The concept of Brand Valuation emerged in late 1970’s when commercial establishments were looking at low profile but sound, business houses for acquisition. At the time of negotiation the balance sheet of such target companies needed to be spruced up by the intangible but yet very much real worth of the brands marketed by these businesses.
Brands are seen as strategic assets whose value is strongly correlated to companies’ value. The relevance of brand valuation goes from marketing portfolio optimization and strategic positioning, M&A pricing, to the day-to-day business for royalty rates definition. The difficulty in brand valuation starts from the definition of brand.
APPROACHES TO BRANDING:
A. Company Name: The Company’s name in itself is a Brand that is promoted and nurtured over a period. Example: Reliance, Britannia, Godrej etc. which are the company’s name themselves.
B. Product Branding: An identified product or service is branded and promoted. Each product has a separate Brand name. Example: Lux, Rin, Pepsodent from HUL etc.
C. Others: There are other variants / approaches to branding such as Derived Brands i.e. branding the products by promoting supplier’s component, Attitude Brands i.e. branding a feeling or experience, more than a product etc.
A. Increased Sales in Competitive Environment: Brand gives tremendous competitive advantage to entities. More often, it is the brand that sells the product, rather than the product selling itself.
B. Ease of Identification: Brand achieves a significant value in commercial operation through the tangible and intangible elements. Brand name distinguishes the entity’s product from that of its rivals, helping customers to identify it while going in for it.
C. Brand Loyalty: Brands make a lasting impact on the consumers and it is almost impossible to change his preference even if cheaper and alternative products are available in the market.
D. Takeover Scenarios: Brands have major influence on takeover decisions as the premium paid on takeover is almost always in respect of the strong brand portfolio of the acquired company and of its long term effect on the profits of the acquiring company in the post-acquisition period.
A. Unique Corporate Identity: Brands assist in creating and manufacturing an unique identity for a company in the market place. This is done by brand popularity and the eventual customer loyalty attached to the brands.
B. TQM: By building brand image, it is possible for a body corporate to adopt and practice Total Quality Management. Brands help in building a lasting relationship between the brand owner and the brand user.
C. Customer Preference: Brand extends as a solution to choices and preferences of a customer, as they associate themselves with a brand only if it meets their requirement. Branding gives the customers the status of fulfillment.
D. Market Segmentation: Markets should be classified into different segments based on homogeneous patterns and strategic areas should be identified to effectively target, reach out to the customers and to meet competition. This is facilitated through building strong brands and with well defined brand values.
E. Strong Market: By building strong brands, firms can enlarge and strengthen their market base and also confidently foray new products lines. This would also facilitate programmes, designed to achieve maximum market share.
**Brand Value = Market Leadership + Relative Stability + Market Share + International Acceptance + Marketing Trends + Strategic Support +Competitive Strength + Brand Protection
1. Cost Based Approach
2. Market Based Approach
3. Income Based Approach
1. Cost Based Approach: The brand is valued according to the cost of developing it. This is an analysis of the past and relies on hard facts. Overall, the cost approach is more appropriate to value those assets that can be easily replaceable, such as software or customer databases. The Cost-based approach includes the following different methods:
A. Accumulated Cost or Historical Cost Method: Historical cost method value the brand as the sum of all costs incurred in bringing the brand to its current state. The biggest drawback in the method is difficulty in identifying the cost involved and separating them from marketing expenditure which was responsible for brand building.
** Value of Brand = Brand Development Cost + Brand Marketing & Distribution Cost + Other Related Costs
B. Cost to Recreate Method: The Cost to Recreate Method uses current prices in order to estimate the cost of recreating the brand today. As the Historical Cost of Creation Method, the Cost to Recreate Method is optimal to obtain a minimum value and when dealing with a newly created brand. This method tries to overcome the difficulties arising from the historical cost by focusing on the present instead of on the past. However, the main issue is that some brands cannot be realistically recreated because they might have been created in a period when advertising expenditure was negligible and when brands were nurtured over time by word-of-mouth, which is not possible today anymore. It could also be difficult to define the cost of recreation of the brand because it is not easy to delineate the performance of brand leaders. The value obtained with this method will include the same pitfalls and obsolescence as the company's intangible assets. The final issue is that the cost to recreate method is still not a good indicator for the future.
