The benefit of ascertaining the correct brand value
will ensure that resources are appropriately channeled to where they will
deliver the greatest value to the organization, particularly in optimizing a
brand portfolio. Decisions regarding the
correct level of marketing spend, the evaluation of brand manager performance,
and the initial decision whether to build a strong brand will be
simplified. Another potential use is
ensuring that the correct value is determined for mergers and acquisition
purposes. It is time for marketing as a profession to adopt common standards
much like the accounting profession has adopted standards of practice in their
field. Furthermore, an accurate brand
equity valuation ensures that brand-licensing fees correctly reflect the
benefits received (Keller, 1998).The objectives of this article are : to
identify and review the various approaches and methods used to value brands and
to discuss the issues managers need to consider when evaluating valuation methods.
The major contribution of this article is that it provides managers with
guidelines on what to look for when going through a brand valuation process.
Brand Valuation
Initial
research into the valuation of brands originated from two areas
: marketing measurement of brand equity, and the financial treatment of
brands. The first was popularized by
Keller (1993), and included subsequent studies by Lassar
et al (1995) on the measure of brand strength, by Park and Srinivasan
(1994) on evaluating the equity of brand extension, Kamakura and Russell (1993)
on single-source scanner panel data to estimate brand equity, and Aaker (1996) and Montameni and Shahrokhi (1998) on the issue of valuing brand equity
across local and global markets.
The financial treatment of brands has traditionally
stemmed from the recognition of brands on the balance sheet (Barwise et.al., 1989, Oldroyd, 1994, 1998), which presents problems to the
accounting profession due to the uncertainty of dealing with the future nature
of the benefits associated with brands, and hence the reliability of the
information presented. Tollington (1989) has debated the distinction between
goodwill and intangible brand assets.
Further studies investigated the impact on the stock price of customer perceptions
of perceived quality, a component of brand equity (Aaker
and Jacobson, 1994), and on the linkage between shareholder value and the
financial value of a company’s brands (Kerin and Sethuraman, 1998).
Simon and Sullivan (1993) developed a technique for
measuring brand equity, based on the financial market estimates of profits
attributable to brands. The
co-dependency of the marketing and accounting professions in providing joint
assessments of the valuation of brands has been recognized by Calderon et al
(1997) and Cravens and Guilding (1999). They provide useful alternatives to the
traditional marketing perspectives of brands (Aaker,
1991; Kapferer, 1997; Keller, 1998; Aaker & Joachimsthaler,
2000).
The debate over the appropriate method of valuation
continues in the literature (Perrier, 1997) and in the commercial world. The commercial valuation of brands has been
led by Interbrand, a UK-based firm specializing in
valuing brands, Financial World, a
magazine which has provided annual estimates of brand equity since 1992, and
Brand Finance Limited, a British consulting organization. These organizations
utilize formulae approaches, and highlight the importance of brand valuation in
the business environment.
Obstacles to Brand Valuation
In
a study conducted by Robbin (1991), the number one
concern was “the wide range of alternative valuation methods which will yield
significantly different results” (Robbin 1991, p
56). A second concern was the difficulty
in assessing the brand’s useful life.
There are several other obstacles to brand valuation. There is a lack of an active market for
brands. This means that estimates of
model accuracy cannot be tested empirically nor can one gain some sort of
assurance of testing the value by putting the brand on the market. Many
practitioners are unwilling to publish their models and open them up to
academic debate. In addition, the large number of models cause confusion amongst marketers and they
are difficult to conceptualise. Another important obstacle is that it is
difficult to separate brand equity from other intangibles like goodwill. Barwise, Higson, Likierman and Marsh (1989
p7) suggest that “at present, there is no general agreement on valuation
methods. Nor can existing
methods be regarded as either totally theoretically valid nor empirically
verifiable.”
It
is important to recognize that only after careful consideration of all the
enterprise’s intangible assets will the valuer be
able to determine the importance of the brand in the organization’s current
market position. Reilly and Schweihs (1999) list many possible intangible assets. These include marketing related assets such
as trademarks, logos and brand names, and corporate identity. Customer related intangible assets include
customer lists and customer relationships.
