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Financial Valuation And Accounting For Brands /What Is Financial Brand Equity?

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What is financial brand equity?

The 1990s witnessed the flourishing of the concept of brand equity (Aaker, 1990). The act of combining a financial concept (equity) with a manifestly marketing-based notion (the brand) is symptomatic of a growing awareness of the financial value of brands, which has emerged from the exclusive world of advertising and marketing to become a very serious factor which – given the importance of equity – has a major impact on overall management. (Figure below)

What is ‘brand equity’?

It is worth mentioning again what is meant by ‘equity’ in financial terms, and thus what connotations emerge from the combination of the terms ‘brand’ and ‘equity’. Literally, equity is ‘the owner’s claim on the business’. It represents an ownership interest in an enterprise. This equity (called equity securities) is opposed to debt securities, although both are sources of funds, hence liabilities in the balance sheet. The use of the term ‘equity’ when attached to a brand refers in fact not to a liability but to an asset, built over time thanks to the investment of the business in it. For the sake of precision one should speak in fact of brand assets, not of brand equity.

Curiously enough, although the term ‘brand equity’ represents an invitation to combine the marketing perspective with the economic and financial perspective, subsequent events have revealed a disagreement within the community of experts. When it came to measuring this brand equity and discussing what makes a strong brand, there was a split between what some called ‘consumer-based brand equity’ and others referred to as ‘financial brand equity’. The former school of thought (consumerbased brand equity) approaches the question of brand value by taking the customer’s point of view.

This in turn leads to several different theories. Some believe that brand value exists wherever the preferences expressed for a brand are greater than a simple assessment of the utility of the product or service’s attributes would have suggested. We can see that this approach considers the brand as a surplus, a preference that cannot be accounted for by the product alone. It is measured as a residual:

BE = Declared preference – preference predicted by product utilities

As we can see, this theory sees the brand as the degree of influence that exists over and above the product itself: the brand is thus restricted entirely to an intangible, emotional dimension. However, BMW – one of the world’s strongest brands – owes its strength and attraction as much to a product with special, unique performance as it does to the image of its owners that the brand conveys.

Others (Aaker, 1990) maintain that brand value incorporates all of the following variables: recognition, perceived quality, imagery, loyalty and patent quality. Note that according to this definition – and in contrast to the previous definition – the product is included in brand equity because of the patents that make it different or even superior.

Still others, taking a highly cognitive approach (Keller, 1998), see the brand as a collection of memory associations that generate a different reaction to the brand. Keller, for example, speaks of positive customer-based brand equity if identification of the brand produces a more favourable reaction than if the brand is not identified. However, he also defines negative customer based brand equity as a situation in which such identification leads to a less favourable reaction.

Note that in the financial context which produced the notion of equity, there is no such thing as negative equity. The latter school of thought is populated by financial analysts whose role it is to evaluate assets (which can sometimes include intangible assets, and thus brands). From their economic perspective, brand equity is the value today of profits imputable to the brand in the future.

An economic analysis of brand equity requires us to look more closely at the word ‘imputable’. The question is, imputable by whom? In contrast to the consumer-based approaches, the economic analysis prompts a simple yet fundamental observation: the brand is a conditional asset (Nussenbaum, 2003). After all, without a product (or service) there is no brand. In order to produce a profit or EVA (economic value added), there must already be sales, and thus a tangible base for the brand and its distribution. Here, ‘already’ means in advance: spending and paying come before receiving. This gives us the basic equation:

Value = –I + R

This equation is exactly the same as the following, more fully developed, version giving the value of any asset. Since an asset is a factor with inherent future values, its value appreciates by the present sum of its future expected profits once the initial investment has been deducted.

Imputation of added value to the conditional asset that is the brand presupposes the following:

That a value already exists to be shared.That the tangible and intangible factors required for its production have been factored in.That a residual or excess profit remains after paying for these advance assets, which make production and distribution possible.

We believe it is time to bring the two approaches to the concept of brand equity together. After all, the brand is a tool for increasing business: its value is linked to, and dependent on, this objective.

Economic analysis tells us that, irrespective of a brand’s reputation, image, preference factors and loyalty, the brand has no value if the company does not produce an excess profit capable of paying off the existing assets (tangible and intangible). Reputation and image do not constitute value in themselves if they do not translate into a profitable product or service.

Seen in this way, it is an illusion to believe that a brand has value simply because it has ‘magic’. Many entrepreneurs have bought brands on this basis, but have never been able to convert this value into a hard profit. A brand is only worth anything if a profitable economic formula can be built around it; which is something of a paradox, given that this is an entirely consumer-based concept. However, the economic realities are clear: even if a name has an attraction for consumers, it does not guarantee future profits.

