **in sales**  **revenue for**  **every $1.00** 

**spent to**  **purchase the**  **equipment.**

6.5.1 Markups for Mechanical Contractors in the Replacement and New Construction

Markets

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

**all contractors**  **including the**  **replacement and**  **new construction**  **markets. This**  **section describes** 

**how DOE**  **further derived**  **the baseline**  **and incremental**  **markups for**  **these latter**  **two markets.**  **As**

**above, the**  **ACCA financial**  **data provided**  **gross margin**  **data, which**  **allows for**  **the determination** 

**of only**  **the baseline**  **markup for**  **the two**  **markets, since**  **the gross**  **margin is**  **the sum**  **of all** 

**contractor labor**  **and operating**  **expenses plus**  **profit. Calculation**  **of the**  **incremental markup**  **uses**

**Census Bureau**  **data, because**  **this was**  **not possible**  **with the**  **ACCA data**  **as the**  **variable costs**  **are**

**not provided**  **separately.**

**6­10 Table**  **6.5.2 summarizes**  **the gross**  **margin and**  **resulting baseline**  **markup data**  **for all** 

**mechanical contractors**  **that serve**  **the replacement**  **and new**  **construction markets.** 

Table 6.5.2 Baseline Markups for the Replacement and New Construction Markets, All

Mechanical Contractors

Description Contractor Expenses or Revenue by Market Type

Replacement New Construction

Per Dollar

Sales Revenue Per Dollar

Cost of Goods Per Dollar

Sales Revenue Per Dollar

Cost of Goods

Direct Cost of Equipment Sales: **Cost**

**of goods**  **sold $0.70**  **$1.00 $0.75**  **$1.00**

Gross Margin: **Labor, occupancy,** 

**operating expenses,**  **and profit**  **$0.30 $0.43**  **$0.25 $0.33** 

Baseline Markup ( MU MECH CONT BASE ):

**Revenue per**  **dollar cost**  **of goods**  **NA** 1.43 **NA** 1.33

**Source: Air**  **Conditioning Contractors**  **of America.**  **2005. Financial**  **Analysis for**  **the HVACR**  **Contracting Industry.**  **3**

**Using the**  **baseline markup**  **data from**  **Table 6.5.2**  **and results**  **of a**  **financial analysis**  **3**

**, DOE** 

**calculated that**  **the baseline**  **markups for**  **the replacement**  **and new**  **markets are**  **4.4 percent**  **higher**

**and 2.9**  **percent lower,**  **respectively, than**  **that for**  **all mechanical**  **contractors serving**  **all markets.** 

**DOE then**  **used the**  **ACCA data**  **to calculate**  **the baseline**  **markup of**  **1.32 for**  **the**

**residential and**  **light commercial**  **building construction**  **section as**  **shown in**  **Table 6.5.3.** 

Table 6.5.3 Mechanical Contractor Expenses and Baseline Markup, Residential and

Light Commercial

Description Contractor Expenses or Revenue

Per Dollar

Sales Revenue Per Dollar Cost of

Goods

Direct Cost of Equipment Sales: **Cost of**  **goods sold**  **$0.76 $1.00** 

Gross Margin: **Labor, occupancy,**  **operating expenses,**  **and profit**  **$0.24 $0.32** 

Baseline Markup ( MU MECH CONT BASE ): **Revenue per**  **dollar cost**  **of goods**  1.32

**Source: Air**  **Conditioning Contractors**  **of America.**  **2005. Financial**  **Analysis for**  **the HVACR**  **Contracting Industry.**  **3**

**The markup**  **deviations derived**  **above (i.e.,**  **4.4 percent**  **higher and**  **2.9 percent**  **of lower** 

**for the**  **replacement and**  **new construction**  **markets, respectively)**  **were then**  **applied to**  **the**

**baseline markup**  **of 1.32**  **for the**  **residential and**  **light commercial**  **building construction**  **section.**

**This resulted**  **in baseline**  **markups of**  **1.38 and**  **1.28, respectively,**  **for the**  **replacement and**  **new**