A further problem arises in the process of valuing an intangible asset
such as a brand which, often requires estimation and
subjectivity.
Brands
on the Balance Sheet
Robbin (1991) highlighted reasons why an organization
should recognise brands as an asset. These include the fact that it decreases the
firm’s gearing ratio as a result of the larger asset base. It is also an internally generated asset and
thus increases shareholder equity. In
addition, a large premium for mergers and acquisitions can be justified.
However,
Robbin (1991) also highlights reasons for keeping
brands off the balance sheet. It
decreases the return on assets as the firm now has a larger capital base. Companies that have adopted Economic Value
Added (EVA) would have to raise a capital charge against the asset. The issue
of brand value or measurement also is a negative until acceptable methods can
be found.
Valuation
Approaches
The
concept of value is one
of the most difficult concepts to grasp. Value has different meanings to different
people and thus is not an objective concept. The valuation approach used is
effectively the objective of the valuation.
The objective of the valuation is determined by its use. Some of the more common valuation approaches
can be classified into five categories:
1.
Cost-based approaches
2.
Market-based approaches
3.
Economic use or income-based approaches
4.
Formulary approaches
5.
Special situation approaches
Cost-based
approaches consider the costs associated with creating the brand or replacing
the brand, including research and development of the product concept, market
testing, promotion, and product improvement.
The accumulated cost approach will determine the value of the brand as
the sum of accumulated costs expended on the brand to date. This method is the easiest to perform, as all
the data should be readily available.
Unfortunately, this historic valuation does not bear any resemblance to
the economic value (Aaker, 1991; Keller, 1998).
The
replacement cost approach determines the cost that would be incurred to replace
the asset if it is destroyed (Aaker, 1991; Keller,
1998). An advantage of this method is
that it provides a better reflection of the true value of the brand. A disadvantage of this approach is that the
value does not bear a relation to the open market value. One could over-capitalise,
by over investing in that asset which may not be recouped if the asset was
sold.
Market-based
approaches are based on the amount for which a brand can be sold. The open market valuation is the highest
value that a “willing buyer and willing seller” is prepared to pay for the
asset. This would exclude a strategic
buyer who may have other objectives (Reilly and Schweihs,
1999). This valuation basis should be
used when one wishes to sell the brand. Barwise et al. (1989) suggest that the market value of an
asset should reflect the possible alternative uses; the value of future options
as well as its value in existing activities; and realism rather than conservatism. Modern financial theory states that one
should sell off assets if the value that a buyer is willing to pay exceeds the
discounted benefits of the brand (Brealey and
Meyers, 1991).
Economic
use approaches, also referred to as “in-use” or income-based approaches,
consider the valuation of future net earnings directly attributable to the
brand to determine the value of the brand in its current use (Keller, 1998; Reilly and Schweihs, 1999; Cravens and Guilding,
1999). This basis is often appropriate
when valuing an asset that is unlikely to be sold as a flanking brand that is
being used for strategic reasons. This
method reflects the future potential of a brand that the owner currently
enjoys. This value is useful when
compared to the open market valuation as the owner can determine the benefit
foregone by pursuing the current course of action.
Formulary
approaches consider multiple criteria to determine the value of a brand. While similar in certain respects to
income-based or economic use approaches, they are included as a separate
category due to their extensive commercial usage by consulting and other
organizations.
Special
situation approaches recognize that brand valuation can be related to
particular circumstances that are not necessarily consistent with external or
internal valuations. A strategic
buyer is often willing to pay a premium above the market value (Bradley and Viswanathan,
2000). This may be a result of synergies
that they are able to develop which other buyers may not be able to
achieve. When an asset is valued, in the
absence of a written offer from the strategic buyer, it cannot be assumed that
a buyer will appear and be prepared to pay a premium price. Each case has to be evaluated on individual
merit, based on how much value the strategic buyer can extract from the market
as a result of this purchase, and how much of this value the seller will be able to obtain from
this strategic buyer.
