CHAPTER 6. MARKUPS ANALYSIS

TABLE OF CONTENTS

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

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

6.2 MARKUP CALCULATION METHODOLOGY ..............................................................6-3

6.3 APPROACH FOR CALCULATING OVERALL MARKUP...........................................6-3

6.3.1 Baseline Markup: New Construction ......................................................................6-3

6.3.2 Baseline Markup: Replacement ...............................................................................6-4

6.3.3 Incremental Markups: New Construction ...............................................................6-5

6.3.4 Incremental Markups: Replacement........................................................................6-6

6.3.5 Approach for Calculating Overall Markup of the National Accounts 

Distribution Channel.................................................................................................6-8

6.4 APPROACH FOR CALCULATING MANUFACTURER MARKUP............................6-9

6.5 APPROACH FOR CALCULATING WHOLESALER AND CONTRACTOR 

MARKUPS......................................................................................................................... 6-10

6.5.1 Key Data Sources and Assumptions of the Markups Methodology................... 6-10

6.5.2 Approach for Wholesaler Markup........................................................................ 6-12

6.5.3 Approach for Mechanical Contractor Markup..................................................... 6-13

6.5.4 Approach for General Contractor Markup........................................................... 6-14

6.6 DERIVATION OF MARKUPS ........................................................................................ 6-15

6.6.1 Base Case Manufacturer Markups........................................................................ 6-15

6.6.2 Wholesaler Markups.............................................................................................. 6-16

6.6.3 Mechanical Contractor Markups .......................................................................... 6-17

6.6.3.1 Aggregate Baseline and Incremental Markups for Mechanical 

Contractors ................................................................................................... 6-17

6.6.3.2 Baseline Markups for Mechanical Contractors in the Replacement 

and New Construction Markets .................................................................. 6-18

6.6.4 Estimation of General Contractor Markups......................................................... 6-19

6.7 SALES TAX....................................................................................................................... 6-20

6.8 OVERALL MARKUPS .................................................................................................... 6-21

6.8.1 Estimation of National Account Markups............................................................ 6-22

REFERENCES ............................................................................................................................... 6-23

LIST OF TABLES

Table 6.1.1 Shares of Market by Distribution Channel .......................................................6-3

Table 6.6.2 Manufacturer Markups by Equipment Type.................................................. 6-16

Table 6.6.3 National Wholesaler Expenses and Markups................................................ 6-16

Table 6.6.4 Baseline and Incremental Markups, All Mechanical Contractors (2007 

Economic Census data)................................................................................... 6-18

Table 6.6.5 Baseline Markups for the Replacement and New Construction 

Markets, Mechanical Contractors (ACCA data) ........................................... 6-19

Table 6.6.6 General Contractor Expenses and Markups................................................... 6-20

6-i 
Table 6.7.1 Average Sales Tax Rates by Census Division and Large State.................... 6-21

Table 6.8.1 Summary of Overall Markups........................................................................ 6-21

Table 6.8.2 National Account Markups............................................................................. 6-22

LIST OF FIGURES

Figure 6.1.1 Distribution Channels for PTACs and PTHPs in New Construction 

Applications........................................................................................................6-2

Figure 6.1.2 Distribution Channels for PTACs and PTHPs in Replacement 

Applications........................................................................................................6-2

6-ii
CHAPTER 6. MARKUPS ANALYSIS

6.1 INTRODUCTION

To carry out the life-cycle cost (LCC) calculations described in Chapter 8 of this 

technical support document (TSD), the U.S. Department of Energy (DOE) needed to determine 

the cost to the commercial customer of a baseline packaged terminal air conditioner (PTAC) or 

packaged terminal heat pump (PTHP), and the cost of the more-efficient unit the customer would 

purchase under the standards. However, the commercial customer price of such units is not 

generally known. What is known is the manufacturer’s price for both baseline equipment and the 

more-efficient equipment. By applying a multiplier called a “markup” to the manufacturer’s 

price, DOE was able to estimate the commercial customer’s price. This chapter describes how 

DOE derived such markups.

The equipment price to the commercial customer depends on how the customer purchases 

the equipment. The Department defines two primary types of distribution channels to describe 

how the equipment passes from the manufacturer to the customer: (1) in the first type of 

distribution channel, the manufacturer sells the equipment to a wholesaler, who in turn may sell

it to a mechanical contractor, who in turn may sell it (and its installation) to a general contractor, 

who in turn sells it to the customer; (2) in the second type of distribution channel, the 

manufacturer sells the equipment directly to the customer through a national account. The 

Department has further subdivided the distribution channels for new and replacement equipment.

For wholesalers and contractors, DOE estimated a baseline markup and an incremental 

markup. DOE defined a baseline markup as a multiplier that converts the manufacturing selling 

price 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 manufacturing selling price of higher efficiency equipment to the 

customer purchase price for the same higher efficiency equipment. Because companies mark up 

the price to cover business cost and profit margin at each step in the distribution channel, both 

baseline and incremental markups are dependent on the particular distribution channel, as 

described in section 6.1.1. 

6.1.1 Distribution Channels

The appropriate markups for determining customer equipment prices depend on the type 

of distribution channels through which equipment moves 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. 

There are two primary types of distribution channels describing the way most equipment 

passes from the manufacturer to the customer, one involving distributors and contractors and one 

from manufacturer directly to customer via national accounts. Within these two primary 

channels, DOE distinguishes between new and replacement applications, as each application has 

a different mechanical contractor markup. 

