Thoughts about brand valuation

Those transactions point to the impressive equity that brands can build. But they also raise the question of how those brand values were arrived at by the bidders. How does one measure the value of a brand? How do you know if you are getting a good deal or a bad one?

There are many answers to those questions but none that is fully satisfactory.

A brand is an intangible asset, so intangible that many branding practitioners do not even agree as to what a brand is. Some see it as a name and a logo. Others will say that those are just the symbols of what the brand stands for and that what the brand stands for really is the brand. We prefer the latter interpretation, i.e., the brand is a covenant with the consumer, a promise that the brand and the products it names will conform to the expectations that have been created over time. A brand exists only because of its commitment to its internal values. Without that commitment, it is nothing but a glorified product name.

How do you put a dollar amount on values and commitment? You can't! For that reason, determining the value of a brand is usually a combination of direct and indirect processes. A direct measurement process is one that arrives at a price based on the communication investment made behind the brand. An indirect measurement will value the brand based on what it can add to the bottom line. (I am leaving aside market valuation because offering a brand for sale isn't a very practical way to measure its worth.)

The simplest direct measurement is to add all the brand's communication investments, adjusted for inflation. An additional adjustment is sometimes made to account for and reward the risk taken by past managers when they opted to invest in the brand rather than use the money to buy treasury notes. This adjustment is called the discount rate and it is used to compute the Net Present Value of the successive investments, i.e., what they are worth today. The method is simplistic and overvalues the brands but it is used by brand buyers for that very reason. It also penalizes brands that do not advertise heavily (like Rolls-Royce).

Other more interesting but less frequently seen direct measurements are the Awareness Valuation and Franchise Valuation methods. Product managers, when projecting the volume for a new product, routinely use equations that convert a given advertising budget into its resulting awareness (aided awareness, please!), awareness into trial, and trial into its resulting consumer franchise and consumption volume. Valuation just takes the same path but reverses its direction. For example, a brand or product that is used by 3% of its target population was probably tried by 9% of them. It has an awareness of 57%, the result of a communication investment of 850 GRPs. Assuming a cost per point of $12,500, the investment can be valued at $10.6m. (It is actually a more complicated process but I just want you to get the idea.) The advantage of the method is that it is easy to use and requires less research than the one previously presented. It also reflects the current cost of re-creating the brand today independently of the way it was actually created. The problem is that it is more difficult to explain. It also results in more conservative estimations of brand values than other methods: this can be a problem when those who are in the market to acquire a brand seek valuation methods that justify bidding a higher price to win the deal.

Indirect valuation methods are those which financial analysts favor in spite of their gaping flaws. One, referred to as the "Excess-Earnings Method," tries to assess the increase in profit (or cash flow) attributable to the brand. Then it projects these cash flows over the useful life of the brand (usually limited to 10 years) and does a "Discounted Cash Flow" analysis, where each year's projected cash flow is discounted according to the assumed risk of the investment and how far away it will materialize. The sum of these cash flows plus the residual value of the brand at the end of the analysis gives the brand value at the time of the analysis. The major difficulty with this analysis resides in estimating the incremental effect of the brand on sales or profits. I recall the "Logo/No-logo" taste tests conducted by the NutraSweet Company where two cans of diet soft drinks were shown, one bearing the NutraSweet logo, one without it. Respondents were served two glasses, theoretically one from each can but in reality both from the same can, and asked which they preferred. In the early 80's, after the bans on cyclamate and saccharin, the can with the NutraSweet logo was clearly preferred. But in 1990, after NutraSweet had invested many dollars in communication, the consumer preference was virtually undetectable! As sophisticated as it may have been, that test wasn't measuring a branding effect. It was measuring the residual consumer scare which followed the banishment of artificial sweeteners. As consumer memory faded, the "preference" for the NutraSweet brand disappeared! The validity of that "brand equity" measurement disappeared with it.

The last method used by financial analysts to value a brand, and possibly their favorite, is called the "Relief-from-Royalty" method. It is based on the concept that, if the company did not have the use of its brand name, it would need to license that right in exchange for a royalty fee. These royalty fees are usually based on a percentage of sales (not profits). The valuation consists of first estimating the fee as a percentage of sales and then projecting that fee over the useful life of the brand. One then computes the "Net Present Value" of the sum of those fees over the expected life of the brand. Do not forget to adjust the discount rate down to account for the lower risk: getting paid based on a percent of sales is much more secure than remuneration based on profit (or cash flow).

Because all those financial valuation methods are but educated guesses, we cannot rely on any one. We regularly use as many of those methods as we can. Then we do our own guess.

But whatever its paper value may be, a brand isn't worth anything without a strategy and an organization to support it. Think about it: you may buy a brand logo, a name with consumer awareness... but logo and awareness alone do not constitute a brand. A brand is a covenant with the consumer. It was created by displaying a set of brand values, consistently, over a period of time. There are two ways to arrive at the required consistency. One is to have an enlightened dictator at the helm. Many brands, from Revlon to McDonald's, were built by dictators. The problem with brand dictatorships, aside from being very unpleasant to work in, is that a) autocratic leaders are generally not for sale along with their brands, and b) they do not see the need for developing a brand strategy. As a result, the brand seldom survives the disappearance of the dictator, or a change of ownership.

The other and better road to achieving the required consistency is to enshrine the brand values in a brand strategy and to nurture an organization to service it. Without that, think twice about buying the brand, whatever good value the finance folks say it may have.

By Jacques Chevron


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