CHAPTER 6. MARKUPS TO DETERMINE EQUIPMENT PRICE 

TABLE OF CONTENTS
 

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

6.2	 MARKUP CALCULATION PROCEDURE ..................................................................... 6-2
 

6.2.1	 Baseline Markups................................................................................................. 6-3
 

6.2.2	 Incremental Markups ........................................................................................... 6-4
 

6.2.3	 Overall Markups .................................................................................................. 6-4
 

6.3	 ASSUMPTIONS USED TO ESTIMATE WHOLESALER AND CONTRACTOR
 

MARKUPS ......................................................................................................................... 6-5 
 

6.4	 ESTIMATION OF WHOLESALER MARKUPS ............................................................. 6-6
 

6.4.1	 Estimation of Wholesaler Markup Probability Distribution................................ 6-8
 

6.5	 ESTIMATION OF MECHANICAL CONTRACTOR MARKUPS.................................. 6-8
 

6.5.1	 Markups for Mechanical Contractors in the Replacement and New 

Construction Markets........................................................................................... 6-9
 

6.5.2	 Estimation of Mechanical Contractor Markup Probability Distribution ........... 6-11
 

6.6	 ESTIMATION OF GENERAL CONTRACTOR MARKUPS........................................ 6-12
 

6.6.1	 Estimation of General Contractor Markup Probability Distribution ................. 6-13
 

6.7	 SALES TAX ..................................................................................................................... 6-14
 

6.8 OVERALL MARKUPS.................................................................................................... 6-15
 

REFERENCES .......................................................................................................................... 6-17
 

LIST OF TABLES 

Table 6.4.1 Wholesaler Expenses and Markups ..................................................................... 6-7
 

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

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

All Mechanical Contractors ............................................................................... 6-10
 

Table 6.5.3 Mechanical Contractor Expenses and Baseline Markup, Residential and 

Light Commercial .............................................................................................. 6-10
 

Table 6.5.4 Mechanical Contractor Expenses and Markups Based on Census Bureau 

Data .................................................................................................................... 6-11
 

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

Table 6.7.1 State Sales Tax Rates (Percent) ......................................................................... 6-15
 

Table 6.8.1 Average Overall Baseline Markups................................................................... 6-15
 

Table 6.9.2 Average Overall Incremental Markups.............................................................. 6-15
 

6-i 
LIST OF FIGURES
 

Figure 6.1.1 Distribution Channels for CAC Equipment......................................................... 6-1 

Figure 6.4.1 Wholesaler Baseline Markup Probability Distribution........................................ 6-8 

Figure 6.4.2 Wholesaler Incremental Markup Probability Distribution .................................. 6-8 

Figure 6.5.1 Residential and Light Commercial Mechanical Contractor Relative 

Markup Probability Distribution........................................................................ 6-12 

Figure 6.6.1 Residential General Contractor Relative Markup Probability Distribution....... 6-14 

Figure 6.6.2 Commercial General Contractor Relative Markup Probability Distribution..... 6-14 

6-ii 
CHAPTER 6. MARKUPS TO DETERMINE EQUIPMENT PRICE 

6.1 INTRODUCTION 

To carry out the life-cycle cost (LCC) calculations described in Chapter 8, the U.S. 

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

central air conditioner or heat pump (CAC) product. This cost was determined for both baseline 

equipment and more-efficient equipment the customer would purchase following the 

promulgation of new energy conservation standards. However, the customer price of baseline or 

higher-efficiency equipment is not known and can be determined based on how the equipment is 

purchased. For the central air conditioner and heat pump rulemaking, direct information on the 

incremental markup on equipment costs for higher efficiency units is not readily available. This 

is partially due to the fact that such units are often included in the construction costs of new 

housing or as a package that includes installation. In addition, because higher efficiency units 

may have different markups than baseline units at minimum efficiency and higher efficiency 

units are not produced at the same volume as baseline units, current incremental equipment costs 

observed in the market may not be representative of the incremental costs under a new standard. 

The manufacturing selling price (MSP) can be determined for both baseline equipment and the 

more-efficient 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 two 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 replacement distribution channel, the manufacturer sells the CAC product to a 

distributor/wholesaler, who in turn sells it to a mechanical contractor, who in turn sells it directly 

to the customer. In new construction distribution channel, the manufacturer sells the equipment 

to a wholesaler, who in turn sells it to a mechanical contractor, who in turn sells it to the 

customer through a general contractor who sells it and its installation to the customer. The 

distribution chain markup consists of a distributor/wholesaler markup applied by distributors and 

wholesalers, a dealer/contractor markup applied by dealers and HVAC contractors and a markup 

for sales tax. For the new housing market, a markup is also applied by housing developers and 

builders. The markups applied in the Pre-NOPR analysis for distributor and dealer markups were 

determined from aggregate average markups for the businesses in the distribution chain. This 

means at each stage of distribution, direct costs of sales, i.e., purchased equipment and materials 

and direct labor costs, were compared with the total volume of business revenues, and the ratio 

of total business revenues to direct costs was used to determine the markup. 

