BRAND VALUATION – CONCEPT AND RELEVANCE
Source : Internet

WHAT ARE BRANDS

Brands are those non-physical elements of a business, which have potential future earnings. They are separately identifiable, intangible assets that one capable of being reliably measured. 

Difference between Brand and Goodwill: Goodwill is defined as the difference between the net assets of a company and the price paid by its purchaser. 

EMERGENCE OF BRANDS

 THE BACKGROUND: The debate of the brands came to the force in the late 1980’s with the activities of a number of food companies. In early 1988, Nestle (UK) made a bid for Rowntree, with more than twice the Company’s market capitalisation at that time. Mc Dougall started capitalising the brands that they owned or acquired, implying that these brands possessed hidden values. The service sector companies like The Daily Telegraph Ltd, Lonhro plc etc have valued their brands and showed them in balance sheets. Thus began the hottest debate on brands in Balance Sheet.

 

THE PRESENT SITUATION 

In UK – It had a divergent treatment for goodwill and brands. If brands can be shown as separable assets, they need not be written off, as goodwill should be. Brands should be fully amortised over their useful economic life of upto 20 years except in special circumstances. Homegrown brands are not allowed to be shown in the balance sheet, as it is very difficult to identify the cost of the brand developed. Many companies have incorporated brand values in their balance sheets. Wide Technical Report 780 UK had removed the differential treatment of brands. Now there is a distinction between brands and goodwill in UK practice. This means like Goodwill, brands should be written off immediately upon acquisition. 

WHY BRANDS SHOULD BE INCLUDED IN BALANCE SHEET 

TRADITIONAL VIEW BLURRED: The traditional view is that any valuation figure, other than one supported by a specific purchase price on change of ownership is too arbitrary at all to be credible. Also the traditional view is that the balance sheet is not intended as a statement of corporate worth and that subsequently, inclusion of values of brands in fixed assets would mislead the figures in the balance sheet. 

The flaw: First of all the view that only those assets which have substance or spatial dimension should be properly considered as a ‘valuable asset’ for accounting purposes is questionable. Any value fixed on a given brand is dubious, but many of the fixed assets that are shown in balance sheets have similar contestable figures- like land etc.  Eg. Assets like ‘Hero Honda’ (two wheeler) after being used for 8 years are being offered for sale at Rs. 17,000 as against the cost of Rs.12, 000. 

UNFAIR VIEW: The effect of the above is that in the failure to recognize brands and in the systematic undervaluation of assets (at historic costs) acknowledged to exist, companies maintain substantial unrevealed reserves. Such a practice can not be justified as fair in the interests of shareholders or investors. The shareholder has the right to be appraised of the totality of assets that are available with the company. Besides understatement of intangible assets like brands, when the company is using them to earn profits is not useful to the shareholders in judging the efficiency of management. We do value real estate on the basis of the future income. Similarly brands should be valued based on their future earnings potential. Adventurous bankers, (in UK), have started to talk about issuing backed securities and/ or using brand collateral as security for debt issues.

 HOW DOES BRAND VALUATION EFFECT STOCK MARKET:

 It is argued that the net worth of a company is readily calculable by the market price of the company. This price is reflective of the present and prospective returns there on. Then the difference between the above net worth of the company and as proclaimed by the company is of great importance to the shareholders and investors. Since the market prices are volatile, the shareholders, investors would rather prefer to look at the Balance sheet that includes future earnings potential of the company, than depending on the stock market prices. Brands in balance sheet would at least reduce his apprehensions since the inclusion lead to a fair picture of the rate of return.  Further, the management’s efficiency is reflected in the ROI that is achieved by the company.

Ex. the ratio, PAT / Fixed assets + Net current assets, without brand value, this would show a much higher value. The ROI thus becomes a better indicator if brand value is included.

 THE ADVANTAGES:

1.       The inclusion of brand value in balance sheet gives a better picture of the company as having good assets and good brand value.

2.       At the same time apparent return on assets (without inclusion of brands) will be brought down to more realistic figures.

3.    In many of the takeovers, goodwill element in the price of the net assets has been increasing. Sometimes the price paid for goodwill is greater than the acquiring company’s net worth with the result that the consolidated accounts show negative shareholders equity. This looks preposterous. Some of the companies have reassessed the assets acquired in take overs and reclassified the goodwill as brands.

4.       Company’s brand management will certainly be sharpened up (e.g. brand P&L accounts)

5.       The Company’s debt equity ratio is improved i.e. it reduces the gearing ratio and so increases the Company’s borrowing capacity.