**construction markets**  **served by**  **mechanical contractors**  **for the**  **residential and**  **light commercial** 

**building construction.** 

**Calculation of**  **the incremental**  **markups for**  **each market**  **type required**  **separation of**  **the**

**fixed and**  **variable costs.**  **Since this**  **was not**  **possible using**  **the ACCA**  **data, DOE**  **used more** 

**detailed 2002**  **Census Bureau**  **data for**  **all plumbing,**  **heating, and**  **air­conditioning contractors.**  **7**

**The Census**  **Bureau data**  **were used**  **to calculate**  **the baseline**  **and incremental**  **markups as**  **shown**

**in Table**  **6.5.4.**

**6­11**Table 6.5.4 Mechanical Contractor Expenses and Markups Based on Census Bureau Data

Description Contractor Expenses or Revenue

Per Dollar

Sales Revenue Per Dollar Cost of

Goods

Direct Cost of Equipment Sales: **Cost of**  **goods sold**  **$0.66 $1.00** 

Labor Expenses: **Salaries (indirect)**  **and benefits**  **$0.17 $0.26** 

Occupancy Expense: **Rent, maintenance,**  **and utilities**  **$0.02 $0.03** 

Other Operating Expenses: **Depreciation, advertising,**  **and insurance.**  **$0.03 $0.05** 

Net Profit Before Taxes **$0.12 $0.18** 

Baseline Markup ( MU MECH BASE ): **Revenue per**  **dollar cost**  **of goods**  1.52

Incremental Markup ( MU MECH INCR ): **Increased revenue**  **per dollar** 

**increase cost**  **of goods**  **sold** 1.23

**Source: U.S.**  **Census Bureau.**  **2002. Plumbing,**  **Heating, and**  **Air­Conditioning Contractors:**  **2002. Report**  **EC02­231­238220,**

**Table 4,**  **Detailed Statistics**  **for Establishments:**  **2002. 7** 

**Using the**  **data Table**  **6.5.4, the**  **incremental markup**  **is 19.1**  **percent lower**  **than the** 

**baseline markup.**  **DOE assumed**  **that this**  **deviation applies**  **equally to**  **the baseline**  **markups**

**calculated for**  **replacement of**  **1.38 and**  **new construction**  **markets of**  **1.28. This**  **yields**

**incremental markups**  **of 1.12**  **and 1.04,**  **respectively, for**  **the replacement**  **and new**  **construction**

**markets served**  **by mechanical**  **contractors.**

6.5.2 Estimation of Mechanical Contractor Markup Probability Distribution

**DOE characterized**  **the markups**  **developed from**  **the ACCA**  **financial data**  **with**

**probability distributions**  **through a**  **statistical analysis**  **of U.S.**  **Census data**  **for plumbing,**  **heating,**

**and air­conditioning**  **contractors. The**  **statistical analysis**  **provided a**  **standard deviation**  **on the** 

**markups of**  **mechanical contractors**  **in the**  **U.S. DOE**  **then applied**  **the standard**  **deviation to**  **the**

**single­point baseline**  **and incremental**  **markups calculated**  **above to**  **create normal**  **probability**

**distributions for**  **these markups.** 

**Based on**  **the analysis**  **of U.S.**  **Census data**  **for mechanical**  **contractors, DOE**  **calculated a** 

**standard deviation**  **of 7.9**  **percent for**  **the baseline**  **markup as**  **described in**  **appendix A.**  **DOE**

**assumed that**  **the variation**  **determined for**  **the baseline**  **markup applied**  **to the**  **incremental markup** 

**as well.**  **For the**  **baseline markup**  **of 1.38**  **and 1.28**  **for the**  **replacement and**  **new construction** 

**markets, respectively,**  **a standard**  **deviation of**  **7.9 percent**  **translates into**  **respective absolute** 

**values of**  **0.109 and**  **0.101. For**  **the incremental**  **markups of**  **1.12 and**  **1.04 for**  **the replacement** 

