CHAPTER 7. MARKUPS FOR EQUI PMENT PRICE DETERMINATION

TABLE OF CONTENTS
7.1 INTRODUCTION

........................................................................................................... 7-1 7.1.1 Distribution Channels

.................................................................................................... .. 7-1 7.1.1.1 Residential Products

....................................................................................... 7-1 7.1.1.2 Commercial Clothes Washers

........................................................................ 7-1 7.1.2 Markup Calculation Procedure

........................................................................................ 7-2 7.1.2.1 Approach for Manufacturer Markups

............................................................ 7-3 7.1.2.2 Approach for Retailer an d Distributor Markups

............................................ 7-3 7.1.2.3 Overall Markup

.............................................................................................. 7-5 7.2 MANUFACTURER MARKUPS

.................................................................................... 7-6 7.3 RETAILER MARKUP FOR RE SIDENTIAL PRODUCTS

.......................................... 7-7 7.4 DISTRIBUTOR MARKUPS FOR COMME RCIAL CLOTHES WASHERS

............... 7-8 7.5 SALES TAXES

............................................................................................................. 7-1 0 7.6 SUMMARY OF MARKUPS

........................................................................................ 7-12

LIST OF TABLES Table 7.2.1 Major Appliance Manufactur er Gross Margins and Markups

............................. 7-7 Table 7.3.1 Data Used to Calculate Reta iler Markups for Dishwashers, Cooking Products, and Dehumidifiers

................................................................................ 7-8 Table 7.4.1 Data Used to Calculate Distributor Markups for Comm ercial Clothes Washers

................................................................................................................ 7-9 Table 7.4.2 Distributor (Mac-Gray) Ba seline Markup for Commercial Clothes Washers

.............................................................................................................. 7-10 Table 7.5.1 Average Sales Tax Rates by Ce nsus Division and Large State

......................... 7-11 Table 7.5.2 Average Sales Tax Rates by Product

................................................................. 7-11 Table 7.6.1 Summary of Markups

........................................................................................ 7-12

LIST OF FIGURES Figure 7.1.1 Distribution Channel for Comm ercial Clothes Washers

..................................... 7-2

7-iCHAPTER 7. MARKUPS FOR EQUIPMENT PRICE DETERMINATION

7.1 INTRODUCTION To carry out the engineering and life-cy cle cost (LCC) analys es, DOE needed to determine the cost to the customer of a baseline product and the co st of more-efficient units. By applying a multiplier called a “markup” to the manufacturers’ equipment costs estimated in the engineering analysis, DOE estimated the consumer prices for baseline m odels and more-efficient equipment. DOE developed one set of markups for the re sidential products that include dishwashers, cooking products, and dehum idifiers, and anothe r set for commercial clothes washers.
7.1.1 Distribution Channels The appropriate markups for determining the consumer equipment price depend on the type of distribution channels through which products move from manufacturers to purchasers. At each point in the distribution channel, compan ies mark up the price of the equipment to cover their business costs and profit margin.
7.1.1.1 Residential Products For residential products, DOE based the di stribution channels on data from the Association of Ho me App liance Manufacturers (AHAM). 1 AHAM estimates that 93 percent of residential dishwashers, cooking products, and dehumidifiers ar e sold through retail outlets. Because an overwhelming majority of products ar e sold through retail outlets, DOE assumed that all of the residential products are purchas ed by consumers from retail outlets.
7.1.1.2 Commercial Clothes Washers For commercial clothes washers, DOE base d the distribution cha nnels (see Figure 7.1.1) on data developed by the Consortium for Energy Efficiency (CEE). 2 The CEE states that the relevant portions of the commercial, family-sized clothes washer market can be divided into three areas: laundromats; private multi-family housi ng; and large institutions. Included as part of large institutions are military barracks, universities, housing authorities, lodging establishments, and health care facilities. For these three market areas, the CEE data indicate that an overwhelming majority of commer cial clothes washers are sold through either distributors or route operators. Laundromats generally purcha se their equipment through distributors while multi-family housing and large institutions generallylease their equipment from route operators. For purposes of developing the markups for co mmercial clothes washers, DOE based its calculations on the distribution ch annel that involves only distri butors. DOE assumed that the markups and the resulting consumer equipment pr ices determined for the distribution channel

7-1involving distributors would be representative of the prices paid by consumers acquiring their equipment from route operators.

