Those of us on the business side of brands are ultimately interested in turning the brand into dollars, either in the form of a revenue stream or as a one-off capital gain. We therefore need to understand how brands can be valued. The Coca-Cola brand, for example, was recently valued in a Newsweek list of the World's Top 10 brands at US$69.6 million - but how do we get comfortable with that number? To answer that question, we have to look at brands as a form of intellectual property (IP). This is certainly not helped by accountants who are reluctant to place a value in the balance sheet on any intangible asset when, for example, a business is acquired. At present there is a lack of global consensus as to the preferred methods of valuing IP. However there are signs that the accounting standard setters are beginning to indicate acceptable valuation methods.
The acceptable methods are:
- Excess operating or 'premium' profits method
- Premium pricing method
- Cost savings method
- Royalty savings method
- Market approach
- Cost approach.
Before explaining each method I would note that no approach used in isolation is likely to give the 'right' answer as each has inherent drawbacks hence they are usually used together. In the case of brands, the approach is either to use the excess operating profits or premium pricing method, or the royalty savings method and then cross-check the results using the market approach.
The excess operating profit method determines the value of IP by capitalising the additional or 'excess' profits generated by a business over and above those earned by another business which does not own similar IP. This can be done by reference to a margin differential or comparing the return on capital employed. The calculated excess profit over the life of the asset is then discounted to arrive at its present value. The premium pricing method is similar and is often used in the consumer products sector where a branded product is more expensive than an unbranded equivalent. The value of this additional revenue is projected over the life of the brand and then discounted to present value. The drawback for both is the difficulty in identifying either a totally unbranded equivalent or a competitor that itself is void of its own brand value.
The royalty method is based on the principle that, if the business did not own the asset, it would have to in-license it in order to make returns.
The value of the asset is the present value of the royalty stream that the business is saving by owning the asset. The difficulty is in determining the appropriate royalty rate. The market approach values the asset based on comparison with sales of similar assets. The transaction price, as a ratio of an asset attribute such as sales, is used to derive a market multiple. This is then applied to the market attribute of the asset being valued in order to give the market value. In an ideal world it is a very good measure of value but it can be difficult to find sufficiently detailed publicly available information on the sales of similar assets. Nonetheless it does provide a good cross-check to the other methods - as with the case of brand valuations.
Valuing of brands remains an art and not a science in a world where the level of information is imperfect.