Brand Valuation Methods

VIVEKANAND EDUCATION SOCIETY S INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH

BRAND VALUATION

Submitted To: Prof. Ganachari Submitted By:

Nija Narayanan Lionell Misquitta Nilesh Nagpal Ruchi Patel Nitesh Nagdev 81 76 78 87 77

August 6, 2011

Brand Valuation Methods Table of Contents BRAND VALUATION I. II. A. B. C. D. E. F. i. ii. iii. G. III. Introduction Approaches to Valuation Valuation Based on Aggregate Cost The Replacement Cost Method Gross Margin Approach Valuation at market price Valuation based on customer relations factors Valuation based on Income Approach Discounted cash flow method Capitalization of Earnings Multiple or discretionary earnings Royalty Relief Method References 1 3 3 3 4 4 6 6 8 8 9 9 10 11

Brand Valuation Methods

I.

Introduction
Brand equity needs to be distinguished from brand valuation, which is the job of estimating the total financial value of the brand. This report contains an overview of the following different approaches for Brand valuation: 1. Valuation based on the aggregate cost of all marketing, advertising and research and development expenditure devoted to the brand over a stipulated period. 2. The replacement cost method 3. Gross Margin Approach: Valuation based on premium pricing of a branded product over a non branded product. 4. Valuation at market price 5. Valuation based on customer related factors such as esteem, recognition or awareness. 6. Valuation based on income approach 7. Royalty relief method: We assume what royalty the firm would have to pay if the brand was not owned by them as a percentage of sales

II.

Approaches to Valuation
A. Valuation Based on Aggregate Cost
Typically, Cost-based brand valuation approaches take into consideration the costs that have been incurred by the company to create the brand. These approaches are not forward looking. Rather, they look backwards into history. The cost-based method is conceptually the least defensible. It is perhaps the weakest. In order to arrive at the value figure, all costadvertising, promotions, research and development-which have gone into brand creation are added and converted into current prices. For instance, for an imaginary brand like FROOTSA , Rs. 80 crores have been spent in brand building. According to the cost based method, the brand s value would be Rs. 80 crores. For cost accounting purposes, the cost-based valuation makes good sense. But the fundamental plan of this method is whether the brand really is worth as much as it has cost to be created. The brand buyer would not be interested in how much has really gone into its creation; rather, his or her concern would be on its earning capacity or market value. This is true of various brands especially Japanese ones, which command greater market value in spite of lower incurred costs compared with their western counterparts.

Brand Valuation Methods

B. The Replacement Cost Method

To overcome the difficulties arising from the historical costs or aggregate 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 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? It is not possible to remake brands like Coca-Cola, Mars, Benetton etc. as their context has changed too much. y They were created in an era when advertising expenditure was negligible and the brand was nurtured over time by word of mouth. Today it costs so much for a 1% share of voice that it has become impossible to create a leading brand through unaided awareness. In any case unaided awareness is a restricted area and to gain access a competing brand must leave. This is because of memory blocks. There is no reason why today s well known brands should allow themselves to be thrown out. It is difficult to imitate the performance level of brand leaders. Backed by research and development and an intangible but very real know-how, they enjoy a long lasting competitive advantage and a resulting image of stability. Any challenger is taking a risk. Unless they have access to the necessary technology, their chances of encouraging repurchasing and loyalty are virtually zero. Major retailers have now become exacting gate-keepers. They give pride of place to their own brands, only selling one or two national brands which tomorrow will be international. Finally, considering the high failure rate of new products launches, it is easy to understand the uncertainty of the return on the large amount of money that has to be invested in the long term. If you are going to pay a lot you might as well buy certainty. Hence the clutter of takeover bids, raids, mergers and acquisitions of the firms with strong brands that are market leaders.