Source: CEE, 1998 Figure 7.1.1 Distribution Channel for Commercial Clothes Washers
7.1.2 Markup Calculation Procedure As just discussed, at each point in the di stribution channel, com panies 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 reve nue and the company cost of sales or cost of goods sold ( CGS ). Inputs for calculating the gross margin are all corporate costs—including overhead costs (sales, general, and administ ration); research and development (R&D) and interest expenses; depreciation, and taxes—and profits. In order for sales of a product to contribute positively to company cash flow, th e product’s markup must be greater than the corporate gross margin. Individual pr oducts may command a lower or higher markup, depending on their perceived added value and the competition they face from similar products in the market.

7-2In developing markups for manufacturers, re tailers, and distributors, DOE obtained data about the revenue, CGS , and expenses of firms that produce and sell the products of interest. DOE’s approach categorizes the expenses into two categories: labor-scaling costs ( LSC ), which are fixed labor and occupancy expenses that increase in proportion to the amount of labor required to produce or sell the pr oduct, and non-labor-scaling costs (NLSC ), which are variable operating costs that do not scale with labor and vary in proportion to CGS . Together, LSC and NLSC represent the gross margin.

7.1.2.1 Approach for Manufacturer Markups DOE uses manufacturer markups to transform a manufacturer’s equipment costs into a m anufacturer sales price. Using the CGS and gross margin, DOE calculated the manufacturer markup ( MU MFG ) with the following equation:
CGS MFG + GM MFG = MU MFG CGS MFG where:
MU MFG = Manufacturer markup, CGS MFG = Manufacturer’s cost of goods sold, and GM MFG = Manufacturer’s gross margin.
7.1.2.2 Approach for Retailer and Distributor Markups DOE based the retailer markups (for reside ntial products) and distributor m arkups (for commercial clothes washers) on financial data from the U.S. Census Business Expenditure Survey. DOE organized the financial data into balance sheets that break down cost components incurred by firms th at sell the products. aThe key assumptions that DOE used to estimate the retailer and distributor markups us ing these financial data were:
1. The balance sheets faithfully represent the variou s average costs incurred by firms selling home appliances and commercial clothes washers.
2. These costs can be divided into two categories: a. Costs that vary in proportion to the manu facturer sales price (variable co sts); and b. Costs that do not vary with the manu facturer sales price (fixed costs).
3. Retailer and distributor sales pr ices vary in proportion to reta iler and distributor costs that are in cluded in the balance sheets. In support of the first assumption, the balanc e sheets item ize firm costs into a number of expense categories, including CGS , operating labor and occupancy costs, and other operating

aThe retailers and distributors to whom these financial data refer handle multiple commodity lines.
7-3costs and profit. Although retailers and distribu tors tend to handle multiple commodity lines, the data provide the most accurate available indication of home appliance and commercial clothes washer expenses. Information obtained from the trade literatu re pertaining to the h eating, ventilation, and air-conditioning (HVAC) contracti ng industry tends to support the second assum ption. This information indicates that retail er and distributor markups should vary according to the quantity of labor and materials used to sell or distribute the equipment, with markups on labor tending to be much larger than markups on materials. 3 This information also describes markups as varying much more in relation to sales volume than inrelation to other fact ors, including appliance efficiency. This last finding st rongly suggests that labor inputs vary more with sales volume than with appliance cost or efficiency. In the di scussion that follows in sections 7.3 and 7.4, DOE assumes a division of costs between those that do not scale with the ma nufacturer sales price (fixed costs—labor and occupancy expenses referred to above as LSC ), and those that do (variable costs—operating expenses and profit referred to above as NLSC ). This division of costs led to the estimate of re tailer and distributor markups de scribed below in sections 7.3 and 7.4. In support of the third assumption, the retail er and distributor indus tries are relatively competitive, and consumer demand for residential home appliances and commercial clothes washers is relatively inelastic, i.e. the demand is not expected to decr ease significantly with a relatively small increase in price. The large number of household applian ce stores and merchant wholesalers of service equipmen t (i.e., distributors of products including commercial clothes washers) listed by the U.S. Census Bureau in its Statistics of U.S. Businesses indicates the competitive nature of the market. 4 For example, there are more than 10,000 household appliance store establishments and over 5000 merchant wholes aler establishments of service equipment in the U.S. b Following standard economic theory, competitive firms facing inelastic demand either set prices in line with costs or quickly go out of business. 5 Using the above assumptions, DOE developed baseline and incremental markups to transform the manufacturer sales price into a consumer equipment price. DOE used the baseline markups, which cover all of a retailer’s or distri butor’s costs (i.e., both LSC and NLSC ), to determine the sales price of baseline models. Th e baseline markup relates the manufacturer sales price to the retailer sales price (in the case of residential products) or distributor sales price (in the case of commercial clothes washers). DOE c onsiders baseline models to be equipment sold under existing market conditions (i.e., without new energy efficiency standards). DOE calculated the baseline markup (MU BASE ) for retailers and distributors using the following equation:

b DOE determined the number of establishments for household appliance stores based on the following North American Industry Classification System (NAICS) code and description: 443111, Household Appliance Stores

. DOE determined the number of establishments for di stributors of commercial clothes washers based on the following NAICS code and description: 42385, Service Establishment Equipment and Supplies Merchant Wholesalers

. 7-4CGS RTL / DIST + GM RTL / DIST CGS RTL / DIST + ( LSC RTL / DIST + NLSC RTL / DIST )

= = MU BASE CGS RTL / DIST CGS RTL / DIST where:
MU BASE = Baseline retailer or distributor markup, CGS RTL/DIST = Retailer’s or distributor’s cost of goods sold, GM RTL/DIST = Retailer’s or distributor’s gross margin, LSC RTL/DIST = Retailer’s or distributor ’s labor-scaling costs, and NLSC RTL/DIST = Retailer’s or distributor’s non-labor-scaling costs. Incremental markups cover only those co sts that scale with a change in the m anufacturer’s sales price (i.e., NLSC ). Incremental markups are co efficients that relate the change in the manufacturer sales price of higher-efficiency models to the change in the retailer or distributor sales price. DOE considers higher-efficiency models to be equipment sold under market conditions with new efficiency standard s. It calculated the incremental m arkup (MU INCR ) for retailers and distributors using the following equation:

MU INCR CGS RTL / DIST + NLSC RTL / DIST = CGS RTL / DIST where:
MU INCR = Incremental retailer or distributor markup, CGS RTL/DIST = Retailer’s or distributor ’s cost of goods sold, and NLSC RTL/DIST = Retailer’s or distributor’s non-labor-scaling costs.
7.1.2.3 Overall Markup The overall markup is the product of the manuf ac turer, retailer, and distributor markups, as well as sales taxes. DOE used the overall baseline markup to es tim ate the consumer equipment price of baseline models, given the manufacturer cost of the baseline models. As stated above, DOE considers baseline models to be equipment sold under existing market conditions (i.e., without new energy efficiency standards). The followi ng equation shows how DOE used the overall baseline markup to determine the equipment price for baseline models. EQP BASE = COST MFG × 

## ( MU MFG × MU BASE × Tax SALES 

## ) = COST MFG × MU OVERALL BASE _ where: EQPBASE = Consumer equipment price for baseline models, COST MFG = Manufacturer cost for baseline models,

7-5MU MFG = Manufacturer markup, MU BASE = Baseline retailer or distributor markup, Tax SALES = Sales tax, and MU OVERALL_BASE = Baseline overall markup (product of manufacturer markup, baseline retailer or distributor m arkup, and sales tax). Similarly, DOE used the overall incremental markup to estimate changes in the consumer equipm ent price, given changes inthe manufacturer cost above the baseline model cost resulting from a standard to raise equipment efficiency. The total consumer equipment price for higherefficiency models is composed of two components: the consumer equipment price of the baseline model and the change in consumer equipment pri ce associated with the increase in manufacturer cost to meet the new efficiency standard. The following equation shows how DOE used the overall incremental markup to determine the c onsumer equipment price for higher-efficiency models (i.e., models meeting new efficiency standards). EQP STD = COST MFG × MU OVERALL BASE _ + ∆ COST MFG × 