6.       It particularly helps service sector companies where there are low assets levels, but strong cash flow and customer bases.

7.       The company is more expensive to acquire which may deter hostile bids.

8.       The asset value does not come down as long as it is maintained by proper promotional and advertising efforts. There is no depreciation and thus no impact on P&L.

9.       The goodwill arising from an acquisition can be reduced.

10.   Recognising the value of brands separately at the time of acquisition reduces the amount of goodwill that must be written off either directly to reserves or by amortisation over a number of years. Immediate write off has detrimental effect on consolidated reserves and confuses the real value of acquisition of the business whereas amortisation has a continuous adverse and unrealistic effect on future profits.

11.   It helps better comparison between companies operating in similar markets, or between companies with varying mixes of acquired and homegrown brands.

12.   Many creditors have found in an insolvency situation that some current assets such as inventory are relatively worthless even though classified as current asset. Also, we cannot recover goodwill but brands can be transferred and can be converted into cash.

13.   For the businessmen brands are often the most important competitive advantage. It is the success or failure of brands that so often determines the manager’s success or failure. This concept will be translated into reality if brands are included in the balance sheet.

 SHOULD BRAND BE AMORTISED? 

The amortisation period is the period during which benefits are expected to arise. The life is deemed to be finite (prudence principle) but not fixed. Most of the businessmen find it easier to write off immediately against reserves and weaken the balance sheet than to touch the EPS by amortising brands. Most of the companies are inclined to amortise it. But the guidelines prescribed by the Accounting bodies are against it.

 DOUBLE COUNTING”: 

The acquisition of the brand is reflected in the balance sheet at cost. The companies spend significantly on marketing support of brands which is charged through P&L account. If the brands are depreciated, this would lead to double counting.

 SHOULD HOMEGROWN BRANDS BE VALUED AND AMORTISED? 

In disallowing the capitalisation of homegrown brands, a degree of comparability between competing company is lost. Whether acquired or home grown, brands require considerable expenditure, generate substantial income and add substantial value to the company. Allowing home grown brands to be capitalised would eliminate this inconsistency.

Companies know more about homegrown brands. Thus it is easier to value them. If a business builds its own factory instead of buying one, we capitalize it; why should brands be treated differently?

If accounting laws force companies not to value home grown brands they could easily find a way out by selling the brands to another company and again buy back from them. Clearly this is the best evidence to show that homegrown brands have a value too.

IN USA: It is a standard practice to capitalise and amortise goodwill. No asset revaluation is permitted. All purchased intangibles must be treated in the same way as goodwill. Maintenance costs of goodwill and all other intangibles must be written off to expenses. Thus there is no incentive for US companies to distinguish brands from goodwill, as the resulting treatment would be identical.

 IN AUSTRALIA: Acquired goodwill has to be amortised though the P&L account for a maximum period of 20 years. But unlike in UK and US, Australian has a modified historical cost accounting system, so that fixed assets may be revalued at market price every 3 to 5 years. Intangible assets like brands may be carried at market value. Acquired brands must initially be recorded at their cost of acquisitions. All brand names may be revalued with either upwardly or downwardly adjustments.

 ELSEWHERE: In most countries the acquired brands are capitalised and then amortised through the P&L, the depreciation period varies considerably. Five years is the maximum in Japan, forty years in France, and the brands expected life in Germany.

The argument in favour of capitalising brand names is related to the old adage – out of sight (if it is written off) out of mind. If brands are capitalised, management is more likely to continue a process of maintaining the values.

A court appeal made a distinction between ‘CAT’ goodwill which is loyal to the business and stays with the buyer if it is sold and a ‘DOG’ goodwill which is loyal to the owner and thus is lost to the business in case of a sale. Hence ‘dog’ goodwill must be written off while ‘cat’ goodwill need to be.

 

IN INDIA: According to AS – 10, Accounting for Fixed Assets, issued by the Institute of Chartered Accountants, goodwill in general, should be recorded in the books only when some consideration in money or money’s worth has been paid for it. As a matter of financial prudence goodwill is written off over a period. However this is not mandatory.

No guidelines has been issued by ICAI on brand valuation, as it is a relatively new concept in India. Major MNC’s like Unilever group, Proctor and Gamble, Nestle and reputed Indian companies like Tatas, Reliance could benefit a great deal by valuing brands and including them in the balance sheet. Now that AS - 26 is applicable, the brands can be valued if and only if they are purchased and not self generated.