New Units: Manufacturer→Distributor→Mechanical Contractor→General
 

Contractor→Customer 

Replacement Units: Manufacturer→Distributor→Mechanical Contractor→Customer 

Figure 6.1.1 Distribution Channels for CAC Equipment 

6-1 
 

 

 

The analysis detailed here for the Pre-NOPR examined the scaling behavior of markups 

for wholesalers and contractors, and determined that markups are neither fixed-dollar, nor 

proportional to all direct costs, but somewhere in-between. Using the available data, we have 

found measurable differences between incremental markups on direct equipment costs and the 

average aggregate markup on direct business costs. Significant differences were found between 

average and incremental markups for heating, ventilation, air-conditioning and refrigeration 

(HVACR) wholesalers/distributors, and for HVAC dealers/contractors. Section 6.3 further 

discusses the differences between average and incremental markups. 

The main reason that the selling price of a product may not be strictly proportional to the 

purchase price of the equipment is that businesses incur a wide variety of costs. Therefore, when 

the purchase price of equipment and materials increases, only a fraction of the business expenses 

increase, while the remainder of the businesses’ expenses stay relatively constant. For example, 

if the unit price of an air conditioner increases by 30%, it is unlikely that the cost of secretarial 

support in an administrative office will increase by 30% also. Certain business expenses are 

relatively uncorrelated with the cost of equipment or cost of goods. 

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 CAC products. 

6.2 MARKUP CALCULATION PROCEDURE 

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. 6.1 

Where: 

EQPCUST = equipment price to the customer ($), 

MSP= manufacturer selling price ($), 

MUWHOLE = wholesaler markup, 

MUMECH CONT = residential and light commercial mechanical contractor markup, 

MUGEN CONT = general contractor markup, 

ST = sales tax ($). 

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

by omitting the applicable markup(s). 

The general contractor markup is only applied to new construction because the general 

contractor not generally involved in the replacement market. The later sections of this chapter 

6-2 
 

 

 

 

 

 

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. 

New equipment is assumed to be sold to a customer by a mechanical contractor through a 

general contractor: 

EQPGEN CONT BASE = MSP BASE x MUWHOLE BASE x MUMECH CONT BASE x MUGEN CONT BASE x 

(1+ST) Eq. 6.2 

Where:
 

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

MSPBASE = manufacturer selling 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, 

ST= sales tax rate. 

Replacement equipment is assumed to be sold to a customer directly by a mechanical 

contractor: 

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

Where:
 

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

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

MUWHOLE BASE= incremental wholesaler markup, 

MUMECH CONT BASE = mechanical contractor markup on baseline equipment, 

MUGEN CONT BASE = general contractor markup on baseline equipment,
 

ST = sales tax rate. 

The use of the markups results in the mechanical contractor (EQPMECH CONT BASE), and 

general contractor (EQPGEN CONT BASE) prices of baseline CAC equipment. 

6-3 
 

 

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 a mechanical contractor through a general contractor: 

EQPGEN CONT INCR = MSP INCR x MUWHOLE INCR x MUMECH CONT INCR x MUGEN CONT INCR x 

(1+ST) Eq. 6.4 

Where: 

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

MSPINCR = manufacturer incremental selling price ($), 

MUWHOLE INCR= incremental wholesaler markup, 

MUMECH CONT INCR = incremental mechanical contractor markup, 

MUGEN CONT INCR = incremental general contractor markup, 

ST= sales tax rate. 

If sold to a customer directly by a mechanical contractor: 

EQPMECH CONT INCR = MSP INCR x MUWHOLE INCR x MUMECH CONT INCR x (1+ST) Eq. 6.5 

Where: 

EQPWHOLE INCR = incremental wholesaler price ($). 

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 MUWHOLE 

INCR, MUMECH CONT INCR, and MUGEN CONT INCR refer to the incremental wholesaler, incremental 

mechanical contractor, and incremental general contractor markups, respectively. The use of the 

incremental markups results in incremental equipment price to the incremental mechanical 

contractor (EQPMECH CONT INCR), and incremental general contractor (EQPGEN CONT INCR) prices 

experienced by the customer. 

