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

EERE-2007-BT-STD-0012 COMMENT 02
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

EERE-2007-BT-STD-0012 COMMENT 02
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.

Manufacturer

National Account

Customer

Wholesaler

Mechanical Contractor

(New Construction or Replacement)

Customer

General

Contractor

Customer Customer

Channel 1 Channel 2 Channel 3 Channel 4

Figure 6.1.1 Distribution Channels for PTAC and PTHP Equipment

6­1

EERE-2007-BT-STD-0012 COMMENT 02
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:

EQPCUST = MSP x MUNATL ACCT x (1+ ST) Eq. 6.1

where:

EQPCUST = equipment price to the customer ($),

MSP = manufacturer selling price ($),

MUNATL ACCT = national account markup,

6­2

EERE-2007-BT-STD-0012 COMMENT 02
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:

EQPCUST = MSPx MUWHOLE x (1+ST) Eq. 6.2

where:

MUWHOLE = 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:

EQPCUST= MSP x MUWHOLE x MUMECH CONT x (1+ ST) Eq. 6.3

where:

MUMECH 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:

EQPCUST = MSP x MUWHOLE x MUMECH CONT x MUGEN CONT x (1+ ST) Eq. 6.4

where:

MUGEN 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

EERE-2007-BT-STD-0012 COMMENT 02
EQPNATL ACCNT BASE = MSPBASE x MUNATL ACCT BASE x (1+ST) Eq. 6.5

where:

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

MSPBASE = manufacturer selling price of baseline equipment ($),

MUNATL ACCT BASE = national account markup on baseline equipment,

ST = sales tax ($).

If sold to a customer by a wholesaler­distributor:

EQPWHOLE BASE = MSPBASE x MUWHOLE BASE x (1+ST) Eq. 6.6

If sold to a customer directly by a mechanical contractor:

EQPMECH CONT BASE = MSPBASE x MUWHOLE BASE x MUMECH CONT BASE x (1+ST) Eq. 6.7

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

EQPGEN CONT BASE = MSPBASE x MUWHOLE BASE x MUMECH CONT BASE x MUGEN CONT BASE x (1+ST) Eq. 6.8

where:

EQPWHOLE BASE = wholesaler price of baseline equipment ($),

EQPMECH CONT BASE = mechanical contractor price of baseline equipment ($),

EQPGEN CONT BASE = general contractor price of baseline equipment ($),

MUWHOLE BASE = wholesaler markup on baseline equipment,

MUMECH CONT BASE = mechanical contractor markup on baseline equipment,

MUGEN CONT BASE = general contractor markup on baseline equipment.

The use of the markups results in the national account (EQPNATL ACCNT BASE ), wholesaler

(EQPWHOLE BASE), mechanical contractor (EQPMECH CONT BASE), and general contractor (EQPGEN 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:

EQPNATL ACCNT INCR = MSPINCR x MUNATL ACCT INCR x (1+ST) Eq. 6.9

where:

EQPNATL ACCNT INCR = incremental equipment price to the national account customer

($),

6­4

EERE-2007-BT-STD-0012 COMMENT 02
MSPINCR = change in the MSP of higher efficiency equipment brought about

by an increase in efficiency due to new energy conservation

standards ($),

MUNATL ACCT INCR = national account incremental markup,

ST = sales tax ($).

If sold to a customer by a wholesaler­distributor:

EQPWHOLE INCR = MSPINCR x MUWHOLE INCR x (1+ST) Eq. 6.10

If sold to a customer directly by a mechanical contractor:

EQPMECH CONT INCR = MSPINCR x MUWHOLE INCR x MUMECH CONT INCR x (1+ST) Eq. 6.11

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

EQPGEN CONT INCR = MSPINCR x MUWHOLE INCR x MUMECH CONT INCR x MUGEN CONT INCR x (1+ST) Eq. 6.12

where:

EQPWHOLE INCR = incremental wholesaler price ($),

EQPMECH CONT INCR = incremental mechanical contractor price ($),

EQPGEN CONT INCR = incremental general contractor price ($),

MUWHOLE INCR = incremental wholesaler markup,

MUMECH CONT INCR = incremental mechanical contractor markup,

MUGEN CONT INCR = incremental general contractor markup.

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

increase in equipment efficiency due to amended energy conservation standards) and MUNATL ACCT

INCR , MUWHOLE INCR, MUMECH CONT INCR, and MUGEN 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 (EQPNATL ACCNT INCR), incremental wholesaler (EQPWHOLE

INCR), incremental mechanical contractor (EQPMECH CONT INCR), and incremental general contractor

(EQPGEN 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:

EQPCUST BASE = MSPBASE x (WTNATL ACCNT BASE x MUNATL ACCT BASE + WTWHOLE BASE x MUWHOLE

BASE+ WTMECH CONT BASE x MUWHOLE BASE x MUMECH CONT BASE + WTGEN CONT BASE x MUWHOLE BASE x

MUMECH CONT BASE x MUGEN CONT BASE) x (1+ST)

= MSPBASE x MUOVERALL BASE ) Eq. 6.13

6­5

EERE-2007-BT-STD-0012 COMMENT 02
EQPCUST INCR = MSPINCR x (WTNATL ACCNT INCR x MUNATL ACCT INCR + WTWHOLE INCR x MUWHOLE

INCR+ WTMECH CONT INCR x MUWHOLE INCR x MUMECH CONT INCR + WTGEN CONT INCR x MUWHOLE INCR x MUMECH

CONT INCR x MUGEN CONT INCR) x (1+ST)