The
liquidation value is the value that the asset would fetch in a distress
sale. The value under a liquidation sale
is normally substantially lower than in a willing buyer and seller
arrangement. The costs of liquidating
the asset should normally be deducted in determining the value of the asset.
When
valuing an asset for special purposes, for example, income tax, the method that
the assessing authority requires should be used. The advantage of this approach is that one is
assured that all requirements are met. The drawback of the
above approach is that the value may bear little relevance to economic reality
or serve another useful purpose.
Available
Approaches for Brand Valuation
Reilly
and Schweihs (1999) identified the attributes that
affect the value of brands, but there are five main aspects that need to be considered
when calculating a brand’s value. These
are: what additional price premium the product can command over a generic; how
much additional market share can be gained; what cost savings can result from
an ability to exercise increased control over the channel; what additional
revenue can be gained through licensing and brand extensions; and the
additional marketing costs that need to be incurred in providing the point of
differentiation as a competitive strategy.
The
approaches available for brand valuation can be grouped into the four major
categories, cost based; market-based; economic use; and formulary approaches.
Some
of the more common valuation models will now be discussed.
Cost-based
Approaches
Brand
Equity Based on Accumulated Costs
The basis of this approach is that it
aggregates all the historical marketing costs as the value (Keller 1998). The
real difficulty here is determining the correct classification as to what
constitutes a marketing cost and what does not.
By way of an example, if an accountant spends two days a month preparing
reports for the marketing department, is that a cost that can be capitalized to
the brand? Even if the classification difficulty were overcome the next problem
would be how to amortize the marketing cost, as a percentage of sales over the brand’s expected life?
The only advantage of the approach is
that the brand manager knows the actual amount that has been spent. Alternate models have been proposed, but they
all suffer from the same problems. An
alternative approach that has been suggested is to adjust the actual cost of
launching the brand by inflation every year.
This inflation adjusted launch cost would be the brand’s value. (Reilly and Schweihs, 1999).
Replacement
Cost Based on Launching a New Brand
This is one of the most difficult
valuation bases to calculate. Aaker (1991) proposes that the cost of launching a new
brand is divided by its probability of success.
The advantage of this approach is that it is easy to calculate. One problem with this approach is that it
neglects to take into account the success of established brands. A brand may be worth a $100 million. However the cost of launching a brand may be
$5 million with a 10% success rate and it therefore has a value of $50 million.
A company in this situation is in a very
weak strategic position if a competitor would enter this market. This approach also does not take the benefit
of first entry into account. The first
brand in the category has a natural advantage over other brands as they do not
have to overcome the clutter. With each
new attempt the probability of success diminishes.
Using
Conversion Models
A possible alternative approach to
replacement cost would be to estimate the amount of awareness that needs to be
generated in order to achieve the current level of sales. This approach would be based on conversion
models, i.e., taking the level of awareness, that induces trial,
that induces regular repurchase (Aaker,
1991). The output may be used for two purposes:
one is to determine the cost of acquiring new customers and the other would be
the replacement cost of brand equity.
From
this an estimate for the value of existing awareness can be made. This can be done if an estimate of the rate
that the awareness decreases is taken and one values the additional margin from
the brand at each interval is valued.
The sum of the profit will equal the value of the existing
awareness. An assumption needs to be
made that no new investment in marketing will take place, and an estimate of
the useful life of the current awareness needs to be made.
A
major shortcoming of this approach is that the differential in the purchase
patterns of a generic and a branded product is needed. Another problem is that the conversion ratio
between awareness and purchase is higher for an unbranded generic than the
branded product. This may indicate that
awareness is not a key driver of sales and that the marketing mix is incorrect.
Although
customers may be aware of a product this does not mean that they understand
what the brand stands for. In the Young
& Rubicam Brand Asset Valuator (Aaker, 1991) a distinction is made between vitality, a
factor of differentiation and relevance, and stature, based on esteem and
knowledge. One needs to be strong on all
four aspects in order to have a strong brand.