 

6-1 
Distribution channels for new construction applications are shown in Figure 6.1.1. In the 

first 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 a general contractor, who in 

turns sells it to the customer and performs the installation. In the second new construction 

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

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

sells the equipment directly to the customer through a national account. 

Channel 1 Channel 2 Channel 3

Manufacturer Manufacturer

Manufacturer

(through 

national 

accounts)

Wholesaler

Wholesaler

Mechanical 

Contractor

General 

Contractor

Customer Customer Customer

Figure 6.1.1 Distribution Channels for PTACs and PTHPs in New Construction 

Applications

Distribution channels for replacement applications are shown in Figure 6.1.2. In the first 

replacement 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 a general contractor, who in turns 

sells it to the customer and performs the installation. In the second, the manufacturer sells the 

equipment to a wholesaler, who in turn sells the equipment to the customer. In the third, the 

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

who sells it to the customer and performs the installation.

Channel 1 Channel 2 Channel 3

Manufacturer Manufacturer Manufacturer

Wholesaler

Wholesaler

Wholesaler

Mechanical 

Contractor Mechanical 

Contractor General 

Contractor

Customer Customer Customer

Figure 6.1.2 Distribution Channels for PTACs and PTHPs in Replacement Applications

Table 6.1.1 lists each distribution channel’s share of the full PTAC and PTHP market.

6-2 
Table 6.1.1 Shares of Market by Distribution Channel

Distribution Channel New Replacement

Wholesaler-Customer 30% 15%

Wholesaler-Mech Contractor-End User 0% 25%

Wholesaler-Mech Contractor-General Contractor-Customer 38% 60%

National Account 32% 0%

Total 100% 100%

6.2 MARKUP CALCULATION METHODOLOGY

At 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 is the 

difference between the company revenue and the company cost of sales or cost of goods sold 

(CGS). The gross margin includes company profits and the expenses of companies in the 

distribution channel, which include overhead costs (sales, general, and administration), research 

and development (R&D) and interest expenses, depreciation, and taxes. In order for sales of 

equipment to contribute positively to company cash flow, the equipment’s markup must be 

greater than the corporate gross margin. Equipment commands lower or higher markups, 

depending on company expenses associated with the equipment and the degree of market 

competition. 

Equipment manufacturers sell most of their equipment directly to wholesalers. 

Wholesalers sell to contractors or customers at the wholesale price. Wholesalers absorb shortterm imbalances in supply and demand, allowing manufacturers to operate more efficiently and 

satisfying customer needs for fast deliveries. In addition, wholesalers are important sources for

parts. Most contractors compete at the local level. Many carry more than one brand of 

equipment, and most install the equipment they sell. 

In addition to the wholesaler and mechanical contractor markups, the general contractor 

adds a markup. In retrofit installations, sales tax applies to the final customer cost. 

6.3 APPROACH FOR CALCULATING OVERALL MARKUP 

6.3.1 Baseline Markup: New Construction

DOE used the overall baseline markup to estimate the customer product price of baseline 

models, given the manufacturer cost of the baseline models. 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 baseline markups to determine the 

product price for baseline models in the first new construction distribution channel. 

6-3 
CPPBASE = COSTMFG × �MUMFG × MUWHOLEBASE × MUMCONTRACTBASE × MUGCONTRACTBASE �

 = COSTMFG × MUOVERALL_BASE_1 

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_BASE = baseline wholesaler markup, 

MUMCONTRACT_BASE = baseline mechanical contractor markup,

MUMGENERAL_BASE = baseline general contractor markup, and

MUOVERALL_BASE_1 = baseline overall markup.

The following equation shows how DOE used baseline markups to determine the product price 

for baseline models in the second new construction distribution channel. 

CPPBASE = COSTMFG × �MUMFG × MUWHOLEBASE �

 = COSTMFG × MUOVERALL_BASE_2 

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_BASE = baseline wholesaler markup, and

MUOVERALL_BASE_2 = baseline overall markup.

6.3.2 Baseline Markup: Replacement

The following equation shows how DOE used baseline markups to determine the product 

price for baseline models in the first replacement distribution channel.

CPPBASE = COSTMFG × �MUMFG × MUWHOLEBASE × MUMCONTRACTBASE × MUGCONTRACTBASE �

× TAXSALES

 = COSTMFG × MUOVERALLBASE_1 × TAXSALES 

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_BASE = baseline wholesaler markup,

MUMCONTRACT_BASE = baseline mechanical contractor markup,

MUGCONTRACT_BASE = baseline general contractor markup, 

TAXSALES = sales tax, and

MUOVERALL_BASE_1 = baseline overall markup.

6-4 
The following equation shows how DOE used baseline markups to determine the product 

price for baseline models in the second replacement distribution channel.

CPPBASE = COSTMFG × �MUMFG × MUWHOLEBASE � × TAXSALES

= COSTMFG × MUOVERALLBASE_2 × TAXSALES

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_BASE = baseline wholesaler markup,

TAXSALES = sales tax, and

MUOVERALL_BASE_2 = baseline overall markup.

The following equation shows how DOE used baseline markups to determine the product 

price for baseline models in the third replacement distribution channel.