## ( MU × MU INCR × Tax SALES 

## ) MFG
= EQP BASE + ∆ COST MFG × MU OVERALL INCR _ where: EQP STD = Consumer equipment price for models meeting new efficiency standards, EQPBASE = Consumer equipment price for baseline models, COST MFG = Manufacturer cost for baseline models, ∆ COST MFG = Change in manufacturer costfor higher-efficiency models, MU MFG = Manufacturer markup, MU INCR = Incremental retailer or distributor markup, Tax SALES = Sales tax, MU OVERALL_BASE = Baseline overall markup (product of manufacturer markup, baseline retailer or distributor markup, and sales tax), and MU OVERALL_INCR = Incremental overall markup (product of manufacturer markup, incremental retailer or distri butor markup, and sales tax).

7.2 MANUFACTURER MARKUPS DOE developed an average manufacturer markup by examining the annual Securities and Exchange Commission (SEC) 10-K reports filed by four publicly-traded manufacturers primarily engaged in appliance manufacturing and whose combined product range includes residential dishwashers, dehumidifiers, and cooking products and commercial clothes washers. 6 The four manufacturers represent a nearly 50 percent market share fore core appliances. Because these companies are typically diversified, producing a range of different appliances, an industry

7-6average markup was assumed by DOE to be repres entative for the manufacture of each type of appliance. DOE evaluated markups for the years between 2002 and 2005, inclusive. Table 7.2.1 lists the average corporate gr oss m argin during the years from 2002 to 2005, and corresponding markups, for each of the four manufacturers.
Table 7.2.1 Major Appliance Manufacturer Gross Margins and Markups Mfr A Mfr B Mfr C Mfr D Average Net Revenues (Million) $372 $280 $4770 $12,682 Corporate Gross Margin 15% 28% 16% 22% Markup 1.18 1.39 1.19 1.28 Source: SEC 10-K reports (2002-2005) The average markup value based on th ese four companies is 1.26.

7.3 RETAILER MARKUP FOR RESIDENTIAL PRODUCTS DOE used financial data from the U.S. Cens us Business Expenditure Survey (BES), in the “Household Appliance Stores” ca tegory, to calculate markups used by retailers that apply to residential dishwashers, cooki ng products, and dehumidifiers. c 7 Table 7.3.1 shows the BES data that DOE used and the retail markups for thes e appliances that DOE estimated following the procedures described above.

c DOE used the 1997 BES because the 2002 BES did not contain sufficient data for the calculation of gross margin or cost of goods sold.
7-7Table 7.3.1 Data Used to Calculate Retailer Markups for Dishwashers, Cooking Products, and Dehumidifiers Item Million Doll ars Sales (revenue) 10343 Cost of Goods Sold (CGS) 7151 Gross Margin (GM) 3193 Labor-Scaling Costs (LSC) Payroll 1366 Fringe Benefits 208

Contract Labor 69 Taxes and License Fees 53 Lease and Rental Payments 238 Telephone and Communications 58

Utilities 70 Repair and Maintenance 36 LCS Subtotal: 2098 Non-Labor-Scaling Costs (NLSC) Depreciation and Amortization 94

Office Supplies 37 Packaging and Other Materials 0

Advertising Services 274 Legal Services 8 Accounting, Auditing, and Bookkeeping 19 Computer Related Services 10 Other Operating Expenses 389 Net Profit Before Taxes 263 NLCS Subtotal: 1094 Baseline Markup (MU BASE ) = (CGS+GM)/CGS 1.45 Incremental Markup (MU INCR ) = (CGS+NLSC)/CGS 1.15

7.4 DISTRIBUTOR MARKUPS FOR CO MMERCI AL CLOTHES WASHERS DOE used financial data from the BES for the category “Machinery, Equipment, and Supplies Merchant Wholesalers” to calculate markups used by distributors for commercial