 VALUATION OF BRANDS:

 One of the most important reasons why a valuable asset like brands is not shown on the balance sheet is because of the complexity involved in its valuation. However if the company can show that it is the beneficial owner of a valuable asset then the seemingly serious difficulty of putting a firm price (value) on brand cannot be accepted as a reason ( by any accounting principle) for refusing to record the value of brands in balance sheet. There are various methods of valuation but each has its own draw backs. They are briefly discussed below:

 METHODS OF VALUATION

  

01.               Valuation based on the aggregate cost of all marketing, advertising and research and development expenditure devoted to the brand over a stipulated period.

 02.               Valuation based on premium pricing of a branded product over a non branded product.

 03.               Valuation at market price

 04.               Valuation based on customer related factors such as esteem, recognition or awareness.

 05.               Valuation based on potential future earnings discounted to present day values.

 

DRAWBACKS IN EACH OF THEM

 01.          Brand value is not always a function of the cost of its development. If it were so failed brands may well be attributed high values.

 02.               The major benefits of branded products to manufacturers often relate to the security and stability of future demand rather than to premium pricing. Further many branded products have no generic equivalents.

 03.               Brands are not developed with the purpose of trading in them. Moreover the use of market value for balance sheet purposes is prohibited by the companies act.

 04.               A brand valuation based solely on consumer esteem or awareness factors would bear no relationship to commercial reality. Not may of those who are aware would actually buy it.

 05.             Discount values of future potential earnings of the brands seems to be an appropriate one. But the determination of reliable forecast cash flows is fraught with difficulty.

 Considering the drawbacks of  the  existing methods of valuation INTERBRAND GROUP, the leading international branding consultancy came up with an earnings multiple system for valuing brands. Conceptually the system is sound as it is based on hard, proven data. In this system to determine brand value certain key factors need to be considered:

 i.                     Brand earnings ( or cash flows)

ii.                   Brand strength ( which sets the multiple or discount rate)

iii.                  The range of multiples ( or discount rates) to be applied to brand earnings

 

BRAND EARNINGS:

 A vital factor in determining the value of a brand is its potential profitability over time. Not all of the profitability of a brand can necessarily be applied to the valuation of that brand. A brand may be essentially a commodity product or may gain much of its profitability from its distribution system. The elements of profitability which do not result from the brands identity must therefore be excluded. Also there is a possibility of the valuation getting affected by an unrepresentative years profit. For this reason, a smoothing element is introduced viz. a three year weighted average of historical profits.

 BRAND STRENGTH:

 Brand strength is a composite of seven weighted factors: Leadership, stability, market, internationality, trend, support and protection. The brand is scored for each of the above factors according to the weights attributed to them and the resultant total known as the “ brand strength score” is expressed as a percentage.

 THE RANGE OF THE MULTIPLES:

From the brand strength score the multiple to apply to the brand related profits is determined.

Stronger the brand, greater the multiple. The relationship between brand strength and multiple applied is represented by a ‘S’ curve

Text Box: MULTIPLE
APPLIED

 

 

 

 

 

 

Text Box: 0
Text Box: 100
Text Box: 50

 

                                                                  

                                                            BRAND STRENGTH

 

 

 

The shape of the ‘S’ curve is because of the following reasons:

 1.                   As brand strength increases from virtually zero ( an unknown or new brand) to a position as number 3 or 4 in a market, the value increases gradually.

 2.                   As the brand moves into the number 2 or particularly the no.1 position in its market there is an accelerated increase in its value

 3.                   Once a brand has become a powerful world brand the growth in value no longer increases at the same rate.

 Once the multiple is determined it is multiplied by the brand earnings to arrive at the brand value. This method is explained with the help of a problem in the exhibit.

 CONCLUSION:

 Valuation of brands is till in its infancy. With a plethora of brands flooding the market, established brand names are going to be a major asset and its importance will be increasingly in the future.

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Theories in Meausuring the financial value of a brand

 The first approach aims to calculate the brand’s value on the basis of its historic costs. These are the aggregated investment costs, such as marketing, advertising and R&D expenditure, devoted to the brand since its birth. However, an assumption is being made that none of these costs were ineffective. By virtue of little more than its heritage, a 100-year-old brand is more likely to have had more investment than a 20-year-old brand. The management team need to agree how the historical costs should be adjusted for past inflation.  Since several years have to pass before it is evident whether the brand is successful, when should a company start to include the brand value in its balance Sheet?  Another drawback of this method is that it ignores qualitative factors such as the creativity of advertising support. The value of a brand also depends on unquantifiable elements, such as management’s expertise and the firm’s culture. Finally there is also a question of financially accounting for the many failed brands that had substantial sums spent on them, out of which experience the successful brand arose. Overall this approach to brand valuation raises many questions and without well-grounded assumptions could be problematic.

