The Value of Brands - The Economy of Brands

THE VALUE OF BRANDS

Jan Lindemann

The value of brands materializes in several ways. The most direct and obvious is the sale of products and services to consumers. The combination of the price paid for a product plus the quantity and frequency of purchase creates the sales revenues for a business. This is converted into profits and ultimately shareholder value. The share price of a company is driven by investor’s expectations about the future ability of the business to attract customer revenue and extract profits from these. The value of brands also materializes in mergers and acquisitions, the subsequent balance sheet recognition, licensing, and other financial transactions such as securitizations. 

BRANDS AS INTANGIBLE ASSETS 

Intangible assets have become the key driver of shareholder value. Over the past 25 years the average price-to-tangible book value of the S&P 500 (a value-weighted index published since 1957 of the prices of 500 largecap common stocks actively traded in the United States) has been about 3.9 meaning that investors valued the companies included in the S&P 500 close to four times their tangible net assets (see Figure 2.1). In this context it is important to note that the S&P 500 index includes a wide range of B2B businesses as well as companies from the energy, resources, and manufacturing industries that have traditionally been more physical asset heavy. The time period also includes several business cycles and stock market bull and bear phases. The average price to tangible book value of the S&P 500 rose steadily from an average of around 1.4 at the beginning of the 1980s to around 3.1 in the mid-1990s. It accelerated rapidly in the late 1990s to exceed 7.0 during the dotcom bubble before falling back to 2.7 during the 2008/9 stock market crash. The long-term price to tangible book value of 3.9 indicates that the tangible assets of a business (land, equipment, inventory, net working capital,

FIGURE 2.1     S&P 500 price to tangible book value

Source: Bloomberg, 2009.

etc.) account for about a quarter of the value that investors are placing on a company. The remaining three-quarters are accounted for by intangible assets such as patents, business systems, distribution rights, brands, customer databases, and the quality of a company’s management and workforce. Although book and market value are only partially comparable, as most accounting items are cost based and the share price represents investors’ expectations of the future cash flows of a business, the price to tangible book value provides a sufficiently clear indication that investors see the majority of value in a company’s intangible assets. 

Among all intangible assets the brand is unique with respect to its durability and holistic nature. Brands can maintain their leading position over long periods of time. Some of the worlds leading brands such as Coca-Cola, Gillette, and Goldman Sachs are over 100 years old. Most brands outlive all other business assets. Brands are also more holistic than other assets as they are the combined result of all customer experiences and communications. Ultimately, brands represent the relationship between a company and its customers who generate its revenues through buying its products and services. This is supported by the fact that consumer and brand related spending accounted in 2008 for 72 percent of US gross domestic product.¹ That means that nearly two-thirds of the GDP of the world’s largest economy are tied to brands and their value generation.

EMERGING RECOGNITION OF THE VALUE OF BRANDS 

Although brands have been important business assets since the early days of commerce and larger scale manufacturing, the wider recognition of their role in business is the result of the M&A activity of the late-1980s and early-1990s when a number of companies with strong brands were taken over. In 1988, Nestlé bought Rowntree for UK£2.8 billion or five times its book value and in the same year Philip Morris bought Kraft General Foods for US$12.9 billion at a multiple of six times its book value. About 90 percent of the value was represented by the Kraft Food’s brand portfolio.²  These large takeover multiples demonstrated the importance of the value of brands and intangible assets relative to the value of the tangible assets such as land and manufacturing facilities. This led to a growing interest in brands and other intangible assets from both the accountancy profession and the executive suite. The accounting profession was primarily interested in updating the treatment of what had, up until then, been termed “goodwill” (defined as the difference between the purchase price of a company and the book value of its assets). As long as this difference was relatively modest, goodwill was regarded as a minor balancing item rather than a serious valuation issue. As the portion of goodwill in transactions increased, and often dwarfed the value of tangible assets, it became necessary to be more specific about its definition and accounting treatment. The United Kingdom was the first market to react by introducing in 1998 the Financial Reporting Standard 10. In 2001, the United States followed suit with the Financial Accounting Standard 141 and in 2005, the International Financial Reporting Standard 3 was published laying out the internationally agreed way of accounting for goodwill in acquisitions. Since then many companies such as The Coca- Cola Company, Vodafone, AT&T, P&G, LVMH, Prada, L’Oréal, have included the value of their acquired brands on the balance sheet. 