CPPBASE = COSTMFG × �MUMFG × MUWHOLEBASE × MUMCONTRACTBASE � × TAXSALES

= COSTMFG × MUOVERALLBASE_1 × TAXSALES 

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_BASE = baseline wholesaler markup,

MUMCONTRACT_BASE = baseline mechanical contractor markup,

TAXSALES = sales tax, and

MUOVERALL_BASE_1 = baseline overall markup.

6.3.3 Incremental Markups: New Construction

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

product price, given changes in the manufacturer cost from the baseline model cost resulting 

from an energy conservation standard to raise equipment energy efficiency. The total customer

product price for more energy-efficient models is composed of two components: the customer

product price of the baseline model and the change in customer 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 product price for more energy-efficient models in the first new construction 

distribution channel. 

6-5 
CPPBASE = COSTMFG × �MUMFG × MUWHOLE_INCR × MUMCONTRACT_INCR × MUGCONTRACT_INCR�

 = COSTMFG × MUOVERALL_INCR

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_INCR = incremental wholesaler markup,

MUMCONTRACT_INCR = incremental mechanical contractor markup,

MUGCONTRACT_INCR = incremental general contractor markup, and

MUOVERALL_INCR= incremental overall markup.

The following equation shows how DOE used the overall incremental markup to 

determine the product price for more energy-efficient models in the second new construction 

distribution channel. 

CPPBASE = COSTMFG × �MUMFG × MUWHOLE_INCR�

 = COSTMFG × MUOVERALL_INCR

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_INCR = incremental wholesaler markup, and

MUOVERALL_INCR= incremental overall markup.

6.3.4 Incremental Markups: Replacement

The following equation shows how DOE used the overall incremental markup to 

determine the product price for more energy-efficient models in the first replacement distribution 

channel.

6-6 
CPPBASE = COSTMFG

× �MUMFG × MUWHOLE_INCR × MUMCONTRACT_INCR

× MUGCONTRACT_INCR × TAXSALES�

 = COSTMFG × MUOVERALL_INCR_1

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_INCR = incremental wholesaler markup,

MUMCONTRACT_INCR = incremental mechanical contractor markup, 

MUGCONTRACT_INCR = incremental general contractor markup,

TAXSALES = sales tax, and

MUOVERALL_INCR_1= incremental overall markup.

The following equation shows how DOE used the overall incremental markup to 

determine the product price for more energy-efficient models in the second replacement 

distribution channel.

CPPBASE = COSTMFG × �MUMFG × MUWHOLE_INCR × TAXSALES�

 = COSTMFG × MUOVERALL_INCR_2

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_INCR = incremental wholesaler markup,

TAXSALES = sales tax, and

MUOVERALL_INCR_2= incremental overall markup.

The following equation shows how DOE used the overall incremental markup to 

determine the product price for more energy-efficient models in the third replacement 

distribution channel.

6-7 
CPPBASE = COSTMFG × �MUMFG × MUWHOLE_INCR × MUMCONTRACT_INCR × TAXSALES�

 = COSTMFG × MUOVERALL_INCR_3

Where:

CPPBASE = customer product price for baseline models,

COSTMFG = manufacturer cost for baseline models,

MUMFG = manufacturer markup,

MUWHOLE_INCR = incremental wholesaler markup,

MUMCONTRACT_INCR = incremental mechanical contractor markup, 

TAXSALES = sales tax, and

MUOVERALL_INCR_3= incremental overall markup.

6.3.5 Approach for Calculating Overall Markup of the National Accounts Distribution 

Channel 

Equipment purchased through national accounts is an exception to the usual distribution 

of heating, ventilating, and air conditioning (HVAC) equipment to end users. Large commercial 

customers of HVAC equipment use national accounts to circumvent the typical chain of 

distribution, thereby allowing them to negotiate equipment prices directly with the manufacturer. 

Due to the large volume of equipment purchased, large commercial customers, such as national 

retail chains, are able to purchase equipment directly from the manufacturer at significantly 

lower prices than could be obtained through the typical distribution chain.

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 one half of that realized from a typical chain of distribution. In other words, if the 

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

contractor markups is $100, the “national account” markup is such that the price increase is onehalf of that, or $50. The Department based the use of a “national account” markup that is onehalf of that realized from a typical chain of distribution on the assumption that the resulting 

“national account” equipment price must fall somewhere between the manufacturer price (i.e., a 

markup of 1.0) and the commercial customer price under a typical chain of distribution. Because 

DOE did not know typical values for the actual “national account” equipment price, it chose a 

value of one-half.

The estimates of national account markups are arrived at through a weighted average of

the overall markups for the other new construction distribution channels. Of all PTAC and 

PTHP equipment used in new construction, 30% are sold directly from wholesaler to end user, 

38% involve mechanical and general contractors, and the remaining 32% are sold through 

national accounts. The national account markups for new construction are calculated using the 

following equations:

6-8 
MUOVERALL_NA = MUOVERALL_BASE_1 × MUOVERALL_BASE_2 (Baseline)

Where:

MUOVERALL_BASE_NA = overall baseline national account markup.

MUOVERALL_BASE_1 = overall baseline markup for distribution channel 1,

MUOVERALL_BASE_2 = overall baseline markup for distribution channel 2, and

MUOVERALL_NA = MUOVERALL_INCR_1 × MUOVERALL_INCR_2 (Baseline)

Where:

MUOVERALL_INCR_NA = overall incremental national account markup.

