What is Brand Valuations?
The brand valuation was introduced in the 1980s, initially as a response to the vulnerability of sound but financially sleepy businesses to the attention of acquisitive conglomerates. Valuing brands necessitates the disaggregation of the company into its component brands and the application of valuation methods to each component brand.
The brand valuation was controversial when it was introduced, and remains so today. Its advocates argue that it is perfectly natural to recognize the financial value of a company’s brands on the balance sheet, given that these are durable assets that deliver real financial benefits to the business in terms of a higher price or market share than would otherwise be the case.
Table of Contents
- 1 What is Brand Valuations?
- 2 Context for Brand Valuation
- 3 Corporate Reputation
- 4 Mergers and Brand Value
- 5 Brands and Wealth Creation
- 6 How Valuable Are Brands?
- 7 Brand Valuation Methods
- 8 Discussion of Brand Valuation
- 9 Brand Management Topics
Its critics, in equal measure, maintain that, whatever the theory, brand valuations are arbitrary, subjective and opaque and consequently of limited use. The final difficulty for brand valuation is that brands are sold infrequently. Businesses or business units are sold regularly, so company valuation theory can be tested in many cases.
Brand valuation theory has been subjected to much less rigorous testing because there are relatively few test cases.
Context for Brand Valuation
- Valuation: A method of estimating the monetary worth of an entity. Its main applications concern how companies and shares are valued.
- Value Based Marketing: A disciplined process of evaluating marketing decisions, based on robust financial valuation principles and market response analysis. The result: optimal marketing decisions, strategy and implementation.
- Economic Value: The monetary worth of an entity, established by a valuation method.
- Valuation Method: The rules and calculations used in the valuation process. Different methods are available, so it is important when reviewing something’s value to know the method used.
- Customer Value: The perceived worth of something to a customer is expressed as a set of evaluative statements. Not necessarily connected or correlated with economic value, despite what the pundits say.
- Profit: Revenues minus costs measured over a specified period. There are several accounting definitions of profit, probably the most useful for general marketing use being EBITDA or Earnings Before Interest, Tax, Depreciation, and Amortisation. Profit Stream: A series of profits over a while. Investment analysts often look at profit streams over 3, 5, and 10 years or more.
- Net Present Value: A single value that represents the profit stream (or other financial flow), is summarised using a method such as Discounted Cash Flow (DCF).
- Profit Maximisation: Making brand management decisions to maximise profit over a specified period.
- Share Price: The price at which company shares are traded on a Stock Market.
- Market Capitalisation: The overall value assigned to a company by a stock market (equal to the share price multiplied by the number of shares).
It may seem paradoxical to many marketing people that most finance people spend little or none of their careers thinking about economic value. On the other hand, economic value is something that investment analysts, concerned with trading shares, think about as a good deal. Understanding this conceptual gap is a good starting point for our thinking.
The concept of assigning a value to a brand naturally leads to the question of whether the valuations assigned by the market to companies depend in part on the good or poor corporate reputation of the company.
The main determinants of company valuations will naturally be the current and expected future financial performance. But are the perceived strengths in areas such as marketing skills, financial management, and the ability to recruit and retain staff also a factor, over and above their direct effect on the financials?
A detailed statistical analysis reported by Bryan Finn (2004) shows that corporate reputation is a statistically significant explanatory factor in both market capitalization and credit risk ratings.
However, as brand valuation and corporate reputation are related (especially when the “brand” is synonymous with the company), it is relevant to note the following important differences:
- Unlike brands, quoted companies have freely-available market values and credit risk rating scores every day.
- Working at the company level avoids the approximations involved in trying to dissect a company’s accounts to attribute costs and revenues across a portfolio of brands.
The assessment of the impact of corporate reputation on the market value of a company is therefore a more rigorous and statistically robust process than brand valuations although, of course, it does not provide information on the individual brands in a multi-brand company.
Mergers and Brand Value
In the 1980s, there was a considerable rise in the number of business mergers and acquisitions. What was even more interesting was the type of assets that were the focus of these mergers.
A study of acquisitions in the 1980s showed that whereas in 1981 net tangible assets represented 82 percent of the amount bid for companies, by 1987 this had fallen to just 30 percent.
