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

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Contents

This presentation contains five sections.

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Generic Analytical Framework Legislative Requirements

In determining whether a standard is economically justified, DOE is

required to consider:

"The economic impact of the standard on manufacturers and on the

consumers of the products subject to such a standard."

"The impact of any lessening of competition, as determined in writing

by the Attorney General, that is likely to result from the imposition of

the standard."

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Generic Analytical Framework Legislative Requirements

In the July 1996 Process Rule, the Department committed to a detailed

review of the 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 cost and capital requirements.

* Develop estimates of critical variables (with input from interested parties) drawing

on multiple sources, both quantitative and qualitative.

* Report the distribution of impacts on manufacturers.

* Use models that are easy to understand and account for uncertainty.

* Consider the cumulative impacts of regulation.

* Consider the impacts on manufacturing capacity, plant closures, and loss of capital investment.

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Generic Analytical Framework Generic Approach

Both qualitative and quantitative assessments are included in the

analysis.

Information Data

Who?

What?

When?

How Much? eWhere?

How?

Why?

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Generic Analytical Framework Generic Approach

The Department intends to use fully documented 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 facilities visits.

-Stakeholders will be consulted though interviews, workshops,

surveys, and other means to develop estimates of critical

variables and identify possible impacts.

* A central core of analytical tools will be developed, maintained, and made

available to all parties.

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

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Analytical Framework

The Water Heater manufacturer impact analysis will be conducted in

four steps.

Industry Profile

"Strawman" Industry Cash Flow

Manufacturer Subgroup Analyses

Industry Cash Flow Analyse 6

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Industry Profile Industry Characterization

Both unit shipments and value of water 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

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Industry Profile Industry Characterization

The residential water-heater market is dominated 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

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Industry Profile Industry Characterization

Residential water heaters are sold through 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 M new construction

3 M replacements

100-200K 300K OEM

Export | Mobile Homes

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Industry Cash Flow GRIM Description

The Department proposes to use the Government Regulatory Impact Model (GRIM) to conduct the Industry Cash Flow Analysis.

GRIM is a tool that helps identify the financial impacts of energy efficiency and

other regulations on manufacturers.

* Based on conventional analysis of discounted cash flows

* Creates full computations of cash flow for both base case

(as is) and standards case (with regulation)

* Computes Industry Values (NPV) for both scenarios

* Offers numerical and graphical comparisons

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Strawman Industry Cash Flow GRIM Description

GRIM uses manufacturer prices, manufacturing costs, shipments, and

financial information to calculate cash flows used for arriving at the

industry value.

Manufacturer Prices ~ 4, Manufacturing Costs

GRIM

Shipments Financial Information

Cash Flow

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Strawman Industry Cash Flow

The Department has developed a "strawman" cash flow using industryaverage values for manufacturer prices, manufacturing costs, shipments, and financial information.

* Manufacturer costs were estimated from a developed industry cost structure.

-The data submitted by GAMA was compared to Current Industrial Reports (CIR) published by the Bureau of Census.

* Manufacturing price data is estimated using the CIR and manufacturer markups estimated from industry cost structure.

* 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.

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Strawman Industry Cash Flow GAMA Data Submittal

The GAMA data submittal provided data associated with full production

costs.

Full Production Cost Non-Production Cost

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Strawman Industry Cash Flow Strawman Estimate of Water Heater Prices

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 of Census, July

24,1998

Since DOE is interested in obtaining an industry value, DOE is

proposing using the industry average prices presented in the CIR

for 1997

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Industry Cash Flow Base Case Cost

A water heater industry cost structure was obtained from a top-down analysis of the industry and used to estimate the manufacturing cost

of a base case water heater.

Profit

before

Financing

SG&A 6.1%

~11.~1% ~~ ~Material

2 R. rialU^ 55.7% _sB llMaterial 72.44 86.93 85.00

Labor 12.62 15.14 18.25

153°/^Overhead ie 19.90 O =ic 23.88 mt e1Overhead 36.00 15.3%

Labor

9.7%

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Industry Cash Flow Post-Standard Price and Costs

GAMA provided DOE the manufacturing costs associated 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 prices can be estimated using different

scenarios:

(a) Mark-up (price) that results in maintenance of current industry value

(b) Mark-up (price) that reduces industry value to zero

(c) Price resulting from pass-through of incremental material,labor, and overhead

costs only.

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Industry Cash Flow Water Heater Shipments

Shipment values used in GRIM are obtained from the National Energy Savings Spreadsheet (NES).

* NES uses shipment values to identify the national energy savings potential of water

heater energy efficiency standards

* Using shipment values from NES will ensure that the 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.

