How brands create value for the company

Why do financial analysts prefer companies with strong brands? Because they are less risky .Therefore, the brand works in the same way for the financial analyst as for the consumer: the brand removes the risk. The certainty, the guarantee and the removal of the risk are include din the price. By paying a high price for a company with brands the financial analyst is acquiring near certain future cash flows.

Table :Brand functions and the distributor/manufacturer power equilibrium

If the brand is strong it benefits from a high degree of loyalty and thus from stability of future sales. Ten per cent of the buyers overlie mineral water are regular and loyal and represent 50 per cent of the sales. The reputation of the brand is a source of demand and lasting attractiveness, the image of superior quality and added value justifies a premium price.

A dominant brand is an entry barrier to competitors because it acts as a reference in its category. If it is prestigious or a trendsetter interns of style it can generate substantial royalties by granting licence's, for example, at its peak, Naf-Naf, a designer brand, earned over £6 million in net royalties. The brand can enter other markets when it is well known, is asymbol of quality and offers a certain promise which is valued by the market.

The Palmolive brand name has become symbolic of mildness and has been extended to a number of markets besides that of soap, for example shampoo, shaving cream and washing-up liquid. This is known as brand extension and saves on the need to create awareness if you had to launch a new production each of these markets.

In determining the financial value of the brand, the expert must take into account the sources of any additional revenues which are generated by the presence of a strong brand. Additional buyers may be attracted to aproduct which appears identical to another but which has a brand name with a strong reputation. If such is the company’s strategy the brand may command a premium price in addition to providing an added margin due to economies of scale and market domination. Brand extensions into new markets can result in royalties and important leverage effects.

To calculate this value, it is necessary to subtract the costs involved in brand management: the costs involved in quality control and in investing in R&D, the costs of a national,indeed international, sales force, advertising costs, the cost of a legal registration, the cost of capital invested, etc. The financial value of the brand is the difference between the extra revenue generated by the brand and the associated costs for the next few years, which rediscounted back to today.

The number of years is determined by the business plan of the valuer (the potential buyer, the auditors). The discount rate used to weigh these future cashflows is determined by the confidence or the lack of it that the investor has in his or her forecasts. However, a significant fact is that the stronger the brand, the smaller the risk.Thus, future net cash flows are considered more certain when brand strength is high.

Figure below shows the three generators of profit of the brand: the price premium, more attraction and loyalty, and higher margin. These effects work on the original market for the brand but they can be offered subsequently on other markets and in other product categories, either through direct brand extension (for example, Bc moved from ballpoint pens to lighters to disposable razors and recently to sailboards) or through licensing, from which the manufacturer benefits from royalties (for example all the luxury brands, and Caterpillar).

Once these levers are measured in euros,yen, dollars or any other currency they may serve as a base for evaluating the marginal profit which is attributable to the brand. They only emerge when the company wishes to strategically differentiate its products. This wish can come about through three types of investment:

Investment in production, productivity and R&D.

Thanks to these, the company can acquire specific know-how, a knack which cannot be imitated and which in accounting terms is also an intangible asset .Sometimes the company temporarily blocks new entrants by registering a patent. This is the basis of marketing in the pharmaceutical industry (a patent and a brand) but also of companies like Ferrero, whose products are not easily imitated despite their success.

The levers of brand profitability

Patents are on their own an intangible asset:the activity of the company benefits from them in a lasting manner.

  • Investment in research and marketing studies in order to get new insights, to anticipate the changes of consumers’ tastes and life-styles in order to define any important innovations which will match these evolutions.

    Chrysler’s Minivan is an example of product created in anticipation of the demands of baby boomers with tall children.
    An understanding of the expectations of distributors is also needed, as they are an essential component of the physical proximity of brands. Nowadays a key element of brand success is understanding and adapting to the logic of distributors, and developing good relations with the channels (even though it is still necessary when valuing brand to make a distinction between what part of its sales is due to the power of the company and what part to the brand itself).

  • Investment in listing allowances, in the sales force and merchandising, in trade marketing and, naturally, in communicating to consumers to promote the uniqueness of the brand and to endow it with saliency (awareness), perceived difference and esteem. The hidden intrinsic qualities or intangible values which are associated with consumption would be unknown without brand advertising.

The value of the brand, and thus the legitimacy of implementing a brand policy,depends on the difference between the marginal revenues and the necessary marginal costs associated with brand management.

How brand reputation affects the impact of advertising
Brands are a form of capital that can slowly be built, while in the meantime one is growing business. Of course it is very possible to grow business without creating such brand capital:a push strategy or a price strategy can deliver high sales and market share without building any brand equity. This is the case for many private labels or own-label brands, for instance.

The volume leader in the market for Scotch whisky in France is not Johnnie Walker or Ballantines or Famous Grouse but William Peel, a local brand that aimed all its efforts at the trade (hypermarkets) and sells at a low price. It has almost no saliency (spontaneous brand awareness).

Now managers are being asked to build both business and brand value. Their salary is indexed on these two yardsticks: sales and reputation. One should not see them as separate, leading to a kind of schizophrenia.Chaudhuri’s very relevant research (2002)reminds us that advertising and marketing are the key levers of sales.

However, their effects on market share and the ability to charge premium price (two indicators of brand strength) are not direct but are mediated by brand reputation (or esteem). In fact, as shown by the path coefficients of Figure below,brand reputation is created by familiarity (I know it well, I use it a lot) and by brand perceived uniqueness (this brand is unique, is different, there is no substitute).

Advertising does play a key role in building sales, but it has no direct impact on gaining both market share and premium price. This is most interesting:in brief, it is only by building a reputational capital that both a higher market share and price premium can be obtained.

Reputation also adds to the impact of advertising on sales. It is well known from evaluations of past campaigns that the more a brand is known, the more its advertisements are noticed and remembered. It is high time to stop treating brands and commerce as opposing forces.

Branding and sales

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