Awareness is only one of many factors.
Brand
Based on Customer Preference
Aaker (1991)
proposed that the value of the brand can be calculated by observing the
increase in awareness and comparing it to the corresponding increase in the
market share. Aaker
(1991) identified the problem as being how much of the increased market share
is attributable to the brand’s awareness increase and how much to other
factors. A further issue is that one
would not expect a linear function between awareness and market share.
Market-based
Approaches
Comparable
Approach
This approach takes the premium (or
some other measure) that has been paid for similar brands and applies this to
brands that the company owns, e.g., a company pays two times sales for a
similar brand. This multiple is then
applied to brands that the company owns (Reilly and Schweihs,
1999).
The advantage of this approach is
that it is based on what third parties are actually willing to pay and it is
easy to calculate. The shortcomings are
that there is a lack of detailed information on the purchase price of brands
and that two brands are seldom alike.
Brand
Equity based on Equity Evaluation
Simon and Sullivan (1993) presented a
paper on using the financial market value to estimate the value of brand
equity. This approach has numerous
advantages in that it recognizes that it is based on empirical evidence. The shortcomings are that it assumes a very
strong state of the efficient market hypothesis (EMH), and that all information
is included in the share price. It is
well documented that this is not the case (Bodie,
Kane and Marcus, 1999). Depending on the
stock market, it is merely a debate on the level of efficiency.
The approach
works as follows:
1.
The value of the intangibles are calculated by
subtracting the replacement cost of the tangible assets from the market value
(market capitalization plus the market value of debt and other securities) of the
firm.
2.
The value of the intangible assets are broken
down into three components, namely brand equity, value of non brand factors
that reduce the firm costs such as R&D and patents, and finally industry
wide factors that permit super normal profits (eg
regulations).
3.
The brand equity component is further broken
down into two components, namely a demand-enhancing component and a component
that caters for diminished marketing spend due to the brand being established.
4.
The demand-enhancing component is calculated
using increased market share. Market
share is broken down into two components, one for the brand and the other for
non-brand factors. The non-brand market
share is the factor of company’s share of patents and research and development
(R&D) share. The market share
attributable to the brand is a function of the order of entry and the relative
advertising share.
5.
The reduced marketing costs are a factor of
order of market entry and the brand’s advertising expenditure relative to that
of its competitors.
The
Use of Real Options in Brand Valuation
The use of real options has been proposed
for the valuation of brand assets (Damodaran,
1996). In order to value an option the
following variables need to be calculated: the risk free interest rate; the
implied volatility (variance) of the underlying asset; the current exercise
price; the value of the underlying asset; and the time to expiration of the
option. The value of the brand is the
value of the underlying asset, and the cost of developing the brand is the
exercise price.
This method may be useful in calculating
the potential value of line extensions.
However the assumptions inherent in this approach make any practical
application very difficult.
The
Residual Method
Keller (1998) has proposed that the
residual value, when the market capitalization is subtracted from the net asset
value, is equal to the value of the “intangibles” one of which is the
brand. Furthermore this is the upper
limit that certain procedures will value a brand at (e.g., Interbrand). There are two assumptions inherent in this
approach. The first is that the market
is efficient in the strong state (ie that ALL
information is included into the share price) and the second, is that the
assets are being used to their full potential.
It is widely recognized that market
efficiency is a myth and the only debate that rages on now is the degree of
inefficiency. Shares often trade at
below their net asset value. Shares of
companies who trade at below their net asset value (NAV) by implication have a negative brand equity.
If the brand had been capitalised into the
balance sheet, a worthless balance sheet would have been produced.
Economic-use
approaches
Royalty
Relief Method
The Royalty Relief method is the most
popular in practice. It is premised on
the royalty that a company would have to pay for the use of the trademark if
they had to license it (Aaker 1991). The methodology is as follows:
1. Determine the underlining base for the
calculation (percentage of turnover, net sales or another base, or number of
units)
2.