There is a wide range of intangible assets. Patents are intangible assets and so is human capital. Accounting standards have tried to bundle them into different classes to ease their assessment and valuation. According to international accounting standards there are marketing related, customer related, artistic, contractual, and technology related intangible assets. Brands according to the definition developed in Chapter 1 fall mainly into the first two categories. However, the complexity of branding according to current management thinking does not fit the accounting approach. In order to understand and quantify how much brands contribute to shareholder value one needs to step beyond the accounting definition and look at the meaning and effect brands have on a business. If the brand is the key driver of customer or consumer choice then its importance relative to the other intangible assets must be significant.

THE ROLE OF BRANDS IN BUSINESS 

The most acclaimed management gurus have acknowledged the important role of branding and marketing. Peter Drucker, the management guru credited with the creation of management science, famously stated that “business has only two functions – marketing and innovation.”³ Later, Michael Porter, another management guru who conceptualized competitive advantage, argued that competitive advantage is a function of either providing comparable buyer value more efficiently than competitors (lower cost), or performing activities at comparable cost but in unique ways that create more buyer value than competitors and, hence, command a premium price, i.e. differentiation through branding. According to Porter, you win either by being cheaper or by being different, that is, being perceived by the customer as better or more relevant.⁴ These examples give some indication about the unique nature of brands over and above other assets. With global competition and excess capacity in virtually every industry, brands are crucial for communicating why a company’s products and services are uniquely able to satisfy customer needs. In an environment where the functional differences between products and services have nearly vanished, brands provide the basis for establishing meaningful differences between competing offers. 

In most categories the choice of offers is overwhelming. From television to mobile phones, telecommunication networks, watches, electricity tariffs, cars, detergents, cornflakes, mustard, chocolate, life insurance, investment funds, shampoo, fashion, etc. there is a plethora of offers to chose from. In the majority of these categories quality is more a perception than a reality. The automotive market is a good example in this respect. The massive improvements in inherent automobile quality over the past decade mean that reliability and functionality are no longer a basis for differentiation. Today, most cars on offer are well built. According to a J.D. Power survey, (a US based marketing services information firm best known for its customer satisfaction research on new-car quality and long-term dependability) the overall quality of cars between 1998 and 2008 improved from an average of 1.76 problems per vehicle to 1.18 problems per vehicle. Comparing the best and worst performers demonstrates the insignificance of the difference in performance between different car brands. According to the 2008 survey, Jeep had 1.67 problems per vehicle while Porsche had 0.87 problems per vehicle. Problems here include every minor failure such as car seat heating and other gadgets.⁵ While the actual quality difference is negligible it offers marketing opportunities for the brands topping the list. Lexus is a brand that has marketed itself heavily on its performance in the J.D Power surveys. However, this is more about perception of quality than actual difference. Perceived quality is only one of many factors that drive customer choice in cars. The purchase is driven by a complex mix of design, price, incentives, dealer networks, features, drive experience, and fuel economy among others. In any given car category there are sufficient choices on offer that do not differ by quality or other technical features. They do, however, differ by the way they are perceived by potential buyers and it is their perception that determines the purchase. 

There are many other examples that demonstrate how businesses depend heavily on the intangible asset brand. Water is a great example for the economic impact of branding. Water is in most developed economies a commodity paid for through utility bills. However, branded bottled water has become a major market over the past 10 years exceeding US$50 billion in 2008.⁶ Bottled water is offered at very different price points. For example, consumers in the UK are willing to pay 141 times more for a liter of Evian water than for tap water. This is even more surprising when blind tests revealed that more than half of participants could not taste a difference between the tap and the bottled water and some even preferred the taste of tap water.⁷ Consumers are willing to pay this enormous price premium because they perceive bottled water to be purer, cleaner, and ultimately healthier. This perception continues despite the fact that in most OECD countries health regulations regarding tap water are more stringent and strict than is the case for bottled water.Water in plastic bottles is often treated with radiation to kill potential germs and allow its storage for many years. In addition, there are many brands such as Aquafina and Dasani that sell reprocessed municipal water which is basically tap water. Clearly, consumers are not paying a high premium for the functional benefit of drinking water but the brand promise of a pure and healthy lifestyle. Similar dynamics can be found in other categories. There are luxury watches with complicated automatic movements and precious metals selling for thousands of dollars that are less accurate than watches with a quartz movement selling for less than US$50. A Cartier lady’s watch with a quartz movement in stainless steel costs around US$2,000 – a similar watch made from the same materials also with a quartz movement can be bought for a fraction of the price. 