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Industry Cash Flow Financial Information

The Department analyzed publicly available sources of firm-specific "industry" financial information to understand the water heater

industry's historical financial performance.

* SEC-1 OK 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%

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Subgroup Impact Analysis

The subgroup impact analysis consists of 5 tasks:

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 |

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Subgroup Impact Analysis Manufacturer Cash Flow

Average industry manufacturing costs will not be used to assess the

impacts for subgroups of manufacturers.

* Manufacturers will be asked to perform cash flow analyses using the GRIM

spreadsheet and their own values for company-specific inputs.

-ADL will assist as needed in adapting 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.

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Subgroup Impact Analysis Interview Guide

The Department will conduct manufacturer interviews to gather manufacturer-specific data and views on important issues.

* The Department will develop a questionnaire to guide the interviews and invites

comments and suggestions on its content from all interested parties.

* The purpose of the interviews is to gain understanding and ensure confidence in the

results of the manufacturer impact analysis.

-Some questions will be irrelevant to some manufacturers, and some

manufacturers or suppliers may want to provide information in addition to that

requested.

* Arthur D. Little is assisting the Department in carrying out the interviews and in

providing third-party confidentiality for proprietary information.

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Interview Guide Topics Covered

The interviews will cover a range of topics.

* Current Organizational Characteristics

* Industry Infrastructure

* Global Competition

* Manufacturer Cash Flow Analysis/ Impacts Assessment

* Employment Impacts Assessment

* Competitive Impacts Assessment

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Interview Guide Organizational Characteristics

DOE is interested in better understanding the current organizational characteristics of each manufacturer.

* The Department's interest is focused toward the plant or profit center directly concerned with water heater production.

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

generally public information at the plant level, so the Department invites

manufacturers to discuss these 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 of the impact that new energy-efficiency standards

might have on future water heater manufacturing.

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Interview Guide Manufacturer Cash Flow Analysis

Cash flow analysis is a key procedure being used to measure the

impact of standards on the water heater industry, and the Department wishes to discuss fully the results with each manufacturer.

* Each manufacturer will be given the GRIM spreadsheet and a sample worked-out

"strawman" industry cash flow to facilitate understanding among manufacturers

about the model and how it works.

* Each manufacturer can then input its own data and assumptions to develop its own

expected cash flow.

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

example provided.

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Interview Guide Manufacturer Cash Flow Analysis

Cash flow analysis is a key procedure being used to measure the

impact of standards on the water heater industry, and the Department wishes to discuss fully the results with each manufacturer.

* An important goal of each interview is to fully discuss the results of this cash flow

analysis under each scenario.

-The cash flow analyses prepared before the interview are for discussion

purposes only.

-Problems and/or unique circumstances affecting the cash flow 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 after the discussion for submission to third-party review and inclusion in the industry rollup.

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Interview Guide Employment Impacts

The employment impacts of new energy efficiency standards is an

important consideration in the rulemaking process.

* DOE seeks to explore current trends in water heater production employment and

solicit manufacturer views on how employment patterns might be affected by new

energy efficiency standards.

-DOE is also interested in the 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 in workforce skills required under

different levels of 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 efficiency standards could occur particularly for

important suppliers, and this is a topic for discussion as well.

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Interview Guide Competitive Impacts

DOE will solicit early involvement of the Department of Justice in

structuring the competitive impact assessment.

* Competitive Analysis will focus on assessing the impacts to smaller, significant manufacturers.

* DOJ has offered to participate in drafting questions to be used in manufacturer

interviews.

* Questions will pertain to an assessment of the 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 of fixed costs potentially increasing business risk

-Barriers to market entry (proprietary technologies, etc.)

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Industry Cash Flow Aggregation Approach

The Department proposes to develop the industry cash 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- efficiency standards scenarios.

* The Department will provide stakeholders with the "strawman" cash flow using publicly available values for price, cost, shipments, and financial information.

* The Department has prepared a list of financial values for input to the GRIM as a

starting point for discussion at the workshop.

* Each manufacturer will provide its own cash flow analysis to be aggregated with

others to build the industry picture.

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Industry Cash Flow Rolling Up Manufacturer Cash Flows to Industry Level

The "Strawman" will serve as a starting 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

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Industry Cash Flow * B |~~~~~~~~~

_________________ I __ ______

"^ , --------

^^ anuactrer^;i

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Industry Cash Flow Public Record

For the public record the information that will be presented is only the

summary sheet of the industry cash flow for each scenario.

* Proprietary information will not be disclosed:

-Shipments by water heater type

-Prices by water heater type

-Manufacturing costs by water heater type

-Manufacturer-specific financial information (tax rate, working capital, etc.)

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