 Another approach is that of comparing the premium price of a branded product over a non-branded product: the difference the two prices multiplied by the volume of sale of a branded product represents the brand value. However it is sometimes difficult to find a comparable generic product. For example, what is the unbranded counterpart of a Mars-Bar? This method also assumes that all brands pursue a price-premium strategy. It is clear that the brand value of Swatch or Daewoo for example could not be assessed on this basis when equivalent competitive brands are sold at a higher price.

 The valuation of a brand based on its market value assumes the existence of a market in which brands, like horses, are frequently sold and can be compared. However, since such a market does not yet exist there is no means of estimating a market price other than putting the brand up for sale on the market. Moreover, while the price of a house is usually set by the seller, the price other than putting the brand up for sale on the market. Moreover, while the price of a house is usually set by the seller, the price actually paid for a brand is determined by the strategy of the buyer, who may plan for the brand to play a very different role from its existing one. For example, Unilever paid 70 million pounds for Boursin just to gain shelf-space for its expansion plans for other parts of its brand portfolio.

 Some have proposed valuing brands on the basis of various customer-related factors, such as recognition, esteem and awareness. These are all important elements of brands and high scores on these are indicative of strong brands. However, it is vary difficult to derive a relationship from an amalgam of these factors to arrive at an objective valuation. For example, most consumers are aware that Rolls-Royce is a famous brand, but what value should be placed on it? Worst of all, however, is the fact that there are many famous brands, such as Co-op, with very little attached to them.

Yet another way of valuing a brand is to assess its future earnings discounted to present-day values. The problem, however, with this method is that it assumes buoyant historical earnings levels, even though the brand may be being ‘milked’ by its owners. One of the most widely-accepted ways of assessing the brand value is provided by Interbrand (Birkin 1994).  In order to determine brand value, a company must calculate the benefits of future ownership, i.e. current and future cash flows of the brand and discount them to take inflation and risk into account. The Interbrand approach is based on the assumption that the discount rate is given by a ‘Brand multiple’, representative of the brand strength. For example, a high multiple characterises a brand in which the firm is confident of continuing stream of future earnings and consequently represents low risk for the company. This also translates into a low discount rate. 

 The interbrand method is similar to deriving a company’s market value through its price/earnings (P/E) ratio.  This provides a link between a share capital and the company’s net profits and thus the brand multiple can be applied to a single brand within the company to calculate its value. Just as the P/E ratio equals the market value of the company divided by its after tax profits, likewise the brand multiple equals the value of the brand divided by the gross profit generated by this brand, i.e.

 P/E = Market value of equity                   Brand Multiple =  Brand equity

                       Profit                                                        Brand Profit

 To calculate the brand value, we multiply the Brand profit by the Brand multiple:

 Brand profit x Brand multiple = Brand Equity

 When calculating the brand profit several issues need to be considered. A historical statement of the brands profit is first required since as a good approximation tomorrow’s profits are likely to be similar to today’s, provided there is no change in brands strategy. The brand profit should be the post-tax profit after deducting central overhead costs. There may be instances where the same production line is used for both the manufacturer’s brand and several own labels. Where this is the case, any profits arising from shade own label production need to be subtracted.

 The next stage in arriving at a realistic assessment of the brand’s profit is to deduct the earning that do not relate to brand strength. For example, a firm may market two brands of bread. One competes through major grocery stores against other branded breads, and the other may be sold to a few distributors who sell this with related products through door-to-door delivery. Both brands may show similar brand profits, yet the profit of the first brand is heavily influenced by the strength of branding, while the profit of the second brand is much more dependent on the few distributors with the distribution systems. To eliminate the earning which do not relate to branding the most common approach is charging the capital tied up in the production of the brand with the return expected from producing a generic equivalent.

When looking at historical profits, to reduce the effect from any unusual year’s performance in previous three years profits are averaged. Following the logic of other forecasting systems, the more recent profits are likely to be more indicative of future profits. Therefore, a three-year weighted average is used, applying a weighting of three to the current year, two to the previous year and one to the year before that. These aggregated profits are then divided by the sum of the weighting factors, that is six in this case. If though a change in strategy for the brand is envisaged these weightings need to be reconsidered. Finally each year’s profit should be adjusted for inflation.

