Boo to Relief from Royalty (BD)

Over the past decade there have been numerous attempts to develop approaches to brand valuation. Between 1988 and 1995 the Boston based Marketing Science Institute (MSI) stimulated much of this by raising the newly conceived concept of brand equity to capital status. That meant it would attract a lions share of funding for academic research. Top academics focused their considerable intellects on finding ways of placing valuations on this most intangible and ephemeral of assets. The results of their work will be found in various academic journals, but the best source is the MSI itself that published them in working paper form and featured them in conferences in 1991 and 1995.

As is often the case, the approaches these academics took and the results they achieved enriched our knowledge of brands from both the financial and consumer standpoints. They did not however produce a single approach to valuation that has stood the test of time.

Mary Sullivan and Carol Simon devised a complex mathematical model that took the premium of market to book value and decomposed it into various components, including brand equity. Their work has subsequently been used by many researchers as a way of looking at the investor generated premium and taking it apart, but it has not endured as a measurement system. There are a number of reasons for this, not the least being that it only applies to companies whose market value is known. Another problem was that it did not deal with companies that owned more than one brand. But most of all the approach assumed that brand value was a function of the market’s view of what it was worth.

Peter Farqhar and his associates, made a detailed evaluation of methods in force at the time. They concluded that all were in some way flawed and then introduced an approach based on momentum accounting. The idea was fascinating, implying that there is a measurable cause and effect relationship between events brought about by, for example, marketing and revenues. These could be tracked in a momentum and in impetus statement so that the relationship between marketing and consumer behaviour could be measured. This never moved beyond the published paper, probably because of the large assumptions that under laid the approach and the fact that businesses have been trying, with limited success, to establish this relationship for most of the last century.

Others used scanner data and a range of estimates and calculations, but ten years later, they all seem to have vanished. If one searches for a reason it probably lies in the complexities of the approaches and the availability of data. It also says something about the basic assumptions that should drive brand valuation.

There is general agreement today that a brand must make an after tax profit for its owner and that this profit should be in excess of a return on the capital employed to produce it. It is also agreed that this profit is not solely attributable to the brand. Other forces are at work as well. The methodology must therefore reduce the profit by the cost of capital and by a further amount representing the non-brand profit generating resources. Discounted Cash Flow is then used to produce the value by estimating the present value of the future cash streams that the brand will generate. The final input is the relative strength of the brand in consumer memory, which is the source of brand equity.

Against this background of intensive research and complex modelling, it is intriguing to speculate why a simple valuation method such as Relief from Royalty is still in use. It has been roundly criticised in much of the literature mentioned above. In essence the problems with it are three fold:

· It uses turnover and not profit as the base. This is unrealistic if the argument that a brand must make an after tax profit for its owner, is accepted.
· The royalty rate applied is something of a guess because each brand is unique and there are few cases where a royalty applicable to one brand would necessarily be applicable to another; even if there were a reliable source of such information.
· The period for the discounted cash flow calculation is often arbitrarily chosen to be ten years. There seems to be no rational explanation as to why this should be.

The accounting profession is giving serious consideration to some form of value reporting as a supplement to the historic cost approach that is presently in force and the tax authorities are examining intangible assets and intellectual property to see how they should be treated in future tax reforms.

This implies a greater role for the valuation of all intangible assets and brands in particular and calls for some form of uniformity of approach in how these values will be estimated.

Roger Sinclair is Professor of Marketing at Wits and MD of BrandMetrics