**and new**  **construction markets,**  **respectively, a**  **standard deviation**  **of 7.9**  **percent translates**  **into**

**respective absolute**  **values of**  **0.089 and**  **0.082.**

**DOE calculated**  **a standard**  **deviation of**  **7.9 percent**  **for mechanical**  **contractor markups.** 

**Figure 6.5.1**  **and Figure**  **6.5.2 show**  **the probability**  **distributions that**  **DOE used**  **to characterize** 

**the mechanical**  **contractor baseline**  **and incremental**  **markups for**  **the replacement**  **and new** 

**markets.**

**6­12 Replacement**  **Market New**  **Construction Market** 

Figure 6.5.1 Mechanical Contractor Baseline Markup Probability Distribution

**Replacement Market**  **New Construction**  **Market**

Figure 6.5.2 Mechanical Contractor Incremental Markup Probability Distribution

**Note that**  **for the**  **incremental markups,**  **the standard**  **deviation of**  **7.9 percent**  **results in**  **markup**

**values that**  **are less**  **than 1.0.**  **Since a**  **markup value**  **of less**  **than 1.0**  **would not**  **allow the** 

**mechanical contractor**  **to recover**  **their costs,**  **DOE truncated**  **all values**  **less than**  **1.0 from**  **the**

**normal distribution**  **as shown**  **in Figure**  **6.4.2.**

6.6 ESTIMATION OF GENERAL CONTRACTOR MARKUPS

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

**commercial and**  **institutional building**  **construction sector.**  **4 This**  **sector includes**  **establishments**

**primarily engaged**  **in construction**  **work, including**  **new construction**  **work, additions,**  **alterations,**

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

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

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

**construction industry**  **as a**  **whole in**  **total dollars**  **rather than**  **in typical**  **values for**  **an average**  **or**

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

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

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

**Table 6.6.1**  **summarizes the**  **expenses for**  **general contractors**  **as expenses**  **per dollar**  **sales revenue** 

**in the**  **first data**  **column (appendix**  **A contains**  **the full**  **set of**  **data).**

Table 6.6.1 General Contractor Expenses and Markups

Description Wholesale Firm Expenses or Revenue

Per Dollar

Sales Revenue Per Dollar

Cost of Goods

Direct Cost of Equipment Sales: **Cost of**  **goods sold**  **$0.78 $1.00** 

Labor Expenses: **Salaries (indirect)**  **and benefits**  **$0.08 $0.10** 

Occupancy Expense: **Rent, maintenance,**  **and utilities**  **$0.02 $0.03** 

**6­13**Other Operating Expenses: **Depreciation, advertising,**  **and insurance.**  **$0.01 $0.01** 

Net Profit Before Taxes **$0.12 $0.15** 

Baseline Markup ( MU GEN CONT BASE ): **Revenue per**  **dollar cost**  **of goods**  1.29

Incremental Markup ( MU GEN CONT INCR ): **Increased revenue**  **per dollar**  **increase cost**  **of goods** 

**sold** 1.16

**Source: U.S.**  **Census Bureau.**  **2002. Commercial**  **and Institutional**  **Building Construction:**  **2002. Report**  **EC02­231­236220,**

**Table 4,**  **Detailed Statistics**  **for Establishments:**  **2002. 7** 

**For example,**  **the direct**  **cost of**  **sales represents**  **about $0.78**  **per dollar**  **sales revenue**  **to the** 

**general contractor.**  **Labor expenses**  **represent $0.08**  **per dollar**  **sales revenue,**  **occupancy**

**expenses represent**  **$0.02 per**  **dollar sales**  **revenue, other**  **operating expenses**  **represent $0.01,**  **and**

**profit makes**  **up $0.12**  **per dollar**  **sales revenue.** 

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

**by dividing**  **each figure**  **in the**  **first data**  **column by**  **$0.78. The**  **data in**  **column two**  **show that,**  **for**

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

**in sales**  **revenue to**  **cover the**  **equipment cost,**  **$0.10 to**  **cover labor**  **costs, $0.03**  **to cover** 