Determine the appropriate royalty rate
3.
Determine a growth rate, expected life and
discount rate for the brand
This
appears to be very easy. However the
real skill is determining what the appropriate royalty rate is. Two rules of thumb have emerged, the “25%
rule” and the “5% rule”. The “25% rule” proposes that the royalty should be 25%
of the net profit. The “5% rule”
proposes that the royalty should be 5% of turnover. Both these “rules” have their base in the
pharmaceutical industry.
Professional
valuers spend a considerable amount of time and
effort determining the appropriate royalty rate. They rely on databases that publish
international royalty rates for the specific industry and the product. This investigation will provide a range of
appropriate royalty rates. The final
royalty rate is decided upon after looking at the qualitative aspects around
the brand, such as the strength of the brand team and management as well as many
other factors.
The
advantages of this approach are that the valuation is industry specific and has
been accepted by many tax authorities as an acceptable model. The disadvantage of this approach is that
very few brands are truly comparable and usually the royalty rate encompasses
more than just the brand. Licenses are
normally for a limited time period and cover some sort of technical know-how payments (Barwise, et al. 1989).
Price
Premium
The premise of the price premium approach
is that a branded product should sell for a premium over a generic product (Aaker, 1991). The
value of the brand is therefore the discounted future sales premium. The major advantage of this approach is that
it is transparent and easy to understand.
The relationship between brand equity and price is easily
explained. The disadvantages are where a
branded product does not command a price premium, the
benefit arises on the cost and market share dimensions.
Conjoint
Analysis
Conjoint analysis is very similar to the
premium price model. It is possible to determine the market share for a given
product at a given price level (Aaker, 1996a).
Conjoint analysis asks respondents to make trade off judgments about product
attributes. In order to determine the
brand value, an analysis would be commissioned of the purchase behaviour of a sample of customers. The brand value would be calculated as the
discounted future revenue potential.
Apart from the problems that the premium
price normally suffers from, as one begins to alter price levels the perceived
value of the brand may diminish. By
means of an example, conjoint analysis might indicate that the manner to
maximize sales is to drop the price as the volume gain would more than offset
the discount price, however once this has been achieved the positioning of the
brand may be compromised which could result in an element of brand
switching. If the brand premium changes
on a regular basis, confusion may be created in customers’ minds, as the
positioning of the brand changes.
Brand
equity based on differences in Return on Investment, Return on Assets and Economic
Value Added
There
are three approaches that fall into this category. They are models based on differences between
return on investment, return on assets or economic value added. These models are based on the premise that
branded products deliver superior returns, therefore if we value the “excess”
returns into the future we would derive a value for the brand (Aaker, 1991).
The main shortcoming of
these approaches are that they do not make the distinction between
brands and other intangible assets that give rise to the superior
performance. As these are also
accounting based models, one has to ensure that all the amounts are treated and
classified in a similar manner in order to ensure that the comparison is
meaningful. Another shortcoming is the
difficulty of finding a company that is in the same industry that has a similar
asset base or capital structure. A
further criticism is that these returns are not risk adjusted, i.e., the
variability of earnings in the two companies could be quite different. The only place that one can make adjustment
for this is in the discount rate (the discount rate affects the implied
multiplier). The advantages of this
model are that it is easy to explain, the information is readily available, and
the calculation is easy to do.
The
Use of Price to Sales Ratios
Increasingly
investors are beginning to use the price to sales multiple (in conjunction with
the price earnings and the price to book ratio) in order to evaluate investment
decisions (Damodaran, 1996). The value of the brand
name is the difference between the price to sales
ratio of a branded firm to that of a generic firm.
The advantages of this approach are that
the information is readily available and it is easy to conceptualize. The drawbacks are that few firms are truly
comparable and it makes no distinction between the brand and other intangible
assets such as good customer relationships.
Brand
Value based on Future Earnings
In this approach the valuer
attempts to determine the earnings that arise from the brand. They would attempt to forecast the brand
profit and discount it back at an appropriate discount rate (Reilly and Schweihs, 1999).