 Having calculated the brand’s profit, the brand multiple then needs to be calculated. This is found through evaluating the brands strength since this determines the reliability of the brand’s future earnings. Interbrand argue that a brand’s strength can be found from evaluating the brand against seven factors:

 Ø       Leadership : There is well-documented evidence showing a strong link between market share and profitability, thus leadership brands are more valuable than followers. A brand leader can strongly influence the market, set prices and command distribution, thus this criteria must be met to score well on leadership.

Ø       Stability : Well-established brand’s, which have a notable historical presence, are strong assets.

Ø       Market : Marketers with brands in non-volatile markets, for example foods, are better able to anticipate future trends in therefore confidently devise brand strategies than marketers operating in markets subject to technological or fashion changes. Thus part of the brand’s strength comes from the markets it operates in.

Ø       Internationality : Brands which have been developed to appeal to consumers internationally are more valuable than national or regional brands because of there greater volumes of sales and the investment to make them less susceptible to competitive attacks.

Ø       Trend : The overall long-term trend of the brand shows its ability to remain contemporary  and relevant to consumers, and therefore is an indication of its value.

Ø       Support : The amount, as well as the quality, of consistent investments and support are indicators of strong brands.

Ø       Protection : Registered trademark protects the brand from competition and any activities to protect the brand against imitators augers well for the future of the brand.

  

Strength Factor

Maximum Score

Leadership

25

Stability

15

Market

10

Internationality

25

Trend

10

Support

10

Protection

5

Total Score

100

The higher brand strength score the greater its multiple score. Interbrand argue that there is an   S-curve relationship between the multiple and the brand strength score, as shown in the graph below. Thus having calculated, for example, a brand strength score of 71, from graph below this gives a multiple of 16, i.e. the brand’s value is 16 times its three-year weighted average profit. 

Several questions have been raised about the interbrand method. Although interbrand has derived the data for the S-curve from the multiples involved in actual brand negotiations, market multiples may not necessarily be a correct indicator of the brand strength. All these multiples have been derived from the final transaction figures and may be inflated because market prices for brand acquisition often include an element of overbid. As the S-curve ignores this additional factor, the brand equity resulting from such a multiple might be overvalued.  

                        A slight variation in the multiple can modify the value of the brand significantly. For Example, in the case of Reckitt & Colman a one-point variation in the multiple corresponds to 54 million pounds difference in brand value.

  Interbrand argues that a new brand grows slowly in the early stages then it increases exponentially as it moves from national to international recognition and then slows down as it progresses to global brand status. However experimental analysis shows that the development of the brand is susceptible to threshold effects. It gradually acquires strength with consumers and retailers in different stages, but beyond a certain point its rate of growth is much greater. Research has found that brands achieve respectable spontaneous awareness scores only after a high level of prompted awareness has been achieved. Therefore the relationship between the brand strength and brand multiple may be better represented by a less regular pattern.

 Despite these limitations, the interbrand method  is a popular method amongst firms valuing there brands and is been adopted by more companies as a practical way to determine the value of their brands. Further more, firms having growing historical brand valuation databases enabling mangers to access which strategies are particularly effective at growing their brands.

 

In Search of Brand Value in the New Economy

 

The dynamics of the new world economy, particularly globalisation, outsourcing and e-business, are fundamentally changing the way business is conducted.  

The growth in recent years in global companies (primarily through cross-border mergers and e-business) has led to an explosion in the number of goods and services, and suppliers thereof, for consumers to choose from. With this increased choice, consumers have also been provided with greater information to make informed decisions, including ease of price comparison through the internet, the introduction of the European single currency, government regulation and increased advertising spend.

 How valuable is Intellectual Property?

 The change in the nature of competition and the dynamics of the new world economy have resulted in a change in the key value drivers for a company from tangible assets (such as plant and machinery) to intangible assets (such as brands, patents, copyright and know how). In particular, companies have taken advantage of more open trade opportunities by using the competitive advantage provided by brands and technology to access distant markets. This is reflected in the growth in the ratio of market capitalised value to book value of listed companies. In the US, this ratio has increased from 1:1 to 5:1 over the last twenty years.

 In the UK, the ratio is similar, with less than 30% of the capitalised value of FTSE 350 companies appearing on the balance sheet. We would argue that the remaining 70% of unallocated value resides largely in intellectual property and certainly in intellectual assets. Noticeably, the sectors with the highest ratio of market capitalisation to book value are heavily reliant on copyright (such as the media sector), patents (such as technology and pharmaceutical) and brands (such as pharmaceutical, food and drink, media and financial services).