C. Replacement Cost Method: This approach values a brand using an estimated cost of creating a similar but new brand. Here the biggest difficulty is in estimating costs. Assumptions required for estimation are often questionable and arbitrary.
D. Capitalization of Brand – Attributable Expenses Method: The Capitalization of Brand-Attributable Expenses Method defines the brand value as the business value attributable to the brand, which depends on the proportion of accumulated advertising expense over the total marketing expenses incurred, including other selling and distribution costs.
E. Residual Method: The Residual Value Method states that the value of the brand is the discounted residual value obtained subtracting the cumulative brand costs from the cumulative revenues attributable to the brand.
2. Market Based Approach: Market based approach, basically deals with the amount at which a brand is sold and is related to highest value that a “willing buyer & seller” are prepared to pay for an asset. This approach is most commonly used when one wishes to sell the brand and consists of methods herein stated:
A. Comparable Approach or the Brand Sale Comparison Method: This method involves valuation of the brand by looking at recent transactions involving similar brands in the same industry and referring to comparable multiples. In other words, this method takes the premium (or some other measure) that has been paid for similar brands and applies this to brands that the company owns. The advantage of this approach is that it looks at a third party perspective that is, what the third party is willing to pay and is easy to calculate but the flaw in this method is that the data for comparable brands is rare and the price paid for a similar brand includes the synergies and the specific objectives of the buyer and it may not be applicable to the value of the brand at issue.
B. Brand Equity based on Equity Evaluation method: Simon and Sullivan (1993) believe that brand equity can be divided into two parts:
• The "demand-enhancing" component, which includes advertising and results in price premium profits,
• The cost advantage component, which is obtained due to the brand during new product introductions and through economies of scale in distribution.
Hence, they basically estimated the value of brand equity using the financial market value and the advantage of this approach is that it is based on empirical evidence but shortfalls of this approach is that it assumes a very strong state of efficient market hypothesis and that all information is included in the share price.
C. Residual Method: Keller has proposed the valuation of the brand by means of residual value which would be when the market capitalization is subtracted from the net asset value. It would be the value of the "intangibles" one of which is the brand.
Another alternative approach that is suggested is that of usage of real options as proposed by Damodaran (1996). The variables that need to be calculated are: risk free interest rate, implied volatility (variance) of the underlying asset, the current exercise price, the value of the underlying asset and the time of expiration of the option. This method is useful in calculating the potential value of line extensions but the inherent assumptions in this approach make any practical application difficult.
3. Income Based Approach: The Income-based Approach is the most popular among financial analysts and it comprehends many different methods.
A. 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. The methodology that needs to be followed here is that the valuer must firstly determine the underlining base for the calculation (percentage of turnover, net sales or another base, or number of units), determine the appropriate royalty rate and determine a growth rate, expected life and discount rate for the brand. Valuers usually rely on databases that publish international royalty rates for the specific industry and the product. This investigation results in a variety and range of appropriate royalty rates and the final royalty rate is decided after looking at the qualitative aspects around the brand, like strength of the brand team and management. This method has an edge of being industry specific and accepted by tax authorities but this method loses out as there are really few brands that are truly comparable and usually the royalty rate encompasses more than just the brand.
B. Price Premium Method: The premise of the price premium approach is that a branded product should sell for a premium over a generic product. The Price Premium Method calculates the brand value by multiplying the price differential of the branded product with respect to a generic product by the total volume of branded sales. It assumes that the brand generates an additional benefit for consumers, for which they are willing to pay a little extra. The fault in this method is that where a branded product does not command a price premium, the benefit arises on the cost and market share dimensions.
C. Brand Equity based on discounted cash flow: The problem faced by this method is the same as 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.
D. Brand Equity based on differences in return on investment, return on assets and 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). This method is easy to apply and the information is readily available, but there is no separation between brand and other intangible assets and does not adjust, by their volatility, the earnings of the two companies compared, including discount rate.
Other methods also include conjoint analysis, income split method, brand value based on future earnings, competitive equilibrium analysis model, etc. The very fact that there are so many methods worth discussing under the income or economic approach show how accurate and sought after this approach is.