This can be illustrated by an example. The now-defunct Ribourel (property development) brand was the subject of a debate on the exact theme of this. How much was it worth? It was shown that it was worth nothing: the brand’s image was associated with value for money, but there was no way of turning this into a profit margin. The Ribourel concept was founded on an idea that was strong and attractive, but economically unachievable. The brand had no economic value under such circumstances.

The reader may remember the terse, shocking statement issued by Daewoo in offering to buy Thomson for the symbolic price of s1. The point being made was that the brand had no value. One might retort that quite the reverse was shown to be true under the management of CEO Thierry Breton; but in fact, what Thierry Breton did was to bring about a change in the business model in order to return the company to added value.

Using the same logic, if a brand can induce the consumer to pay a price differential but the cost of creating the brand is greater than the price increase, the brand has no value.

We should therefore put forward a unifying definition of a brand that has value (strong brand equity): a strong brand is a name that influences buyers through the value it offers and is backed by a profitable economic formula. In this definition, several points should be noted:

Modern competition revolves around concepts and ideas. A name is associated with an attractive, unique value that provides the source of its purchasing influence.Strength can also refer to the number of people who associate the brand with this idea. A brand is a strong shared idea; for example, everyone says that BMWs are the best cars.This must be turned into an economically profitable reality.

We can clearly see both the connection and the ambiguity between the purely consumerbased and purely economic approaches. It all hangs on the use of one common word ‘value’, which takes on two different meanings. From the point of view of the marketer, taking his cue from the work of the psychologist M Rokeach, a value is an ideal to be attained, mobilising our energies and directing our choices. For the economist, however, it is a balance:

V = – I + R.

A strong brand thus focuses its efforts on attaining a value through the consumption of a product or service which is given its meaning by marketing and advertising. However, this same brand has no economic value if this approach does not result in EVA: it is useless.

An economic formula for the brand does exist: this is one of the two keys to its value.

From economic value added to the brand

Over the last 10 years, intense accounting debates have raged in the United States, mainland Europe and Great Britain over the evaluation of brands. These debates centre around questions with significant repercussions for companies and their profit-and-loss accounts:

When can a brand be activated and recorded on the balance sheet? Does it have to have been bought? If so, this excludes home-grown brands.Should brands be depreciated? If so, over what period?How do you reliably assess the value of a brand?

These issues should not be perceived as being of academic interest only: in fact, they ask important questions as to the very nature of brands and their impact on the added value created by the company over the lifespan of the brand. This last point thus prompts the following question: do brands have a life cycle? We know that in retrospect, we can reconstruct the life cycle of a product, with its typical launch, growth, maturity and decline phases.

We say ‘in retrospect’ because during the life of a product, it is always possible to maintain that the situation we know as the mature stage simply points to insufficient effort (too few line extensions, too little international expansion, and so on).

Now, by feeding on new products that replace the old, the brand ‘surfs’ product life cycles and acquires from them an apparently indefinite lifespan. Nevertheless, the debate on the depreciation of brands leads to very different conclusions depending on whether one believes that brands have a life cycle (and should thus be depreciated), or that they do not. If a brand’s lifespan cannot be determined in advance, there is no justification for depreciation.

However, we should start at the beginning, with the question of the nature of brands. Remember that a brand cannot exist without a product (or service): a product or service is needed before the brand can perform its economic role, which is to add value through the differentiation it creates and the added values it promises. In this respect, a brand is a true conditional asset.

Its value can take a tangible form only if the company has already made a capital investment in producing and deploying the brand platform – its products or services. The consequences of this point are crucial: the brand is an added value, and thus if we are to take financial advantage of it, we must have profits, but only once we have allowed (at a given rate, t) for the capital required for its production (Nussenbaum, 2003). The company must therefore already have produced EVA. Remember the EVA equation:

EVA = nett EBIT after tax – t (Tangible Assets + Working Capital Requirement)

Still following the basic theory which dictates that the brand is a conditional asset, we should also factor in the cost of other intangible assets that have contributed to the business; for example, patents (which are crucial in the high-tech or medical marketing industries). Once these directly evaluable assets have been factored in, the residual thus derived will create the envelope within which we find the economic value of the brand and of other intangibles that cannot easily be evaluated directly.

This once again raises the question of identifying these other sources of added value. It stems from an assumption which forms the basis of economic and accounting practice worldwide – that a brand has no value unless it is able to produce excess profit even after taking into account the factors that enable the production and distribution of the products and services, regardless of whether these factors are physical and tangible or nonphysical and intangible.

This theory of conditional assets accounts for the progressive, steady process of evaluating brands by means of allocating successive residual balances: EBIT, nett EBIT (after the imposition of company tax), EVA, and EVA after the direct identification of certain intangible assets.