 Brands clearly have significant value. Businesses, such as Nike, Unilever and Coca Cola spend billions each year supporting their brands. In the UK, the growth in trademark registrations has also demonstrated the increased focus on brand importance:

 

Year

Number of trademark registrations

1998

25,169

1994

28,828

1990

28,389

1986

17,089

1982

13,134

1978

10,643

1974

10,626

We should stress that owning a trademark does not, in itself, provide ownership of value. The value in a trademark is the protection it provides to a brand that generates cash flow. Many companies spend millions of pounds protecting trademarks that are of no, or very limited, value to the company.

 

If it is valuable, then why isn't it accounted for?

 It is often asked why this value does not reside on the balance sheet. Essentially, it is because balance sheets are a record of historic cost whereas value is a reflection of the market's expectation of a company's future cash flows and the risks inherent in those projected cash flows being achieved. In other words, accounting and value should not be confused.

 

Attempts have been made to account for IP. The first attempt was in 1988 when Nestle acquired Rowntree for £5 billion, a price representing five times the recorded net assets of the target company. Such an acquisition can lead to some distinctly funny looking accounting results. As you can imagine, if a collection of assets is acquired for, say, £500 million and the recorded assets are only £100 million then the remaining £400 million gets written off through the profit and loss account. This results in a balance sheet substantially less healthy than prior to the acquisition.

 

The current position is that internally generated intangible assets cannot be capitalised unless they have a "readily ascertainable market value". As no such market exists for brands, clearly it is not possible to capitalise such internally generated assets. On the other hand, acquired brands can be capitalised but only where it can be shown that they are separable from goodwill.

 

Intellectual property is more often created internally than acquired, with the associated expenses (such as research and development or advertising costs) being expensed through the profit and loss account rather than being capitalised on the balance sheet. As a result, some IP that is acquired goes on the balance sheet (as there is a point in time opportunity to place a cost on it) but most does not. Many balance sheets are therefore inherently inconsistent, showing some brands but not others.

 

The issue is not whether brands are accounted for but whether and how they are actively managed to enhance the company's value. The problem that arises from not accounting for brands is that it removes a key metric by which brand management might be measured.

 

Some companies now make an effort to report on the importance of their IP, if not its value. This recognition of value in IP is, not surprisingly, led by organisations with leading brands. Indeed, it is difficult to identify leading companies that do not have strong brands. One reason for this is that companies compete either through price or product differentiation, with the latter being preferable as it helps to maintain profit margins. However, in the new global economy there are an increasing number of suppliers of similar products, making product differentiation very difficult. Accordingly, companies often try to differentiate their products not through physical characteristics or product specifications but through emotive characteristics contained and developed in their brands.

 

The key strength of brands is in their ability to maintain customer loyalty. Accordingly, companies selling branded products have a more stable level of sales than non-branded companies. This certainty of future cash flows is of great benefit to companies and would be reflected in a higher valuation than an equivalent company with greater uncertainty over future cash flows.

 

Do Brands have value on the internet?

 

The focus on brand development is not limited solely to traditional companies but is also key for internet companies and companies investing in e-businesses.

 

However, internet companies face intense competition, as there are few barriers to entry. New companies have quickly entered the market, and have the ability to offer exactly the same products and services. A good idea on the internet can be imitated almost immediately. If a consumer has 100 internet book stores to choose from, what will make it use any particular store? Clearly, internet companies have to establish brands very quickly in order to develop and maintain their subscriber base. This is supported by data on UK advertising spend which shows that advertising by .com companies in 1999 is forecast to exceed £100 million compared to £35 million in 1998. In the US the growth in advertising for .com companies is even more dramatic, a trend which is likely to be followed in the UK.

 

It remains to be seen whether these large investments in internet branding will yield long term results. Everybody has heard of Amazon.com but it hasn't yet made a profit. Some questions remain: Will Amazon.com benefit in the long term from the subscriber base it is building in the short term? Will its customers remain loyal or will they move to lower price options later?

 

Why value brands?

 We find it surprising that, despite brands being so critical in the New Economy, few companies use metrics of any sort to monitor the growth or otherwise in their brand values, their return on brand investment or brand contribution to shareholder value. Certainly such measures are rarely reported publicly. For companies whose primary assets are their brands, surely such measures would be worth considering when making investment and other management decisions.

 The importance to a business of its brands and underlying trademarks is unquestionable. Once it is accepted that brands do have value then there is a need to understand and protect that value. We have set out below the more common circumstances in which brands either are or should be valued.

 Management

The regular valuation of brands would allow a company to monitor the effect thereon of its strategy. Has the implementation of management strategy resulted in brand value creation or brand value destruction? Would more value be achieved with a different strategy? Should investment dollars be diverted to other brands? A policy may well increase sales and even profits in the short term but may reduce the value of the brands and ultimately the company in the longer term.

