US Services Producer Price Indices

1. US Services Producer Price Indices Roslyn Swick Bureau 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.

2. Topics • Background of the SPPI • Industry-specific methodologies

3. Background of the SPPI • Defining the SPPI • Historical Perspective • General PPI Principles • Developing Service Indices • Keeping Indices Up to Date

4. 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.

5. Historical Perspective Development of price indices with conceptually “easy” to define output Industry Publication date Line-haul railroads 1985 Deep sea freight transportation 1988 Scheduled passenger air transportation 1990 General freight trucking, long distance 1992

6. Historical Perspective Development of price indices with conceptually “complex” definitions of output Industry Publication date Hospitals 1992 Professional services 1995 Real estate 1996 Insurance 1998 Prepackaged software 1998 Retail trade 2000

7. Historical Perspective 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

8. Historical Perspective New service price indices to be introduced in July 2007: Industry Computer Training Commercial and Industrial Machinery and Equipment Maintenance and Repair SPPI will then cover approximately 77.4% of in-scope service industries based on 1992 GDP.

9. 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.

10. General SPPI Principles 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.

11. General SPPI Principles 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 be updated to a 2001 Honda Civic.

12. General SPPI Principles 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.

13. Developing Service Indices A comprehensive definition of the industry output must be developed. Primary output is the ultimate service provided by an industry.

14. Developing Service Indices 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.

15. Developing Service Indices 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.

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

17. Keeping Indices Up to Date 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.

18. Keeping Indices Up to Date Quality adjustment is used for keeping index data up to date: • Explicit quality adjustment • Hedonic modeling • Other alternatives

19. Keeping Indices Up to Date 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.

20. Keeping Indices Up to Date 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

21. Industry-Specific Methodologies • Banking • Lessors of nonresidential buildings • Hospitals • Retail trade • Internet service providers • Professional Services • Employment Agencies • Passenger air transportation

22. 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.

23. 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.

24. 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.

25. Banking Reference Rate To measure these implicit costs, interest is allocated between loans and deposits by means 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.

26. Banking Pricing Formula Loans . . . Interest received + service charges - reference rate Deposits . . . Reference rate - (interest paid - service charges)

27. Lessors of Nonresidential Buildings Primary Output Provision of physical space and management of the property.

28. Lessors of Nonresidential Buildings Average Gross Rent Average gross rent per occupied (rented) square foot eliminates the measurement of revenue caused solely by occupancy changes.

29. Lessors of Nonresidential Buildings 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)

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

31. 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.

32. Hospitals Pricing Characteristics • Diagnosis Related Group (pre-selected for each sample unit) • Principal diagnosis • Principal procedure • Type of payer • Length of stay

33. Retail Trade Primary Output Provision of the marketing functions necessary to allow consumers access to purchase various goods.

34. 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.

35. Retail Trade Pricing Characteristics Product . . . • Type of product • Size/weight • Material composition Store . . . • Store area • Number of available choices of product • Existence of scanners • Hours of operation

36. 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.

37. Internet Service Providers 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 (or connections for dial-up and DSL).

38. Internet Service Providers Pricing Characteristics • Connection speed • Data transfer capacity • Bandwidth • Services included(e.g. instant messaging, email)

39. Professional Services 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.

40. Professional Services 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.

41. Professional Services Two options for pricing: • Prices based on working time • Model prices

42. Professional Services 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 $ 3,750 Manager $300 40 $12,000 Senior accountant $220 60 $13,200 Associates $125 180 $22,500 Total for services rendered: $51,450

43. Professional Services 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.

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

45. 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.

46. Employment Agencies Pricing Characteristics • Commission percentage • Compensation level • Type of position • Education level • Experience level

47. Passenger Air Transportation Primary Output Transportation of passengers over regular routes and on regular schedules.

48. Passenger Air Transportation Average Revenue per Passenger Preferred price is an average calculated for a 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.

49. Passenger Air Transportation Pricing Characteristics • Region (domestic or international) • Market (origin and destination) • Cabin (first/business or coach)

50. Summary • Developing a PPI for service industries is challenging • Adhere to general PPI principles • Use lessons learned from PPIs for mining and manufacturing industries