US Services Producer Price Indices Roslyn Swick Bureau of Labor Statistics This presentation has been prepared for the Third International Conference on

US Services Producer Price Indices

Roslyn SwickBureau of Labor Statistics

This presentation has been prepared for the Third International Conference on Establishment Surveys: Survey Methods for Businesses, Farms, and Institutions, June 2007. It represents work in progress and does not represent any agency's final positions on issues addressed.

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Topics

Background of the SPPI Industry-specific methodologies

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Background of the SPPI

Defining the SPPI

Historical Perspective

General PPI Principles

Developing Service Indices

Keeping Indices Up to Date

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Defining the SPPI

The mission of the PPI program is to measure average change in output prices received by domestic producers of goods and services.

The PPI universe includes output from all industries providing US domestic marketed goods and services.

Excluded from the universe are output generating activities with no observable prices such as Social Assistance and Funds and Trusts.

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Development of price indices with conceptually “easy” to define output

Industry Publication dateLine-haul railroads 1985

Deep sea freight transportation 1988

Scheduled passenger air transportation 1990

General freight trucking, long distance 1992

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Development of price indices with conceptually “complex” definitions of output

Industry Publication dateHospitals 1992

Professional services 1995

Real estate 1996

Insurance 1998

Prepackaged software 1998

Retail trade 2000

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Development of price indices with conceptually “very complex” definitions of output

Industry Publication date

Banking 2004

Wholesale trade 2004

ISPs and web search portals 2004

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New service price indices to be introduced in July 2007:

IndustryComputer Training

Commercial and Industrial Machinery and Equipment Maintenance and Repair

SPPI will then cover approximately 77.4% ofin-scope service industries based on 1992 GDP.

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General SPPI Principles

As with traditional manufacturing pricing, service PPIs measure the net return to the service establishment for providing a specified service to a specified buyer under specified terms for a specified time.

A detailed description of the selected service is required in order to accurately price that service over time.

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In some service industries, adjustments or updates have to made to the service items over time in order to maintain continuous pricing of the same constant quality service.

In some cases, the company respondents are able to update the service descriptions. In other cases, a secondary source is used.

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For the private passenger auto insurance index, an actual policy for a specific auto and driver is priced.

The age of the auto is held constant by updating the model year on an annual basis.

For example, a 2000 Honda Civic would beupdated to a 2001 Honda Civic.

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Changing the model year can also move the auto into a different risk category.

The Insurance Services Office (ISO) assigns a value to this risk change.

This valuation is used to explicitly quality adjust the premium so that the change in risk is not reflected in the index.

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A comprehensive definition of the industry output must be developed.

Primary output is the ultimate service provided by an industry.

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For the some industries, such as broadcasting, the output is not as clearly defined.

Stations produce a broadcast signal that is delivered free of charge to the viewers and listeners.

However, what is actually bought and sold in these industries is access to an audience through the broadcast signal.

This access is sold to advertisers through the sale of airtime.

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A pricing methodology must be developed that accurately measures the price change over time for the defined output.

Identify the service characteristics of the industry.

Analyze the services provided to determine how to maintain constant quality.

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If you cannot find a pricing methodology that accurately measures the defined output, you might not have the right output definition.

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A constant challenge that occurs in both services and manufacturing PPIs is keeping the indices up to date.

PPI is a modified Laspeyres index based on the fixed input output price index concept, or FIOPI.

While adhering to the FIOPI model is conceptually correct, there is a danger that the services will no longer represent current market conditions.

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Quality adjustment is used for keeping index data up to date:

Explicit quality adjustment

Hedonic modeling

Other alternatives

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In order to ensure that the indices are representative, several strategies have been developed to reduce or eliminate new item bias.

New item bias can occur in industries where there is rapid service or product development that cannot be captured by the usual resampling process.

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Methods used to ensure that there is no new item bias include:

Directed substitution Used when the new items or new services are provided or

produced by currently sampled establishments

Sample augmentation Used when there are industries with rapid changes in services being provided

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Industry-Specific Methodologies

Banking

Lessors of nonresidential buildings

Hospitals

Retail trade

Internet service providers

Professional Services

Employment Agencies

Passenger air transportation

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Banking

Primary Output

Provision of financial services including financial intermediation.

For this industry, financial intermediation can be defined as the assumption of risk that arises from taking money from depositors and lending it to borrowers.

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Banking

FISIM

One of the primary challenges in this industry is to measure financial intermediation services indirectly measured or FISIM.

Banks often provide services for which they do not explicitly charge by paying or charging different rates of interest to lenders and borrowers.

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Banking

User Cost

The user cost methodology is implemented in the PPI.

The user cost for a financial service is the difference between its revenue and the sum of its implicit and explicit costs.