 

The monitoring of brand value is also a useful tool in determining the success or failure of advertising campaigns and the efficiency of marketing spend. Marketing spend which does not increase the value of the brand may be misdirected. It was recently reported, for example, that Proctor and Gamble have changed the way they pay for advertising fees. Previously they paid a fixed fee for an advertising campaign. In future, they will pay the advertisers a fee, in part determined by the level of additional sales derived from the campaign. Ultimately, perhaps, the fees might be linked to measures of customer loyalty or brand value.

 

 

Strategic management is ultimately focused on creating shareholder value. For many consumer goods companies, the value of their brands significantly exceeds the value of their plant and machinery. For these companies to maximise shareholder value it is essential to maximise the value of their brands.

 

Transactions

Brands are often valued in connection with proposed or completed transactions. Although the price will ultimately be a matter for negotiation, each party to the transaction will be better placed to negotiate if they have valued the brand(s) in advance. This theory applies equally well regardless of whether the transaction is a sale, joint venture or strategic alliance.

 

 

Reporting

As noted above, current accounting standards and practice do not require intellectual property to be accounted for on a balance sheet, indeed they make it difficult to do so. Nevertheless, once brands have been capitalised, it is necessary to ensure that their value does not fall below the value shown in the balance sheet. This necessarily requires a valuation to be performed.

 

Reporting is not only a reference to financial statements. Management that do not report to shareholders may nevertheless want regular valuations done to enable them to assess over time whether the value of a brand has been enhanced or whether it has greater value if used differently.

 

Litigation

IP damages arising from litigation is all about IP value. Although IP damages typically manifests itself in a claim for lost profit, that profit is underpinned at the very least by a reasonable royalty rate. That royalty rate, in turn, represents the amount a willing third party licensee would pay to use the IP. As our brief commentary on valuation methodologies below shows, the royalty approach is a common form of IP valuation. In addition, there are disputes which actually require the IP to be valued.

 

Taxation and transfer pricing

The ownership, and methods of charging for the use of IP are key factors in the location of a multi-national group's profits. Identifying the optimum framework for ownership, licensing and use of IP across a world-wide business can save a multinational group millions of pounds in tax. It is important when considering such arrangements to understand, inter alia, the value of the IP.

 

Can brands be valued?

 

For an asset to be valued, it needs three key properties:

 

(1)     it needs to be separable from the other assets of the business - i.e. can be sold without selling a business of the entity. Whether brands are separable from the underlying business is often debated and needs to be considered in each case. This is a bigger problem for corporate brands than product brands;

 

(2) it needs to have legal title which can be transferred - enter the trademarks; and

 

(3) it needs to be able to generate cashflows in its own right. This manifests itself in the practical problem of separating the cash flows attributable to the brand from cash flows attributable to other factors. All methodologies attempt to identify that part of earnings or price which can be attributed purely to the brand. However, it is often very difficult to separate the value of the brand from other intangible assets, particularly goodwill. Accordingly, care must be taken to separate out goodwill from any brand valuation to avoid over valuing a brand.

 

Brand valuation methodologies

 

Having established that brands are valuable and should be valued the question arises as to how to value them. This area is complex and, like business and property valuations, subjective. However, certain robust methodologies have been developed, some of which are summarised below. Due to the judgmental elements, we recommend the use of more than one methodology in each case, with the results cross-checked to ensure a reasonable result. We also recommend consistency of use over time so as to reduce the comparative effect of judgement wherever possible.

 

 

The basic premise underlying the value of any asset is that its current value equals the future economic benefits derived from its use, at today's prices. If an asset has no future economic benefit then it has no value. The difficulty is in (1) forecasting future cash flows (2) estimating what proportion of those future cash flows can be attributed to the brand, and (3) determining an appropriate discount rate to put those cash flows in present day terms. The following methods attempt to answer these questions.

 

Premium profits

The underlying principle supporting the premium profits method is that a value can be determined by capitalising the additional profits generated by the intangible asset. This approach is often used for brands on the theory that a branded product can be sold for more than an unbranded product. For instance Coca Cola may be able to charge 50p for a Coke whereas an unbranded cola may only sell for 35p per can. The price difference of 15p can be described as the value of the brand, per can. To value the brand it would be necessary to forecast the number of annual sales of the branded product and multiply this by the price premium (i.e. the 15p). The sum of the discounted annual price premium would be the estimated value of the brand.

