Presented at the United Health Care Conference – Chicago, April 2013
The Brand Ranking Fever
- We have witnessed a brand valuation ranking fever by renowned publications; Financial Times, Forbes, Business Week; and by companies such as Interbrand, CoreBrand, Brand Finance, FutureBrand, Millward Brown Optimor, Y&R, among others marketing and brand research providers.
- As of 2012, a number of at least 67 providers and authors of valuations models have been identified.
- On the dark side, methodological differences will often lead to very dissimilar value estimations
- One of the hottest business topics during the last 25 years.
- Derives from the old Norse word “brandr” meaning literally “to burn” or the action by which owners of livestock marked their animals.
- The goal of brand valuation is to determine the economic or monetary value of a brand combining financial and marketing knowledge.
- Usually confused with the word evaluation, which goal is to determine brand equity.
- Regardless of the industry of which the firm is in, the methodology is the same. Nevertheless, there are differences across industries, as well as products and services that would make the brand valuation process unique and specific to every firm.
Why bother with brand valuation?
- What is the value of my brand?
- Is this the right question that most companies in every industry must be answered?
- Rather companies need an answer to the question “How – and for how much – can my brand contribute to the total success of my business?” (Haigh and Knowles, 2004b.)
Purpose and Applications
- Brand Management Purposes: brand architecture, brand portfolio, marketing budget allocation, and marketing strategy, among others.
- Transactional Purposes: Securitization and Tax Planning (Internal). Mergers & Acquisitions (External)
- Accounting Purposes: The value of acquired brands should be included in the balance sheet.
Approaches to Brand Valuation
- Cost Approach: The brand is valued considering all the cost involved during all phases brand development. However, figures are difficult to track back accurately, brand value is based on book value, and it does not capture the value added by brand management.
- Market Approach: Brand value is based on recent transactions (e.g. sales, acquisitions, licenses) of similar brands for which the price is well-known or available. Nevertheless, it requires temporality and similarity between the brands.
- Income Approach (Price Premium and Royalty Relief): Value is assessed by identifying future earnings attributable to the brand and these earnings are discounted back to present value (Discounted Cash Flows). Less subjective than the two approaches described above.
Income Approach: Price Premium
- Traditional in the valuation of intellectual property, particularly of patents (pharmaceutical drugs, inventions, etc.)
- Assumes the brand generates additional benefits from consumers willing to pay an extra price.
- Estimates the brand incremental profits by comparing its price with that of an equivalent generic or unbranded product.
- Uses statistical approaches such as Conjoint and Hedonic analyses reducing subjectivity.
- Disadvantages: Hard to find comparable brands; Premium price positions are hard to sustain for an extended period; Assumes brand and unbranded products or services will sell the same volume.
Income Approach: Royalty Relief Method
- Based on the royalty rate a company have to pay for using the brand it does not own.
- Brand value is determined as the present value of the royalty stream after taxes.
- Brand strength, brand driver analysis, or econometric model (e.g. price-demand elasticities combined with market share) can be used to establish a pseudo royalty rate by extracting the portion of economic profits attributable to the brand.
- Disadvantages: Hard to define the “right” royalty rate, though workable if data are available; It may not consider the upside value of having total control of the brand; Professionals rely excessively on industry’s royalties published by third parties; It is assume that royalties are stable throughout the years.
- Advantages: When it used correctly, this approach may be the most objective and accurate of all approaches available.
Income Approach: The Ideal Process
Two Important Concepts
Future Cash Flows to the Firm (FCFF) are the cash flows before debt payments, but after taxes and reinvestment needs. FCFF must be discounted at the Weighted Average Cost of Capital (WACC). Why?
- People prefer consuming today to consuming in the future
- Inflation decreases the purchasing power of cash over time
- A promised cash flow in the future may not be delivered. There is a risk in waiting
The Weighted Average Cost of Capital (WACC) must be assessed correctly. An inaccurate WACC may overestimate or underestimate the value of the entire company and the value of the brand.
Weighted Average Cost of Capital (WACC)
- WACC Includes the cost of debt plus the cost of equity, as follows
WACC = (D/D+E)(1-t)*rd+ (E/D+E)*re
D = Debt
E = Equity
t = Tax rate
rd = Interest rate of debt
re = Return rate of equity or simply, the cost of equity
- Using this formula, one can calculate the cost of the debt (short and long term debt) given by the interest rate associated with that debt.
- The cost of equity can be obtained econometrically using the Capital Asset Price Model (CAPM), developed in the early 1960s by Harry Markowitz.
- Briefly, Markowitz proposition is that the only risk you care about is the risk you cannot diversify away. Then, the expected return on the investment or equity can be written as:
Cost of Equity (re) = Risk-free rate + Beta*(ERP)
Risk-free rate = Usually the interest rate of U.S. Treasury Bonds
Beta = The relative risk measure standardize around one. It is specific for every industry and firm and can be obtained econometrically
ERP = Equity Risk Premium (difference between the expected market return and the risk-free rate)
- Though not yet well-known, betas can be estimated adding firm size and firm growth metrics, improving predictive power of risk and uncertainty.
- Having the future cash flows discounted at the correct WACC, the Net Present Value (NVP) of the enterprise (Enterprise Value) is obtained.
- This enterprise value represents the total value of the firm, which comprises the value of all physical assets and intangible assets including the value of the brand.