In 2008, Smart, a brand of Daimler AG’s personal car group, introduced a 10 year anniversary model designed by Hermès International, a leading French fashion group. While the Smart usually retails for around US$14,000, the special Hermès edition costs about US$48,000, over three times that of the standard model.⁸ The premium is not paid for the fine leather interior or coloring but for the co-branding with Hermès. 

The impact of branding is not limited to the B2C market. The professional buyer is equally prone to the influence of brand perceptions when choosing a supplier or firm. From financial services to IT systems the choice is from a wide range of similar offers.⁹ For example, a survey by UBS in 2003 found that there was very little differentiation between banks on the key attributes on which customers choose their investment bank.¹⁰ Most of them can produce similar expertise, experience, and track records. Nevertheless, fear, uncertainty, and doubt also known as FUD lead many professional buyers to seek the services of established brands. There is also the glamor and perception of success that drive many senior executives to buy the services of famous consulting and advisory firms. These brands are also often used to enable and support change and senior executive decisions. After all, if firms such as McKinsey or Goldman Sachs suggest certain strategies and transactions it is implied that as the best of their breed they will be the right decisions. This is epitomized by the traditional axiom of purchasing agents that “nobody ever got fired for buying IBM equipment.”¹¹ It is therefore not surprising to find among the top leading global brands B2B brands such as IBM, Intel, Microsoft, and GE. 

BRANDS AND SHAREHOLDER VALUE 

The specific value that brands contribute to shareholder value has been most prominently demonstrated by the “Best Global Brands” survey published in BusinessWeek in cooperation with Interbrand annually since 2001. This ranking has been most influential in boardrooms and among c-level executives around the world. Based on a survey of

TABLE 2.1 Selected brand values according to brand value surveys published in 2009

Brand value in $ million	BusinessWeek/ Interbrand	Millward Brown	Brand Finance	Brand value average	% of market capital
Coca-Cola	68,734	67,625	32,728	56,362	49
IBM	60,211	66,662	31,530	52,801	34
GE	47,777	59,793	26,654	44,741	30
Nokia	34,864	35,163	19,889	29,972	74
Apple	15,433	63,113	13,648	30,731	21
McDonald’s	32,275	66,575	20,003	39,618	65
HSBC	10,510	19,079	25,364	18,318	17
American Express	14,971	14,963	9,944	13,293	37
Google	31,980	100,039	29,261	53,760	38
Nike	13,179	11,999	14,583	13,254	48

Sources: Compiled from Best Global Brand 2008; BrandZ Top 100, 2009; Global 500, 2009.

leading global companies, this ranking has continuously been voted by leading PR-firm Burson-Marsteller among the top most influential reputation rankings.¹² The survey has firmly established the importance of branding among CEOs and other senior management worldwide. The author of this book established and has managed this survey for a considerable time. Many companies have utilized the survey for benchmarking or as KPI for their marketing executives. According to the BusinessWeek survey, brands account on average for more than onethird of shareholder value. Other firms have also published brand values most notably market research firm Millward Brown and brand valuation specialist BrandFinance although these surveys do not have a comparable reputation to the BusinessWeek study. Despite significant valuation differences between these surveys, they all demonstrate the substantial value brands contribute to shareholder value. For example, the value of the McDonalds brand accounts, according to the average brand value of all three surveys, for 65 percent of the company’s stock market value (see Table 2.1). 

The rankings clearly show that brands do not only contribute significant value to consumer focused business but also B2B businesses such as IBM and GE. In the case of IBM, for example, the brand accounts for 34 percent of shareholder value. For most companies the brand represents the largest business asset. 

Several studies have used the brand values published in the Best Global Brands survey to prove the shareholder value impact of brands.