MUOVERALL_INCR_1 = overall incremental markup for distribution channel 1,

MUOVERALL_INCR_2 = overall incremental markup for distribution channel 2, and

The half of the overall markup proportion above cost is then calculated as follows:

ρNA_MU_COST = MUOVERALL − 1

2

Where:

ρNA_MU_COST = national account markup proportion above cost.

MUOVERALL= overall markup, and 

Adding 1 to the national account markup proportion above cost, DOE arrives at the 

estimated national account markup:

MUOVERALL_NA = 1 + ρNA_MU_COST

Where:

MUOVERALL_NA= national account overall markup.

ρNA_MU_COST = national account markup proportion above cost, and

6.4 APPROACH FOR CALCULATING MANUFACTURER MARKUP 

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

manufacturer sales price. Using the CGS and gross margin, the manufacturer markup can be 

calculated as follows:

6-9 
MUMFG = CGSMFG + GMMFG

CGSMFG

Where:

MUMFG = manufacturer markup,

CGSMFG = manufacturer cost of goods sold, and

GMMFG = manufacturer gross margin.

6.5 APPROACH FOR CALCULATING WHOLESALER AND CONTRACTOR 

MARKUPS 

DOE examined the manner in which markups change by efficiency level and other 

factors for wholesalers and contractors. DOE determined that markups are neither fixed-dollar, 

nor proportional to all direct costs, which means that the selling price of equipment may not be 

strictly proportional to the purchase price of the equipment. Using the available data, DOE has

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

average aggregate markup on direct business costs. Additionally, DOE discovered significant 

differences between average and incremental markups for heating, ventilation, air-conditioning 

and refrigeration (HVACR) wholesalers and for HVAC contractors. 

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

the purchase price of the equipment is that businesses incur a wide variety of costs. When the 

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

increase, while the remainder of the business’ expenses stays relatively constant. Certain 

business expenses are uncorrelated with the cost of equipment or cost of goods. For example, if 

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

secretarial support in an administrative office will increase by 30 percent also.

6.5.1 Key Data Sources and Assumptions of the Markups Methodology

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

the costs associated with PTAC and PTHP equipment. DOE based the wholesaler and 

mechanical contractor markups on firm-level income statement data, while it based the general 

contractor markups on U.S. Census Bureau data for the commercial building construction 

industry. DOE obtained the firm income statements from the Heating, Air-conditioning & 

Refrigeration Distributors International (HARDI) 2010 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 2007 U.S. Economic Census to develop general contractor markups in the same form as 

the income statement data for wholesalers and mechanical contractors.3, 4 Additionally, DOE 

used 2007 Economic Census data to supplement the income statement data obtained from 

6-10
ACCA. These income statements break down 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:

 

1. The firm income statements faithfully represent the industry average for the various costs 

incurred by firms distributing and installing HVAC equipment including commercial air 

conditioners.

2. These costs can be divided into two categories: 1) costs that vary in proportion to the 

manufacturer selling price (MSP) of commercial air conditioners (variant costs); and 2) 

costs that do not vary with the MSP commercial air conditioners (invariant costs).

3. Overall, commercial air-conditioner wholesaler and contractor prices vary in proportion 

to commercial air conditioner wholesaler and contractor costs included in the income 

statements.

In support of the first assumption, the income statements 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 room air conditioners, furnaces, central air 

conditioners and heat pumps, and boilers, the data provide the most accurate available indication 

of the expenses associated with commercial air conditioners. 

Information obtained from the trade literature, and from selected HVAC wholesalers, 

contractors, and consultants, tends to support the second assumption; this information indicates 

that wholesale and contractor markups vary according to the quantity of labor and materials used 

to distribute and install equipment. In its analysis, DOE assumes a division of costs between 

those that do not scale with the manufacturer price (labor and occupancy expenses), and those 

that do (operating expenses and profit). This division of costs led to the estimate of wholesale 

and contractor markups described subsequently. 

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 2007 Census indicates the competitive nature of the 

market. For example, there are more than 700 HVAC manufacturers,5 5,300 wholesalers of heat 

pumps and air-conditioning equipment,6 more than 170,000 general residential contractors, 

36,000 commercial and institutional building contractors,7, 8 and 91,000 HVAC contractors listed 

in the 2007 Census.9 Additionally, the 2007 Census estimated that the four firm concentration 

ratio (FFCR) for the HVAC wholesale sector is 29.7%.10 The FFCR is the market share of the 

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

residential and commercial air-conditioners. 

6-11

 
four largest firms in the industry; an FFCR under 40% represents a competitive industry.11, 12 

Following standard economic theory, competitive firms facing inelastic demand either set prices 

in line with costs or quickly go out of business.13

6.5.2 Approach for Wholesaler Markup 

Using these assumptions, DOE developed baseline and incremental markups for 

wholesalers using the firm income statement from the (HARDI 2010 Profit Report). (See 

Appendix 6-A.) DOE used the baseline markups, which cover all of the wholesaler’s costs (both 

invariant costs and variant costs), to determine the sales price of baseline models. Here variant 

costs were defined as costs that vary in proportion to the change in MSP induced by increased 

efficiency standards; in contrast, invariant costs were defined as costs that do not vary in 

proportion to the change in MSP due to increased efficiency standards. The baseline markup 

relates the manufacturer sales price to the wholesaler sales price. DOE calculated the baseline 

markup for wholesalers using the following equation:

MUWHOLE_BASE = CGSWHOLE + GMWHOLE

CGSWHOLE

= CGSWHOLE + (IVCWHOLE + VCWHOLE)

CGSWHOLE

Where:

MUWHOLE_BASE = baseline wholesaler markup, 

CGSWHOLE = wholesaler cost of goods sold,

GMWHOLE = wholesaler gross margin, 

IVCWHOLE = wholesaler invariant costs, and

VCWHOLE = wholesaler variant costs.