It became clear that companies were being acquired less for their tangible assets and more for their intangible assets. This raised the whole issue of accounting for goodwill – the ‘gap’ left between the amount paid for a business and the value of its identifiable assets.
Many branded good companies were acquiring or being acquired in the 1980s and because the brands of these companies, though genuine intangible assets, were usually unrecognized, the impact of these acquisitions on their financial reporting was significant.
Brands and Wealth Creation
Brands create wealth. Maximizing brand value is simply a part of maximizing shareholder value. Companies have increasingly come to be reorganized around brands. Several accounting standards around the world have made it mandatory for companies to declare to their shareholders how valuable their brands are.
More recently, a large Australian brewery found an increasingly depleted balance sheet due to high levels of prescribed depreciation on brewery equipment.
Putting their brand properties on their balance sheet provided a much fairer picture of the kind of value creation that shareholders were deriving. Simply because, in fact, these were their primary value creators.
How Valuable Are Brands?
Before looking in detail at brand valuation, it is worth defining the minimum requirements for a “brand” to be worthy of consideration for a brand valuation analysis (Haigh 1996). At least the following criteria need to be satisfied:
- The brand must be identifiable.
- The title of the brand must be unambiguous.
- The brand must be capable of being sold separately from the business (otherwise the brand valuation becomes identical to the valuation of the business).
- There must be a premium value over the equivalent commodity product.
If these criteria are met, there seems little doubt that such brands are valuable analysis from brand consultancy Interbrand.
Brand Valuation Methods
The brand valuation was pioneered by Interbrand who developed and refined the “economic use” method of brand valuation. Some of the approaches to brand valuation are discussed below:
- Historical Cost
- Replacement Cost
- Market Value
- Premium Price
- Royalty Relief
- Economic use Method
- Economic Use/Historical Earnings Approach
- Economic Use/future Earnings Approach
- Brand Value
This approach values the brand as the sum of the costs incurred in bringing the brand to its current state.
The main disadvantages are:
- The historical costs of creating a brand appear to bear little relation to the current value of the brand, based on the other approaches to brand valuation (and are often considerably lower).
- In practice, it is difficult to identify the costs involved in creating a brand and, in particular, to separate that part of marketing expenditure responsible for brand building.
This approach values the brand at the cost of creating a new but similar brand.
The main disadvantage is:
- The difficulty in estimating how much it would cost to create a new equivalent brand now. It would be a questionable assumption to base the estimate on the cost of creating the original brand as the existence of the original brand will often have changed the marketplace. However, even if this assumption were to be justifiable, then the approach suffers from the same disadvantages as the historical cost approach.
The market value of the brand is what it might be sold for in the open market, assuming a willing buyer and willing seller.
The main disadvantages are:
- There is scant information available about the sales of brands and,
- Even where such information is available, it is difficult to extrapolate from one brand to another.
This approach values the brand in terms of the premium price that it commands over an unbranded or generic equivalent.
A premium price can be used to calculate the additional profits earned by the brand (after allowing for any additional production or marketing costs), and these can be used in a Net Present Value calculation to arrive at the value to the business now of the profit stream attributable to the premium price.
The main disadvantages are:
- It is not always easy to find an equivalent unbranded or generic product.
- The effect of the brand is not always or entirely reflected in a premium price. It may also be reflected in sales volumes or, equivalently, market share.
Indeed, the profit maximizing optimum for a brand will normally be to use the brand strength to gain some combination of a premium price and market share.
The royalty relief approach values a brand at the Net Present Value of the royalty payments that the business would have to pay to license the brand if it did not own the brand. In other words, the brand is valued at the amount by which ownership of the brand “relieves” the company from the need to pay license fees or royalties.
Where royalty data are readily available, this approach is workable. However, royalty data are generally applicable only to specific sectors and markets and are not easily extrapolated beyond these boundaries.
Economic use Method
This method of assessing brand value attempts to calculate the value of the brand to its owner in terms of the Net Present Value of the profit stream attributable to the brand. This is the approach of choice for brand valuation companies such as Interbrand Ltd and Brand Finance Ltd and will be described in more detail below.
The “economic use” method of brand valuation has been implemented in several ways and various proprietary techniques have been developed to estimate some of the key factors. Here we present a simplified form of the approach, broadly following the methodology of Brand Finance Ltd, as described in the excellent review by David Haigh (1996).