At the end of the forecast period, if it has been determined that the
brand’s useful life will exceed the period of the forecast, a perpetuity value
will be calculated. The main drawback is
trying to determine what part of the profits are
attributable to brand equity and not other intangible factors. It also fails to take any balance sheet
implications into consideration such as increased working capital.
Brand
Equity based on Discounted Cash Flow
This method suffers from the same
problems that are faced when trying to determine the cash flows (profit)
attributable to the brand. From a pure
finance perspective it is better to use Free Cash Flows as this is not affected
by accounting anomalies; cash flow is ultimately the key variable in
determining the value of any asset (Reilly and Schweihs,
1999). Furthermore Discounted Cash Flow
do not adequately consider assets that do not produce cash flows currently (an
option pricing approach will need to be followed) (Damodaran,
1996). The advantage of this model is
that it takes increased working capital and fixed asset investments into
account.
Formulary
Approaches
Interbrand
Approach
The Interbrand
approach is a variation on the Brand Earnings approach. Interbrand
determines the earnings from the brand and capitalizes them after making
suitable adjustments (Keller, 1998).
Interbrand takes the
forecast profit and deducts a capital charge in order to determine the economic
profit (EVA). Interbrand
then attempts to determine the brand’s earnings by using the “brand
index”. The “brand index” is based on
seven factors. The factors as well as
their weights are:
1.
Market (10%) – Whether the market is stable,
growing and has strong barriers to entry
2.
Stability (15%) – Brands that have been
established for a long time that constantly command customer loyalty
3.
Leadership (25%) – A brand that leads the sector
that it competes in
4.
Trend (10%) – Gives an indication where the
brand is moving
5.
Support (10%) – The support that the brand has
received
6.
Internationalization/Geography (25%) – The
strength of the brand in the international arena
7.
Protection (5%) – The ability of the company to
protect the brand
The advantages
of this approach is that it is widely accepted and it takes all aspects of
branding into account; by using the economic profit figure all additional costs
and all marketing spend have been accounted for. The major shortcoming is that it compares
“apples with oranges”. The international
component should not be applied over the local brand earnings. If a company wants to bring the international
aspect into play it must include potential international profits. Here two valuation bases are muddled. On the one hand there is an “in use” basis
and on the other hand, there is an “open market” valuation.
The
appropriate discount rate is very difficult to determine as parts of the risks
usually included in the discount rate have been factored into the Brand Index
score. Even the appropriate rate for the
capital charge is difficult to ascertain.
Aaker (1996a pg 314) reveals that “ … the Interbrand
system does not consider the potential of the brand to support extensions into
other product classes. Brand support may
be ineffective; spending money on advertising does not necessarily indicate
effective brand building. Trademark
protection, although necessary, does not of itself create brand value.”
Financial
World Method
The Financial World magazine
method utilizes the Interbrand Brand Strength
multiplier or “brand index”, comprising the same seven factors and
weightings. The premium profit attributable
to the brand is calculated differently, however; this premium is determined by
estimating the operating profit attributable to a brand, and then deducting
from this the earnings of a comparable unbranded product. This latter value could be determined, for
example, by assuming that a generic version of the product would generate a 5%
net return on capital employed (Keller, 1998). The resulting premium profit is
adjusted for taxes, and multiplied by the brand strength multiplier.
Brand
Equity Ten
Aaker’s “Brand Equity Ten” utilizes five categories of
measures to assess brand equity (Aaker, 1996a):
§
Loyalty Measures
1.
Price premium
2.
Customer satisfaction or loyalty
§
Perceived Quality or Leadership Measures
3.
Perceived quality
4.
Leadership or popularity
§
Other customer-oriented associations or
differentiation measures
5.
Perceived
value
6.
Brand personality
7.
Organizational associations
§
Awareness measures
8.
Brand awareness
§
Market behavior measures
9.