= MSPINCR x MUOVERALL INCR Eq. 6.14

EQPCUST= EQPCUST BASE+ EQPCUST INCR Eq. 6.15

where:

EQPCUST BASE = baseline customer price ($),

EQPCUST INCR = incremental customer price ($),

EQPCUST = total customer price ($),

MUOVERALL BASE = overall weighted baseline markup that is the product of all the

weights and baseline markups for each step of the distribution

channel,

MUOVERALL INCR = overall weighted incremental markup that is the product of all

the weights and incremental markups for each step of the

distribution channel,

WTNATL ACCNT BASE = weight (percent) of baseline equipment sales through national

accounts,

WTWHOLE BASE = weight (percent) of baseline equipment sales through

wholesalers,

WTMECH CONT BASE = weight (percent) of baseline equipment sales through mechanical

contractors,

WTGEN CONT BASE = weight (percent) of baseline equipment sales through general

contractors,

WTNATL ACCNT INCR = weight (percent) of higher efficiency equipment sales through

national accounts,

WTWHOLE INCR = weight (percent) of higher efficiency equipment sales through

wholesalers,

WTMECH CONT INCR = weight (percent) of higher efficiency equipment sales through

mechanical contractors,

WTGEN 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 (EQPCUST BASE) and the incremental customer price (EQPCUST INCR). For a particular

higher efficiency level that increases MSP, the total equipment price (EQPCUST ) to the customer

is the sum of the baseline customer price (EQPCUST BASE) and the incremental customer price

(EQPCUST 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

EERE-2007-BT-STD-0012 COMMENT 02
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 contractors8 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

EERE-2007-BT-STD-0012 COMMENT 02
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 (MUWHOLE BASE) 1.43

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

Incremental Markup (MUWHOLE 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 (MUWHOLE 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

EERE-2007-BT-STD-0012 COMMENT 02
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 (MUWHOLE 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

EERE-2007-BT-STD-0012 COMMENT 02
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 (MUMECH 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 (MUMECH 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

EERE-2007-BT-STD-0012 COMMENT 02
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 (MUMECH 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 analysis3, 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 (MUMECH 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

EERE-2007-BT-STD-0012 COMMENT 02
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 (MUMECH BASE): Revenue per dollar cost of goods 1.52

Incremental Markup (MUMECH 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

EERE-2007-BT-STD-0012 COMMENT 02
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

EERE-2007-BT-STD-0012 COMMENT 02
Other Operating Expenses: Depreciation, advertising, and insurance. $0.01 $0.01

Net Profit Before Taxes $0.12 $0.15

Baseline Markup (MUGEN CONT BASE): Revenue per dollar cost of goods 1.29

Incremental Markup (MUGEN 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 (MUGEN 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 (MUGEN 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

EERE-2007-BT-STD-0012 COMMENT 02
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

EERE-2007-BT-STD-0012 COMMENT 02
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 onehalf 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

EERE-2007-BT-STD-0012 COMMENT 02
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

EERE-2007-BT-STD-0012 COMMENT 02
Table 6.9.1 Overall Baseline Markups

6­18

Replacement Market New Construction Market

Market Sector Wholesaler 

Mechanical

Contractor

General

Contractor

National

Account Wholesaler

Mechanical

Contractor

General

Contractor

Wholesaler 1.43 1.43 1.43 ­ 1.43 1.43 1.43 

Mechanical Contractor ­ 1.38 1.38 ­ ­ 1.28 1.28

General Contractor ­ ­ 1.29 ­ ­ ­ 1.29 

National Account ­ ­ ­ 1.77 ­ ­ ­ 

Sales Tax 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 

Overall Weighted Average 1.93 2.08 

Table 6.9.2 Overall Incremental Markups

Replacement New Construction

Market Sector Wholesaler 

Mechanical

Contractor

General

Contractor

National

Account Wholesaler

Mechanical

Contractor

General

Contractor

Wholesaler 1.10 1.10 1.10 ­ 1.10 1.10 1.10 

Mechanical Contractor ­ 1.12 1.12 ­ ­ 1.04 1.04

General Contractor ­ ­ 1.16 ­ ­ ­ 1.16 

National Account ­ ­ ­ 1.21 ­ ­ ­ 

Sales Tax 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 

Overall Weighted Average 1.28 1.29 

EERE-2007-BT-STD-0012 COMMENT 02
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 weightedaverage 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.

EERE-2007-BT-STD-0012 COMMENT 02
REFERENCES

1. Ducker Worldwide. 2001. 2000 U.S. Market for Residential and Specialty Air

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

2001. Ducker Industrial Standards, 6905 Telegraph Road Suite 300, Bloomfield Hills,

Michigan 48301.

2. Heating, Air Conditioning & Refrigeration Distributors International. 2005. 2005 Profit

Report (2004 Data).

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

Contracting Industry.

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

Report EC02­231­236220.

5. U.S. Census Bureau. 2002. Air­Conditioning and Warm Air Heating Equipment and

Commercial and Industrial Refrigeration Equipment Manufacturing: 2002.

Report EC02­311­333415.

6. U.S. Census Bureau. 2005. Product Lines: 2002. Report EC02­42SL­LS.

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

Report EC02­231­236220.

8. U.S. Census Bureau. 2002. Plumbing, Heating, and Air­Conditioning Contractors: 2002.

Report EC02­231­238220.

9. Pindyck, R. and D. Rubinfeld, Microeconomices, Prentice Hall. 2000.

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

6­20

EERE-2007-BT-STD-0012 COMMENT 02