Brand Valuation: One of the most significant sources of economic value creation
The past six decades have seen a massive shift in the source of economic value creation from tangible to intangible assets.
If one was to consider this change in terms of the S&P 500, in 1975, 83% of the index value was tangible assets. Over the subsequent decades, this contribution shrunk as industries accelerated intangible and IP investment and creation. So much so that by 2020 only 10% of the S&P 500 value was tangible, the remaining 90% being capitalized and undisclosed intangible value, including goodwill.
Naturally, the global evolution of intangible value creation is nuanced and varies by economy and industry type, but there is universal agreement that intangible assets are now largely central to creating and maintaining economic value for businesses.
Under U.S. GAAP, and international accounting standards (IFRS), there are five defined groups of intangible assets:
Unsurprisingly the level of importance and inherent value of these intangible classes vary by industry. Drilling contracts between the contractor and oilfield owner are of utmost significance and value within the oil & gas industry. Similarly, there is considerable value for airlines in their contractual arrangements with airport authorities for landing rights. Aerospace, software, and pharmaceuticals are industries in which patented technology, trade secrets, and secret formulas are large contributors to economic value.
Within the consumer goods industry, such as fashion and cosmetics, brand is probably the single most valuable intangible asset owned by the organization.
However, the inherent value of brand is not exclusive to consumer-facing sectors. Within the mix of intangible assets owned across most industries, brands play an important role in helping companies differentiate themselves in their strategic markets and communicate why their products and services are uniquely able to satisfy customer needs.
Even within the business-to-business sector, where some might assume the role of brand is less relevant, one could almost argue that brand is actually more important. Within a business context, a B2B customer likely demands high-quality products or services, strong customer service, and reliability. Their project or job can often depend on it, and therefore a B2B brand that can authentically encapsulate these attributes is likely to command strong customer preference and even a price premium.
The truth is that there are many ways of defining a brand, depending on the context. In the world of licensing, for instance, one might define brand in the narrowest sense as the trademark and tradename, representing the specific visual elements that are typically included in arms-length brand licensing arrangements and representing the usual legally protected components of a brand.
A wider definition of brand is trademark and associated marketing IP, including a wider bundle of IP components to clearly differentiate the brand and to generate consumer demand.
Under this definition, the wider bundle of IP typically includes trademarks, trade names, wordmarks, domain names, typography, trade dress, design elements, and related copyrights. It is most often utilized for financial valuation exercises as brand under this definition represents the full capital value of the asset as a separable and transferable asset.
A broader definition of brand encapsulates the visual elements of IP and legal rights with the overarching organizational culture, its people, and business activities. This wider definition extends beyond what can be legally protected and, indeed, packaged up and sold as a brand asset in an arms-length transaction but represents the full organizational brand value proposition and promise.
This latter definition implies that brand-building investment and communication should not simply be focused on the customer or consumer in an act to drive consideration and preference for your products and services but rather address all brand stakeholder groups that are engaged with the business and brand.
Take the organization’s employees, for instance. A strong brand is typically able to attract higher-quality staff and is often able to retain them for longer. This has a direct effect on staff recruitment, retention, and training expenditure.
What about company suppliers and financiers? A strong brand is likely able to attract better supply partners on more favorable terms and at lower prices. Equally, a strong brand could potentially negotiate better borrowing costs and terms.
CEOs and business owners cannot, therefore, afford to overlook brand as one of the most significant sources of economic value creation.
Within the mix of intangible assets, brands play an important role in helping companies differentiate themselves in their strategic markets.
Although brands cannot be capitalized on the organization’s balance sheet under international accounting standards unless acquired in a purchase transaction or acquired through a business combination, there are still many commercial and technical motivations for brand valuation, such as:
- Business Performance – Attribute a financial value to the brand to determine its significance in driving business performance, how the brand is driving value and how it can be leveraged across the business
- Tax & Transfer Pricing – Ensuring compliance with the latest tax and internal transfer pricing of brand IP
- Brand Damages & Litigation Support – Valuation of business and brand damages through IP exploitation
- Fair Value Exercises – Valuation of all intangible assets acquired as part of a business combination under IFRS
- Fundraising – IP (including brand) valuations can facilitate access to credit or help in negotiating greater availability and lower interest rates
- M&A – Understanding the value of brand IP supports M&A activities, where precedence is almost always given to other assets and investment case factors.
There are various valuation approaches that can be adopted depending on the circumstances and information available. These are:
- Cost Approach
- Market Approach
- Income Approach
The use of a cost approach involves the valuer ascertaining the cost to create or recreate the subject asset. The cost to create the asset to date or to recreate a similar asset with identical functionality can, in certain circumstances, be considered as a simile for value, particularly in the absence of credibly observed economic performance.
One fundamental issue with the cost method is that future economic benefits, and therefore value, are excluded. For example, the U.S. car manufacturer Tesla enjoys high levels of brand equity and awareness globally; however, it has spent very little in terms of marketing, advertising, and direct brand building. Under the cost basis, it is likely the valuation would not be strictly indicative of the true economic value of the brand. As the value of brands seldom equates to the costs invested in creating them (or hypothetically replacing or reproducing them), this is not a widely used approach. However, in certain instances, a cost approach can serve as a useful basis for gauging the value of intangible assets, for example, where the asset is not being marketed or at a stage when commercialization is a realistic prospect.
The second approach is the market basis. This approach considers how the market views the brand concerned.
If there have been recent transactions in the subject brand, then this can provide a good indication of the value that the market places on that brand.
The market approach is rather straightforward, as it is effectively a benchmarking exercise, yet despite it being a common approach for the valuation of businesses, it has many drawbacks in the valuation of ‘brand.’ For instance, there are relatively few brand sales by way of comparison, and as brands are unique, it is often hard to find a relevant comparable. Moreover, market benchmarks are susceptible to different negotiating skills on both sides of the transaction, and ‘special purchasers’ may be willing to pay a premium for a brand to take advantage of things like synergies or competitive advantage.
The income approach focuses on the income-producing capability of the subject brand. The underlying premise of this approach is that the value of an asset can be measured by the present worth of the net economic benefit to be received over the life of the subject asset. The steps followed in applying this approach include estimating the expected after-tax cash flows or profits attributable to the brand over its life and converting these to present value.
In order to drive out cash flows for brands where separate forecasts of specific profitability are unavailable, one of the most widely used methodologies is royalty relief. In royalty relief methodology, the hypothesis is that if the business did not own the intellectual property, it would need to license it, and therefore the royalty paid can be taken as a simile for the income driven out by the intellectual asset in isolation.
Brands are one of the most important value-creating assets within an organization, so it stands to reason that the asset’s performance should be measured, evaluated, and valued much like other assets, many of which are capitalized in the books. Understanding what drives brand value and how brand fuels business and shareholder value creation is crucial to ensuring brand decision making is in lockstep with business strategy.
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