Market share
10. Market price
and distribution coverage
These
measures represent the customer loyalty dimension of brand equity. They can be utilized to develop a brand
equity measurement instrument, depending on the type of product or market, and
the purpose of the instrument.
Brand
Finance Method
Another
commercial approach to brand valuation has been developed by Brand Finance
Limited, a UK consulting
organization. This method comprises four
elements (David Haigh in Jones, 1999):
-
Total market modeling : to identify the position
of the brand in the context of a competitive marketplace
-
Specific branded business forecasting : to
identify total business earnings from the brand
-
Business drivers research: to determine the
added value of total earnings attributed specifically to the brand
-
Brand risk review: to assess the earnings or
“Beta” risk factor associated with the earnings
Brand
valuation is determined by assessing the brand added value after tax, and
discounting this at a rate that reflects the risk profile of the brand.
Discount
Rate, Growth Rate and Useful Life
The
discount rate, growth rate and the useful life of the brand are often the most
neglected issues in brand valuation, yet they play an important role in the eventual valuation of the
brand. Managers need to ask brand valuers pertinent questions regarding the assumptions made
in determining these key variables. Most
approaches make use of the discount rate and the growth rate in order to
determine an appropriate multiplier that needs to be applied to the estimated annual
value of brand earnings.
The
perpetuity formula that is the basis for all these calculations is stated as:
Implied Multiplier = (1+ growth rate)/(Discount rate – growth rate)
The
discount rate is one of the most difficult variables to determine. In most Discounted Cash Flow analysis (DCF)
the discount rate used is the firm’s weighted average cost of capital (WACC) (Breally and Meyers, 1996).
This is shown as:
WACC = After tax
cost of debt x target debt to total assets ratio + cost of equity x target
equity to total assets ratio
Using
a firm specific WACC raises certain issues.
The first issue is that WACC is a factor of the firm’s gearing
ratio. It therefore seems illogical that
an asset’s value can change based on the leverage of the firm. It would be far more appropriate if the WACC
represented the gearing that a financial institution would extend to this firm
or the standard industry wide gearing ratio.
The
second issue is how does a firm determine the correct
cost of equity. The most commonly used
method is the Capital Asset Pricing Model (CAPM). This model determines the risk of the company
relative to the market by regressing the share price movements against the
market movements (Damodaran, 1996).
The problems with CAPM are well documented (Bodie,
Kane and Marcus, 1999).
These
problems include the appropriate rate for a non listed company. Proxy beta’s can be used, but assumptions
need to be made with regard to the capital structure and operating similarities
of different firms.
The
last issue is whether using a firm specific WACC in the first place is the
correct measure. One of the major
benefits of branding is that the earnings are less volatile. By using the firm’s WACC one may be undervaluing
the brand. Less volatile earnings result
in a lower Beta and consequently a lower cost of equity.
This
is a classic case of double counting.
Some alternatives to using a firm specific WACC include an industry
WACC; using a debt: equity ratio based on what a financial institution would
extend to the company in order to purchase this asset; and determining the
discount rate from economic principles.
The
growth rate is another area where there is considerable debate. According to Damodaran (1996) there are a number of measures used to
determine the growth rate. These include historical trends; forecast growth; an
estimate of future real growth in the economy; and the inflation rate plus a
real growth adjustment. Numerous factors
should be considered when determining the appropriate growth rate. These factors include the industry size and
prospects as well as the company's ability to satisfy the market demands in
terms of the growth rate (Damodaran, 1996).
Determining
the useful life of a brand is another area that requires a considerable amount
of thought. Many of the world’s leading brands have been around for over 50
years. Most brand managers hold the
belief that their brands will have a similar life. However manager’s need to be realistic and
consider a brand in terms of its lifecycle and what plans are being made to
keep their brand contemporary.
Managerial
Issues
There
are a number of issues that need to be discussed when considering the
approaches managers want to use to value their brands.
The
first is the portfolio effect. Some
companies have developed a portfolio of brands for strategic reasons. The value of the brands
individually do not equal the value of the brands as a whole. A method of valuing a portfolio of brands
would be to value the brand in its current use as well as add on the effect of
that brand not entering into the single brand optimum space.
