18 Brands in the Boardroom IAM supplement No.1

There is now widespread acceptance thatbrands play an important role in generatingand sustaining the financial performance ofbusinesses. With high levels of competitionand excess capacity in virtually every industry,strong brands help companies differentiatethemselves in the market and communicatewhy their products and services are uniquelyable to satisfy customer needs.

In an environment in which the functionaldifferences between products and serviceshave been narrowed to the point of nearinvisibility by the adoption of Total QualityManagement, brands provide the basis forestablishing meaningful differences betweenapparently similar offers. Competitiveadvantage now depends on being able tosatisfy not just the functional requirements ofyour customers, but also their more intangibleneeds. It means understanding not just whatyour products can do for them, but also whatthey can mean to them.

Brands are ideally suited to this taskbecause they communicate on a number ofdifferent levels. Brands have three primaryfunctions – navigation, reassurance andengagement. Navigation – brands helpcustomers to select from a bewildering arrayof alternatives. Reassurance – theycommunicate the intrinsic quality of theproduct or service and so reassure customersat the point of purchase. Engagement – theycommunicate distinctive imagery andassociations that encourage customers toidentify with the brand.

Branding is the process of transformingessentially functional assets into relationshipassets by providing the basis for apsychological connection between the brandand the customer. This ability to endow a

product, service or company with an emotionalsignificance over and above its functional valueis a substantial source of value creation.

The past 20 years have witnessed adramatic shift in the sources of value creationfrom tangible assets (such as property, plant,equipment and inventory) to intangible assets(such as skilled employees, patents, businesssystems and brands). This is reflected in thegrowing divergence between the net assetvalue of companies and their marketcapitalisation. The aggregate market-to-bookratio of the S&P 500 (the broad-based indexof the 500 leading companies in the US) rosesteadily from an average of around 1.4 at thebeginning of the 1980s to around 3.5 in themid 1990s. It accelerated rapidly in the late1990s to reach a peak of 7.3 at the height ofthe dot.com bubble in early 2000 beforefalling back to its current level of 4.7(February 2003).

A market-to-book ratio of 4.7 implies that thetangible assets of a business account forunder 25% of the value that investors areplacing on a company. Intangible assetsaccount for the remaining 75%. In this context,it is not surprising that the topic of brandvaluation is generating significant interest.

Forms of intangible assetThere is currently no standard classification forintangible assets. The pioneering work of LeifEdvinsson and Michael Malone put forward twobasic classes of intangible asset: human capitaland structural capital. Asked to distinguishthem, Leif Edvinsson is said to have remarked:“Structural capital is what is left when thehuman capital has gone home for the night”.

Subsequent researchers have generated anumber of different categories of intangible

Brand valuation

Brand valuation:what it means andwhy it matters

Over recent years, intangible assets have become more important tobusinesses operating in a wide variety of industries. This in turn has put apremium on being able to come up with credible ways to value brands.David Haigh and Jonathan Knowles report

Brands in the Boardroom IAM supplement No.1 19

asset. We believe that it is useful to identifyfour broad categories of intangible asset thatsupport the superior market performance ofbusinesses:• Knowledge intangibles: for example,

patents, software, recipes, specific know-how, including manufacturing and operatingguides and manuals, product researchincluding product trials data, informationdatabases etc.

• Business process intangibles: these includeunique ways of organising the businessincluding innovative business models,flexible manufacturing techniques andsupply chain configurations.

• Market position intangibles: for example,retail listings and contracts, distributionrights, licences such as landing slots,production or import quotas, thirdgeneration telecom licences, governmentpermits and authorisations and rawmaterials sourcing contracts.

• Brand and relationship intangibles: theseinclude trade names, trademarks and tradesymbols, domain names, design rights, tradedress, packaging, copyrights over associatedcolours, smells, sounds, descriptors,logotypes, advertising visuals, and writtencopy. In addition, associated goodwill (thegeneral predisposition of individuals to dobusiness with one brand rather than anotherbrand) should be included.

