Coffee and cake in the hallowed halls of academe (unpublished)

I once wrote: “the bloodiest battlefield in advertising is the one where media and creative slug it out.” But there is another that makes the Battle of the Somme look like a children’s party game. If you have ever had to stand before the general management of a client company and defend the advertising budget; or, worse: if you are the marketing manager trying to motivate an increase in the marketing allocation, you will be carrying war wounds of the most vicious kind.

Marketing and advertising people are largely to blame for this situation. They have done little to translate their highly jargonised patois into a more commonly understood language. Just after the executive committee has caluated the net present value of an investment in a new piece of machinery that will cost R2 million, the marketing man comes in and asks for a budget increase of R4 million. He supports the request with beautifully produced charts and graphs that show portions of bars called LSMs, ringed and shaded differently. Those, he claims, are areas of potential market share gain where awareness and brand essence are weak and, as a result, Nielsen data show regional and segmental disparities. What’s more, he states, delivering the clincher, our measures of ad liking and noting are impacting on our brain grid pattern. Sales, he concludes, are affected negatively by a major shift from right to left-brain orientation.

I recently accompanied an agency boss to a meeting with his major client. I was about to make my pitch for the brand valuation businesses when the client, a young, highly successful businessman who qualified as a chartered accountant, interrupted to make a short speech.

“Before you start,” he said, “ let me tell you the problem. Yesterday we took a management decision to invest in a new R8 million milling machine. It was not hard because we had done a thorough evaluation of the economic life of the machine and we had calculated its Internal Rate of Return (IRR). The arithmetic was straight forward as was the decision.” He placed his hand on the shoulder of the marketing director sitting beside him. “But Jim here is waiting for us to decide on his marketing budget of R12 million. Give me an IRR or an NPV and I will have no problems. He does not seem to be able to do this. Can you help?”

No wonder in only 19% of South African companies is there a marketing person on the board.

No promises, but brand valuation could provide the answer. Certainly if the numerous companies for whom we have conducted valuations over the past few years are anything to go by, this might prove to be the case. The sophisticated versions of brand valuation methodology that merge accounting, finance and marketing are extremely powerful and do just what the young CA Chief Exec was asking for.

The reason for this is that the valuation technique draws primarily on accounting and corporate finance methods with which general management are familiar. The marketing input is uncomplicated and, as with the R8 million machine’s more complex inner workings, has been stripped of obfuscating jargon and confounding technical detail

The basic concept of brand valuation is that revenues generated by the brand, incremental to what a non-branded version would generate, are forecast to some future horizon and discounted back to present value. The capitalised present value is the value of the brand.

There are four stages to the calculation: financial; separation of brand profits from those generated from the rest of the business; an estimation of the brand’s expected life; and, a survey based measure of the relative strength of the brand compared with its competitors.

Financial: The brand income statement is examined line by line in order to arrive at a net operating profit. Gross revenues are reduced to represent those earnings that the brand alone has produced. Cost of sales, fixed and variable costs are then deducted. The close examination is to uncover any line items imposed on the brand by head office or by corporate dictate that are not part of the brand’s proper expense. A tax rate is then applied to produce the Net Operating Profit After Tax.

We then estimate the cost of capital for the brand. It is established in finance theory that a business is unviable if it cannot generate earnings in excess of its cost of capital. Scottish economist Adam Smith proposed this idea over two hundred years ago. Today we use the Capital Asset Pricing Model (CAPM) for the calculation. Its relevance here is that if competitors in the market were willing to earn no more than the cost of capital on their capital employed in bringing the brand to market, the effect would be to push all prices down to commodity level. Therefore the cost of capital is a proxy for the non-branded version.

The resource set: Brands may earn profits in excess of the cost of capital for a variety of reasons. A bank may manage the margin between deposits and withdrawals well; a high tech company may have specialised computer programs and software that are in demand; the strength of a large multi-brand-owning company with the retailers may guarantee distribution; or it might be the pulling power of the brand itself. These are called resources and usually from a long list a small number are identified as being the key generators of this profit. The process results in the resource set to which a statistical technique is applied to identify the brand portion. This premium brand profit is the proportion of the profit that could be sold, lost or damaged. It is the brand’s equity. The graph shows the brand equity proportions of several brand types ranging from the low 50% to high 80%’s.

(place graph about here)


Expected life: Students of finance theory will be familiar with expected life. This is the period of time over which an asset is expected to generate predictable earnings. Nothing of course is certain because we are dealing in the future, but that is the challenge inherent in virtually any form of investment whether it be shares of buying a property. This part of the process draws on facts about the market, and make educated projections about the market’s vulnerability to external forces and to new competitors. If conducted systematically using the best available data, it provides a set of time horizons for the brand’s category and for the brand within that category.

There are two parts to the brand expected life profile: the franchise run during which the brand is projected to continue to earn incremental profits in line with its current, base year; and the decay pattern which is a mathematical calculation of what will happen when the franchise runs out. This is not the product life cycle. It is defining the shape of each brand’s incremental profit earning capacity into the future. It is the shape that captures the incremental profits to which discounted cash flow is applied.

Brand Knowledge Structure (BKS): While the decay pattern is purely theoretical and a mathematical function of what has been projected in the early part of the model, the franchise run is substantially in the hands of the marketers. Brands succeed because of a number of factors. They have to be priced correctly to provide acceptable profits, they have to be made conveniently available to the consumers, they have to consistently satisfy consumer quality needs; and, they must be known, trusted and thought well of. The first of these are what the marketer has to do to achieve what is known as brand salience or presence. The last are perceptual and reside in the collective mind of the public.

The BKS estimates the length of the franchise run. The higher the BKS scores extracted from consumer research, the greater will be consumer loyalty. Marketing theory has established that loyalty brings with it certain financial benefits such as a willingness to buy more frequently, pay a premium price, refer the brand to others, be less susceptible to competitive price promotions, and to be more resistant to competitive claims. Also loyal existing customers cost less to keep than new customers do to acquire, so there is a marketing cost saving too.

The valuation that this process produces is a robust, well-grounded calculation of the future economic benefits that will flow to the owner of the brand. But it is more than that. The procedures outlined above are useful in other aspects of the business. Knowing the resource set that drives what in finance theory are known as “super” profits, provides management with a new tool that can be used to fine tune a variety of business strategies.
Companies use brand valuation for a variety of applications including financial statements, where this is permitted by the new accounting standards; tax purposes; merger and acquisitions; investor relations and for management decision-making. The last item is where the current focus of interest lies. Because the valuation methodology is based on projections of future cash flows discounted to present value, it is possible to treat marketing investments in the same way as capital expenditure. Marketing managers can leave their esoteric vocabulary back in the advertising agency and converse with their accounting and management colleagues in the language of finance.

Moreover it is possible to set marketing targets of a financial nature, linked directly to shareholder value. Marketing investment is judged by the return it will achieve: an increase in brand value. What’s more the nature of the methodology provides guidelines as to what marketing tactics should be employed to bring this about.

Brand valuation is here to stay because it is being incorporated into generally accepted accounting standards. It provides marketers with a real opportunity to be fully accepted by mainstream management. All they have to do is learn its language.

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Source: BrandMetrics’s valuations 1999 -2001
Graph. Examples of the brand asset value of sectoral resource-sets