CoreBrand featured in The Journal of Business Strategy

19 April 2011

Brand value: Does it belong on the balance sheet?
Original article at: The Journal of Business Strategy: Volume 32 Number 3, Pages 13-18, 2011

Today, US public companies value tangible assets on the balance sheet and buy insurance to protect them. But for intangible assets, which may be worth far more if brands matter to buyers, valuation is required only when a company is merged, bought, or sold. At that time, accountants are told, they can calculate the net present value of an intangible asset based on five-year and ten-year projections of the cash flow it will produce (Jordan, 2009).

But what about tomorrow’s accounting rules? If the US follows European precedent and if those setting US accounting rules listen to marketers and intellectual property attorneys, the rules may change. The rationale for expecting that they will do so stems from two sources. One is the pressure to improve the information available to investors. The other is the belief by marketers that investment in brands is short-changed because their value is underestimated.

Certainly marketing managers are skeptical about the idea of five-year and ten-year projections of cash flow as the basis for brand valuation at the time of sale. They are likely to think that spending by their own company and by competitors – in the broadest sense, because competitors can include other industries – can significantly enhance or diminish the value of a brand far more quickly than a five-year time horizon. Furthermore, they know that legally protecting individual components of what that brand is worth – in marketing terminology, its brand equity – may depend on as unpredictable a factor as what proportion of buyers identify a brand name in a product portfolio, a logo, or a key element of product design or packaging solely with their brand. Intellectual property (IP) lawyers are even more aware of the difficulties in predicting the outcomes of lawsuits alleging infringement of those same names, logos, or design and packaging elements.

Therefore, not only marketers but also some accountants and IP attorneys believe that placing the value of a brand on the balance sheet will highlight its actual importance to the financial outcomes that are material to investors and improve their assessments of total company value. It appears, then, that this is likely to be an idea whose time is coming. The question addressed here is what managers should do about it.

We first present the case that such change may well be in the offing. Then we explain why managers should welcome the possibility. We discuss how they should prepare: by valuing now, for internal use, the corporate brand and its intangible elements that are material to the overall value of the company, and we conclude by outlining how such valuation might be undertaken.

A likely prospect?
Predicting a change in accounting standards to require the valuation of intangibles on the balance sheet rests on a set of disparate indicators:

1. Some member companies in the Association of National Advertisers (ANA) strongly advocate such a requirement, although the association itself has not yet taken an official stand. The ANA, composed of 400 companies with 9,000 brands that collectively spend over $200 billion in marketing communications and advertising, has recognized the importance of this issue and begun a formal evaluation process.
2. European companies have moved in this direction. Since 2005 all listed companies there must report the value of their acquired intangible assets, such as brands, on their balance sheets, based on International Accounting Standards. The Deloitte (2010) web site describes requirements in Europe, and an IVSC ‘‘Guidance note’’ (2010) concerning international standards specifically refers to ‘‘Marketing-related intangible assets . . . used primarily in the marketing or promotion of products or services. Examples include, but are not limited to:
   • trademarks, trade names, service marks, collective marks and certification marks;
   • trade dress (unique colour, shape or package design);
   • newspaper mastheads;
   • internet domain names; or
   • non-compete agreements.’’
3. That development has prompted some accountants and intellectual property attorneys to advocate going even further, to require the valuation of internally generated brands and publication of those values. They are using Weblogs as their chief communication medium for such advocacy. Interestingly, some offer pure marketing arguments. For example, one accountant noted:

   One of the main strategic benefits of applying IFRS for brands is the opportunity to construct a value contribution analysis tool [. . .] If a brand is valued in the different markets, categories, and territories it operates in – the sum of which is total brand value – the contribution each makes to the overall brand value is easily identified. Each individual brand can then be analyzed to find what is driving the value and what needs attention (Whitwell, 2005).

   More tersely, a New Zealand patent attorney observed: ‘‘A book value should be placed on all company IP and this value should be reported’’ (Cockburn, 2009). The same author notes that undervaluing intangible assets is nearly universal.

4. Recent academic writing in marketing supports the proposition that brand metrics add incremental explanatory power to accounting variables such as margins and turnover. Substantiating evidence indicates that trademarks can contribute to cash flow growth and firm value, and brand assets can be leveraged to enhance revenue and reduce risks while launching brand extensions (Hanssens et al., 2009). Other authors find that brand assets influence firm valuation through direct effects on sales multipliers, most strongly the case for consumer durable goods (Mizik and Jacobson, 2009.)

