Water Heater Manufacturer November 9-10,1998 US. Department of Energy Office of Energy Efficiency 

### Impact Analysis and Renewable Energy 1000 Independence Avenue, SW Washington, DC 20585 

### DOE Workshop T`Contents 

### This presentation contains fivesections.

Office Code document code 1Generic Analytical Framework Legislative Requirements 

### Indetermining whether astandard iseconomically justified, DOE is required to consider: "The economic impact ofthe standard on manufacturers and on the consumers of the products subjectto such astandard." "The impact of any lessening of competition, as determined inwriting by the Attorney General, that is likelyto resultfrom the imposition of the standard."

Office Code document code 2Generic Analytical Framework Legislative Requirements 

### IntheJuly1996 Process Rule, the Department committed toadetailed review ofthe manufacturer impact analyses methodologies. The new methodology must: * Provide for early stakeholder input. * Utilize an annual cash flow approach to determine quantitative impacts, including an assessment of short-term costand capital requirements. * Develop estimates of criticalvariables (with inputfrom interested parties) drawing on multiple sources, both quantitative and qualitative. * Reportthe distribution of impacts on manufacturers. * Use models that are easyto understand and account for uncertainty. * Consider the cumulative impacts of regulation. * Considerthe impacts on manufacturing capacity, plant closures, and lossof capital investment.

OfficeCode document code 3Generic Analytical Framework GenericApproach 

### Both qualitative and quantitative assessments are included in the analysis.
Information Data Who? What? When? How Much? eWhere?

How? Why?

Office Code document code 4Generic Analytical Framework GenericApproach 

### The Department intendsto use fullydocumented qualitative and quantitative analytical methods. * Qualitative assessments of impacts will draw on multiple types of stakeholder inputs.

-Manufacturer inputs will be invited through voluntary interviews

and facilitiesvisits. -Stakeholders will be consulted though interviews, workshops,

surveys, and other meansto develop estimates ofcritical variables and identify possible impacts. * A central core of analyticaltoolswill be developed, maintained, and made availableto all parties.

-The primary focus will be on the Government Regulatory Impact Model (GRIM) and possible enhancements.

Office Code document code 5Analytical Framework 

### The Water Heater manufacturer impact analysis will be conducted in foursteps. Industry Profile "Strawman" Industry Cash Flow Manufacturer Subgroup Analyses

Industry Cash Flow Analyse 6

Office Code document code 6Contents

O Cod

Office Code document code 7Industry Profile Industry Characterization 

### Both unit shipments and value ofwater heaters have increased since 1992. 1400 10-- 9 . ^--^--^O- -- Total 1200 '8 1000

E 4 0 7 0

JS 5- _, .^ ____ . 3 ., 1992 1993 1994 1995 1996 1997 1992 1993 1994 1995 1996 1997
Other includes: other fuel-fired, indirect, instantaneous and circulating water heating systems. Source: U.S. Department of Commerce, Bureau of Census
Office Code documentcode 8Industry Profile IndustryCharacterization 

### The residential water-heater market isdominated by five manufacturers, each having virtually identical shares of both the gas and electric waterheater markets.

A.O. Smith Bradford-White A.O. Smith Bradford-White 16% 10% ' 15% 10%

16% 17% Rheem Rheem

28% 1SBl ~ ~~~~27%

State State Indusries Industries 29% 30% Source: 1995 Market Profile, Appliance Manufacturer, April 1996
OfficeCode document code 9Industry Profile IndustryCharacterization 

### Residential water heaters are soldthrough wholesalers and retail outlets.

4.2 Million4.7 Million Plumbing Wholesalers Large Retail Outlets (Noland, Furguson Westburn, (Home Depot, Sears, Builders Hughs, Familian Group...) Square, Montgomery Ward...)

1.2 Mnew construction 3 M replacements
100-200K 300K OEM Export | Mobile Homes

Office Code documentcode 10Contents

0 C

Office Code document code 11Industry Cash Flow GRIMDescription 

### The Department proposes to use the Government Regulatory Impact Model (GRIM) to conductthe Industry Cash Flow Analysis. GRIM is atool that helps identifythe financial impacts of energy efficiency and other regulations on manufacturers. * Based on conventional analysis of discounted cash flows * Creates full computations of cashflow for both base case (as is) and standards case (with regulation) * Computes Industry Values (NPV) for both scenarios * Offers numerical and graphical comparisons

Office Code document code 12Strawman Industry Cash Flow GRIMDescription 

### GRIM uses manufacturer prices, manufacturing costs, shipments, and financial information to calculate cash flows used for arriving atthe industry value.

Manufacturer Prices 4, ~ Manufacturing Costs 

## GRIM Shipments Financial Information

Cash Flow

Office Code document code 13Strawman Industry Cash Flow 

### The Department has developed a"strawman" cash flow using industryaverage values for manufacturer prices, manufacturing costs, shipments, and financial information. * Manufacturer costswere estimated from a developed industry cost structure. -The data submitted by GAMA was compared to Current Industrial Reports (CIR)

published bythe Bureau of Census. * Manufacturing price data is estimated using the CIR and manufacturer markups estimated from industry coststructure. * Financial information (e.g., tax rate, working capital, depreciation, etc.) is obtained from manufacturers' 10-K statements and other publicly available industry statistics (e.g., Robert Morris Associates). * Shipments are obtained from the "National Energy Savings Spreadsheet" developed by LBNL.

