A number of methods have been proposed to define the value posted in the balance sheet when a brand is part of the assets of an acquired company, or any other instance when this valuation is needed. They can be positioned on a two-dimensional mapping. The horizontal axis refers to time (but do we base the analysis on the past, the present or the future?).
This axis discriminates between valuations based on historical costs (those that helped build the brand), valuations based on present earnings, on market price, and those which rely on a business plan: that is to say, a forecast. The vertical axis is a real/virtual dimension. Some analysts rely on hard facts (historical accounts are facts, as well as present earnings). However, some methods rely more on estimates about the present (the replacement method), or about the future (the discounted cashflow method). We now analyse these methods in turn.
Positioning brand valuation methods
Valuation by historical costs
The brand is an asset whose value comes from investments over a period of time (even though accountants do not strictly regard this as a true form of investment). The logical approach would therefore be to add together all the costs associated with a particular period: development costs, marketing costs, advertising and communication costs, etc. These costs can be determined objectively, and will have been in past income statements.
As we can see, this approach allows us to overcome the tricky problem of separability, by isolating the direct costs associated with the brand and also by attributing to it the indirect costs such as the sales force and general expenses. Even though this method is simple and logical, it nevertheless raises the following practical difficulties, which reintroduce a certain subjectivity:
Valuation by replacement costs
To overcome the difficulties arising from the historical costs approach, it might be better to place oneself in the present and to confront the problem by resorting to the classic alternative – as we cannot buy this brand, how much would it cost to recreate it? By taking its various characteristics into account (awareness, percentage of trial purchases and repurchases, absolute and relative market share, distribution network, image, leadership, quality of the legal deposition and presence in how many countries), how much would we have to spend, and over what period, in order to create an equivalent brand?
Is it possible to remake Coca-Cola, Schweppes, Mars, Buitoni or Martell? Probably not. How about Benetton, Bang & Olufsen, Saab or Epson? More than likely. For a certain number of brands, the question no longer arises since it is impossible to recreate them. The context has changed too much:
On the other hand, when these factors which hinder market entry are no longer present, the market is more accessible. The possibility of creating tomorrow’s brand leaders from scratch ceases to be theoretical, even though uncertainty and the necessary time element may still exist. Therefore, future Benettons will probably be created. Franchising allows wider market penetration without admitting defeat at the hands of major retailers.
What is more, the fashion industry is open to new ideas. In this domain, style is more important than technology. Computer services and the high-tech world in general are also open to innovation. Generally speaking, the future will see the emergence of new international brands, each positioned in its own particular niche. They will thus no longer seek global awareness but will aspire to be leaders in particular market segments.
Brand valuation by replacement costs nevertheless remains very subjective. It requires the combined opinions of experts and ambiguous procedures. On top of this it should be remembered that the aim of the valuation process is not, in itself, to arrive at a value but to get an idea of the economic value of the asset in question – in this case the brand. Cost methods focus on the inputs, whereas the economic value is based on the outputs – what the brand produces and not what it consumes. Profit is not generated through investments but through market domination and leadership.
Valuation by market price
When valuing a brand why not start with thevalue of similar brands on the market? This is how property or second-hand cars are valued. Each apartment or car is inspected and given a price that is above, equal to or below the average market price of similar goods.
Even though this method is very appealing, it raises two major problems when applied to brands. First, the market doesn’t exist. Although such transactions are often cited in the financial pages, acquisitions and brand sales are relatively few. Brands are not bought to be sold again. In spite of this, we can get an idea of the multiples applicable to each sector of activity (from 25 to 30) thanks to the number of transactions that have taken place since 1983. Thus, such an approach could tempt some wishing to value a brand.
However, there is a major difference between the real estate market and the market for brands, which is relatively small. On the real estate market the buyer is a price-taker, that is, the price is fixed by the market. Irrespective of the use that he or she will make of the property, the price remains the same. For brands, the buyer is a price-setter, that is, he or she sets the price of the brand. Each buyer bases his/her valuation on his/her own views, on potential synergies and on his/her future strategy.
Why did Unilever pay s100 million for Boursin, the well-known brand of cheese? It can be explained by the pressing need of this group to acquire shelf space in major supermarkets in which it had previously been absent. Having at its disposal a compulsory brand, they saw a way of opening the door to other speciality products. In April 1990 Jean-Louis Sherrer was bought for three times less than the price that Mr Chevalier paid for Balmain two months earlier. For Mr Chevalier, Balmain was a means of entry – or rather re-entry – into the luxury market. Hermès, which was already present on this market, didn’t need to pay this price (Melin, 1990).
In abstract terms the purchase price is not the price paid for the brand but is the interaction between brand and purchaser. To use the price paid for a similar brand as a reference, without knowing the specific reasons behind that brand’s purchase, ignores the fact that an essential part of the price probably included the synergies and the specific objectives of the buyer in question. Each buyer has his/her own intentions and ideas. The value cannot be determined by proxy.
