CAPM for Brands - A Beta Idea

Any student of finance will tell you that making long term profits that exceed a company’s cost of capital is not possible. These profits, that they were taught to call “economic rents”, “economic” or “super” profits, are not sustainable. Competitors soon learn that there are rich pickings in this market and swoop in precipitating market forces that depress the profit potential of the sector until no one earns more than the cost of capital. At least that is the theory.

Companies do make economic profits over and above their cost of capital and they sustain them for long periods of time. If they don’t they are destroying shareholder wealth.

But what are the forces that sustain this class of profits?

Companies that conduct brand valuations have to find the answer to this question. They have to develop techniques that identify the resources that generate “super” profits and they must quantify the influence of brand equity on each. If they can do this in a credible way they can provide the brand owning company with two valuable tools: 1) An identified resource-set of the company’s “super” profits” drivers; 2) the relationship, if any, between each driver and brand equity.

Knowing that the company is creating sustainable shareholder wealth due to a set of unique resources is important. Sussing our what these resources are and their relative importance is a competitive advantage not to be taken lightly. If you can also learn the extent to which these profits are reliant on the brand name and the quality of the bond with the consumers who buy it, you are in possession of a powerful business tool.

Typically companies fall into sectoral bands.

Industry sector Typical brand portion of “super” profits - %
Industrial companies 40 to 55
Insurance companies 50 to 55
Banks 60 to 65
FMCG products 65 to 75
Media titles 75 to 85
Source: BrandMetrics (Pty) Ltd

The surprise is that media titles are more reliant on brand equity than fmcg brands and yet this is a consistent finding. The reason appears to be that most fmcg brands are part of a brand portfolio marketed by a company that has a corporate (key account) relationship with the distribution channel. The brand, as a member of the portfolio, slots into this channel. Media titles stand or fall by their titles. If they are popular, they are given distribution and attract advertising and the best journalists. The brand drives the business.

Insurance companies have low scores because they are governed to an extent they wish they weren’t by the broker intermediary. One well-known young local insurance brand adopted a different approach and as a result does not conform. Its brand influence is in the mid 70%s.

It is a strange coincidence that listed companies that have a market capitalisation higher than their Net Asset Value (NAV) tend to be those which own brands. A measure of this is the approach developed by the late Nobel prize winning economist, James Tobin. Named Tobin’s “q”, it divides NAV into Market Cap. A score of 1 or more means there are intangibles at work. Minus 1 means that there are not. This is not the same thing as economic profit, but it is a reflection of what the investment community thinks of the company’s prospects; and capital market analysts know all about brands. Perhaps not such a coincidence after all.

Appeared in the Brands and Branding Survey - 2003