The relative importance of these fourcategories of intangible asset varies byindustry. Pharmaceuticals is an industry inwhich knowledge assets are of particularsignificance. Retailing is an industry wherebusiness process assets (such as thosedeveloped by Wal-Mart and Dell) are majorsources of financial value. Airlines is anindustry in which market position assets (inthe form of landing rights at popular airports)are primary drivers of competitive advantage.

In industries such as consumer-packagedgoods, luxury items, media and some types ofconsumer durables, brands may well representthe single most important form of intangibleasset. Even in sectors that are driven largelyby technology and research, brands play a vitalrole in translating a company’s technicalcompetencies into market success. Effectivemanagement of brands is therefore anincreasingly important element of businessstrategy and determinant of the valuationaccorded to a business by investors.

This should herald the golden age ofmarketing. Instead it has given rise to whatPeter Doyle, the former Professor of Marketingat Warwick University in the UK, has dubbedthe “marketing paradox”. In the preface to his

highly-acclaimed book Value-based Marketing(2000), he wrote: “Many senior managershave noticed a paradox in how firms perceivemarketing. On the one hand, every chiefexecutive and mission statement putsmarketing at the very top of the agenda … Atthe same time, marketing professionals,marketing departments and marketingeducation are not highly regarded …Theparadox will never be resolved until marketingprofessionals justify marketing strategies inrelevant financial terms.”

In similar vein, Professor Don Lehmann,Professor of Marketing at Columbia Universityin New York, has observed that: “Whenmarketing people talk about what they do, thevariables they cite aren’t the ones that theCEO cares about. Customer awareness,customer satisfaction and market share areall metrics, and they are nice to know about.But the CEO is more concerned withshareholder value, market capitalization,return on assets and return on investment. Inmarketing, people don’t talk that way.”

We believe that two things are necessary tosupport the effective communication of thecontribution of brands to businessperformance: a more precise definition of thebrand asset; and a robust methodology forquantifying the shareholder value that isgenerated by the brand.

What exactly do you mean by brand?One of the great challenges in marketing isthat there is no uniform definition of brand:the term is used differently by different peopleto encompass a relatively broad range ofassets. In our experience there are threedifferent concepts all of which are sometimesreferred to as the brand.

First there are logos and associated visualelements. This is the most specific definitionof brand focusing on the legally protectable,visual and verbal elements that are used todifferentiate one company’s products andservices from another and to stimulatedemand for those products and services. Themain legal elements covered by this definitionare trade names, trademarks and tradesymbols. However, in order to add value,trademarks and trade symbols need to carryassociated goodwill in the minds of customersbased on the experience or reputation of highquality products and good service.

This definition of brand is useful in thecontext of licensing agreements because itcovers the core elements of the asset beinglicensed.

For brands that are operated by theirowners, academics and practitioners oftenuse two broader definitions.

Brand valuation

20 Brands in the Boardroom IAM supplement No.1

The first of these is a larger bundle oftrademark and associated intellectual propertyrights. Under this definition, brand is extendedto encompass a larger bundle of intellectualproperty rights. Marketing intangibles such asdomain names, product design rights, tradedress, packaging, copyrights in associatedcolours, smells, sounds, descriptors,logotypes, advertising visuals and written copyare often included in this wider definition.

Some commentators have interpreted theintellectual property rights included in thedefinition of brand very widely indeed. In fact,tangible as well as intangible property rightshave been referred to as integral componentsof brands. Some argue that the Mercedesbrand would be incomplete if it wereseparated from the other tangible andintangible assets used to build Mercedesproducts. The reason that some argue a largerbundle of intangibles should be included inthe definition of brand is because consumerloyalty is created over a long period by manytouch points and consumer experiences.

Protagonists of a more holistic definition ofbrand ask whether the Mercedes brand wouldcommand such fierce loyalty and pricepremium without the benefit of Daimler Benzdesign, engineering and service. Similarly theyargue that the Zantac brand would beincomplete without the Ranitidine patent. TheGuinness brand would not be Guinnesswithout the genuine recipe and productionprocess. This more holistic view is consistentwith the opinion that brand is a much broaderand deeper experience than the logo andassociated visual elements.