A welcome prospect?
Why welcome the idea of placing brand value on the corporate balance sheet? The simplest answer is the obvious one: leaving off such a critical area for investment currently distorts corporate resource allocation. Advertising, for example, looks today like an expense when it should be viewed as an investment. Marketing expenses and legal expenses to protect intellectual property from imitation can be short-changed if the value of these assets is underestimated, a common error. The basic point is that in absolute terms a corporation lacks a way to compare the value of intangibles in which it should invest to the value of tangibles.

Further, it lacks a basis for comparison to competitors – which investors will certainly focus on if public valuation becomes a requirement. If that change takes place, every public corporation will find that it is being compared by securities analysts and investors to its industry peers in the contribution of brand equity to market capitalization. That possibility offers a powerful motivation for corporations to begin a valuation process now, so that if the future brings intra-industry comparisons of brand value, they will not be found wanting by stockholders.

Currently, the many companies that lack a standard to measure brand value are likely to determine marketing budgets either based on the previous year’s spending or on gut instinct and emotion. Given awareness of the dollar importance of the brand, however, it is reasonable to expect that investing in brand building vs other investments can be more sensibly considered.

Also, and of current significance, the valuation of corporate brand equity and the specific elements contributing to it should guide decisions for increasing that value and protecting it. Companies face the threat of imitation of non-patented elements, such as a brand name, trademark, or package design. Valuing these elements allows managers to prioritize when they target marketing dollars to increase the association of that element in the public mind with their company alone, often the only way to ensure its protection. Also, the corporate brand can be affected by everything the company says and does – for example, cause-related marketing to enhance its image, or provision of beyond-expected customer service. Decisions about expenditures in these realms can be made more wisely if the value of the corporate brand is known.

It should be noted here also that functional (and therefore ineligible for a patent) product characteristics cannot be protected from imitation unless in the mind of the relevant population they are associated specifically with one source. Such association is not guaranteed by significant marketing expenditures, but surely when Owens Corning communicates with potential customers in pink type on its homepage and tells them ‘‘The color PINK is a registered trademark of Owens Corning,’’ it is protecting the current association of that color with its insulation and no other.

Protection is not the only issue, however. Zadrozny (2006) notes that managers make better decisions if they track the value of their intangibles, using as examples the possibility of licensing patents and of monitoring quality issues that affect the value of a brand. Overall, he recommends skillfully leveraging the power of intangible assets – and such opportunities are far likelier to claim the attention of management if the value of those intangibles is known and is public.

A call to action: valuation
Thus, what companies should be doing now, if they already are not doing so, is twofold. One possibility is joining the call to publicize brand value on the balance sheet. A second, assuming that others are issuing that call even if a given firm is not doing so, is to value one’s own brand.

Several consulting firms currently offer for a company’s own use the service of valuing brands, using survey data, financial data, and statistical analysis. Since 1990 all of these consulting companies have invested significantly in developing their own proprietary models. Because each holds these methods as closely guarded secrets, it is impossible to objectively evaluate the virtues of one over another. However, the important lesson that can be garnered from these various firms’ creating their own models is that they are directionally similar in their methods, leading to the possibility of developing standard acceptable models across industries. Fortunately, scrutiny of the top 100 corporations’ brand equity results as established by the most credible firms performing such measurements shows already that the various measurements are within a relatively close range of each other in terms of their value calculation for any given company.

Most consulting firms evaluate brands in one of three ways – as corporate brands, product brands, or a combination of corporate and product brands. Kraft is a corporate brand; Philadelphia Cream Cheese is a product brand, and the entire entity is the combination. So it is important when valuing brands to understand what aspect is considered. Consultants at one firm in this field, CoreBrand, believe that the corporate brand should be identified independently from the product brand, because each brings value in a different manner. Box 1 shows information on its valuation method.