This is what distinguishes fundamentally the market for brands from that for real estate, or for example for advertising agencies. In the case of the latter, norms and standards exist that are not dependent on the buyers’ intentions (50 to 70 per cent of the gross margin on top of the net assets). Despite this, valuations in the luxury market frequently take into account recent transactions and use a multiple of the sales (1.5 for Yves Saint Laurent, 2 for Lanvin and for Balmain, 2.9 for Martell, 2 for Bénédictine).
Considering the difficulties which are inherent in the cost-based methods or in the referential methods on a hypothetical market, prospective buyers tend rather to look at the expected profits from brand ownership. Since the third type of approach relies on two major philosophies, we are devoting a special section to it.
Valuation by royalties
What annual royalties could the company hope to receive if it licensed the rights to use the brand? The answer to this question would form a means of directly measuring the brand’s financial contribution and would also solve the problem of separability. The figure obtained could subsequently be used to calculate the discounted cashflows over several years. The difficulty is that this is not a very common practice in most markets. They are found in the luxury and textile markets.
From a conceptual point of view, it is not certain that this method properly separates just the value of the brand (Barwise, 1989). In fact, companies often use licences to reach countries where their brand is not present. However, the royalty fee does not include solely the use of the brand. The brand owner also undertakes to supply a package of basic materials, know-how and services, which allow the licensee to maintain the brand’s appropriate quality level.
Valuation by future earnings
Since the brand aspires to become an asset, it is best to begin by a reminder of what an asset is. It is an element which will generate future profits with reasonable certainty. Valuation methods have been developed on the basis of expected returns of brand ownership. Naturally, these tie in fully with the purchaser’s intentions. If he/she wishes to internationalise the brand, it will be of more value to him/her than to a buyer wishing to keep it as a local brand.
The value measured by expected profits cannot be separated from the characteristics of the future buyer and from his/her strategies for the brand. This explains why the stock market value compared to a predator’s value of a branded company will always be structurally lower. The former valuation is related to the existing business, taking into account current facts and figures provided by the firm. The latter comes from the overvaluation created by the prospect of synergies, complementary marketing processes and the attainment of strategic market positions.
The process of valuing the expected profits of the brand can be divided into three independent stages (see Figure below):
A multi-step approach to brand valuation
This is the classic method of valuing all investments, whether tangible or intangible. The analyst calculates the anticipated annual income attributable to the brand over a 5- or 10- year period. The discount rate used is the weighted average cost of capital, which if necessary is increased to take account of the risks arising from a weak brand (that is to reduce the weight of future revenues in the calculation of the present value). Beyond this period, the residual value is calculated by assuming that the income is constant or growing at a constant rate for infinity (Nussenbaum, 1990). The following formula is used:
This is the classic model for valuation by the discounted cashflow method, even though analysts offer numerous variations of it (Mauguère, 1990; Melin, 1990). This method was used to value Cognac Hennessy at 6.9 billion francs, based on a capitalisation of its net revenue over 25 years at a rate of 6.5 per cent (Blanc and Hoffstetter, 1990).
This method was also used to value the Candia milk brand as part of a restructuring programme. The final figure, which was around 1.8 billion francs, was the result of a business plan within which two questions were discussed:
Sceptics of this method (Murphy, 1990; Ward, 1989) object to its three sources of uncertainty: the anticipation of cashflows, the choice of period and the discount rate:
Valuation by present earnings
Who can predict the future? How can one be sure that the forecasts of a business plan will be matched? In fact, one of the reasons so many internet brands have been heavily overvalued is that they made no profit whatsoever (eBay excepted).
The brand valuation process relied exclusively on forecasts and business plans which were created just to attract new investors, so the founders could resell before the collapse of the illusion. Interbrand, a major brand valuation company, has promoted a specific approach to circumvent this problem. No business, no brand.
Interbrand valuations rely exclusively on three years: last year, this year and next year. After partitioning each year’s revenue to pay for the invested capital which made the business possible and other direct intangible assets, one is left with a global residue, made of a weighted average of the residues of each of these three years.
This residue should be then multiplied by a figure called ‘the multiple’, hence the name of the Interbrand proprietary method: the multiple method. Although Interbrand seems to have moved now to the most orthodox method (discounted cashflow), we analyse this former approach on which many brand valuations have been based.
In the financial valuation of companies, it is typical to examine what is known as the price/ earnings ratio (P/E). This ratio links the market capitalisation of a firm to its net profits. A high ratio is a signal of high investor confidence and optimism in the growth of future profits. Even though the brand is not the company, the same reasoning can be applied:
The only difference lies in the fact that for a brand there are no data on its market capitalization because it doesn’t exist, therefore it is this that we are trying to calculate. This notional market value of equity is the price to be paid for the brand (before the effect of overbidding). In order to calculate this, it is necessary to determine M, the multiple which is equivalent to the P/E ratio specific to the brand.