And that takes us to the holistic company ororganisational brand. The debate as to whichintellectual property rights should or shouldnot be incorporated into the definition of brandoften leads to the view that brand refers tothe whole organisation within which thespecific logo and associated visual elements,the larger bundle of visual and marketingintangibles and the associated goodwill aredeployed.

A combination of all these legal rightstogether with the culture, people andprogrammes of an organisation all provide abasis for differentiation and value creation bythat organisation. Taken as a whole theyrepresent a specific value proposition andprovide the basis for strong customerrelationships.

This is the broadest definition of brand. Itstresses the need for consistent communicationwith all stakeholder audiences. Rather than justincreasing the preference of customers forbuying the company’s products and services thebrand becomes a tool for affecting the

preference of other audiences to do businesswith the organisation. For example, the brandmay favourably affect staff, suppliers, businesspartners, the trade, regulators, and providers ofcapital. The benefits of a strong organisationalbrand are increased demand and distributionbut also lower costs of materials, personnel,debt and equity.

For the purposes of this article we refer tothe first definition as trademark. The seconddefinition we refer to as the brand. The thirddefinition we refer to as the branded business.

Approaches to brand valuationThere are two critical questions to answer inbrand valuation. The first is exactly what isbeing valued. Are we valuing the trademarks,the brand or the branded business? Thesecond important question is the purpose ofthe valuation. An important distinction can bemade between technical and commercialvaluations.

Technical valuations are generally conductedfor balance sheet reporting, tax planning,litigation, securitisation, licensing, mergersand acquisitions and investor relationspurposes. They focus on giving a point in timevaluation that represents the value of thetrademarks or of the brand as defined above.

Commercial valuations are used for thepurposes of brand architecture, portfoliomanagement, market strategy, budgetallocation and brand scorecards. Suchvaluations are based on a dynamic model ofthe branded business and aim to measure therole played by the brand in influencing the keyvariables in the model.

We recommend that the starting point forevery valuation – whether technical orcommercial - should be a branded businessvaluation. This provides the most completeunderstanding of the commercial context ofthe brand.

A branded business valuation is based on adiscounted cash flow analysis of futureearnings for that business discounted at theappropriate cost of capital. The value of thebranded business is made up of a number oftangible and intangible assets. Trademarksare simply one of these and brands are amore comprehensive bundle of trademark andrelated intangibles.

There are a number of recognised methodsfor valuing trademarks or brands as definedhere.

We can look at historic costs – what did itcost to create? In the case of a brand one canlook at what it cost to design, register, andpromote the trademarks and associatedrights. Alternatively, one can address whatthey might cost to replace. Both the historic

Brand valuation

Brands in the Boardroom IAM supplement No.1 21

cost method and the replacement costmethod are subjective but we are often askedto value this way because courts may want toknow what a brand might cost to create.

It is also possible to consider market value,though frequently there is no market value forintangibles, particularly trademarks andbrands. Generally speaking, therefore, themost productive approach to brand valuationis to employ an economic use valuationmethod, of which there are a number.

First there is the price premium or grossmargin approach that considers pricepremiums or superior margins versus ageneric business as the metric for quantifyingthe value that the brand contributes. However,the rise of private label means that it is oftenhard to identify a generic against which theprice or margin differential should bemeasured.

Economic substitution analysis is anotherapproach - if we didn’t have that trademark orbrand what would the financial performance ofthe branded business be? How would thevolumes, values and costs change? Theproblem with this approach is that it relies onsubjective judgments as to what thealternative substitute might be.

The difficulties associated with these twoapproaches mean that the two most usefuleconomic use approaches are the earningssplit and royalty relief approaches.

Under a royalty relief approach we imaginethat the business does not own itstrademarks but licenses them from anotherbusiness at a market rate. The royalty rate isusually expressed as a percentage of sales.This is the most frequently used method ofvaluation because it is highly regarded by taxauthorities and courts, largely because thereare a lot of comparable licensing agreementsin the public domain. It is relatively easy tocalculate a specific percentage that might bepaid to the trademark or brand owner.