 

It may be that the branded product can not sell at a higher price than the non-branded product but instead can sell greater volume. The same valuation technique still applies. The future economic benefits will thus be the profits attributable to the additional volume generated by the brand. In many cases, branded products will be able to charge a price premium as well as sell greater volumes than the non-branded competitors.

 

There are problems with the premium pricing method. Firstly, it is difficult to find a non-branded competitor to compare prices with. Secondly, prices charged for each product will vary between regions, and will change throughout the year, given promotions etc. In addition it is very difficult and subjective to establish how much of the pricing differential can be attributed to the brand and how much relates to other factors.

 

The relief from royalty method

This method is based upon the amount a hypothetical third party would pay for use of a trademark, alternatively the amount the owner is relieved from paying by virtue of being the owner rather than the licensee. The estimate of how much a hypothetical third party would pay to be able to use, for example, the name Gucci on their products, provides an estimate of the value of the brand name Gucci. This estimate is based on either actual license agreements, comparable market data or financial analysis. For example, Gucci may actually be charging licensees a royalty for use of the name; if they are not, then names comparable to Gucci may be used to derive benchmarks for reasonable royalty rates. For valuation purposes, the royalty rate is usually expressed as a percentage of sales.

 

Once a royalty rate has been estimated it is necessary to estimate the life of the brand and the level of annual sales. By multiplying the level of annual sales by the royalty rate and summing all years gives you an estimate of the future economic benefit of the brand. The final step is to bring these projected future cash flows back to today's prices by discounting for the time value of money and the risks associated with achieving those cash fows.

 

This is the most simplistic and, in our experience, most commonly used method for valuing intellectual property. One difficulty with it is the lack of actual, comparable agreements on which to base the hypothetical royalty rate. We seek to resolve this problem either by reference to our own confidential database of royalty rates or by analysing the profitability of the products in question in order to estimate the royalty that a hypothetical third party would be prepared to pay in order to generate those profits.

 

 

 

Earnings basis

This method focuses on the maintainable profitability attributable to the intangible asset. The profitability of the product that can be attributed to all other factors, such as tangible assets and working capital, is deducted from the total forecast profitability. The profit remaining, by matter of deduction, can then be attributed to intangible assets. For example, if Gucci had expected future profitability of £100 million and the profit attributed to other factors was estimated at £80 million, then the profit attributed to intangible assets is £20 million. This would then be divided between the company's various intangible assets.

 

To calculate the value of the brand a multiple is applied to the portion of the £20 million profit attributed to the brand. Therefore if a multiple of 10 was considered appropriate and, for simplicity, the profit attributed to the brand is the full £20 million, then the value of the brand would be £200 million (20 x 10). The multiple could be determined by the companies P/E ratios, comparable rates used for other companies, or calculated from scratch, possibly based on factors relating to the strength of the brand.

 

One shortcoming of this approach is that it is difficult to objectively attribute a profit element to all of the other factors, such as tangible assets. Secondly, the profit attributed to the brand will depend on how certain costs are allocated. Thirdly, the calculation of a multiple is highly subjective.

 

Marketing transaction comparatives

As companies restructure to successfully compete in the New Economy there are an increasing number of brand sales in certain industries. These brand disposals can be used as a bench mark by which to value the brands of other products in the same industry. For example, in 1998 Diageo sold its Bombay Gin and Dewar's Scotch whisky to Bacardi for US$1.9 billion. By analysing the acquisition price as a multiple of current or forecast sales it would be possible to estimate the value of another brand in the same sector.

 

 

 

Summary

 

Brands have never been as important or as valuable as they are at present, owing to the dynamics of the new world economy and the increased power of the consumer. Their importance was summarised by Sir Allen Sheppard (then the Chairman of Grand Metropolitan plc).

 

"Brands are the core of our business. We could, if we so wished, subcontract all of the production, distribution, sales and service functions and, provided that we retained ownership of our brands, we would continue to be successful and profitable. It is our brands that provide the profits of today and guarantee the profits of the future."

 

As such, brands should be managed as the key business asset that they are; not only at the protection and enforcement level, but also in terms of building shareholder value. This level of management requires the development of appropriate metrics for measuring brand management performance, of which we would argue valuation is a key management tool.

 

Although brands are key to the success of many companies, they do not guarantee earnings stability. All aspects of the brand mix will need to be actively managed to ensure that the brand remains continually relevant and desirable to consumers. It is mainly because of this need to actively manage all aspects of the brand that regular valuations are essential to determine whether the company strategy and tactics are maintaining, creating or destroying its value.