Office Code document code 14Strawman Industry Cash Flow GAMA Data Submittal 

### The GAMA data submittal provided data associated with full production costs.

Full Production Cost Non-Production Cost

Office Code document code 15Strawman Industry Cash Flow Strawman Estimate of WaterHeaterPrices 

### Comparing data provided by manufacturers to GAMA to Current Industrial Reports.

Material Cost 62.16 75.02 85.00 Q | lios 4.008 4.691 NA Labor Cost 12.41 12.49 18.25 Quantity 4.108 4.733 NA ______(milion. 14.108 4.733 NA Value $521.3 $732.2 NA Overhead Cost 50.99 50.10 36.00 milli $521.3 $732.2 NA

_____ $491.4 $745.3 NA GAMA data submittal *Not supplied by GAMA Current Industrial Reports, U.S. Bureau ofCensus, July 24,1998 

### Since DOE is interested inobtaining an industryvalue, DOE is proposing usingthe industryaverage prices presented inthe CIR for 1997 Office Code document code 16Industry Cash Flow Base CaseCost 

### Awater heater industrycoststructure was obtained from atop-down analysis ofthe industryand used toestimate the manufacturing cost ofa base case water heater. Profit before Financing SG&A 6.1% ~11.~1%

~~ ~Material 2R. rialU^ 55
.7% _sB llMaterial 72.44 86.93 85.00 Labor 12.62 15.14 18.25 153°/^Overhead O =ic ie mt e1Overhead 19.90 23.88 36.00 15.3%
Labor 9.7%

Office Code document code 17Industry Cash Flow Post-StandardPrice andCosts 

### GAMA provided DOE the manufacturing costsassociated with meeting different design options. * DOE is proposing using a mark-up approach to estimate post-standard manufacturer price.

-Post-Standard Manufacturer Price =Base Case Manufacturer Price (from CIR) + [Incremental Production Cost (from Engineering Analysis) x Manufacturer Mark-up] * DOE estimated a base case manufacturer mark-up of 1.24. -Mark-ups for Post-Standard manufacturer pricescan be estimated using different

scenarios:

(a)Mark-up (price) that results inmaintenance of current industry value (b)Mark-up (price) that reduces industry valueto zero (c)Price resulting from pass-through of incremental material,labor, and overhead

costs only.

OfficeCode document code 18Industry Cash Flow WaterHeaterShipments 

### Shipment values used in GRIM are obtained from the National Energy Savings Spreadsheet (NES). * NES uses shipment valuesto identifythe national energy savings potential of water heater energy efficiency standards * Using shipmentvaluesfrom NES will ensure thatthe shipment inputs are consistent with other parts of the water heater regulatory impact analyses * LBNL is developing a price-volume relationship to forecast shipments for the water heater rulemaking.

OfficeCode document code 19Industry Cash Flow Financial Information 

### The Department analyzed publiclyavailable sources offirm-specific "industry"financial information to understand the water heater industry's historicalfinancial performance.

* SEC-1OK reports * Working Capital 12.91% * Company's Annual Reports * SG&A 11.06% * Dun and Bradstreet Company * R&D 2.11% Data Reports * Depreciation 3.09% * Capital Expenditures 3.71% * Effective tax rate 35.8%

Office Code document code 20Contents

i131 IP Fs m c 21

Office Code document code 21Subgroup Impact Analysis 

### The subgroup impact analysis consists of 5tasks:

1. Manufacturer Cash-Flow Analysis | \ | 2. Estimate Competitive Impacts | \ 1 3. Estimate Employment Impacts 4. Estimate Impact on Manufacturing Capacity | 5. Summarize Quantitative and Qualitative Findings |

Office Code document code 22Subgroup Impact Analysis Manufacturer Cash Flow 

### Average industry manufacturing costswill not be used toassess the impacts forsubgroups of manufacturers. * Manufacturers will be asked to perform cashflow analyses using the GRIM spreadsheet and their own values for company-specific inputs.

-ADL will assist as needed inadapting the GRIM procedure to individual manufacturer situations. -Important variances from the strawman or industry norms will be discussed and

documented. * Cash flow reports will be prepared with and without new energy efficiency standards.

Office Code document code 23Subgroup Impact Analysis Interview Guide 

### The Department willconduct manufacturer interviews to gather manufacturer-specific data and views on important issues. * The Department will develop a questionnaire to guidethe interviews and invites comments and suggestions on its content from all interested parties. * The purpose of the interviews isto gain understanding and ensure confidence inthe results ofthe manufacturer impact analysis.

-Some questionswill be irrelevant to some manufacturers, and some

manufacturers or suppliers may wantto provide information inaddition tothat requested. * Arthur D.Little is assistingthe Department in carrying outthe interviews and in providing third-party confidentialityfor proprietary information.