Incremental markups relate the change in the manufacturer sales price of more energyefficient models, or those equipment that meet 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 manufacturer sales price (i.e., variant costs, VC). DOE

calculated the incremental markup for wholesalers using the following equation:

MUWHOLE_INCR = CGSWHOLE + VCWHOLE

CGSWHOLE

Where:

MUWHOLE_INCR = incremental wholesaler markup,

CGSWHOLE = wholesaler cost of goods sold, and 

VCWHOLE= wholesaler variant costs.

These data are provided for seven regions, which are defined similarly to Census 

Divisions. Each state is assigned the baseline and incremental wholesaler markup of the region 

to which it is assigned by HARDI.

6-12
6.5.3 Approach for Mechanical Contractor Markup 

Similar financial data to that used to estimate wholesaler markups are also available for 

mechanical contractors and general contractors from ACCA and the 2007 Economic Census.

2, 9

To estimate mechanical contractor markups for commercial air conditioners, DOE collected 

financial data from ACCA and from the Plumbing, Heating and Air-Conditioning Contractors

(NAICS 23822) data series of the 2007 Economic Census. This data series provides limited data 

at the state level and highly detailed national aggregate data. As the Census data is the most 

recent, DOE relies on it as the primary source for this analysis, using the greater detail of the 

ACCA data to refine the estimates.

The 2007 Economic Census data include the number of establishments, payroll for 

construction workers, value of construction, cost of materials, and cost of subcontracted work at 

both the state and national levels. DOE calculated national average and state-level estimates of

the baseline markup for mechanical contractors and general contractors using the following 

equation:

MUBASE = VCONSTRUCT

PAY + MATCOST + SUBCOST

Where:

MUBASE = baseline mechanical contractor or general contractor markup,

VCONSTRUCT = value of construction,

PAY = payroll for construction workers,

MATCOST = cost of materials, and

SUBCOST = cost of subcontracted work.

Analogously to the wholesaler markup, DOE estimated the national average incremental 

mechanical contractor markup by only considering those costs that scale with a change in the 

manufacturer sales price (variant costs, VC) for higher efficiency equipment. Necessary data to 

perform the incremental markups calculation were not available at the state level. As stated in 

section 6.5.1, DOE assumes a division of costs between those that do not scale with the 

manufacturer price (labor and occupancy expenses) and those that do (other operating expenses 

and profit). Hence, DOE categorized the 2007 Economic Census cost data in each major cost 

category and estimated incremental contractor markups using the following equation: 

MUCONTRACT_INCR = CGSCONTRACT + VCCONTRACT

CGSCONTRACT

Where:

MUCONTRACT_INCR = incremental contractor markup,

CGSCONTRACT = contractor cost of goods sold, and

VCCONTRACT= contractor variant costs.

ACCA financial data provide gross margin (GM) as percent of sales for several market 

subcategories of mechanical contractor (e.g., residential and commercial, new construction and 

6-13
replacement, small and large companies, etc.). In this analysis, DOE distinguishes between 

replacement and new construction applications. From the ACCA data, baseline mechanical 

markups are estimated for replacement, new construction, and the overall average of all 

mechanical contractors. The mechanical contractor markups estimated from the 2007 Economic 

Census data were scaled by applying the following factors developed from the ACCA data:

MUMKT_SEGMENT = SALESMKT_SEGMENT (%)

SALESMKT_SEGMENT (%) − GMMKT_SEGMENT (%)

MUFULL_MKT = SALESFULL_MKT (%)

SALESFULL_MKT (%) − GMFULL_MKT (%)

MKT MODIFIER = MUMKT_SEGMENT

MUFULL_MKT

Where:

MKT_MODIFIER = factor used to disaggregate replacement and new construction 

mechanical contractor applications from the 2007 Economic 

Census data for the overall market, 

SALESMKT_SEGMENT = sales of the relevant market segment (i.e., replacement or new 

construction),

SALESFULL_MKT = sales of the overall mechanical contractor industry,

GMMKT_SEGMENT = gross margin of the relevant market segment,

GMFULL_MKT = gross margin of the overall mechanical contractor industry,

MUMKT_SEGMENT = baseline markup of the relevant market segment, and

MUFULL_MKT = baseline markup of the overall mechanical contractor industry.

DOE estimated state-level incremental mechanical contractor markups by calculating the 

ratio of the national average incremental markup to the national average baseline markup. This 

ratio was then used to scale the state-level baseline markups, arriving at a state-level estimate of 

incremental mechanical contractor markups.

