Circumstances of valuation of brand08/10/2022 1 By indiafreenotes
Brand valuation is the process of estimating the total financial value of a brand. A conflict of interest exists if those who value a brand were also involved in its creation. The ISO 10668 standard specifies six key requirements for the process of valuing brands, which are transparency, validity, reliability, sufficiency, objectivity; and financial, behavioral, and legal parameters. Brand valuation is distinct from brand equity.
Brands are ideally suited to this task because they communicate on a number of different levels. Brands have three primary functions; navigation, reassurance and engagement:
- Navigation: brands help customers to select from a bewildering array of alternatives.
- Reassurance: they communicate the intrinsic quality of the product or service and so reassure customers at the point of purchase.
- Engagement: they communicate distinctive imagery and associations that encourage customers to identify with the brand.
Traditional marketing methods examine the price/value relationship in terms of dollars paid. Some marketers believe customers perceive the value to mean the lowest price. While this may be true for commodities, some branding techniques are moving beyond this evaluation.
Brand valuation emerged in the 1980s. Early pioneers in brand valuations included the British branding agency, Interbrand, led by John Murphy and Michael Birkin, which is credited with leading the concept’s development. Millward Brown was also a leading brand valuer.
Both companies maintained “Top 100” lists of companies by valuation. In 1989, Murphy edited a seminal work on the subject: Brand Valuation; Establishing a true and fair view; and in 1991, Birkin laid out a brand earnings multiple models of brand valuation in the book, Understanding Brands. A 2009 paper identified “at least 52” brand valuation companies.
There are three main types of brand valuation methods:
The cost approach
This is based on the cost of creating the brand. The fundamental premise of the cost approach is that it should not be worth more than it would cost to build an equivalent. The cost of building a brand minus any expenses is reflective of market value.
The market approach
In this approach, the market price is compared. This valuation method relies on the estimation of value based on similar market transactions (e.g. similar license agreements) of comparable brand rights. Given that often the asset undervaluation is unique,[clarification needed] the comparison is performed in terms of utility, technological specificity and property, considering the asset’s perception by the market. Since the market approach relies on comparisons to similar assets, it is most useful when there is substantial data available regarding recent sales of comparable assets. Data on comparable or similar transactions may be accessed through the following sources:
- Company annual reports.
- Specialized royalty rate databases and publications.
- Court decisions concerning damages.
The income approach
This approach measures the value by reference to the present value of the economic benefits received over the rest of the useful life of the brand. There are at least six recognized methods of the income approach, with some authorities listing more.
- Price premium method: Estimates the value of a brand by the price premium it generates when compared to a similar but unbranded product or service. This must take into account the volume premium method.
- Volume premium method: Estimates the value of a brand by the volume premium it generates when compared to a similar but unbranded product or service. This must take into account the price premium method.
- Income split method: This values the brand as the present value portion of the economic profit attributable to the brand over the rest of its useful life. This has problems in that profits can sometimes be negative, leading to unrealistic brand value, and also that profits can be manipulated so may misrepresent brand value. This method uses qualitative measures to decide the portion of economic profits to be accredited to the brand.
- Multi-period excess earnings method: this method requires a valuation of each group of intangible assets to calculate the cost of capital of each. The returns for each of these are deducted from the present value of future cash flows and when all other assets have been accounted for, the remaining is used as the value of the brand.
- Incremental cash flow method or Excess Margin: Identifies the extra cash flow in a branded business when compared to an unbranded, and comparable, business. However, it is rare to find conditions for this method to be used since finding similar unbranded companies can be difficult.
- Royalty relief method: Assume theoretically a company does not own the brand it operates under but instead licenses the use from another. The royalty relief method uses available data of similar arrangements in the industry and assigns the value of the brand as the present value of future royalty payments.
Historical Cost Method
Brand valuation through the historical cost method is used at the initial stage of brand creation. The historical cost method isolates the direct costs and contributes to indirect costs. It attempts to recreate the historical development and creates an assessment value for the future. However, the cost of creating a brand does not play a major role in the present value.
Replacement Cost Method
This method values the brand keeping the investment and expenditure necessary to replace the brand with a new one which has equivalent utility to the company.
Market-Based Approach: A market-based method of brand valuation deals with the amount at which a brand is sold and the highest value that a buyer is willing to pay for it. The market-based approach is classified into:
Brand Sale Comparable Approach
In this method, the brand is valued by the recent transactions that involve similar brands in the same industry. It is viewed from a third party perspective and cannot be applied to all cases for comparing data.
Brand Equity Approach
The brand equity approach includes advertising and results in price premium profits. In this case, the value of brand equity is estimated using the financial market value.
The residual value is arrived at when the market capitalisation is subtracted from the net asset value. The variables such as risk-free interest rate, current exercise price, the variance of the asset, time of expiration of the option and value of the underlying asset are included. It helps to calculate the potential value of line extensions.
Income-Based Approach: In this approach, the potential of the brand is calculated by the future net earnings that directly contribute to determining the value of the brand. The following are the classifications in the Income-Based Approach:
Royalty Relief Method
As per this method, the value of the brand is related to characteristics applied by the company or valuer. The valuer will have to estimate the base for calculation and determine the appropriate royalty rate, a growth rate, expected life and a discount rate for the brand. This method is accepted by tax authorities and has an edge of being industry-specific.
Differential Price to Sales Ratio Method
This method will calculate the brand value as a difference between the estimated price to sales ratio for a company with a brand and the price to sales ratio for an unbranded company. This will be multiplied by the sales of the branded company.
Price Premium Method
The approach of this method is that a branded product should sell for a premium over an unbranded product. The value is calculated by comparing the cost involved for production and cost produced after sales. It creates the impact of assuming that the brand helps to accumulate additional profit.
Discounted Cash Flow
Cash flow acts as an important component for determining the value of an asset. It takes into account the increasing working capital and fixed asset investments. It estimates the amount of future cash flow that the brand can generate.