These studies compared the performance of companies with strong brands featured in the survey with a market portfolio representing the rest of the stock market in the US. According to their findings a portfolio based on brand value significantly outperforms the market portfolio with respect to both return and risk. The brand portfolio showed a monthly return of 64 basis points (0.64 percent) or 48 percent above the market portfolio excluding the companies in the brand portfolio. At the same time the brand value weighted portfolio had a significantly lower risk profile than the market. Its beta, a financial measure for risk, was 0.85 or 15 percent lower than the market portfolio.¹³ This research demonstrates that strong brands can provide a business with sustainable higher returns than the market at significantly lower risk. Other published studies based on brand values show a similar outperformance of stocks with strong brands relative to key indices such as the S&P 500 and the MSCI World Index, a stock market index consisting of 1,500 stocks of companies from 29 countries.¹⁴

The success of the Best Global Brands has led many other institutions to publish brand value rankings on a local and global scale. As most of these cover a much shorter time period they have not been academically verified in the same way as the Best Global Brands survey. Institutions that provide brand value rankings include Millward Brown, Brand Finance, and Intangible Business. Although all these surveys identify a significant value variance for the same brands they confirm the overall value creation of brands¹⁵

Several rationales support the hypothesis that brand value is linked to the market value of a firm’s equity. For example, high brand value smoothes earnings in cyclical industries or in general periods of lower sales. During these downturns, consumers tend to spend less. As consumers are comfortable with highly regarded brands, sales of these products tend not to decline as much as the industry in general. Brand value also provides protection from competitors due to increased customer loyalty. Overall, companies with stronger brands do not suffer as much from external threats and, therefore, are less likely to experience financial distress. 

THE VALUE OF BRANDS IN MERGERS AND ACQUISITIONS 

The value of brands is also evidenced by their increasing importance in large financial transactions. One of the largest leveraged buyouts was completed on the back of a strong portfolio of brands. In 1988, KKR one of the pioneers of leveraged buyouts acquired RJR Nabisco for US$31.4 billion. The portfolio included iconic brands such as Oreo, Ritz, Camel, andWinston. Two recent transactions in the spirits industry illustrate the value an even relatively recently created brand can achieve. In August 2005 Bacardi acquired Grey Goose Vodka for US$2.2 billion, 15 times its EBITDA (earnings before interest, tax depreciation and amortization) or 4.7 times its annual revenue. The brand was created in 1998 and became the leading premium vodka brand in the US by 2003. In 2008, 3 years later, Pernod Ricard acquired Vin & Sprit for a5.6 billion implying a EBITDA multiple of 20.8.¹⁶ The main asset of this transaction was the Absolut brand which was created in 1979. The acquisition multiple topped even the heady price Bacardi had paid for Grey Goose Vodka. In 2005 SBC Communications one of the leading regional telecoms in the US acquired AT&T for US$16 billion. Although the AT&T brand had a 120 year history its reputation had suffered in the recent past. The announcement of SBC’s CEO Edward E. Whitacre Jr. that the new company would adopt the AT&T brand came to the surprise of many marketing experts. Whitacre quoted the brand’s heritage and its international recognition as the main reasons for adopting the AT&T brand for the merged businesses. The value of the AT&T brand in the acquisition price of US$16 billion amounted to US$4.9 billion, or 31 percent of the company’s value.¹⁷ 

The high multiples that have been paid for businesses with strong brands match the findings of the stock market performance of companies with strong brands. In most businesses brands are a key value driver and often the single most valuable business asset. However, their value is not static and requires careful handling and management. In order to assess the economic value of brands it is therefore crucial to have a clear understanding of how this value is generated. The following chapters will explore methods and techniques for valuing brands and how to use them to optimize the value creation of brands.

NOTES

1. John A. Quelch and Katherine E. Jocz, 2009.
2. Sundar S. Bharadwaj, 2008.
3. Peter F. Drucker, 1954, p. 32.
4. Michael E. Porter, 1985.
5. Associated Press, 2008.
6. International Bottled Water Association and the Beverage Marketing Corporation, 2008.
7. Which online.
8. Women’s Wear Daily, 2008.
9. Philip Kottler and Waldemar Pförtsch, 2006.
10. Investment Dealer’s Digest, 2003.
11. Eric S. Raymond, 2003.
12. Burson-Marstellar, 2008.
13. Frank Fehle, Susan M. Fournier, Thomas J. Madden and David G.T. Shrider, 2008; T. Madden, F. Fehle and S. Fournier, 2006.
14. Tara Kalwarski, 2009.
15. Financial Times, 2009; Mark Ritson, 2009.
16. Pernod Ricard, 2008.
17. AT&T Inc., 2005.

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