**occupancy expenses,**  **$0.01 for**  **other operating**  **expenses, and**  **$0.15 in**  **profits. This**  **totals to** 

**$1.29 in**  **sales revenue**  **earned for**  **every $1.00**  **spent on**  **equipment costs.**  **Thus, the**  **general**

**contractor baseline**  **markup (**  MU GEN CONT BASE **) is**  **1.29.**

**DOE was**  **also able**  **to use**  **the data**  **in column**  **two in**  **the table**  **above to**  **estimate the** 

**incremental markups**  **by being**  **able to**  **separate the**  **fixed and**  **variable costs.**  **At one**  **extreme, if** 

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

**general contractor**  **price will**  **be $1.29,**  **implying that**  **the incremental**  **markup is**  **1.29, or**  **the same** 

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

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

**an incremental**  **markup of**  **1.0. DOE**  **believed the**  **labor and**  **occupancy costs**  **to be**  **fixed and**  **the**

**other operating**  **costs and**  **profit to**  **scale with**  **the equipment**  **price (i.e.,**  **be variable).**  **In this**  **case,**

**for a**  **$1.00 increase**  **in the**  **equipment price,**  **the general**  **contractor price**  **will increase**  **by $1.16,** 

**giving a**  **general contractor**  **incremental markup**  **(** MU GEN CONT INCR **) of**  **1.16.**

6.6.1 Estimation of General Contractor Markup Probability Distribution

**DOE characterized**  **the markups**  **developed above**  **with probability**  **distributions derived** 

**from a**  **statistical analysis**  **of U.S.**  **Census data**  **for general**  **contractors engaged**  **in commercial**  **and**

**institutional building**  **construction. The**  **statistical analysis**  **provided a**  **standard deviation**  **on the** 

**markups of**  **general contractors**  **in the**  **United States.**  **DOE then**  **applied the**  **standard deviation**  **to**

**the single­point**  **baseline and**  **incremental markups**  **calculated above**  **to create**  **normal probability** 

**distributions for**  **these markups.** 

**Based on**  **the analysis**  **of U.S.**  **Census data**  **for general**  **contractors, DOE**  **calculated a** 

**standard deviation**  **of 9.0**  **percent for**  **the baseline**  **markup as**  **described in**  **appendix A.**  **DOE**

**assumed that**  **the variation**  **determined for**  **the baseline**  **markup applied**  **to the**  **incremental markup** 

**as well.**  **For the**  **baseline markup**  **of 1.29,**  **a standard**  **deviation of**  **9.0 percent**  **translates to**  **an**

**absolute value**  **of 0.116.**  **For the**  **incremental markup**  **of 1.16,**  **a standard**  **deviation of**  **9.0 percent** 

**translates to**  **an absolute**  **value of**  **0.104.**

**6­14 Figure**  **6.6.1 and**  **Figure 6.6.2**  **show the**  **probability distributions**  **that DOE**  **used to** 

**characterize the**  **general contractor**  **baseline and**  **incremental markups.**  **Note that**  **for the** 

**incremental markup,**  **the standard**  **deviation of**  **9.0 percent**  **results in**  **markup values**  **that are**  **less**

**than 1.0.**  **Since a**  **markup value**  **of less**  **than 1.0**  **would not**  **allow the**  **general contractor**  **to recover** 

**its costs,**  **DOE truncated**  **all values**  **less than**  **1.0 from**  **the normal**  **distribution.**

Figure 6.6.1 General Contractor Baseline

Markup Probability Distribution Figure 6.6.2 General Contractor

Incremental Markup Probability Distribution

6.7 SALES TAX

**The sales**  **tax represents**  **State and**  **local sales**  **taxes that**  **are applied**  **to the**  **customer price** 

**of the**  **packaged terminal**  **equipment. The**  **sales tax**  **is a**  **multiplicative factor**  **that increases**  **the**

**customer equipment**  **price. DOE**  **derived sales**  **taxes representative**  **of both**  **State and**  **local sales** 