7-8clothes washers. d 8 Table 7.4.1 shows the data from the BES and the distributor markups DOE estimated using the procedures described above.
Table 7.4.1 Data Used to Calculate Distribut or Markups for Commercial Clothes Washers Item Million Doll ars Sales (revenue) 225425 Cost of Goods Sold (CGS) 158097 Gross Margin 67328 Labor-Scaling Costs (LCS): Payroll 25904 Fringe Benefits 3233

Contract Labor 954 Taxes and License Fees 823 Lease and Rental Payments 2932 Telephone and Communications 1185

Utilities 705 Commissions Paid 963

Contract Work 958 Repair and Maintenance 826 LCS Subtotal: 38483 Non-Labor-Scaling Costs (NLCS): Depreciation and Amortization 2650

Office Supplies 885 Packaging and Other Materials 346

Advertising Services 959 Legal Services 277 Accounting, Auditing, and Bookkeeping 346 Computer Related Services 403 Other Operating Expenses 8149 Net Profit Before Taxes 14830 NCLS Subtotal: 28845 Baseline Markup (MU BASE ) = (CGS+GM)/CGS 1.43 Incremental Markup (MU INCR ) = (CGS+NLSC)/CGS 1.18

d DOE used the 1997 BES was used becau se the 2002 BES did not contain suffic ient data for the calculation of gross margin or cost of goods sold. Al so, because complete financial data were not available for the category Service Establishment Equipment and Supplies Merchant Wholesalers , DOE used data from the classification of Machinery, Equipment, and Supplies Merchant Wholesalers which encompasses a broader set of merchant wholesalers.

7-9As a check on the above markup values for distributors, DOE calculated markups based on the annual report of one distributor company (Mac-Gr ay) within th is sector. e 9 The report includes data regarding revenue and CGS for this company, but not a breakdown of other expenses. As a result, it was only possible to es timate a baseline markup. Table 7.4.2 below shows the data for the commercial clothes washer dist ributor from the annual report as well as the baseline distributor markup DOE estimated for the sector as a whole using the procedures described above. The average value of 1.27 over the 2000–2004 tim e period for one company is lower than the value of 1.43 developed from th e Census data. Although this one company has a lower baseline markup than that determined with the Census data, DOE decided to base its distributor markups on the Census data because this data is supposed to be representative of all distributors of commercial clothes washers.
Table 7.4.2 Distributor (Mac-Gray) Baseline Ma rkup for Commercial Clothes Washers Firm Year Revenue Cost of goods sold Baseline Markup

Mac-Gray Services Inc. 2000 154268 119120 1.30 2001 152069 121127 1.26 2002 150368 117956 1.27 2003 149656 118349 1.26 2004 182694 145080 1.26 Average Baseline Markup 1.27 Source: Mac-Gray Services Inc. 2004 annual report.

7.5 SALES TAXES The sales tax represents state and local sa les taxes that are applied to the consumer equipment price of the equipment. The sales tax is a multiplicative factor that increases the consumer equipment price. DOE derived state and local taxes from da ta provided by the Sales Tax C learinghouse. 10 These data represent weighted averages that in clude county and city rates. DOE then derived population-weighted average tax values for each Ce nsus division and large state, as shown in Table 7.5.1 below.

e Mac-Gray also serves the multi-family sector and can also be considered a route operator.

7-10Table 7.5.1 Average Sales Tax Rates by Census Division and Large State Census Division/State Tax Rate New England 4.98% Mid Atlantic 6.07% East North Central 6.56% West North Central 6.65% South Atlantic 5.95% East South Central 7.85% West South Central 8.30% Mountain 6.46% Pacific 4.97% New York State 8.25% California 7.95% Texas 7.95% Florida 6.70% DOE then derived U.S. average tax values for each product (as shown in Table 7.5.2 below) based on the product’s sa turation within each Census di vision and large state. It determined the saturations from the DOE En ergy Information Administration (EIA)’s 2001 Residential Energy Consumption Survey. 11 Note that the range of tax rates is relatively narrow—ranging from a low of 6.53 percent for de humidifiers to a high of 7.07 percent for gas non-self-cleaning ovens.
Table 7.5.2 Average Sales Tax Rates by Product Product Tax Rate Dehumidifiers 6.53% Dishwashers 6.83% Commercial clothes washers 6.84% Cooking products

