CHAPTER 6

. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

TABLE OF CONTENTS

6.1 INTRODUCTION

................................ ................................ ................................ ........... 6

- 1

6.1.1 Distribution Channels

................................ ................................ ................................ ...... 6

- 1

6.1.2 Markup Calculation Procedure

................................ ................................ ........................ 6

- 2

6.2 WHOLESALER MARKUP

................................ ................................ ............................ 6

- 2

6.2.1 Approach for Wholesaler Markups

................................ ................................ .................. 6

- 3

6.2.2 Derivation of Wholesaler Markup

................................ ................................ ................... 6

- 4

6.3 SALES TAXES

................................ ................................ ................................ ............... 6

- 7

6.4 OVERALL MARKUPS

................................ ................................ ................................ ... 6

- 7

LIST OF TABLES

Table 6.2

- 1 Wholesaler Expenses and Markups

................................ ................................ ..... 6

- 5

Table 6.2

- 2 Data for Incremental Markup Calculation: Professional and Commercial Equipment and Supplies (2007)

................................ ................................ ........... 6

- 6

Table 6.3

- 1 Average Sales Tax Rates by Census Division and Large State

........................... 6

- 7

Table 6.4

- 1 Summary of Markups for Beverage Vending Machine

................................ ....... 6

- 8

LIST OF FIGURE

Figure 6.1

- 1 Distribution Channels and Shares for Beverage Vending Machines

................... 6

- 2

6

- iCHAPTER 6. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

6.1 INTRODUCTION

To carry out the life

- cycle cost (LCC) calculations described in chapter 8 of the technical support document (TSD), the U.S. Department of Energy (DOE) needs to determine the cost to

the customer of beverage vending machines. This cost is determined for both baseline equipment and more efficient equipment that the customer would purchase following the promulgation of

any new or amended energy conservation standards. The manufacturer selling price (MSP ) for both baseline equipment and more

- efficient equipment are determined in the engineering analysis (chapter 5 of the TSD). 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 these markups.

DOE determines customer prices for beverage vending machines from MSP and equipment price markups using industry balance sheet data and U.S. Census Bureau data. To determine price markups, DOE identifies distribution channels for equipment sales and determines the existence and amounts of markups within each distribution channel. For each distribution channel, DOE distinguishes between “baseline markups” applied to t he MSP for baseline equipment and “incremental markups” applied to the incremental increase in MSP for higher efficiency equipment. Overall baseline and overall incremental markups are calculated separately based on the product of all baseline markups at e ach step within a distribution channel or the product of all incremental markups at each step within a distribution channel, respectively. The combination of the overall baseline markup applied to the baseline MSP and the incremental markups applied to the incremental increase in MSP for higher efficiency equipment, including sales tax, determ ines the final customer price.

6.1.1 Distribution Channels

The appropriate markups for determining consumer equipment price s depend on the type

of distribution channels th rough which equipment move from manufacturers to purchasers

. At each point in the distribution channel, companies mark up the price of the equipment to cover their business costs and profit margin. As shown in Figure 6.1

- 1 , DOE defined three distribution channels to describe how the equipment passes from the manufacturer to the customer. In the first distribution channel, the manufacturer sells the eq uipment to the bottler/distributor, who in turn installs, operates, and maintains the equipment on site at the user’s location. In the second and third distribution channels, the manufacturer sells the equipment to a wholesaler/distributor,

who in turn sel ls it directly to the customer (vending machine operator or site owner). The site

owner (third channel) purchases outright a small percentage of the machines from the distributor

and stocks and maintains them on site. Figure 6.1

- 1 also g ives the distribution channel shares (in percentage of total sales) through each of the three distribution channels. The distribution

channel shares are based on industr y comments from the 2009 BVM Final Rule

.

6-185% 10% 5%

Figure 6.1

- 1 Distribution Channels and Shares for Beverage Vending Machines

6.1.2 Markup C alculation Procedure

A t each point in the distribution channel, companies mark up the price of the equipment to cover their business costs and profit margin. In financial statements, gross margin (GM) is the difference between the company revenue and the company cost of sales or cost of goods sold ( CGS ). T he GM includes the expenses of companies in the distribution channel

— including overhead costs (sales, general, and administration); research and development (R&D) and interest expenses; depreciation ; an d taxes

— and company profits

. T o cover costs and to contribute positively to company cash flow, the price of equipment must include a mark up. Equipment command s lower or higher markup s , depending on company expenses associated

with the equipment and the d egree of market competition. In develo ping markups for

manufacturers and retailers , DOE obtained data about the revenue, CGS , and expenses of firms that produce and sell the equipment of interest.