**taxes from**  **The Sales**  **Tax Clearinghouse,**  **10 shown**  **in Table**  **6.7.1.**

Table 6.7.1 State Sales Tax Rates

State Combined

State and

Local Tax

Rate State Combined

State and

Local Tax

Rate State Combined

State and

Local Tax

Rate

**Alabama**

**Alaska**

**Arizona**

**Arkansas**

**California**

**Colorado**

**Connecticut**

**Delaware**

**Dist. of**  **Columbia**

**Florida**

**Georgia**

**Hawaii**

**Idaho**

**Illinois**

**Indiana**

**Iowa**

**Kansas 8.05%** 

**1.15%**

**7.65%**

**8.00%**

**7.95%**

**6.15%**

**6.00%**

**0.00%**

**5.75%**

**6.70%**

**6.90%**

**4.00%**

**5.05%**

**7.55%**

**6.00%**

**6.60%**

**6.95% Kentucky** 

**Louisiana**

**Maine**

**Maryland**

**Massachusetts**

**Michigan**

**Minnesota**

**Mississippi**

**Missouri**

**Montana**

**Nebraska**

**Nevada**

**New Hampshire** 

**New Jersey** 

**New Mexico** 

**New York** 

**North Carolina**  **6.00%**

**8.60%**

**5.00%**

**5.00%**

**5.00%**

**6.00%**

**6.70%**

**7.00%**

**6.85%**

**0.00%**

**6.30%**

**7.50%**

**0.00%**

**6.00%**

**6.55%**

**8.25%**

**7.05% North**  **Dakota**

**Ohio**

**Oklahoma**

**Oregon**

**Pennsylvania**

**Rhode Island** 

**South Carolina** 

**South Dakota** 

**Tennessee**

**Texas**

**Utah**

**Vermont**

**Virginia**

**Washington**

**West Virginia** 

**Wisconsin**

**Wyoming 5.50%** 

**6.75%**

**8.15%**

**0.00%**

**6.25%**

**7.00%**

**5.80%**

**5.25%**

**9.40%**

**7.95%**

**6.45%**

**6.00%**

**5.00%**

**8.45%**

**6.00%**

**5.40%**

**5.35%**

**6­15 The**  **State level**  **combined tax**  **rates can**  **be applied**  **to the**  **estimated value**  **of State**  **level**

**PTAC and**  **PTHP equipment**  **shipments to**  **obtain the**  **total purchase**  **cost to**  **the customer**  **located**

**in any**  **state.**

**The distribution**  **of sales**  **tax rates**  **ranges from**  **a minimum**  **of zero**  **percent to**  **a maximum** 

**of 9.4**  **percent with**  **a mean**  **value of**  **6.8 percent.**  **DOE applied**  **sales taxes**  **to the**  **customer**

**equipment price**  **irrespective of**  **the distribution**  **channel and**  **the market**  **in which**  **the customer**  **is**

**located.**

6.8 NATIONAL ACCOUNTS

**As mentioned**  **in section**  **6.1 in**  **this chapter,**  **equipment purchased**  **directly from** 

**manufacturer through**  **a national**  **account constitutes**  **approximately 15**  **percent for**  **the**

**replacement market**  **and 30**  **percent for**  **the new**  **construction market,**  **respectively, of**  **the usual** 

**distribution of**  **PTAC and**  **PTHP equipment**  **to customers.**  **Large customers**  **of PTAC**  **and PTHP** 

**equipment use**  **national accounts**  **to circumvent**  **the typical**  **distribution chain,**  **thereby allowing** 

**them to**  **negotiate significantly**  **lower equipment**  **prices directly**  **with the**  **manufacturer.**

**To capture**  **the price**  **savings realized**  **from equipment**  **purchased through**  **national**

**accounts, DOE**  **derived a**  **“national account”**  **markup, assuming**  **that the**  **resulting equipment**  **price**

**increase was**  **one­half of**  **that realized**  **from a**  **typical chain**  **of distribution.**  **In other**  **words, if**  **the**

**price increase**  **resulting from**  **the product**  **of the**  **wholesaler, mechanical**  **contractor, and**  **general**

