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BRANDS DON’T HAVE FINANCIAL VALUE

Brands create both economic and financial value. They are specific assets which generate a security of income for any business.

In 1988, a little-known but highly successful Australian foods business, Goldman Fettes Wattie (GFW) launched an audacious bid for one of the UK’s best-known companies, Rank Hovis McDougall (RHM), owner of much-loved brands such as Hovis bread and McDougall flour.

That bid would start a series of events which would eventually lead to the now long-established practice of brand valuation; the assignment of a specific financial value to any trademark owned by a company. It would mean that, technically and legally, brands – separate from whichever goods or services they endorsed – had financial value.

For the first time, people could prove that brands really did make their owners money. Up to then, brands were not widely regarded as financial assets. Brands and marketing more generally were regarded as costs. And costs whose returns were difficult to prove.

‘I know 50 per cent of my money on advertising is wasted,’ said Lord Leverhulme (of the original Lever Brothers which eventually merged into Unilever). ‘I just don’t know which 50 per cent.’

Businesses were valuable, brands weren’t. People bought products and products were made in factories. Real tangible things were valuable and so were the real tangible buildings, raw materials, machines and production lines that made them.

Brands were important, of course. You needed to stick a name on your product or else what were consumers going to call it? And you had to advertise it or else how would people find out about it? And it had to be packaged or else how would people see it on a shelf and carry it home? But these were necessary costs of business. They weren’t what people were buying. They weren’t the value people sought and for which they were prepared to pay a premium.

The limits of league tables

In fact, the myth that brands have no financial or economic value persists today. Despite the fact that the major accountancy boards of the world approve the valuation of brands, despite the fact that the value of brands appears on the balance sheets of major companies, there are still people who think you can’t value a brand because a brand is not what people are buying.

A columnist started a recent debate in a UK marketing magazine, claiming brand valuation was ‘bullshit’ and ‘spin’. He based his judgement on the numerous brand valuation league tables that are publicly produced by consultancies as publicity exercises to promote their brand valuation services. These league tables often provide varying valuations for the same brands. And in one notorious case a public valuation of the Nokia brand at $4bn seemed to be undermined when Microsoft, who had bought it for $7bn, actually sold it for just $350m.

The columnist had a point.

But rejecting brand valuation because consultancies might inflate values in a PR exercise would be like rejecting house valuations because estate agencies might occasionally inflate their values in their shop windows. Houses are sold sometimes for more and sometimes for less than the publicly stated valuation. That is how all valuations work. But that does not mean that privately those houses don’t have value and can’t be valued.

Brands create financial and economic value

Brands create value for their owners. Even the columnist agreed with that. And brands are specific assets – they are intellectual property, properly and securely protected by trademark law. And so like any other asset they can and should be valued. We just don’t need to accept the valuation we are given if we are in negotiation to buy them.

But brands aren’t just worth a specific financial valuation at a moment in time. Brands have economic value, not just financial value.

There are a few different definitions of economic value. Broadly, one definition is that economic value is the maximum price someone is prepared to pay for something (as opposed to market or financial value, which is the minimum price they might pay). The other definition – much more interesting – is the potential for wealth generation that they bring.

Simply put, financial value means that something can be turned into money. Your house has financial value because someone will pay you something for it. Economic value means something has the ability to generate wealth for you and for others. And that can be harder to quantify but it’s still worth trying so to do.

Your house can generate economic value in a number of ways: it requires heating and lighting, decorating and running repairs, so it creates an economy (of plumbers, electricians, painters, plasterers to support it as well as causing you to pay bills to power companies, water companies, the local government etc). It houses people who need to sleep and eat, dress and entertain themselves – so there are beds, fridges, ovens, wardrobes to be bought and filled with food, clothes, books, toys etc. And a house provides a stable home in which people are raised to be good citizens and that means they have a positive impact on the economy.

In other words, financial value is what you are paid when you sell the house; economic value is what you create by what you (or someone else) could do with the house.

And the financial value of the house increases with the economic value of the house. That extension which generated work for the architect, builder, plumber and decorator also puts extra money on the value of the property.

Brands create economic value because of what their owners do with their brands. How they invest in them, how they extend them, how they update them and keep them relevant and fit-for-purpose for their consumers.

Which takes us back to the RHM story.