All “economic use” methods start with an analysis of the profitability of the brand to the business. It should be emphasized that all of the analysis that follows is based on separating the finances of the brand of interest from other brands that may be produced by the company, and also from any unbranded products that may be produced in parallel by the company.
Economic Use/Historical Earnings Approach
The simplest “economic use” method is the “historical earnings” approach, the main steps for which are as follows:
- Starting with the revenue attributable to the brand, multiply by the profit margin for the brand to get the operating profit for the brand (or, equivalently, deduct from the revenue the operating costs associated with the brand).
- Estimate the capital employed by the brand, including both fixed assets and working capital. Multiply this by an appropriate capital charge to obtain the charge for capital employed by the brand.
- Subtract the charge for capital employed by the brand from the operating profit for the brand to get the earnings after the capital charge.
- Not all of these earnings are attributable to the strength of the brand itself – there could well be some earnings after capital charges even if the brand were weak. Therefore multiply the earnings after capital charge by the proportion of the earnings that are attributable to the strength of the brand to obtain the brand earnings.
- Multiply the brand earnings by the tax rate to get the tax payable on the brand earnings. Then subtract the tax payable from the brand earnings to get the brand earnings after tax.
- Finally, multiply the brand earnings after tax by the multiple to obtain the brand valuation.
Economic Use/future Earnings Approach
In theory, the multiple used in the “historical earnings” approach should reflect both the growth prospects for the brand and the uncertainty attached to future earnings from the brand.
Although the calculation method could be improved by calculating a weighted average of earnings over recent years, the preferred and most widely-used approach for brand valuation is to estimate the brand value as the Net Present Value of the future brand earnings after tax.
For this method of brand valuation, the procedure is as follows:
- Calculate the brand earnings after tax as per steps 1 to 12 in the table above, but do this not only for the current year (Year 0) but also for the next 5 years.
- Discount the brand earnings after tax for Years 0 to 5 back to the current year.
- Estimate the “terminal value” of the brand (representing the Net Present value of after-tax brand earnings from year 6 through to infinity). This is usually calculated by assuming no further growth beyond year 5.
- Estimate the brand value as the discounted brand earnings after tax for Years 0 to 5 plus the terminal value.
This approach has two important advantages in that it provides:
- A more rigorous methodology for taking into account the future growth of the brand, and
- A mechanism for taking into account the effect of brand strength on the level of risk associated with future earnings.
However, the advantages of this approach come at a cost:
- It requires that a forecasting model for the brand is developed. The forecasting model has to include estimates for the next 5 years of revenues, margins (or costs), and total capital employed attributable to the brand.
- It introduces another key factor that has to be estimated, namely the discount rate to be used in the Net Present value calculation.
- It introduces a further arbitrary factor in the choice of a 5-year period for the forecasting model.
- It frequently exhibits the behavior (exemplified in the table) that the terminal value is of comparable importance to the Net Present Value of the brand earnings after tax for the initial period of 5 years, emphasizing the importance of the assumptions made for the period more than 5 years into the future.
The general principle behind “future earnings” systems of brand valuation is that strong brands benefit not only from a favorable combination of a premium price and a high market share but are also more resilient in the adverse market or economic conditions.
This means that they have a lower risk profile and therefore that a lower discount rate should be used in calculating the present value of future earnings.
Both Interbrand Ltd. and Brand Finance Ltd. have developed proprietary methodologies based on ranking and rating systems to assess brand strength and to map this parameter onto the discount rate to be used in the Net present Value calculation.
Discussion of Brand Valuation
The principal advantage of brand valuation is that it reduces the complexity of assessing the worth and attributes of a brand to a single financial number. Difficult and imprecise though this process is, in some situations it is essential.
For example, in mergers and acquisitions or legal and tax cases, this is exactly what is required. What is more debatable is whether a brand valuation is a useful tool as a means of brand health monitoring and as a way of informing decisions on budget setting and brand development processes.
Although it can be used in this role, the balance of opinion currently seems to weigh significantly in favor of more direct and transparent measures for these purposes, based mainly on two approaches:
- Forecasting models of brand revenues, costs and profitability – but without the additional calculations and assumptions necessary to extend the forecasts to produce a brand valuation.
- Metrics derived from market research on customer opinions and attitudes towards the brand.