**contractor markups**  **is $100,**  **the “national**  **account” markup**  **is such**  **that the**  **price increase**  **is one** 

**half of**  **that, or**  **$50. DOE**  **determined this**  **markup for**  **national accounts**  **(Table 6.8.1)**  **on the** 

**assumption that**  **the resulting**  **national account**  **equipment price**  **must fall**  **somewhere between**  **the**

**MSP (i.e.,**  **a markup**  **of 1.0)**  **and the**  **customer price**  **under a**  **typical chain**  **of distribution**  **(i.e., a** 

**markup of**  **wholesaler, mechanical**  **contractor, or**  **general contractor).** 

Table 6.8.1 National Account Markups

Markup Type

and Market Wholesaler Mechanical

Contractor General

Contractor Total National

Account*

**Baseline Markups** 

**Replacement 1.43**  **1.38 1.29**  **2.546 1.773** 

**New**

**Construction 1.43**  **1.28 1.29**  **2.361 1.681** 

**Incremental Markups** 

**Replacement 1.10**  **1.12 1.16**  **1.429 1.215** 

**New**

**Construction 1.10**  **1.04 1.16**  **1.327 1.164** 

***** **Nation account**  **is calculated**  **using the**  **formula of**  **(total­1) x**  **0.5 +1.** 

**For example,**  **using a**  **MSP price**  **of $1,000**  **for a**  **PTAC unit**  **and baseline**  **wholesaler,**

**mechanical contractor,**  **and general**  **contractor markups**  **of 1.43,**  **1.38, and**  **1.29, respectively,**  **the**

**resulting baseline**  **customer equipment**  **price without**  **sales taxes**  **is $2,546**  **($1,000** x **1.43** x **1.38** x **1.29). The**  **dollar value**  **increase due**  **to the**  **above distribution**  **channel markups**  **is $1,546**  **($2,546**

**­ $1,000). Under**  **the assumption**  **that national**  **account customers**  **realize equipment**  **price**

**increases equal**  **to one**  **half of**  **that in**  **a typical**  **distribution channel,**  **the dollar**  **value of**  **the**

**equipment price**  **increase under**  **the national**  **account for**  **the replacement**  **market is**  **$773 (one­half** 

**6­16 of**  **$1,546). The**  **resulting equipment**  **price is**  **$1,773 ($773**  **+ $1,000),**  **which results**  **in a**  **national**

**account markup**  **of 1.77**  **for the**  **replacement market**  **(i.e., $1,773**  **÷ $1,000=1.77).**  **Similarly,**

**DOE derived**  **a national**  **account markup**  **of 1.68**  **for the**  **new construction**  **market, using**  **baseline**

**wholesaler, mechanical**  **contractor, and**  **general contractor**  **markups of**  **1.43, 1.28,**  **and 1.29,** 

**respectively.**

6.9 OVERALL MARKUPS

**DOE multiplied**  **the wholesaler,**  **mechanical and**  **general contractor,**  **and national**  **account**

**markups described**  **above by**  **the sales**  **tax to**  **obtain the**  **overall baseline**  **and incremental**  **markups**