OfficeCode document code 24Interview Guide Topics Covered 

### The interviews willcover arange oftopics. * Current Organizational Characteristics * Industry Infrastructure * Global Competition * Manufacturer Cash Flow Analysis/ Impacts Assessment * Employment Impacts Assessment * Competitive Impacts Assessment

Office Code document code 25Interview Guide Organizational Characteristics 

### DOE isinterested inbetter understanding the current organizational characteristics ofeach manufacturer. * The Department's interest isfocused toward the plant or profit center directly concerned with water heater production.

-The details of production levels, product mix, costs, and othervariables are not

generally public information at the plant level, so the Department invites manufacturers to discussthese and other characteristics confidentially to the extent practical. * The organizational setting within which the plant operates is important to round out the Department's understanding ofthe impact that new energy-efficiency standards might have onfuture water heater manufacturing.

OfficeCode document code 26Interview Guide Manufacturer Cash FlowAnalysis 

### Cash flow analysis is akey procedure being used to measure the impact ofstandards on the water heater industry,and the Department 

### wishes to discussfullythe resultswith each manufacturer. * Each manufacturer will be given the GRIM spreadsheet and asample worked-out "strawman" industry cash flowto facilitate understanding among manufacturers aboutthe model and how itworks. * Each manufacturer can then input its own data and assumptions to develop its own expected cashflow.

-This cash flow output should exhibit aformat and content similar to the strawman

example provided.

Office Code documentcode 27Interview Guide Manufacturer Cash FlowAnalysis 

### Cash flowanalysis isa key procedure being used to measure the impact of standards on the water heater industry,and the Department wishes to discussfullythe resultswith each manufacturer. * An important goal of each interview isto fully discussthe results ofthis cash flow analysis undereach scenario.

-The cash flow analyses prepared before the interview arefor discussion

purposes only. -Problems and/or unique circumstances affectingthe cashflow results can be

discussed and resolved during the interview. * Each interview should include an informal review of a draft cash flow analysis for the manufacturer.

-The draft can then be revised afterthe discussion for submission to third-party review and inclusion inthe industry rollup.

Office Code document code 28Interview Guide Employment Impacts 

### The employment impacts of new energy efficiency standards isan important consideration inthe rulemaking process. * DOE seeks to explore current trends inwater heater production employment and solicit manufacturer views on how employment patterns might be affected by new energy efficiency standards.

-DOE is also interested inthe extent to which the workforce at US facilities might need extensive retraining or replacement? * Existing data and manufacturer interviews will be used to estimate employment level differences between different standards levels. * Interviews will be used to establish differences inworkforce skills required under different levelsof energy-efficiency standards. * DOE interviews with manufacturers will establish likely impact of new energy- efficiency standards on product mix and employment levels. Secondary employment impacts of new energy efficiencystandards could occur particularly for important suppliers, and this isatopicfor discussion as well.

Office Code document code 29Interview Guide Competitive Impacts 

### DOE willsolicitearly involvement ofthe Department ofJustice in structuringthe competitive impact assessment. * Competitive Analysiswill focus on assessing the impacts to smaller, significant manufacturers. * DOJ has offered to participate indrafting questions to be used inmanufacturer interviews. * Questions will pertain to an assessment ofthe likeliness of increased concentration levels and other market conditions that could lead to non-competitive pricing behavior.

-Asymmetrical cost increases to some manufacturers -Increased proportion offixed costs potentially increasing business risk -Barriers to market entry (proprietary technologies, etc.)

Office Code document code 30Contents

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OfficeCode document code 31Industry Cash Flow Aggregation Approach 

### The Department proposes to develop the industrycash flow using a "bottom-up" approach. * The Government Regulatory Impact Model (GRIM) will be used to encourage all parties to use a common annual cash flow analysis under current vs. new energy- efficiencystandards scenarios. * The Department will provide stakeholders with the "strawman" cashflow using publicly available values for price, cost, shipments, andfinancial information. * The Department has prepared a list of financial values for input to the GRIM as a starting pointfor discussion atthe workshop. * Each manufacturer will provide its own cashflow analysis to be aggregated with others to buildthe industry picture.

Office Code document code 32IndustryCash Flow RollingUp Manufacturer Cash Flows to IndustryLevel 

### The "Strawman" willserve as astarting point and benchmark from which individual manufacturers' cash flows can be created.
Manufacturer A "Strawman" 

## I Manufacturer : : Industry Cash Flow Industry Cash Flow B Manufacturer << Straw man , IC

Office Code document code 33 Industry Cash Flow * B |~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I

_________________ I

__ ______

"^ , -------- ^^ anuactrer^;iIndustry Cash Flow Public Record 

### Forthe public record the information thatwill be presented isonlythe summary sheet ofthe industrycash flowforeach scenario. * Proprietary information will not be disclosed: -Shipments bywater heatertype -Prices bywater heater type -Manufacturing costs bywater heater type -Manufacturer-specific financial information (tax rate, working

capital, etc.)

OfficeCode document code 34