C. Gross Margin Approach

Customers are constantly looking for ways to save money rather than spend more of it, so companies that position products in the premium price range may struggle. However, with the right formula, you can earn the right to charge customers more than your competitors

Brand Valuation Methods do. If you ve been marketing your products or services as low-cost options, it s difficult to move up the price ladder without devoting significant dollars to aggressive marketing outreach and realistic differentiation between product offerings. The best approach is to launch products as premium offerings from the beginning--if that s what your business model calls for--because it s easier to mark products down (and nearly impossible to mark them up) once they ve been identified with a specific price point. Few factors that will influence your ability to establish and maintain your premium price position and reap the rewards: y
Don't Sacrifice Price, Even When Times are Tough. Just explain why your product or service is worth the investment, but be a little flexible for long-time customers. Do yourself a favor, though, and make a list of the customers you are willing to be flexible with; then make sure your sales team is aware of which customers are on the list so they won t be pressured to make snap decisions. Give employees freedom in dealing with customers, but make sure they know which customers are worthy of special treatment. Don't Play the Lowest Price Game. Weaker competitors are quick to cut prices to earn business. Don't play their game. Many competitors will fail because they can't generate cash flow to sustain this discounting strategy. Another disadvantage to playing the discount game is that this strategy is the fastest way to push your product or service into the commodity category. Select businesses have carved out a distinctive market by not discounting their products. The challenge is to create and sustain a brand that supports your premium pricing strategy.

The brand value is calculated multiplying the unit price differential of the brand in comparison with a generic product by the volume of sales. There are, at least, two options to calculate price premium statistically: y y Conjoint Analysis: It identifies the utility relative to independent product attributes Hedonic Analysis: The hedonic approach considers the price as a function of different product traits, being the brand one of them.

Brand value by gross margin approach is the product of the branded sales revenues and the premium branded gross margin that is the excess above the average gross margin of comparable competitors. This kind of approach is attractive as it is universally understood. The statistical methods to calculate price differentials are perceived as methods that remove the subjectivity inherent to the valuation process. It allows the valuation of brands that do not have price advantage, since it also considers the cost advantage.

Brand Valuation Methods

D. Valuation at market price

When valuing a brand why not start with the value of similar brands on the market? This is how property of second hand cars is 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 will make of the property, the price remains the same. For brands, the buyer is a price setter, that is, he sets the price of the brand. Each buyer bases his valuation on his own views, on potential synergies on his future strategy. Why did Unilever pay 700 million francs 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 super markets in which it had previously been absent. Having at its disposal a compulsory brand, they saw a way of opening the door to other specialty products. In abstract terms the purchase price is not the price paid for the brand but is the interaction between the brand and the purchaser. To use the price paid for a similar brand as a reference, without knowing the specific reason 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 its 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 which are not dependant on the buyers intention (50-70% of the gross margin on top of the net assets). Despite this, valuations in the luxury market frequently takes into account recent transactions and use a multiple of the sales. Considering the difficulties which are inherent in the cost based market or in the referential methods on a hypothetical market, prospective buyers tend rather to look at the expected profits from brand ownership.

E. Valuation based on customer relations factors

Brand Valuation Methods Nearly all businesses have customers. However, not every one has identifiable customer relationships, whose value can be properly estimated. A reasonably identifiable relationship includes, but is not limited to: the ability to identify specific buyers and the income stream they generated; and the expectation of the business continuing or being renewed along with its expected duration. Generally, if these characteristics are present, an intangible asset exists, and a customer relationship asset value can be estimated. In addition, it is important to segment the relationships based on various criteria, including the types and level of goods and services purchased, geographies, and so on. This segmentation is critical as it enables a deeper understanding of the basis for the value creation. Once a customer relationship has been identified and segmented, one should understand the two key value drivers: the amount of inertia in the relationship, and the amount of information available about the buyer.

Customer Inertia Companies that typically have valuable relationship assets experience high-inertia with their customers. These arise from various factors (including barriers to entry, high switching costs, differentiated products and services, etc.) thereby creating a stickiness factor enabling ongoing, and reasonably predictable, purchasing patterns. Customer Information A strong and valuable relationship can be based on collecting, managing, and protecting key information. This may include: historical data on contact information, products ordered, quantity ordered, order date, ship date, payment history, marketing and satisfaction surveys; as well as past and projected financial results including revenue growth, profitability, and investments. The key value drivers are estimated from this information, since it often serves as an indicator of the profits that will be generated over the life of the customer relationship. Understanding these drivers and their impact on customer value should facilitate the value creation process. Possibly the most important drivers are the customer attrition and cash flow profiles. The customer attrition profile suggests the likelihood of an existing buyer continuing to purchase products and services with reasonable certainty and predictability. It also establishes the time period for estimating the value of existing customers. The cash flow profile reflects revenue components including price and volume, cost structure to serve the customers, and the impact of other assets (both tangible and intangible) in this value creation process. The customer attrition and cash flow profiles combine to form the basis for developing a customer relationship valuation analysis.