**shown in**  **Table 6.9.1**  **and Table**  **6.9.2, respectively.** 

**6­17**Table6.9.1OverallBaselineMarkups

**6­18**ReplacementMarketNewConstructionMarketWeighted­AverageMarketSectorWholesalerMechanicalContractorGeneralContractorNationalAccountWholesalerMechanicalContractorGeneralContractorNationalAccountWholesaler**1.43 1.43** **1.43 ­** **1.43 1.43** **1.43 ­** MechanicalContractor**­ 1.38** **1.38 ­** **­ 1.28** **1.28**GeneralContractor**­ ­** **1.29 ­** **­ ­** **1.29 ­** NationalAccount**­ ­** **­ 1.77** **­ ­** **­ 1.68** SalesTax**1.068 1.068** **1.068 1.068** **1.068 1.068** **1.068 1.068** Overall**1.53 2.11** **2.72 1.89** **1.53 1.95** **2.52 1.79** OverallWeightedAverage**1.93 2.08** **1.96**Table6.9.2OverallIncrementalMarkupsReplacementNewConstructionWeighted­AverageMarketSectorWholesalerMechanicalContractorGeneralContractorNationalAccountWholesalerMechanicalContractorGeneralContractorNationalAccountWholesaler**1.10 1.10** **1.10 ­** **1.10 1.10** **1.10 ­** MechanicalContractor**­ 1.12** **1.12 ­** **­ 1.04** **1.04**GeneralContractor**­ ­** **1.16 ­** **­ ­** **1.16 ­** NationalAccount**­ ­** **­ 1.21** **­ ­** **­ 1.16** SalesTax**1.068 1.068** **1.068 1.068** **1.068 1.068** **1.068 1.068** Overall**1.17 1.32** **1.53 1.29** **1.17 1.22** **1.42 1.24** OverallWeightedAverage**1.28 1.29** **1.28 6­19**  **DOE based**  **overall markups**  **on one**  **of four**  **assumed distribution**  **channels as**  **well as** 

**whether the**  **equipment is**  **being purchased**  **for the**  **new construction**  **or replacement**  **market. DOE** 

**based the**  **distribution channel**  **on whether**  **equipment is**  **purchased through**  **a (1)**  **wholesaler, (2)** 

**mechanical contractor,**  **(3) general**  **contractor, or**  **(4) national**  **account. Thus,**  **Table 6.9.1**  **and**

**Table 6.9.2**  **present eight**  **overall markups,**  **each for**  **both the**  **overall baseline**  **and**

**incremental markups.**  **In addition,**  **the markups**  **from Tables**  **6.8.1 and**  **6.8.2 provide**  **overall**

**weighted­average baseline**  **and incremental**  **markups. Thus,**  **in Table**  **6.8.1, the**  **overall baseline** 

**markups are**  **1.93 and**  **2.08 for**  **replacement and**  **new markets,**  **respectively, and**  **in Table**  **6.8.2, the** 

**overall incremental**  **markups are**  **1.28 and**  **1.29 for**  **the replacement**  **and new**  **markets,**

**respectively. The**  **weighted­average overall**  **baseline markup**  **equals 1.96,**  **while the**  **weighted**

**average overall**  **incremental markup**  **equals 1.28.** 

**DOE used**  **the overall**  **markups to**  **estimate the**  **customer price**  **of baseline**  **equipment,**

**given the**  **manufacturer selling**  **price of**  **baseline equipment.**  **For example,**  **if the**  **manufacturer**

**selling price**  **of a**  **baseline PTAC**  **unit is**  **$1000, DOE**  **can multiply**  **this by**  **the weighted­average** 

**overall baseline**  **markup (1.96)**  **to estimate**  **that the**  **baseline customer**  **price of**  **the PTAC**  **unit is** 

**$1960. Similarly,**  **DOE used**  **the overall**  **incremental markup**  **to estimate**  **changes in**  **the customer** 

**price, given**  **changes in**  **the manufacturer**  **selling price**  **above the**  **baseline price**  **resulting from**  **a**

**standard to**  **raise equipment**  **efficiency. For**  **example, if**  **a standard**  **increases the**  **PTAC**

**manufacturer selling**  **price by**  **$100, DOE**  **can multiply**  **this by**  **the weighted­average**  **overall**

**incremental markup**  **(1.28) to**  **estimate that**  **the customer**  **price will**  **increase $128.** REFERENCES

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**Conditioning: Packaged**  **Terminal Air**  **Conditioning. HVAC0002.**  **Final Report,**  **March**

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**Report EC02­231­236220.** 

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**Report EC02­311­333415.** 

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**7. U.S.**  **Census Bureau.**  **2002. Commercial**  **and Institutional**  **Building Construction:**  **2002.**

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**10. The**  **Sales Tax**  **Clearinghouse at**  **https://thestc.com/STRates.stm (Accessed**  **on July**  **10, 2007)** 

**6­20**