Integrating Finance and Marketing: Economic Use Method - The Economy of Brands

INTEGRATING FINANCE AND MARKETING: ECONOMIC USE METHOD

Jan Lindemann

The purely market research and financially focused methods deliver unsatisfactory results for assessing the economic value of brands because they are either weak on the marketing or financial understanding. As a result, new valuation approaches emerged that integrate financial and marketing analyses into one valuation approach. This is referred to as the “economic use” method. This method values the brand as an integral part of a company and focuses on the added value the brand provides to the underlying business. This approach emerged due to a need to go beyond the mechanics of calculating a financial value to understand and manage the value creation of brands. This requires a detailed understanding and valuation of the specific value creation of a brand. There are several consulting firms that have developed their version of the economic use approach including Interbrand, Brand Finance, and Millward Brown. 

One of the most famous economic use approaches was developed by Interbrand – a consulting company that pioneered brand valuation in the late 1980s. The initial approach was developed for financial purposes to help companies to recognize the value of their brands on the balance sheet. The model was a relatively simple multiples approach. The basis for determining the earnings attributable to the brand was the operating profit of the business using the brand. Taxes and a charge for the capital employed in the business were subtracted from the operating profit to derive brand earnings. The multiplier was determined through a brand strength assessment. The strength of a brand was assessed on a scale of 0–10. The extreme ends of the scale represented theoretical concepts. A completely unknown brand would receive a score of 0 while a notionally perfect brand would receive a score of 100. A brand with a brand strength score of 0 would have a multiple of 0 and thus no value. A brand with a score of 100 would receive a multiple of 20 which was derived from P/E (Price/Earnings) multiples of quoted companies with strong brands. The multiples between the two extremes are determined through an “S” shaped curve representing the relationship between brand strength and brand value, i.e., the stronger the brand the higher the value and vice-versa. The brand strength is determined according to seven factors. Each factor has a different maximum weight with the sum of all factors adding up to 100. The factors and their weighting are as follows:

1. Leadership (25/100)

This factor assesses the degree to which a brand influences the market it operates in. Indicators are setting price points, command distribution, and being resistant against competitive pressures.

2. Stability (15/100)

This factor refers to consumer loyalty and whether the brand has become the “fabric” of the market it operates in.

3. Market (10/100)

This factor refers to the market the brand operates in. This is assessed according to growth rates, barriers to entry, and risk of structural change.

4. Internationality (25/100)

This factor looks at the geographic spread of the brand based on the assumption that the more markets and cultures the brand can penetrate the more valuable it is.

5. Trend (10/100) 

This factor measures the ability of a brand to stay contemporary and relevant in its markets.

6. Support (10/100)

This factor assesses the amount of marketing spend as well as the management of the contents of a brand.

7. Protection (5/100)

This factor assesses how well the legal protection is managed including trademark registration and management.¹

The brand strength model has been the most consistent element of Interbrand’s brand valuation approach. Although the firm has adjusted its valuation approach over the years, the principles of the brand strength model remained mainly unchanged.² The firm made two significant changes to its valuation approach. First, it switched from a multiples approach to a NPV calculation of brand specific earnings. Second, it introduced a profit-split element called “role of branding” that separated the earnings attributable to the brand from the earnings of the other intangibles.³ The switch from a multiples approach to a NPV calculation resulted in the brand strength model being applied to the discount rate instead of a P/E multiple. The model assumes that the strongest possible brand receives a score of 100 and has a risk profile similar to government bonds. The discount rate changes according to the strength of the brand meaning that the weaker the brand the higher the discount rate and vice-versa.⁴ Through these adjustments Interbrand has defined the main elements of the economic use approach that values a brand in the context of owner and user. This valuation approach comprises three key elements: Financial forecasting of intangible earnings; identification and separation of the earnings attributable to the brand; and a brand strength assessment to determine a brand specific discount rate. The steps in detail are as follows: 

1. Financial forecasting: The firm forecasts the current and future revenue specifically attributable to the branded products. It then subtracts operating costs, taxes, and a charge to the brand’s profit for capital employed to derive the economic earnings. 
2. Role of brand analysis: Here Interbrand assesses which part of the economic earnings is attributable specifically to the brand. The role of brand measures how the brand influences customer demand at the point of purchase. This is applied to the economic earnings to arrive at Branded Earnings. The approach is proprietary and not disclosed in further detail. 
3. Brand strength analysis: The seven brand strength factors determine the discount rate which is used to calculate the NPV of the brand specific earnings. 