Brand Valuation Methods

F. Valuation based on Income Approach

The Income approach methods determine the value of a business based on its ability to generate desired economic benefit for the owners. The key objective of the income based methods is to determine the business value as a function of the economic benefit. The economic benefit such as the seller's discretionary cash flow or net cash flow is capitalized, discounted or multiplied to perform the valuation. Key to the effective use of the income-based business valuation methods is the proper selection of the capitalization rate, discount rate, and valuation multiples. The well known methods under the income approach are:
y y y

Discounted cash flow method Capitalization of earnings method Multiple of discretionary earnings method

i.

Discounted cash flow method A key income-based small business valuation method that establishes the business value as a stream of future economic benefits discounted to their present value. Discounted Cash Flow method determines the business value by considering these inputs: y y y A stream of expected economic benefits, such as the net cash flows. A discount rate which establishes the required rate of return on investment. An expected gain from the disposition of the business at the conclusion of the ownership period, or the long-term (terminal) value.

The objective of the method is to determine what the expected economic benefits stream is worth in present day dollars, given the risks associated with owning and operating the small business. Because of the method's solid financial theory foundation, it is favored by seasoned investors and business valuation professionals. Business appraisers and economists sometimes use the formal name Discounted Future Economic Income when referring to the Discounted Cash Flow business valuation method. The reason is that this method is quite flexible with the choice of the income measures that can be used as its input. Key to the method's accuracy, though, is a careful match between the income measure, known as the earnings basis, and the discount rate.

Brand Valuation Methods ii. Capitalization of Earnings A common income-based small business valuation method that establishes the business value by dividing the expected business economic benefit, such as the seller's discretionary cash flow, by the capitalization rate. Capitalization of Earnings Method determines the business value using a single measure of the expected business economic benefit as the numerator. This is divided by the capitalization rate that represents the risk associated with receiving this benefit in the future. We discuss the capitalization and discounting business valuation methods in the Guide and show that the two are equivalent if the business earnings grow at a constant rate. In using this valuation method, care must be given to the proper selection of the economic benefit being capitalized and the appropriate capitalization rate. Accurate matching of the income being capitalized and selection of the capitalization rate are the key advantages of the Multiple of Discretionary Earnings business valuation method.

iii.

Multiple or discretionary earnings A key income-based small business valuation method that establishes the business value as a multiple of an economic benefit adjusted for net working capital, non-operating assets and long-term business liabilities. Multiple of Discretionary Earnings method establishes the business value by multiplying the seller's discretionary cash flow by a composite valuation multiple which is derived from a number of business, industry, market, and owner preferences factors. The method is especially well suited for valuing owner/operator managed businesses whose purchase is driven by both economic and lifestyle considerations.

Brand Valuation Methods

G. Royalty Relief Method

The Royalty Relief method is the most popular in practice. It is premised on the royalty that a company would have to pay for the use of the trademark if they had to license it (Aaker 1991). The methodology is as follows: 1. Determine the underlining base for the calculation (percentage of turnover, net sales or another base, or number of units) 2. Determine the appropriate royalty rate 3. Determine a growth rate, expected life and discount rate for the brand This appears to be very easy. However the real skill is determining what the appropriate royalty rate is. Two rules of thumb have emerged, the 25% rule and the 5% rule . The 25% rule proposes that the royalty should be 25% of the net profit. The 5% rule proposes that the royalty should be 5% of turnover. Both these rules have their base in the pharmaceutical industry. Professional valuers spend a considerable amount of time and effort determining the appropriate royalty rate. They rely on databases that publish international royalty rates for the specific industry and the product. This investigation will provide a range of appropriate royalty rates. The final royalty rate is decided upon after looking at the qualitative aspects around the brand, such as the strength of the brand team and management as well as many other factors. The advantages of this approach are that the valuation is industry specific and has been accepted by many tax authorities as an acceptable model. The disadvantage of this approach is that very few brands are truly comparable and usually the royalty rate encompasses more than just the brand. Licenses are normally for a limited time period and cover some sort of technical know-how payments (Barwise, et al. 1989).

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Brand Valuation Methods

III.

References

http://en.wikipedia.org/wiki/Category:Brand_valuation http://knol.google.com/k/management-accounting-brand-valuation#Methods_of_Brand_Valuation

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