Under an earnings split approach weattribute earnings above a break-eveneconomic return to the intangible capital. Thisinvolves four principal steps. The first is anappropriate segmentation of the market toensure that we study the brand within itsrelevant competitive framework. The secondstep is to forecast the economic earnings ofthe branded business earnings within each ofthe identified segments. These are the excessearnings attributable to all the intangibleassets of the business. The third step is toanalyse the business drivers research todetermine what proportion of total brandedbusiness earnings may be attributedspecifically to the brand. The final step is todetermine an appropriate discount rate based

on the quality and security of the brandfranchise with both trade customers and endconsumers.

In our experience, it is very important toexpress the final valuation number in context.This means explaining exactly what has beenvalued, using what method, and what the keyinsights are as to the influence of the brandon the key operating variables of thebusiness.

In this context, it is useful to remember thatvalue is a function of three primary variables –profitability, growth and risk. Investors careabout the level of free cash flow generated bya company (profitability), the prospects forincreasing those cash flows (growth) and thevolatility of these cash flows (risk).

Understanding the contribution of brands toshareholder value therefore depends on beingable to express the impact of brands onprofitability, growth and risk. The traditionalview of customers as the only relevantaudience (implicit in the price premiumapproach above) fails to recognise the fullvalue-creating power of brands because itconfines the impact of the brand to the pricepremium that the branded product is able tosustain.

It is important to understand the impact ofa brand on four major audiences in order toquantify the scale of its financial significance.These four audiences are consumers,suppliers, staff and investors/financiers. Foreach of these audiences we analyse both theextent and the nature of the awareness andimage profile that the brand enjoys, andcapture the impact of these on the behaviourof that audience. With consumers, the impactof brand health drives both profitability andgrowth. With suppliers and staff the impact ofbrands is evident in lower costs and thereforehigher profitability. With investors andfinanciers, the benefit of strong brands isseen in lower funding costs.

This broader perspective on the business isof significant value when the client hasresponsibility for business and branddevelopment because it illuminates theprincipal value drivers of the business andidentifies how brand perceptions andpreferences affect consumer purchasebehaviour and staff and supplier relationships.

As such, it makes a substantive contributionto understanding the sources and scale of acompany’s competitive position. It quantifiesthe size of the asset that the brand representsand – perhaps more important yet – identifiesways in which the value can be enhanced.

Brand valuation

Brand Finance plc8 Oak Lane, London, TW1 3PA, UKTelephone: +44 (0) 20 8607 0300Facsimile: +44 (0) 20 8607 0301

Brand Finance (USA) Inc.1430 Broadway, 17th Floor, New York, NY10018, USATelephone: 646 345 6782Facsimile: 212 658 9869www.brandfinance.com

David Haighd.haigh@brandfinance.com

David Haigh is chief executive officer of BrandFinance. He qualified as a charteredaccountant with Price Waterhouse in London.He worked in international financialmanagement then moved into the marketingservices sector, firstly as financial director ofThe Creative Business and then as financialdirector of WCRS & Partners.He left to set up a financial marketingconsultancy, which was later acquired byPublicis, the pan European marketing servicesgroup, where he worked as a director for fiveyears. David moved to Interbrand as Directorof Brand Valuation in its London-based globalbrand valuation practice, leaving in 1996 tolaunch Brand Finance.David is a fellow of the UK Chartered Instituteof Marketing.

Jonathan Knowlesj.knowles@brandfinance.com

Jonathan Knowles is managing director ofBrand Finance USA and a passionate believerin the importance of brands in creating bothcustomer and shareholder value.Jonathan’s expertise in integrating thefinancial and marketing perspectives on brandis the result of practising brand consultingfrom both the analytical and creativeperspectives. Prior to joining Brand Finance hewas senior vice president of BrandEconomics,a brand strategy and valuation business basedin New York. His previous role as head ofconsulting for Wolff Olins, a leading corporateidentity and brand consultancy based inLondon, provided the experience of brandconsulting within a highly creative environmentand acted as a counterpoint to his analyticaltraining with the value-based strategyconsultants Marakon Associates.