There are four stages to this method:
Interbrand used the profits for the last three years (t–2, t–1, t), thus avoiding a possibly atypical evaluation based upon a single year. These profits were discounted to take account of inflation. A weighted average of these three figures was calculated in accordance with what we consider to be the most and least important years. This weighted average after-tax net profit which is attributable to the brand forms the basis of all calculations.
This method uses a set of marketing and strategic criteria to give the brand an overall mark. Interbrand uses only seven of these factors and takes a weighted sum of the individual marks for each factor in order to calculate the overall mark, as can be seen in Table below.
A method of valuing brand strength
A relationship necessarily exists between the multiple (an indicator of confidence about the future) and this score for brand strength. If this relationship was known precisely, the multiple would then be predicted by the brand strength score. For this, Interbrand developed a model known as the ‘S-curve’ which plots the multiple against brand strength.
The model is based on Interbrand’s examination of the multiples involved in numerous brand negotiations over recent periods – in sectors close to the one being studied. The P/E of the companies with the closest comparable brands are used. Interbrand then reconstructed the company’s profile and brand strength. Plotting the multiples (P/E) against the reconstructed scores results in an S-shaped curve (see Figure below).
The Interbrand S-curve – relation between brand strength and multiple
Reckitt & Colman estimated that 5 per cent of profits on these brands came from sales under distributors’ own-brands. Interbrand considered that the remaining 95 per cent was the brand’s gross profit. The income generated by the brand can be calculated by subtracting the expected return on investment from net assets. The net revenue was weighted according to the importance of each brand and discounted for the previous three years. The following results were obtained for each category:
What multiple should be applied? For the first group, the multiple used by Reckitt & Colman in 1985 when buying Airwick was applied. A multiple of 17 was used for food products and was based on recent transactions in the sector during the last few years, for example the BSN–Nabisco takeover bid. Finally, a multiple of 20 was used for the pharmaceutical group. In fact, recent transactions in the pharmaceutical industry had been using multiples which were closer to 30. A lower multiple was chosen in this case because of Reckitt & Colman’s relatively weak position in the sector. By applying these figures to the net revenue in each category, the following brand values were estimated:
Comparison of the cash flow and multiple method
The multiple method, which was developed in the UK, is becoming a classic. It was, in fact, used by such companies as Rank Hovis McDougall and Grand Metropolitan whose decisions to post brand values to their balance sheets caused a controversy which is still not settled. It is also the method which communicates the most through books, articles and seminars. The simplicity of the method used is such that it is uncharacteristic of the stringent world of financial analysis. All this said, is it valid?
First, the multiple method is not all that different from the classic method of discounted cashflow. It is a particular example of it. When a constant and infinite annual cashflow is expected, the present value of the brand is defined thus:
As we can see, the multiple is none other than the inverse of the cost of capital adjusted for risk (1/r). If a constant growth rate (g) of annual income is expected, the multiple is:
Equations aside, the point to remember is that we cannot reproach the method of discounted cashflows for making certain hypotheses, since the multiple approach is itself a particular hypothesis, which is equally as questionable but not explicit. It draws its apparent validity from the fact that all its calculations are based upon:
However, face validity (or appearance) does not mean validity per se. In its present form, Interbrand’s method poses various problems:
Stepped graph showing relationship between brand strength and multiple
In conclusion, the widespread use of the multiple method is not proof of validity, as we have just seen, but testifies to its simplicity and handiness for non-specialists, and therefore its internal educational value. A small variation in the chosen multiple leads to important differences in the value of the brand. The present method of choosing the multiple is unsatisfactory from the point of view of reference multiples and of the brand strength scores.
What can we make of a total score which is obtained after subjective weightings of factors which are sometimes redundant or in any case correlated? This wish for simplicity is to the detriment of the method’s validity. Despite its claim to be accurate, the multiple method in its present form is just as subjective as that of discounted cashflows. To use a hundred or so criteria instead of seven would change nothing. By doing this, we introduce a certain amount of redundancy between the criteria, which results in more weight being given to some factors.
As long as the method is subjective, it should remain transparent. The multi-criteria method gains nothing from being summarised in a single score since there are many implicit hypotheses in the weightings. The brand profile should be used instead to make a realistic, valid business plan, materialising in discounted cashflows.
Last but not least, the multiple method is too sensitive to small variations of the multiple itself. Multiplying 800 million by seven or eight makes a lot of a difference. Such sensitivity is at odds with the principle of prudence. Brand valuation is not an exact science. It is not acceptable to obtain outputs that can vary by millions of pounds just by changing the multiple by 1 unit. This is probably why recently Interbrand moved unobtrusively towards the classic financial methodology, the discounted cashflow approach (Table below).
Another estimate of the financial value of brands (2007)
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