Secondly,
umbrella brands or co-brands infer benefits due to the associations with the
company (Aaker, 1996a). The difficulty here is to determine how much
of the benefits are due to the product’s brand name and how much is due to the
umbrella or corporate brand.
Thirdly,
media inflation plays a role. It makes
it more difficult for companies to recreate the brand, and the cost of
maintaining the brand increases. Some
strength of a brand is related to awareness levels, due partly at least to the
media inflation. A generic competitor
does not have this pressure on their costs.
Fourthly,
when a competitor enters the market, a decline in market share could
result. In most models, this would be
seen as a reduction in brand equity.
However, it can be argued that the customers that remain loyal are now
worth more, resulting in an increase in brand equity.
Fifthly,
Aaker (1991) goes into detail about the effect of
sales promotions on brand equity and the temptation to milk the brand. Most of the models use current sales. Mathematically the temptation is to raise
brand equity by discounting the brand and thereby raising revenue. However, there is a possibility that this
could destroy brand equity.
Sixthly,
approaches that rely on marketing research need to ensure that the methodology
used in the research conform to the scientific standards. Inappropriate sample sizes, bias, and other
errors could occur, thus influencing the calculations.
Lastly,
there are a number of practical issues that need to be considered with respect
to brand valuation. These include the legal, accounting and tax implications.
While these factors differ from country to country, managers must understand
that no brand valuation will be complete without dealing with these
requirements in their country.
Conclusion
and Implications
It
is relatively easy to manipulate the results of measuring brand equity in order
to deliver any value that management wishes.
The only way to prevent this abuse is to understand the objective of the
valuation and to use the appropriate assumptions in order to derive a fair
value.
No
single approach will give all the answers to a correct valuation. The starting point is to understand the
purpose of the valuation and what benefits the brand delivers. Due to a lack of transparency of the workings
and the underlying assumptions, some managers are not prepared to accept brand
equity valuations. Provided that
information on the assumptions are made available to
managers, they can make their own judgements on what
the correct value should be. “Valuation
is neither the science that some of its proponents make
it out to be nor the objective search for true value that idealists would like it
to become. The models that we use in
valuation may be quantitative, but there is a great reliance on subjective
inputs and judgements. “Thus the final value that we
obtain from these models is coloured by the bias that
we bring into the process”
(Damodaran 1996, p2).
When
management is embarking on an exercise to value their organization’s brands, it
is recommended that they do the following:
Management
must firstly understand the nature of their firm’s intangible assets. If one of the organization’s intangible
assets is marketing related, they must determine on what attribute the brand
derives its benefit. The purpose of the
valuation must then be determined. A
method must then be chosen that meets management’s needs in terms of the
attribute it measures, the information requirements and the model’s
shortcomings. Management must also
ensure that an appropriate discount rate, growth rate and useful life are
used. They must ensure that the model
used is robust enough to deal with the peculiarities of the organisation. A key issue is to check and question the
underlying assumptions.
Lastly,
management should ensure that the mathematical calculations have been done
correctly.
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About
the Authors
Geoffrey
Bick is a Senior lecturer in Marketing at the Graduate School of Business
Administration, University of the Witwatersrand, Johannesburg. He has a MBA
from the University of California at Berkley. He has extensive experience as a marketing
practitioner in the industrial and office automation fields. His interests are in Business-to-Business
marketing, the impact of technology on marketing, and Branding.
Russell
Abratt is a Professor of Marketing at the H. Wayne Huizenga School of Business
and Entrepreneurship, Nova Southeastern University. He holds an
MBA and Ph.D from the University of Pretoria, South
Africa. He has published in Business
Horizons, the European Journal of Marketing, Industrial Marketing Management,
Journal of Business Ethics, Journal of Marketing Management, Journal of
Advertising Research and the International Journal of Advertising, among
others. His interests are in marketing
strategy and marketing communications