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 (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. 6.6 

6-4 
 

 

 

 

EQPCUST INCR = MSPINCR x (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. 6.7 

EQPCUST = EQPCUST BASE + EQPCUST INCR	 Eq. 6.8 

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, 

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

contractors, 

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

contractors, 

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 

CAC costs. DOE based the wholesaler and mechanical contractor markups on firm balance-sheet 

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

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

sheets from the Heating, Air-conditioning & Refrigeration Distributors International (HARDI) 

2008 Profit Planning Report and from the Air Conditioning Contractors of America (ACCA). 1,2 

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.3 These balance sheets break out the components of all costs incurred by 

6-5 
 

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 CAC and HP 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 CAC and HP 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,4

 6,000 wholesalers of heat 

pumps and air-conditioning equipment,5 more than 37,000 general contractors,6 and 87,000 

HVAC contractors7

 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.8 

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, 

a

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

residential and commercial air-conditioners and warm-air furnaces. 

6-6 
 

 

 

 

 

 

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

Data for Equipment Price Markups. Table 6.4.1 summarizes them as cost-per-dollar 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 0.730 1.000 

Labor Expenses: Salaries and benefits 0.156 0.214 

Occupancy Expense: Rent, maintenance, and utilities 0.031 0.042 

Other Operating Expenses: Depreciation, advertising, and insurance. 0.052 0.071 

Profit 0.031 0.042 

Baseline Revenue: Baseline revenue earned per dollar cost of goods sold 1.370 

Wholesaler Baseline Markup (MUWHOLE BASE) 1.370 

Incremental Revenue: Increased revenue per dollar increase cost of goods sold 1.114 

Incremental Markup (MUWHOLE INCR) 1.114 

Source: Heating, Air Conditioning & Refrigeration Distributors International. 2008. 2008 Profit Report (2007 Data).2 

In this case, direct equipment expenses (cost of goods sold) represent about $0.73 per 

dollar sales revenue, so for every $1 wholesalers take in as sales revenue, $0.73 is used to pay 

the direct equipment costs. Labor expenses represent $0.16 per dollar sales revenue, occupancy 

expenses represent $0.03, other operating expenses represent $0.05, 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 $0.73 (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, $0.214 

to cover labor costs, $0.042 to cover occupancy expenses, $0.071 for other operating expenses, 

and $0.042 in profits. This totals to $1.370 in sales revenue earned for every $1.00 spent on 

equipment costs. Therefore, the wholesaler baseline markup (MUWHOLE BASE) is 1.37 

($1.37 ÷ $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 $1.370, implying that the 

incremental markup is 1.370, 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 

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

increase by $1.114, giving a wholesaler incremental markup (MUWHOLE INCR) of 1.114. 

6-7 
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 C). The analysis provided a standard deviation on the markups of wholesaler firms in 

the U.S. DOE then applied the standard deviation to the single-point 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 relative 

standard deviation as 7.7 percent as a percentage of the baseline markup of 1.362, which resulted 

in a standard deviation of 5.7 percent as described in appendix C. DOE assumed that the 

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

baseline markup of 1.370, a standard deviation of 7.7 percent translates into an absolute value of 

5.6 percent. For the incremental markup of 1.114, a relative standard deviation of 7.7 percent 

translates into an absolute value of 6.9 percent. 

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 6.4.2 Wholesaler Incremental 

Markup Probability Distribution 

Figure 6.4.1 Wholesaler Baseline 

Markup Probability Distribution 

Note that for the incremental markup, the standard deviation of 6.9 percent results in 

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

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

 These data are shown in Table 6.5.1. 

6-8 
 

Table 6.5.1 Baseline Markup, All Mechanical Contractors 

Description 

Contractor Expenses or Revenue 

Per Dollar 

Sales Revenue 

$ 

Per Dollar 

Cost of 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.2 

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. 

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. 

6-9 
 

 

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 air-conditioning contractors.7 

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

in Table 6.5.4. 

6-10 
 

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 Air-Conditioning Contractors: 2002. Report EC02-231-238220, 

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 air-conditioning 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 

single-point 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 

relative standard deviation of 3.7 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 relative standard deviation of 3.7 percent translates into 

respective absolute values of 0.051 and 0..047. For the incremental markups of 1.12 and 1.04 for 

the replacement and new construction markets, respectively, a standard deviation of 3.7 percent 

translates into respective absolute values of 0.041 and 0.038. 

DOE calculated a relative standard deviation of 3.7 percent for mechanical contractor 

markups but applied the relative markups on a state-by-state basis. Figure 6.5.1 illustrates the 

probability distribution that DOE used to characterize the mechanical contractor baseline and 

incremental markups for the replacement and new markets. The relative values are multiplied 

times the mean markups for all four categories of mechanical contractor markup: both baseline 

and incremental markups for both new construction and replacements. The probability of 

purchasing a CAC or heat pump unit is different in the different U.S. states, and the relative 

markup is different in each state. While the actual probability of a sale in a particular state 

depends on a number of climate, product-specific, regulatory, and population factors, 

Figure 6.5.1 shows what the distribution of relative markups looks like if population were the 

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only determinant. The far right-hand bar shows, for example, that based on population, there is a 

12.1 percent chance that a given CAC sale would be in California (which had an estimated 

12.1 percent of the U.S. population in July, 2008). The relative mechanical contractor markup 

value for California is 1.037, which would be multiplied times the mean markup factor of 1.28 

for a new baseline unit, yielding a mechanical contractor markup of 1.327. If instead the 

incremental markup on a replacement unit were needed, the 1.037 relative markup value would 

be multiplied times the mean incremental markup factor for replacement units of 1.12, yielding a 

mechanical contractor markup value of 1.161. 