Brand’s Drivers Model
Linking Marketing with Finance
The Brand’s Driver Model provides both the quantitative and qualitative dimension of the brand.
The driver modeling is based from past or current field market research. Brand metrics that need to be collected are:
- Awareness (unaided, aided, top of mind)
- Brand Loyalty
- Purchase/Usage Consideration, Intent, and Preference (across time)
- Brand Identity Measures
- Perceptions of Quality
- Likelihood to Consider and Recommend
- Advocacy measures
- Performance Battery on Attributes (Category and/or Brand)
- Other (Leadership, Stability, Growth, Trend, support, Internationality, etc.)
Using all the information gathered from the above and any additional metric, a brand multiple is constructed using a value-to-sales or another suitable multiple as a dependent variable.
Value-to-Sales = f(Brand Metrics)
- This brand multiple will indicate the fraction of those enterprise cash flows that are effectively obtained due to the existence of the brand.
- In other words, the multiple may act as the royalty company has to pay for not owing the brand.
- But, how about if the market research information is inaccurate or incomplete to account for what the brand really represents?
Additional Measurements: The Royalty Relief
- Regardless of the reliability of the market research from where we estimate the brand multiple, the royalty relief method is an extra step to assess the fraction of DCFs attributable to the brand.
- There are firms specializing in royalty estimations across industries. However, these numbers are just averages not accounting for differences such as geography (local and global), market imperfections, unique products or services, company’s prominent position in a specific market, etc.
- The good news is this shortcoming can be overcomed by using firm’s data to estimate elasticities and market share econometrically.
Royalty Rates vs. Gross Profit Margins
Brand Risk Model
Firms, industries, and markets are just like cells. They are surrounded by other cells and by the environment in which they are functioning. In other words, risk is always present at the three levels; macroeconomic, market, and industry levels.
- This analysis will evaluate how vulnerable the brand is to the macroeconomic environment, competitors, and to the overall market conditions.
- The underlying concept is that the risk attached to brand-related cash flows is different from the risk attached to the rest of the firm. However, the risk associated to the brand may have a tremendous impact on the enterprise value, as macroeconomic and market conditions change.
- The analysis also has important brand and marketing strategy implications identifying threats and opportunities, as well as providing metrics for ongoing tracking of brand performance.
- Overall, the strength of the brand is given by the combination of hard metrics that measure the “quantity” of the brand as well as the behavioral or soft metrics that determine the “quality” of the brand.
- Part of the quantity of the brand includes metrics such as the wide presence of the brand, the amount of marketing spent, the time the brand has been in the market, etc. The quality metrics include among others measures such as brand growth, presence, relevance, authenticity, recall, loyalty, appeal etc.
- BMI: Brand Mix Index
- CPI: Consumer Price Index
- CSI: Consumer Sentiment Index
Brand Value: The Sum of Three Steps
- The Cash Flows to the Firm (FCFF) projection identified in the financial analysis, discounted at the WACC obtaining the Discounted Cash Flows (DCF).
- From the brand’s drivers analysis (or alternative methods), the portion of those DCF that can be in fact attributed to the brand, are calculated.
- From the brand’s risk model, the sum of these DCF from the brand adjusted by the risk assessed plus its Terminal Value (or the Future Cash Flows and growth prospective beyond the 5-years valuation), one can obtain the Net Present Value (NPV) of these future brand earnings or simply the economic value of the brand.
Can this methodology be applied to not-for-profit organizations?
The answer is yes with some provisions:
- A nonprofit organization does not pay any income taxes. Then, tax is excluded from cash flows of non-profit organizations.
- A non-profit entity cannot procure equity capital by selling ownwership certificates (common stock) in the open market, though they can procure debt financing in the tax-exempt bond market. Consequently, the WACC may be lower compared to for-profit organizations.
- Any other provision that may apply to a specific entity.
A Real World Example
- Mid-sized for-profit healthcare provider (320 beds), seeking funds for expansion using the brand as collateral for the long-term debt.
- Valuator followed the process of estimating discounted FCFF and firm’s value, as explained in this presentation.
- Firm’s marketing investments are minimal and the available data are out of date and unreliable.
- Valuator proceeded with valuation process using the royalty relief approach. Based on theoretical assumptions, valuator estimated such royalties at 7%.
- The hospital offers good surgery and special procedure services. Outpatient services are also above of what its competitors can offer. It enjoys some monopolistic position in the market with an estimated market share of 41.3%. Market share of its closer competitor is estimated at 29.7%.
- Using econometrics, price-demand elasticity at means were estimated at 2.12 and 1.54 to both main companies, respectively.
- Using this information, the final royalty is calculated at 13%, a difference that would save to the HC provider $3.2MM in financing costs.
- There is still a gap to be filled between the academic and the professional practice approach to brand valuation (BV).
- Brand valuation is fostering a better understanding and convergence between two old foes; marketing and finance.
- Need of agreement and consensus between theory and practice. This will also serve as a consistency check point for all approaches.
- Income (Royalty Relief) is growing as the most widely used method, though the use of multiples, stock price movements, and advanced econometrics are getting more traction recently.
- CAPM still remains as the best approach to estimate the cost of equity. Currently, econometric estimation of betas can also account for firm size and growth prospective adding more information and accuracy to beta calculations.
- The industry needs to create more transparency about approaches to brand valuation. They need to educate their audience and final users of BV.
Pedro V. Piffaut, Ph.D.
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