Based on these three steps Interbrand calculates brand value as the NPV of the forecast brand earnings.⁵

Another firm that has developed a similar economic use approach is Brand Finance. Their approach is very similar to that of Interbrand (which is not surprising as the founder previously worked for Interbrand) but differs in some aspects in the brand analyses. The value of a brand is calculated as NPV of future expected earnings attributable to the brand. Brand Finance’s valuation methodology follows the following steps: 

1. Financial forecasting 

Brand Finance prepares a 5-year revenue forecast based on company data, analyst estimates, and overall macroeconomic data such GDP growth. The company also identifies a final growth rate for the perpetuity calculation. 

2. Brand specific earnings 

For identifying the brand specific earnings Brand Finance uses the royalty relief method. Based on publicly available data, it identifies and selects royalty rates from brands that are assumed to be comparable to the brand being valued. From these comparable royalty rates it derives a fictitious licensing rate that is applied to the revenue forecast to derive the brand earnings forecast. The main flaw here is the assumed comparability (discussed earlier). In order to create value, brands need to be different and therefore, should not be comparable. 

3. Brand rating 

Similar to Interbrand, Brand Finance measure the strength of a brand on a 0–100 rating scale according to a number of attributes such as brand presence, emotional connection, market share, and profitability. The brand rating benchmarks the strength, risk, and future potential of a brand relative to its competitors on a scale ranging from AAA to D. The rating results are defined in the following way: 

– AAA Extremely strong 

– AA Very strong 

– A Strong 

– BBB-B Average 

– CCC-C Weak 

– DDD-D Failing 

The brand rating is converted into a brand beta, which takes additional factors into consideration such as geographic presence and reputation that are beyond the rating attributes. The brand beta determines the discount rate that is applied to the future brand earnings. The value of the brand is the net present value of the forecast brand earnings.⁶ The Brand Finance approach relies on comparable royalties to derive the brand specific profits. However, in many categories royalties can vary more than 100 percent making the final selection very judgmental. 

Another version of the economic use approach is provided by Millward Brown based on the BrandZ brand equity study. The approach has been discussed previously. 

While these are the main internationally established and used brand valuation approaches there many more variations on the same themes. Several studies have identified more than 40 brand valuation approaches.⁷ While in principal rather similar they all claim to use proprietary research analysis tools to determine the value of brands. 

The brand valuation methodologies of Interband, Brand Finance, and Millward Brown have become prominent due to the brand value rankings these firms publish on an annual basis. Although there are many other versions of the economic use approach they tend to follow similar frameworks. The ranking surveys published by the brand consulting firms show that the different methods produce rather different results for the same brands (see Table 6.1).

TABLE 6.1     Brand value comparison

Brand value in $ million	Interbrand	Millward Brown	Brand Finance
Coca-Cola	68,734	67,625	32,728
IBM	60,211	66,662	31,530
GE	47,777	59,793	26,654
Nokia	34,864	35,163	19,889
Apple	15,433	63,113	13,648
McDonald’s	32,275	66,575	20,003
HSBC	10,510	19,079	25,364
American Express	14,971	14,963	9,944
Google	31,980	100,039	29,261
Nike	13,179	11,999	14,583

Sources: Best Global Brands (2009) BrandZ Top 100, 2009; Global 500, 2009.

While there are occasional similarities in the values at least between two of the firms there are staggering differences in the value of established brands such as IBM and McDonald’s. The value differences are even more dramatic with respect to the annual value changes. This has caused considerable confusion and has given the impression that valuing brands is a rather arbitrary affair. The cause is not helped by the fact that many agencies use proprietary tools based on their own research and experience for their brand specific analyses. The lack of disclosure of the valuation inputs and assumptions is responsible for the differences in brand values these models produce. Neither the financial nor the marketing inputs are sufficiently disclosed to allow a reconciliation of the brand values published in the surveys of these agencies. This is confirmed by a study published by a German magazine in 2004. The publication asked nine agencies offering brand valuations to value the brand of a fictitious petrol retailing chain. This included prominent brand valuation firms such as Interbrand and leading accounting firms such as PwC and KPMG. The agencies were given the same data and information and were asked to use their approaches to come up with a brand value for the fictional retail petrol company called Tank AG. The results showed dramatic differences in values ranging between a173 million and a958 million representing a difference of 454 percent.⁸ This study also confirms that due to the lack of disclosure and the use of “proprietory” models, the brand values cannot be compared or assessed. It would however, be unfair and counter productive to dismiss brand valuation as a discipline due to the differences in approaches and valuation results. Personal experience has shown that brand valuation can deliver significant strategic insights and guidance on brand and business strategy. Knowing how brands create value is very useful in understanding business and stock market performances of companies. It would be wise to be more realistic regarding the expectations toward brand valuation. 