Figure 6.5.1 Residential and Light Commercial Mechanical Contractor Relative Markup 

Probability Distribution 

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). 

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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 

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 1.17 

Source: U.S. Census Bureau. 2002. Commercial and Institutional Building Construction: 2002. Report EC02-231-236220, 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 $1.17, 

giving a general contractor incremental markup (MUGEN CONT INCR) of 1.17. 

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 single-point baseline and incremental markups calculated above to create normal probability 

distributions for these markups. 

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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 1.17, a standard deviation of 9.0 percent 

translates to an absolute value of 0.105. 

Figure 6.6.1 and Figure 6.6.2 show the relative probability distributions that DOE used to 

characterize the residential general contractor and commercial general contractor markups. Both 

are for new construction, because general contractors are not part of the distribution channel for 

replacement CACs. The same relative markups apply to both baseline and incremental markups, 

but they are multiplied times different mean values (1.29 for baseline, 1.17 for incremental). The 

state incremental values are applied in the same way as the mechanical contractor values 

discussed in section 6.5.2. 

Figure 6.6.1 Residential General 

Contractor Relative Markup Probability 

Distribution 

Figure 6.6.2 Commercial General 

Contractor Relative 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,9

 shown in Table 6.7.1. 

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Table 6.7.1 State Sales Tax Rates (Percent) 

State 

Combined 

State and Local 

Tax Rate State 

Combined 

State and 

Local Tax Rate State 

Combined 

State and 

Local Tax Rate 

Alabama 8.15 Kentucky 6 North Dakota 5.75 

Alaska 1.45 Louisiana 8.75 Ohio 6.85 

Arizona 7.15 Maine 5 Oklahoma 8.1 

Arkansas 8.2 Maryland 6 Oregon -­

California 9.0 Massachusetts 5 Pennsylvania 6.25 

Colorado 6.4 Michigan 6 Rhode Island 7 

Connecticut 6 Minnesota 6.85 South Carolina 7.05 

Delaware -­ Mississippi 7 South Dakota 5.5 

Dist. of Columbia 5.75 Missouri 7.10 Tennessee 9.4 

Florida 6.7 Montana -­ Texas 8.05 

Georgia 6.95 Nebraska 6 Utah 6.7 

Hawaii 4.4 Nevada 7.5 Vermont 6.05 

Idaho 6.05 New Hampshire -­ Virginia 5 

Illinois 8.4 New Jersey 6.95 Washington 8.75 

Indiana 7 New Mexico 6.4 West Virginia 6 

Iowa 6.8 New York 8.25 Wisconsin 5.4 

Kansas 6.9 North Carolina 6.8 Wyoming 5.40 

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

CAC 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 population-weighted mean value of 6.99 percent, or approximately 

7.0 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 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 6.8.1 and Table 6.8.2, respectively. 

Table 6.8.1 Average Overall Baseline Markups 

Replacement 

Market 

New Construction 

Market 

Wholesaler 1.370 1.370 

Mechanical Contractor 1.380 1.280 

General Contractor - 1.290 

Sales Tax 1.071 1.071 

Overall 2.025 2.422 

Table 6.8.2 Average Overall Incremental Markups 

Replacement 

Market 

New Construction 

Market 

Wholesaler 1.114 1.114 

Mechanical Contractor 1.120 1.040 

General Contractor - 1.170 

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Sales Tax 1.071 1.071 

Overall 1.336 1.452 

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REFERENCES 

1. Heating, Air Conditioning & Refrigeration Distributors International. 2008. 2008 Profit 

Report (2007 Data). 

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

Contracting Industry. 

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

Report EC02-231-236220. 

4. U.S. Census Bureau. 2002. Air-Conditioning and Warm Air Heating Equipment and 

Commercial and Industrial Refrigeration Equipment Manufacturing: 2002. 

Report EC02-311-333415. 

5. U.S. Census Bureau. 2005. Product Lines: 2002. Report EC02-42SL-LS. 

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

Report EC02-231-236220. 

7. U.S. Census Bureau. 2002. Plumbing, Heating, and Air-Conditioning Contractors: 2002. 

Report EC02-231-238220. 

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

9. The Sales Tax Clearinghouse at https://thestc.com/STRates.stm (Accessed on June 4, 2009) 

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