For example, AFLAC increased its advertising significantly over a three year period between 2002 and 2005 primarily to increase awareness and revenue. However, the firm also achieved a secondary effect of improving corporate brand equity, creating an identifiable ‘‘premium effect’’ of $1.48 billion on its market cap attributable to an increase in brand equity resulting from the campaign. The advertising campaign increased the corporate brand equity as a percentage of market cap for AFLAC from 7.0 percent to 11.0 percent over that three year period vs a change of 4.8 percent to 4.9 percent for the industry over the same period. Considering the $196 million invested in the advertising campaign over three years the ROI was $7.54 for every dollar invested, over and above the impact the campaign had on the traditional drivers of stock performance: revenue, cash flow and earnings growth. By separating the corporate brand from the product brand this premium effect can be readily identified.

Companies that manage both product brands and a corporate brand create an even more significant premium value for the market cap of the company. For example, Kraft is worth more as a brand because of the value of Philadelphia Cream Cheese, an entity in the firm’s brand portfolio. In turn, the value of Philadelphia Cream Cheese will be greater if any foil-wrapped rectangular solid in the shape of a 3-ounce or 8-ounce block of cream cheese is associated in the public mind only with Philadelphia Brand and ideally also with Kraft.

This last example provides several additional reasons to publish brand value. One relates to any kind of ‘‘legal intangible’’: to the extent that a significant fraction of brand value rests with a patent, trademark, or other type of intellectual property, the value of that intellectual property can be estimated, a useful calculation for licensing decisions. Likewise, valuation of brand takes into account customer service and other synergy between the business process and the culture/behavior of the company. Finally, elements like trade dress, the ‘‘look and feel’’ of a product, can be valued as well, as noted earlier. However, that value may be more volatile; for example, trade dress may be successfully imitated if not associated with one source alone. Investors and potential investors can deduce from the value of a corporate brand that depends on such intangibles a worst-case or best-case financial scenario if they were to be imitated by competitors.

For example, Krishnamurthy (2007) conducted a behavioral experiment to help value the Gateway ‘‘cowbox’’ package. Box 2 shows the result: $133 as the increment to revenue for each computer sold. Comparing that valuation, multiplied by units sold, to the value of the Gateway brand itself would be possible if that brand value were published on the balance sheet. Then an investor – and Gateway management – could see what proportion of brand value is at risk if the box design were to be imitated and then in a lawsuit found not to be associated only with Gateway in the public mind. The same method could be adapted to value a logo, a brand name in a company’s portfolio, or any trademark or trade dress. The legal question in any such circumstance is whether customers or prospective buyers associate a name/logo/trade dress with YOUR company and/or brand. If they don’t, you can’t necessarily protect it.

That realization raises the question of the extent to which any given intangible element is material to the value of a brand. That question is answered by comparing the value of the element to the value of the brand. Is that latter value available to all? Today the answer is negative. But good management and the prospect of a different set of rules tomorrow should provide more than enough spur to action to value that potentially critical asset

References
Cockburn, I. (2009), ‘‘IP Management – a practical guide’’, available at: www.piperpat.com/IPManagement/APracticalGuide,tabid/261/Default.aspx (accessed November 2, 2009)

Deloitte, IAAS Plus (2010), available at: www.iasplus.com/standard/ias38.htm (accessed August 26, 2010).

Hanssens, D.M., Rust, R.T. and Srivastava, R.K. (2009), ‘‘Marketing strategy and Wall Street: nailing down marketing’s impact’’, Journal of Marketing, November, pp. 115-18.

International Valuation Standards Council (2010), ‘‘Valuation of Intangible assets’’, Guidance Note 4, available at: www.ivsc.org/pubs/gn4-2010.pdf Jordan, D. (2009), ‘‘Valuing intangibles in a business combination’’, available at: www.nybusinessvaluation.com/Articles/Intangible_Asset_Methodology.pdf (accessed September 13, 2010).

Krishnamurthy, P. (2007), ‘‘Protect your product’s look and feel from imitators’’, working paper, Bauer College of Business, University of Houston, Houston, TX.

Mizik, N. and Jacobson, R. (2009), ‘‘Valuing branded businesses’’, Journal of Marketing, November, pp. 137-63.

Whitwell, S. (2005), ‘‘Brands on the balance sheet’’, available at: www.intangiblebusiness.com/BrandValuation-News/ (accessed September 8, 2010).

Zadrozny, W. (2006), ‘‘Leveraging the power of intangible assets’’, MIT Sloan Management Review, Fall, pp. 85-9.