Theoretically speaking, then, the brand evaluation process is simple (it consists of a series of successive residual balance allocations). However, for reasons related not so much to methodology as to the company’s information system, it is tricky to implement in practice. To put a value on a brand, we have to be able to identify its profits – yet a brand can span many markets governed by a variety of different economic mechanisms, or markets in which factors such as the relative value of the brand in comparison to other assets might not be the same.

For example, the relative importance of the brand in sales of a hair products brand is not the same in all distribution channels: it is important in the modern channel (supermarkets and hypermarkets), but very weak when the same product is sold directly by hairdressers, on account of the strong influence of the hairdresser’s recommendation to the customer. To develop this idea further: for any given brand in any given channel, the degree to which this brand influences the customer’s purchasing decision will vary depending on whether the product is a shampoo or a hair colouring product.

Analyses must therefore be conducted individually at the relevant level, not collectively at the overall level. The question thus becomes: do we have the appropriate reporting data that such an analysis requires?

The brand: an identifiable asset?

We know that according to standard accounting practices, an asset can only be entered in the accounts if it can be identified and clear future economic benefits can be attributed to it. Inter-country debate currently rages on the criteria for such identifiability.

Some countries implement a difficult criterion: transferability. It is a tough condition because before an asset can be transferable, legal rights for this asset must be held; not only this, but a market must also exist. An alternative criterion has a more economic basis: it is sufficient to be able to trace specific revenue back to this asset. How is this viewed in worldwide terms?

Under current international accounting standards (IAS), an asset is deemed to be identifiable if we hold rights over it: in other words, if these rights can be protected. Logically, therefore, according to this concept, the company can exercise no legal rights over market share or a client base. From the IAS standpoint, an intangible asset can be recorded if:

the recorder controls, holds the aforementioned legal rights;it is transferable (separable);it is the source of specific future revenue extending beyond the yearly accounting period.

In other countries such as France, market share can be activated and posted in the balance sheet.

The US position is a pragmatic one: what conditions must be met here before an intangible asset can be entered separately into the consolidated accounts once a company has been absorbed or bought out? They are twofold: separability (it can be transferred independently of the rest of the company) and the unambiguous allocation of specific revenues.

Pragmatically, to avoid ambiguity, the US standard supplies a list of intangible assets. In the Statement of Financial Accounting Standards no 141, (FASB), this list specifies exactly what can be allocated: no reference is made to market share. Nor is know-how included, as this is an abstract concept (except in the form of computer software). However, it does include the valuation of a customer database. The US position thus concerns itself less with legal property, instead taking a more economic approach.

The new draft IAS, which will become prevalent in stock-exchange-listed companies throughout the world, is similar in design to the US model.

However, a case does exist where the brand is, and remains, unrecordable: when it is an ‘internal’ brand, that is, one created by the company itself and thus not bought, or one found in a company that has been bought by or merged with the company. Accounting is subject to the principle of prudence: what is a brand worth? The price paid by a party buying the company already offers an indication in the form of an upper threshold, once all other assets within the company have been deducted at their economic value.

When there is a market transaction, then, the value acquires a physical form. Until that time, it is merely a virtual, potential value. In all countries, recording unreliable information in the accounts is perceived as a much greater evil than that of failing to take an economic value (the brand) into consideration.

Value depends on the evaluation goals

Incongruous though it may seem, the brand contains not one value but many: everything depends on the evaluation goals. Thus, if the goal is to assess a contribution containing an intangible asset, to be checked by an auditor, a prudent approach should be taken.

Similarly, it is a universal truth that value is in the eye of the beholder. For example, only Coca-Cola could offer US $1 billion to buy the little round Orangina bottle. With its network of bottlers in all countries worldwide, it would instantly be able to multiply sales of the product – which was based on the same business model as Coke (selling syrup to bottlers) – ten-fold. Pepsi-Cola offered less, as did Schweppes: hardly surprisingly, since their brand development plan was simply not on the same scale as Coca-Cola’s.

Lastly, we are bound to get different figures when evaluating for estimation purposes than when evaluating for balance sheet recording purposes. In producing an estimate, it is permissible to include future plans, new production factories and shops that may be opened, or brand extensions into other categories. This makes the brand’s future potential look even brighter.

However, when it comes to recording for accounting purposes, prudence is required. It is not possible to make use of such predictions, since the projected factories, stores and extensions do not actually exist, and therefore cannot be included. Under European accounting law, no allowance can be made for that which does not exist. However, under IAS such possibilities could be taken into account, taking their cue from the more flexible US standards.

In the Coca-Cola/Orangina case, we therefore find ourselves in an odd situation: the value of the brand appears to differ depending on which company perspective we consider the question from. In the consolidated accounts of Coca-Cola in the United States, the value recorded for the Orangina brand would have taken into consideration the expansion potential from its new distribution. In the accounts of Pernod-Ricard, the company originally holding the Orangina brand, it would have had a different value as part of a transfer operation.

 

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