How brand valuation started

RHM’s decision to formally value its brands and place that valuation at the centre of its strategy to defend itself against GFW’s hostile bid was forced on it by circumstance and necessity. But the idea of valuing its brands was the audacious brainchild of John Murphy, who was the founder of a small branding consultancy called Interbrand. In his book Brandfather, John explains how in 1988 he was on a business trip in Australia when he saw the news story in the country’s press about the GFW bid. The idea of an Australian firm buying out a British one had great appeal down under. But John knew intuitively that the appeal of RHM to GFW was not the sense of corporate chest-beating that buying a big British company would allow, nor even the size of the combined companies it would create. The appeal to GFW was RHM’s brands. He knew that what GFW valued about RHM was the value of well-established brands that would give GFW instant and enduring returns on an investment through acquisition.

He had got to the heart of matter: brands were assets that created economic and financial value. They were not just costs of business. The reason for their value was and remains quite simple.

Brands represent a security of future income.

That security is not dependent on any one product. Or any one market. In fact, the product or service can completely change. It can even change from being a product to a service. But as long as the values that customers or consumers appreciate about the brand remain, the brand will continue to have economic and therefore financial value.

Take IBM. Few people would argue that IBM is not one of the world’s best-known brand names. But what does it do? It used to make computers. Now it offers consultancy. Virgin is a well-known name, but is it an airline? A fitness centre? A train service? A bank? A range of soft drinks? A bridal service? It’s been all of these things and more.

The concept of economic value takes that further. It means they are assets that don’t simply have value when they are valued. It means that they create value on an ongoing basis for their owners.

They can do this in a number of ways. For example:

And they add economic value to others:

Brand valuation puts a dollar figure on the amount of money you earn as a business and could be reasonably expected to earn in the future. It ties the soft factors of marketing (awareness, preference, advocacy, image) with the hard factors of finance (earnings before interest and taxes (EBIT), forecast revenues, capital employed). It makes brand performance an enterprise-wide accountability issue, not just a marketer’s metric.

Why and how you should put a financial value on your brand

Nic Liddell, the former Head of Brand Valuation at Interbrand, explained this lucidly in the book Don’t Mess with the Logo. We think it’s a good exposition. In the cold, clinical world of valuation, Nic explained, brands are seen as a business asset, like a factory, an assembly line or even a simple biro pen. The argument goes that strong brands create value for their owners because they encourage a higher level of sales (and therefore profit) and because strong brands also encourage a stable, loyal relationship with customers, those sales are more secure in the future. In a nutshell:

strong brands = higher profits at lower risk

Crucially, if the ‘brand’ is protected by a trademark (or set of trademarks) then it can be bought and sold like any other asset. But unlike most other assets, there is no open market for brands. The price of a factory can be assessed by looking at recent transactions involving similar factories in similar locations (a bit like when you move house), or by working out how much it would cost to buy land and build the factory from scratch. But brands are unique by definition and aren’t bought and sold as often as factories, machines and biros. Fortunately many different companies (including the major accountancy firms) have come up with different ways of valuing brands:

The favoured valuation method, according to international accounting standards, is a discounted earnings (or cash flow) approach:

  1. How much of the earnings (or cash) that a business is forecast to generate can be attributed to the brand?
  2. What level of risk should be associated with these forecast brand earnings (or cash)?

1 How much of the earnings (or cash) that a business is forecast to generate can be attributed to the brand?

Brand preference is always important but it is more important in some categories than in others. In fact, people might not like your brand very much but still be forced to buy you for other reasons. For example, take petrol stations. You might not like Shell very much, you might prefer BP (or vice versa) but if your car needs petrol you are going to fill up at the nearest station regardless of who owns it. Whereas if you like Chanel No 5, you’ll buy Chanel No 5; you won’t just get something to make you smell nice. So ‘brand preference’ is less important in the petroleum industry than in comparison it is in the perfume industry.

Therefore, to work out how much of your earnings are due to people preferring your brand, you have to separate the earnings the business makes into ‘tangible’ and ‘intangible’ ones (tangible means things like factories, equipment, the petrol stations and the petrol you might own etc – ie things you can touch). And then identify how much of the ‘intangible earnings’ are generated by your brand as opposed to other intangibles such as patents, distribution agreements etc.

2 What level of risk should be associated with these forecast brand earnings (or cash)?

People might prefer your brand but do they ‘demand’ you? Take banks as an example. A lot of people use Barclays but there is little evidence that most people love them. Whereas, in the UK, First Direct or Metro Bank have loyal customers who recommend them. So security of demand for the Barclays brand might be comparatively lower than that for First Direct or Metro Bank.

Therefore, you have to identify how strong the loyalty and affinity to your brand are with your customers and also the other factors that affect that demand, such as how available you are. Accountants can use an analysis of that strength and turn that into a risk rate. By applying that risk rate to the forecasted brand earnings for a number of years into the future and adding those earnings up, you get a Net Present Value. And that is the financial value of the brand – assuming someone is prepared to pay that for it. Figure 1 shows the process.