6.5.4 Approach for General Contractor Markup 

To estimate general contractor markups, DOE collected data from the Commercial and 

Institutional Building Construction series from the 2007 Economic Census (NAICS 236220). As 

for mechanical contractors, the 2007 Economic Census data include the number of 

establishments, payroll for construction workers, value of construction, cost of materials, and 

cost of subcontracted work at both the state and national levels. DOE estimated the baseline 

markup for general contractors using the following equation:

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MUBASE = VCONSTRUCT

PAY + MATCOST + SUBCOST

Where:

MUBASE = baseline general contractor markup,

VCONSTRUCT = value of construction,

PAY = payroll for construction workers,

MATCOST = cost of materials, and

SUBCOST = cost of subcontracted work.

DOE estimated the national average incremental general contractor markups by 

considering only those costs that scale with a change in the manufacturer sales price (variant 

costs, VC) for higher efficiency equipment. Necessary data to perform the incremental markups 

calculation was not available at the state level. As stated in section 6.5.1, DOE assumes a 

division of costs between those that do not scale with the manufacturer price (labor and 

occupancy expenses) and those that do (other operating expenses and profit). Hence, DOE 

categorized the 2007 Economic Census cost data in each major cost category and estimated 

incremental general contractor markups using the following equation: 

MUCONTRACT_INCR = CGSCONTRACT + VCCONTRACT

CGSCONTRACT

Where:

MUCONTRACT_INCR = incremental contractor markup,

CGSCONTRACT = contractor cost of goods sold, and

VCCONTRACT= contractor variant costs.

DOE estimated state-level incremental general contractor markups by calculating the 

ratio of the national average incremental markup to the national average baseline markup. This 

ratio was then used to scale the state-level baseline markups, arriving at a state-level estimate of 

incremental general contractor markups.

6.6 DERIVATION OF MARKUPS

6.6.1 Base Case Manufacturer Markups

DOE developed a set of base case manufacturer markups using data developed as part of 

the 2008 Final Rule for PTACs and PTHPs (73 FR 58772). DOE then solicited feedback on its 

markup estimates during confidential manufacturer interviews. Based on this content and 

manufacturer comments, DOE calculated and applied an average baseline markup of 1.27 for all 

equipment classes analyzed. This markup includes selling, general and administrative expenses 

(SG&A), research and development (R&D) expenses, interest, and profit. 

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Table 6.6.1 Manufacturer Markups by Equipment Type

Equipment Type Cooling Capacity (Btu/h) Baseline Markup

PTAC

<7,000 Btu/h 1.27

≥7,000 Btu/h and ≤15,000 Btu/h 1.27 

>15,000 Btu/h 1.27

PTHP

<7,000 Btu/h 1.27

≥7,000 Btu/h and ≤15,000 Btu/h 1.27

>15,000 Btu/h 1.27

6.6.2 Wholesaler Markups 

Wholesalers reported median data in a confidential survey that HARDI conducted across 

its members. In the survey, HARDI itemized revenues and costs into categories, including direct 

equipment expenses (cost of goods sold), labor expenses, occupancy expenses, other operating 

expenses, and profit. DOE presents these data in full, by HARDI region, in Appendix 6-A, 

Detailed Data for Equipment Price Markups. Table 6.6.2 summarizes HARDI wholesaler data, 

aggregated to the national level, in terms of cost-per-dollar sales revenue in the first data column

and in terms of cost-per-dollar of cost of goods sold in the second column. 

Table 6.6.2 National Wholesaler Expenses and Markups

Descriptions

Per Dollar

Sales Revenue

$

Per Dollar Cost 

of Goods

$

Direct Cost of Equipment Sales: Cost of goods sold 0.737 1.000

Labor Expenses: Salaries and benefits 0.151 0.205

Occupancy Expense: Rent, maintenance, and utilities 0.036 0.049

Other Operating Expenses: Depreciation, advertising, and 

insurance.

0.055 0.075

Operating Profit 0.020 0.027

Baseline Revenue: Baseline revenue earned per dollar cost of goods sold 1.357

Wholesaler Baseline Markup (MUWHOLE BASE) 1.357

Incremental Revenue: Increased revenue per dollar increase cost of goods sold 1.103

Incremental Markup (MUWHOLE INCR) 1.103

Source: Heating, Air Conditioning & Refrigeration Distributors International. 2012. 2012 Profit Report (2010 Data).

In this case, direct equipment expenses (cost of goods sold) represent about $0.74 per 

dollar sales revenue, so for every $1 wholesalers take in as sales revenue, $0.74 is used to pay 

the direct equipment costs. Labor expenses represent $0.15 per dollar sales revenue, occupancy 

expenses represent $0.04, other operating expenses represent $0.06, and profit accounts for $0.02 

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 $0.74 (i.e., cost of goods sold per dollar of 

sales revenue). For every $1.00 the wholesaler spends on equipment costs, the wholesaler spends 

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$0.205 to cover labor costs, $0.049 to cover occupancy expenses, $0.075 for other operating 

expenses, and $0.027 in profits. This totals to $1.357 in sales revenue earned for every $1.00 

spent on equipment costs. Therefore, the wholesaler baseline markup (MUWHOLE BASE) is 1.357

($1.357 ÷ $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 6.6.2 are variant or invariant with 

respect to MSP. 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 variant), the increase in wholesale price will be $1.357, implying that 

the incremental markup is 1.357, or the same as the baseline markup. At the other extreme, if no 

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. 