6.2 WHOLESALER MARKUP

DOE based the wholesaler/distributor m arkups on U.S. Census Bureau data for the “Other commercial equipment merchant wholesaler” segment of durable goods and merchant wholesaler category of Wholesale Trade. Three key assumptions used to estimate markups for the beverage vending machine (BVM) w holesaler/distributor industry were:

1. The data accurately represent the various costs incurred by firms distributing and installing beverage vending machine equipment.

2. The costs can be divided into two categories: (1) costs that vary in proportion to the MSP of beverage vending machine equipment ( variant costs), and (2) costs that do not vary with the MSP of beverage vending machine equipment ( invariant costs). Beverage Vending Machine Manufacturer

Wholesaler/Distributor

Bottler/Distributor Site Owner Vending Machine Operator

6-23. Wholesaler/distributor prices vary in proportion to the stated wholesaler/distributor costs.

In support of the first two assumptions, the cost data are categorized correctly to reflect the direct costs to purchase or install the equipment, operating labor and occupancy costs, and other operating costs and profit.

Although BVM wholesaler/distributors may handle multiple commodity lines (including non

- refrigerated vending machines and other equipment), the data provide the most accurate available indication of beverage vending machine equipment costs. DOE searched

for

, but did n ot find

, data on two topics that relate to the price determined by the markup analysis. The first is the division and application of invariant and variant costs, and the second is the level of competition.

In the case of the division and application of i nvariant and variant costs to determine baseline and incremental markups, DOE relied on prior analysis of the heating, ventilation, and air conditioning wholesalers, contractors, and consultants, including information obtained from

the trade literature. Th is analysis indicates 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 larger than markups on materials. The analysis implies th at these distribution channel markups vary more with sales volume than with other factors, including appliance efficiency. Distribution channel labor inputs also vary more with sales volume than with appliance cost or efficiency. DOE assumed a division of costs between those that do not scale with the MSP (labor and occupancy costs) and those that do (operating costs and profit). This division of costs led to the estimation of wholesaler/distributor markups, as

described subsequently

.

6.2.1 Approach for Wholesal er Markups

Using the previously mentioned assumptions, DOE was able to obtain the baseline markup for wholesalers using the industry financial data from the 2007 Economic Census for the Other Commercial Equipment Merchant Wholesalers ( NAICS 423440)

. 1 However, data from the 2007 Economic Census did not provide enough of a detailed cost breakdown to calculate the individual values for occupancy and other operating expenses in order to estimate the incremental markup for this industry. DOE then used the 2007 Wholesale Trade Report for Professional and Commercial Equipment and Supplies (NAICS 42340), which represents a more aggregated industry but with detailed cost breakdown available. 2 The baseline markups cover all of the wholesaler’s costs ( both invariant costs and variant costs ). Here, variant costs were defined as costs that likely vary in proportion to the change in MSP induced by increased efficiency standards; in contrast, invariant costs were defined as costs that are unlikely to vary in proportion to the change in MSP due to increased efficiency standards. DOE calculated the baseline markup for wholesale rs using the following equation:

WHOLE WHOLE WHOLE WHOLE

WHOLE WHOLE WHOLE

BASE 

### CGS VC IVC CGS

CGS GM CGS MU ) ( + +

= +

=

6-3Where:

MU BASE = b aseline wholesaler markup,

CGS WHOLE = w holesaler cost of goods sold,

GM WHOLE = w holesaler gross margin,

IVC WHOLE = w holesaler invariant costs, and

VC WHOLE = w holesaler variant costs.

Incremental markups are coefficients that relate the change in the MSP of more energy

efficient models , or equipment that meet s the requirements of new energy conservation

standards

, to the change in the wholesaler sales price. Incremental markups cover only those costs that scale with a change in the MSP (variant costs, VC ). DOE calculated the incremental markup ( MU INCR ) for wholesalers using the following equation:

WHOLE WHOLE WHOLE

INCR CGS VC CGS MU +

=

Where:

MU INCR = i ncremental wholesaler markup,

CGS WHOLE = w holesaler cost of goods sold, and

VC WHOLE = w holesaler variant costs.

6.2.2 Derivation of Wholesaler Markup

DOE first attempted to use the 2007 Economic Census for the Other Commercial Equipment Merchant Wholesalers ( NAICS 423440) to calculate markups for

wholesaler/distributors

. This sector includes establishments primarily engaged in distributing and wholesaling beverage vending machines and other equipment to restaur ants and hotels (NAICS 4234401) and stores (NAICS 4234402). However, as mentioned previously, the lack of a detailed cost breakdown only allows DOE to estimate the baseline markup but not incremental markup. The sales revenue and gross margin report ed in t his series resulted in a baseline markup of 1.488 for other commercial equipment merchant wholesalers.