All financial valuations are based on a set of assumptions at a particular point in time. NPV valuations represent the cash flows that an asset is expected to generate during its economic life.⁹ The share price targets for the next 12 months for a stable branded business such as The Coca- Cola Company from 11 analysts covering the company had a variance of about 30 percent as of 31 August 2009.¹⁰ This demonstrates that even analysts that spend their careers analyzing and valuing this company and its peers differ significantly in their valuations. The point here is not to question the validity of valuation in general and the discounted cash flow (DCF) approach in particular. DCF is the dominant and most widely used approach for valuing nearly all assets. It is the foundation and guiding valuation principle for corporate finance theory, capital markets, and businesses. Although DCF is the professional asset valuation approach it is not a precise science. The period 2008/9 has proven how a change in circumstances can affect valuation most notably in capital markets. As brand valuation is a derivative of business valuation the same issues apply. Although all NPV valuations based on the DCF approach use the same principles and underlying model the results can differ dramatically. This is due to the amount of assumptions that need to be made for such valuations. This includes revenue growth rates, profit margins, investment requirements, capital structure, and discount rate to name a few. Due to different inputs for these items valuations can vary substantially despite using the same valuation approach. This means the judgment about the valuation inputs has a significant impact on the outcome and validity of the valuation. In order to assess different valuations one needs to understand the underlying assumptions. The ultimate test for the validity of a valuation is the market test or exchange value of an asset in a transaction between two parties. In the case of capital market predictions about asset valuations, share prices are constantly validated due to the liquidity of these markets. Unfortunately, for brands such a market does not exist. Their value is mostly wrapped up with other assets. A direct market validation of brand values is therefore not possible. However, brand value can be compared to shareholder value as well as the value of other intangibles. These ratios provide some cross and reasonability checks. Most importantly, the consulting firms that publish the league tables need to improve disclosure about their models and assumptions. This would very quickly explain the valuation difference between different approaches. 

The need to find more common ground and clarity in valuing brands has prompted several initiatives. The German standardization office Deutsches Institut für Normung (DIN) has initiated a work group for creating an ISO standard for brand valuation.¹¹ Such a standard already exists for market research. DIN believes that an ISO standard would provide some transparency and quality standards that would lift the reputation of the discipline and would make the results of brand valuation more reliable. Although many countries are participating in the effort, there are some prominent absentees most notably the US, Russia, and the Latin American countries. A wide-range of constituencies has been involved including brand consulting firms, accounting firms, law firms, and market research companies. Given the diversity of backgrounds and approaches many of them offer it will be a difficult task to get a meaningful consensus. A realistic outcome would be a set of guidelines that clarify approach, data input, and assumptions of a brand valuation that enable an outside party to understand the individual valuation steps as well as the valuation results. Additionally, German representatives from several accounting, brand consulting, and market research firms engaged in the valuation of brands have formed a brand valuation forum that published 10 principles of monetary brand valuation. They stipulate that a brand should be valued as NPV of future brand earnings where the brand specific earnings and risks should be identified through a set of parameters.¹²

NOTES

1. Noel Penrose, 1989, pp. 37–9.
2. See Best Global Brands, 2009; Raymond Perrier (ed.), 1997, pp. 55–60; Brand Valuation, 2008.
3. Raymond Perrier (ed.), 1997, pp. 33, 43–53.
4. Best Canadian Brands, 2008.
5. see Best Global Brands, 2009.
6. “Global 500,” 2009.
7. Anita Zednik and Andreas Strebinger, 2008; Best Global Brands 2009; Gabriella Salinas 2009.
8. See Markenbewertung – Die Tank AG, Absatzwirtschaft, 2004.
9. Tom Koller, Marc Goedhart and David Wessels, 2005, pp 277–8.
10. See Financial Times, 2009.
11. DIN ISO .
12. Brand Valuation Forum 2008.

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