As stated in section 6.5, DOE believes that the labor and occupancy costs are invariant

with respect to MSP, while other operating costs and profit are variant with respect to MSP. In 

this case, for a $1.00 increase in the MSP, the wholesale price will increase in line with changes 

in the categories “other operating costs” and “operating profit”; these approximately amount to

$0.067, which when divided by $0.737 cents in cost of goods sold yields an increase of $0.103, 

giving a wholesaler incremental markup (MUWHOLE INCR) of 1.103. See Appendix 6-A for cost 

details.

These data are provided for seven regions, which are defined similarly to Census 

Divisions. Each state is assigned the baseline and incremental wholesaler markup of the region 

to which it is assigned by HARDI.

6.6.3 Mechanical Contractor Markups 

6.6.3.1 Aggregate Baseline and Incremental Markups for Mechanical 

Contractors

DOE derived national average markups for mechanical contractors from U.S. Census 

Bureau data. The 2007 U.S. Census data for mechanical contractors include detailed statistics 

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

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

total dollars for the industry as a whole, 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. Table 6.6.3 summarizes the national 

average expenses for general contractors as expenses per dollar sales revenue in the first data 

column. (Appendix 6-A contains the full set of data.) The process used to calculate markups 

from the table values is analogous to the process explained in detail in section 6.6.2.

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Table 6.6.3 Baseline and Incremental Markups, All Mechanical Contractors (2007 

Economic Census data)

Descriptions

Per Dollar

Sales Revenue

$

Per Dollar Cost 

of Goods

$

Direct Cost of Equipment Sales: Cost of goods sold 0.68 1.00

Labor Expenses: Salaries and benefits 0.18 0.26

Occupancy Expense: Rent, maintenance, and utilities 0.02 0.03

Other Operating Expenses: Depreciation, advertising, and 

insurance.

0.08 0.12

Operating Profit 0.04 0.06

Wholesaler Baseline Markup (MUWHOLE BASE) 1.48

Incremental Markup (MUWHOLE INCR) 1.18

Incremental Markup as % of Baseline Markup 80%

Source: U.S. Census Bureau. 2007 Economic Census, Plumbing, Heating, and Air-Conditioning Contractors. 

Sector 23: 238220. Construction: Industry Series: Preliminary Detailed Statistics for Establishments: 2007. 

The markups derived for mechanical contractors are the national average values for all 

contractors, including large and small contractors serving the replacement and new construction 

markets. The results of this calculation are subsequently scaled based on state-level data also 

obtained from the 2007 U.S. Census Geographic Area Series for mechanical contractors.3 The 

following section describes how DOE further derived the baseline and incremental markups for 

two distinct categories of mechanical contractors: (1) contractors in the replacement market and

(2) contractors in the new construction market. 

6.6.3.2 Baseline Markups for Mechanical Contractors in the Replacement and 

New Construction Markets

The ACCA Financial Analysis for the HVACR Contracting Industry report is used to 

disaggregate markups for the replacement and new construction markets. ACCA financial data 

provided only gross margin data, which allows for the determination of only the baseline markup 

for the two types of contractors, as the gross margin is the sum of all contractor labor and 

operating expenses plus profit. 

Table 6.6.4 summarizes the gross margin and resulting national baseline markup data for 

mechanical contractors that serve the replacement and new construction markets. 

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Table 6.6.4 Baseline Markups for the Replacement and New Construction Markets, 

Mechanical Contractors (ACCA data)

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 0.703 1.000 0.745 1.000

Gross Margin: Labor, occupancy, 

operating expenses, and profit 0.297 0.422 0.255 0.342

Baseline Markup (MUMECH 

CONT BASE): Revenue per dollar 

cost of goods

NA 1.42 NA 1.34

% Difference from Aggregate 

Mechanical Contractor Baseline 

MU

NA 3.6% NA -2.2%

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

Using the baseline markup data for replacement and new construction contractors from 

Table 6.6.4, DOE calculated that the baseline markups for the replacement and new markets are 

3.6 percent higher and 2.2 percent lower, respectively, than that for all mechanical contractors 

serving all markets shown in Table 6.6.3. These percentage differences are applied to the 

previously calculated state-level incremental and baseline markups based on U.S. Census data to 

estimate separate national and state-level markups for the two categories of mechanical 

contractor of interest. 

6.6.4 Estimation of General Contractor Markups 

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

commercial building construction sector. The commercial construction sector includes 

establishments primarily engaged in the construction of commercial and institutional buildings, 

including new construction work, additions, alterations, and repairs. 

The 2007 U.S. Census data for the commercial construction sector include detailed 

statistics for establishments with payrolls, similar to the data reported by HARDI for 

wholesalers. The primary difference is that the U.S. Census Bureau reports itemized revenues 

and expenses in total dollars for the commercial construction industry as a whole, 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. The results of 

this calculation are subsequently scaled based on state-level data also obtained from the 2007 

U.S. Census. Similar to the data for wholesalers, Table 6.6.5 summarizes the national average 

expenses for general contractors as expenses per dollar sales revenue in the first data column. 

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(Appendix 6-A contains the full set of data.) The process used to calculate markups from the 

table values is analogous to the process explained in detail in section 6.6.2.