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Banking

Reference Rate

To measure these implicit costs, interest isallocated between loans and deposits bymeans of a “reference rate.”

Reference rate is the opportunity cost rate of money from which the risk premium is eliminated to the greatest extent possible and which does not include any intermediation Services.

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Banking

Pricing Formula

Loans . . .

Interest received + service charges - reference rate

Deposits . . .

Reference rate - (interest paid - service charges)

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Lessors of Nonresidential Buildings

Primary Output

Provision of physical space and management of the property.

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Average Gross Rent

Average gross rent per occupied (rented) square foot eliminates the measurement of revenue caused solely by occupancy changes.


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Pricing Characteristics

Location Quality of property Management intensity Number of anchors (retail) Level of sales (retail) Percentage of available seats (auditorium) Number of berths (pier/dock) Cargo throughput (pier/dock)

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Hospitals

Primary Output

Total treatment package that patients receive during their entire length of stay (admission to discharge).

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Hospitals

Reimbursements

Total reimbursement for the entire stay or the interim billing period, whichever is shorter, is collected to measure the output of this industry.

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Hospitals


Diagnosis Related Group (pre-selected for each sample unit)

Principal diagnosis

Principal procedure

Type of payer

Length of stay

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Retail Trade

Primary Output

Provision of the marketing functions necessary to allow consumers access to purchase various goods.

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Retail Trade

Margin Price

Preferred price is an average margin for a relatively homogeneous grouping of products.

Margin for a unique product is an acceptable fallback method.

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Retail Trade


Product . . . Type of product Size/weight Material composition

Store . . .

Store area Number of available choices of product Existence of scanners Hours of operation

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Internet Service Providers

Primary Output

Provision of Internet access to a group of subscribers.

Subscribers may be residential households, business or institutional facilities, or other Internet access providers.

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Average Price per Line

Total revenue earned from all customers on a specific billing cycle for a specific form of access within a specific period of time is divided by the number of lines (orconnections for dial-up and DSL).

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Connection speed

Data transfer capacity

Bandwidth

Services included (e.g. instant messaging, email)

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Primary Output

Provision of services by professionals with specialized knowledge and the experience necessary to apply this knowledge.

These professionals include lawyers, accountants, engineers, and architects.

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Pricing

Most of the services provided in these industries are based on unique, non-recurring transactions.

Such industries require a specific contract to be collected and set as a baseline transaction.

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Two options for pricing:

Prices based on working time

Model prices

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Price Based on Working Time - Example

Type of service: Auditing. Time required for service completion: 290 hours. Client information: Repeat customer; commercial business. Length of billing period: Single bill for entire service. Services included in engagement:

Service rendered Rate Hours Total fee

Partner $375 10 $ 3,750Manager $300 40 $12,000Senior accountant $220 60 $13,200 Associates $125 180 $22,500

Total for services rendered: $51,450

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Model Price - Example

Type of Service: Building related engineering services. Contract identifier: Project BLS-PPI. Billing invoice number: 123. CLIENT #456. Multi-use building. Non-fixed (variable-hourly fee). Qualifications based selection. Monthly billing. Review soils @ excavation base; test engineered fill, backfill, observe concrete reinforcement & masonry construction for compliance; provide proofroll of parking areas; sample & test fresh concrete & compressive strength; masonry grout & prism testing.

Charge Category Hours Rate Hours X Rate

Compaction testing 1 $40.00 $40.00

Special inspections, concrete 15 $50.00 $750.00

Concrete testing 25 $40.00 $1,000.00

Sample pick-up 6 $40.00 $240.00

Special inspections, masonry 8 $50.00 $400.00

Project mgmt – Senior project engineer 2 $80.00 $160.00

Total fee $2,590.00

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Employment Agencies

Primary Output

Employment agencies are essentially engaged in the business of connecting employers and potential employees in the labor market.

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Employment Agencies

Commission

Preferred price is actual commission on received for a single employee placement.

Commission is a percentage of the expected first year earnings of the employee.

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Employment Agencies


Commission percentage

Compensation level

Type of position

Education level

Experience level

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Passenger Air Transportation

Primary Output

Transportation of passengers over regular

routes and on regular schedules.

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Average Revenue per Passenger

Preferred price is an average calculated fora given origination/destination and seating class (first class vs. coach).

Method allows the PPI to capture price trends from all levels of pricing (published

and unpublished) and all distribution channels.

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Region (domestic or international)

Market (origin and destination)

Cabin (first/business or coach)

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Summary

Developing a PPI for service industries is challenging

Adhere to general PPI principles

Use lessons learned from PPIs for mining and manufacturing industries

Documents

US Services Producer Price Indices Roslyn Swick Bureau of Labor Statistics This presentation has been prepared for the Third International Conference on