Electric cooktops 6.70% Gas cooktops 7.06% Electric non-self-cleaning ovens 6.74% Electric self-cleaning ovens 6.64% Gas non-self-cleaning ovens 7.07% Gas self-cleaning ovens 6.98%

Microwave ovens 6.83%

7-117.6 SUMMARY OF MARKUPS Table 7.6.1 summarizes the markups at each stage in the distribution channel and the overall baseline and incremental markups, as well as sales taxes, for each product.
Table 7.6.1 Summary of Markups Commercial Dishwashers Dehumidifiers Cooking Products Clothes Washers Markup Baseline Incr. Baseline Incr. Baseline Incr. Baseline Incr. Manufacturer 1.26 1.26 1.26 1.26 Retailer 1.45 1.15 1.45 1.15 1.45 1.15

- - Distributor

- - - - - - 1.43 1.18 Sales Tax 1.0683 1.0653 1.069* 1.0684 Overall 1.95 1.55 1.95 1.54 1.95 1.55 1.93 1.59

* Represents average of all seven product classes of cooking products. The example for dishwashers, provided belo w, illustrates how DOE used the baseline and incremental markups to derive a consumer equipment price. Assuming the baseline manufacturer cost is $225 and the change in manuf acturer cost to meet a given energy efficiency standard is $10, the resulting ba seline consumer equipment price ( EQPBASE) and higherefficiency equipment price ( EQP STD ) are: 

## ) EQP BASE = COST MFG × 

## ( MU MFG × MU BASE × Tax SALES

. . . = $ = 068 1 × 45 1 × 30 1 × 225 $ 453 

## ) EQP STD = EQP BASE + ∆ COST MFG × 

## ( MU MFG × MU INCR × Tax SALES

. . . = $ + 453 $ = 068 1 × 15 1 × 30 1 × 10 $ + 453 $ = 16 $ 469

7-12REFERENCES

1 Association of Home App liance Manufacturers. AHAM 2003 Fact Book , 2003. Washington, DC. p. 25.

2 Consortium for Energy Efficiency, Commercial Family-Sized Washers: An Initiative Description of the Consortium for Energy Efficiency , 1998. Boston, MA. < http://www.cee1.org/com/cwsh/cwsh-main.php3 >

3 Skaer, M. What should you charge? Try these Tested Formulas. The Air Conditioning, Heating, and Refrigeration News , 2001. < http://www.achrnews.com/CDA/ArticleInformation/ features/BNP_Features_Item/0,1338,23113,00.html >

4 U.S. Census Bureau. Statistics of U.S. Businesses , 2004. Washington, DC. < http://www.census.gov/csd/susb/susb04.htm >

5 Pindyck, R.S. and D.L. Rubinfeld, Microeconomics, 5 th ed. , 2000. New Jersey: Prentice Hall.

6 Security Exchange Commission, SEC 10-K Reports, Various dates, 2002-2005, Security Exchange Commission. < http://www.sec.gov/ >
7 U.S. Census Bureau. 1997 Economic Census, Business Expenses Survey, Retail Trade, Household Appliance Stores , 1997. Washington, DC. < http://www.census.gov/csd/bes/bes97.htm >

8 U.S. Census Bureau. 1997 Economic Census, Business Expenses Survey Merchant Wholesalers , Machinery, Equipment, and Supplies , 1997. Washington, DC. < http://www.census.gov/csd/bes/bes97.htm >

9 Mac-Gray Corporation. 2004 Annual Report , 2004. Waltham, MA.

10 Sales Tax Clearinghouse, Inc. State sales tax rates along with combined average city and county rates , 2006. <http://thestc.com/STrates.stm>

11 U.S. Department of Energy-En ergy Information Administration. Residential Energy Consumption Survey, 2001 Public Use Data Files , 2001. Washington, DC. < http://www.eia.doe.gov/emeu/recs/recs2001/publicuse2001.html >

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