Table 6.6.5 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 0.76 1.00

Labor Expenses: Salaries (indirect) and benefits 0.08 0.10

Occupancy Expense: Rent, maintenance, and utilities 0.01 0.01

Other Operating Expenses: Depreciation, advertising, and insurance. 0.03 0.04

Net Profit Before Taxes 0.12 0.15

Baseline Markup (MUGEN CONT BASE): Revenue per dollar cost of goods 1.31

Incremental Markup (MUGEN CONT INCR): Increased revenue per dollar increase 

cost of goods sold

1.19

Source: U.S. Census Bureau. 2007. Sector 236220 (Commercial and Institutional Building Construction). 

Construction: Industry Series: Preliminary Detailed Statistics for Establishments: 2007.

6.7 SALES TAX 

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

of the equipment. The sales tax is a multiplicative factor that increases the customer equipment 

price.

DOE derived state and local taxes from data provided by the Sales Tax Clearinghouse.15

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

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

shown in Table 6.7.1. The average sales tax presented in the bottom row of the table is the 

weighted average accounting for commercial building floor space with packaged cooling by 

Census division, calculated using CBECS 2003. Detailed sales tax data by state can be found in 

Appendix 6-A.

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Table 6.7.1 Average Sales Tax Rates by Census Division and Large State

Census Division/State Tax Rate (2014)

New England 5.68%

Mid Atlantic 7.47%

East North Central 6.90%

West North Central 7.09%

South Atlantic 6.47%

East South Central 8.01%

West South Central 8.13%

Mountain 6.44%

Pacific 7.65%

New York 8.40%

California 8.45%

Texas 7.90%

Florida 6.65%

U.S. Average 7.15%

Source: The Sales Tax Clearinghouse at https://thestc.com/STRates.stm (Accessed February 2014) 

6.8 OVERALL MARKUPS 

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

markups, as well as sales tax in the case of replacement applications (Table 6.8.1). 

Table 6.8.1 Summary of Overall Markups 

Distribution Channel 

Segment

Replacement New Construction

Baseline 

Markup

Incremental 

Markup

Baseline 

Markup

Incremental 

Markup

Manufacturer 1.27 - 1.27 -

Wholesaler 1.36 1.10 1.36 1.10

Mechanical Contractor 1.52 1.22 1.43 1.15

General Contractor 1.34 1.22 1.34 1.22

Sales tax (replacements) 1.07 1.07 -- --

Overall Markup 3.76 1.75 3.31 1.54

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6.8.1 Estimation of National Account Markups 

DOE derived markups for national accounts for new construction through a weighting of 

the overall markups estimated for the other new construction distribution channels. To capture

the price savings realized from equipment purchased through national accounts, DOE applies a 

national account markup one half of that of a typical chain of distribution, as described in section 

6.3.5 (Table 6.8.2). 

Table 6.8.2 National Account Markups

Market Baseline 

Markup

Incremental

Markup

New Construction 2.14 1.47

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REFERENCES 

1. Heating Air Conditioning & Refrigeration Distributors International, 2010 Profit Report, 

2010. 

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

Contracting Industry, 2005. 

3. U.S. Census Bureau, Data set for Sector 23, EC0723A1, Construction: Geographic Area 

Series, Detailed Statistics for Establishments, 2007. 

4. U.S. Census Bureau, Data set for Sector 23: EC0723I1, Construction: Industry Series, 

Preliminary Detailed Statistics for Establishments, 2007. 

5. U.S. Census Bureau, Manufacturing Industry Series: Detailed Statistics for the United 

States: 2007. Air-Conditioning and Warm Air Heating Equipment and Commercial and 

Industrial Refrigeration Equipment Mnufacturing. Data set for Sector 31: EC073111. 

2007. 

6. U.S. Census Bureau, Wholesale Trade: Industry Series: Preliminary Summary Statistics 

for the United States: 2007. HVAC Equipment Merchant Wholesaler. Data set for Sector 

42: EC0742111, 2007. 

7. U.S. Census Bureau, Construction: Industry Series: Preliminary Detailed Statistics for 

Establishments: 2007. Commercial and Institutional Building Construction, 2007. 

8. U.S. Census Bureau, Construction: Industry Series: Preliminary Detailed Statistics for 

Establishments: 2007. New Single-Family General Contractors, New Multifamily 

Housing Construction (Except Operative Builders), New Housing Operative Builders 

Residential, 2007. 

9. U.S. Census Bureau, Plumbing, Heating, and Air-Conditioning Contractors. Sector 23: 

238220. Construction: Industry Series, Preliminary Detailed Statistics for 

Establishments, 2007. 

10. U.S. Census Bureau, Wholesale Trade: Subject Series: Estab and Firm Size: Summary 

Statistics by Concentration of Largest Firms for the United States: 2007. Data set for 

Sector 42: EC074373, 2007. 

11. University of Maryland University College, Note on Industry Structure, 2002. (Last 

accessed February, 2013.) 

<http://info.umuc.edu/mba/public/AMBA607/IndustryStructure.html>

12. QuickMBA, Industry Concentration, 2010. (Last accessed February, 2013.) 

<http://www.quickmba.com/econ/micro/indcon.shtml>

13. Pindyck, R. and D. Rubinfeld, Microeconomics, Fifth Edition. 2000. Prentice Hall.

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14. Security Exchange Commission, SEC 10-K Reports, 2006-2011. <http://www.sec.gov/>

15. The Sales Tax Clearinghouse, 2014. (Last accessed February 2014.) 

<https://thestc.com/STRates.stm >

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