In order to obtain the incremental markup, DOE instead used the 2007 Wholesale Trade Report for Professional and Commercial Equipment and Supplies (NAI CS 42340) as a proxy to
the Other Commercial Equipment Merchant Wholesalers . Data for this sector include industry

level sales revenue an d expense data

, which include labor expenses, occupancy expenses, other operating expenses

, and profit. The baseline ma rkup estimated from th ese data is 1.481, which is

a close match to what DOE has seen in the Other Commercial Equipment Merchant Wholesalers (1.488), indicating that this more aggregated industry is representative of the beverage vending

6-4machine wholesalers

. Table 6.2

- 1 summarizes the simplified expenses and associated baseline and incremental markup estimation.

Table 6.2

- 1 Wholesaler Expenses and Markups

Desc riptions Wholesaler Expenses or Revenue

Per Dollar

Sales Revenue
$ Per Dollar Cost

of Goods
$ Direct Cost of Equipment Sales: Cost of goods sold 0.675 1.000 Labor Expenses: Salaries and benefits 0.099 0.147 Occupancy Expense: Rent, maintenance, and utilities 0.021 0.031 Other Operating Expenses: Depreciation, advertising, and insurance. 0.054 0.080

Operating Profit 0.150 0.223 Wholesaler Baseline Markup ( MU WHOLE BASE ) 1.481 Incremental Markup ( MU WHOLE INCR ) 1.303

Source: U.S. Census Bureau, 2007 Wholesale Trade Report (NAICS 42340 Professional and Commercial Equipment and Supplies) http://www.census.gov/wholesale/index.html

In this case, direct equipment expense s (cost of goods sold) represent about $0. 675 per dollar sales revenue, so for every $1 wholesalers take in as sales revenue, $0. 675 is used to pay the direct equipment costs. Labor expenses represent $0. 099 per dollar sales revenue, occupancy

expenses rep resent $0.0 21 , other operating expenses represent $0.0 54 , and profit accounts for
$0. 15 per dollar sales revenue.

DOE converted the expenses per dollar sales into expenses per dollar cost of goods sold, by dividing each figure in the first data column by $0. 675 ( 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 allocates $0. 147 to cover labor costs, $0.0 31 to cover occupancy expenses, $0.0 8 for other operating expenses, and $0. 223 in profits. This totals to $1. 481 in sales revenue earned for every $1.00 spent on equipment costs. Therefore, the wholesaler baseline markup ( MU WHOLE BASE ) is 1. 481 ($1. 481 ÷ $1.00).

DOE also used the data in co lumn two to estimate the incremental markup. The incremental markup depends on which of the costs in 0 are variant and which are invariant with MSP. For example, fo r a $1.00 increase in the MSP, if all of the other costs scale with the MSP ( i.e., all costs are variant), the increase in wholesale price will be $1. 481 , implying that the incremental markup is 1. 481 , or the same as the baseline markup. At the other extre me, if none

of the other costs are variant, then a $1.00 increase in the MSP will lead to a $1.00 increase in the wholesale price, for an incremental markup of 1.0. DOE believes that the labor and occupancy costs will be invariant and that the other operat ing costs and profit will scale with the MSP ( i.e., be variant). In this case, for a $1.00 increase in the MSP, the wholesale price will increase to match changes in ”other” operating costs and operating profit of $0. 204 , which when divided by 67.5 cents i n cost of goods sold yields an increase of $0. 303 , giving a wholesaler

6-5incremental markup ( MU WHOLE INCR ) of 1. 303

. The more detailed cost breakdown is shown in

Table 6.2

- 2

.

Table 6.2

- 2 Data for Incremental Markup Calculation: Professional and Commercial Equipment and Supplies (200 7 )

Amount ($1,000,000)

Sales $ 354,304
Cost of Goods Sold (CGS) $239,155

Gross Margin (GM) $115,149

Labor & Occupancy Expenses (“ Invariant ”)
Total payroll, other employees’ wages $29,537
Total fringe benefits $5,015
Temporary staff and leased employee expenses $673
Rental costs of machinery and equipment $291
Rental costs of buildings $2,325
Cost of repair to building $411
Cost of repair to machinery and equipment $294

Purchased communication services $812
Purchased transportation, shipping and warehousing services $2,869
Purchased electricity and fuel $431

Subtotal: $ 42,658

Other Operating Expenses & Profit (“ Variant ”)
Purchased professional and technical services $2,827
Data processing and other purchased computer services $257
Expensed equipment $599
Expensed purchases of software $246
Advertising and promotion services $2,807
All other expenses $6,978
Refuse removal (including hazardous waste) services $69

Taxes and license fees $499
Total depreciation $2,271
Commission expenses $1,825
Purchases of other materials, parts, and supplies (not for resale) $833
Net Profit Before Income Taxes $53,280

Subtotal: $ 72,491

Baseline Markup = Sales/ CGS 1.48

Incremental Markup = (CGS+Total Other Operating Expenses and Profit)/CGS 1.30

Source: U.S. Census Bureau, 2007 Wholesale Trade Report (NAICS 42340 0 Professional and Commercial Equipment and Supplies) http://www.census.gov/wholesale/index.html

6-66.3 SALES TAXES

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

equ ipment price. The sales tax is a multiplicative factor that increase s the consumer equipment price. DOE derived state and local taxes from data provided by the Sales Tax Clearinghouse

. 3

DOE derived p opulation

- weighted average tax values for each Census division and la rge state, as
shown in Table 6.3

- 1

.

Table 6.3

- 1 Average Sales Tax Rates by Census Division and Large State

Census

Division/State 201 9 Population Tax Rate (2014)

% New England 15,309,528 5.69

Middle Atlantic 22,248,989 6.63

East North Central 48,208,733 6.91

West North Central 21,246,442 7.10

South Atlantic 45,035,501 6.08

East South Central 18,978,828 8.02

West South Central 11,515,069 8.65

Mountain 25,557,049 6.45

Pacific 13,879,323 5.30

New York 19,576,920 8.40

California 42,206,743 8.45

Texas 28,634,896 7.95

Florida 23,406,525 6.65

Population

- weighted av era g e 7.108

6.4 OVERALL MARKUPS

The overall markup for each distribution channel is the product of the appropriate markups

. DOE used the overall baseline markup to estimate the consumer product price of baseline models, given the manufacturer cost of the baseline models. As stated previously, DOE

considers baseline models to be equipment sold under existing market conditions ( i .e., without new energy conservation standards). The following equation shows how DOE used the overall baseline markup to determine the product price for baseline models.



### ( )

BASE OVERALL MFG SALES BASE MFG MFG BASE MU COST Tax MU MU COST CPP

_ × = × × × = Eq. 6.4

. 1

Where:

CPP BASE = consumer product price for baseline models,

COST MFG = manufacturer cost for baseline models,

MU MFG = manufacturer markup,

6-7MU BASE = baseline wholesaler markup,

Tax SALES = sales tax, and

MU OVERALL_BASE = baseline overall markup.

Similarly, DOE used the overall incremental markup to estimate changes in the consumer product price, given changes in the manufacturer cost from the baseline model cost resulting from an energy conservation standard to raise product energy efficiency. The total consumer product price for more energy

- efficient models is composed of two components: the consumer product price of the baseline model and the change in consumer product price associated with the increase in manufacturer cost to meet the new energy conservation standard. The following equation shows how DOE used the overall incremental markup to determine the consumer product price for more energy

- efficient models ( i.e., models meeting ne w energy conservation standards).



## ( )

INCR OVERALL MFG BASE SALES INCR MFG MFG BASE OVERALL MFG STD

MU COST CPP Tax MU MU COST MU COST CPP

_ _

× ∆ + = × × × ∆ + × =

Where:

CPP STD = consumer product price for models meeting new energy conservation standards,

CPP BASE = consumer product price for baseline models,

COST MFG = manufacturer cost for baseline models,

Δ COST MFG = change in manufacturer cost for more energy

- efficient models,

MU MFG = manufacturer markup,

MU INCR = incremental wholesaler markup,

Tax SALES = sales tax,

MU OVERALL_BASE = baseline overall markup, and

MU OV ERALL_INCR = incremental overall markup.

Table 6.4

- 1 summarize s the national average markups at each stage in the distribution

channel and the average sales tax for each product class

.

Table 6.4

- 1 Summary of Markups for Beverage Vending Machine

Distribution

Channel Manufacturer  Bottler /Distributor Manufacturer  Wholesaler  Operator/Site Owner

Baseline Incremental Baseline Incremental

Manufacturer 1.26 1.26 1.26 1.26

Wholesaler

- - 1.48 1.30

Sales Tax 1.071 1.071 1.071 1.071 Markup Not Including

Manufacturer 1.071 1.071 1.585 1.392

Overall Markup 1.349 1.349 1.997 1.754

6-8REFERENCES

1. U.S. Census Bureau, 2007 Economic Census, Wholesale Trade: Subject Series

-- Misc Subjects: Gross Margin and Gross Profit . Washington, DC. Report No. EC0742SXSB06; EC0742SXSB07. < htt p://www.census.gov/econ/census07/ >

2. U.S. Bureau of the Census, 2007 Annual Wholesale Trade Report, NAICS 4234: Professional and Commercial Equipment and Supplies , 2007. Washington, DC.

< http://w ww.census.gov/wholesale/index.html >

3. Sales Tax Clearinghouse Inc., State Sales Tax Rates Along with Combined Average City and County Rates, 2014. (Last accessed January 10, 2014.)

< http://thestc.com/STrates .stm >

6-9