It has been almost a decade since the international standard on monetary brand valuation, ISO 10668, was first published. ISO 10668 was a watermark moment as it solidified the principles and methodologies that should be a part of any robust brand valuation: transparency, replicability, objective, and supported by robust data.
Since then much has moved on, including the introduction of ISO 20671, which is the international standard on brand evaluation (measuring the strength of a brand).
Measuring the strength of a brand is an inherent part of any brand valuation, as such ISO 20671 nestles in as a composite part of ISO 10668.
As we approach the 10 year anniversary of ISO 10668 and the prospect of an update to the original standard, it is an appropriate time to revisit the subject to explore how and why one values brands, what one is valuing when doing so.
We will also highlight some key developments there have been in the practice since its inception.
How has the practice of brand valuation advanced in recent years?
When the Smirnoff brand valuation was completed by KPMG in 1987 and the Rank Hovis McDougal portfolio of brands was valued by Interbrand shortly after, the first brands were valued and put on balance sheets. There was an uproar because the concept was new with many claiming it was creative accounting.
Following that, financial reporting bodies worked to update accounting standards that everyone could agree on. In 2003, IFRS 3 (Business Combinations), IAS 38 (Intangible Assets), and IAS 36 (Impairment Reviews) were all created to overcome the issues. Most local GAAPs followed suit with similar standards and rules.
IFRS 3 mandated that the value of an acquired business should be split between all assets – tangible and intangible – plus general goodwill; IAS 38 defined intangible assets; IAS 36 stated that the value of all of these identified assets should be reviewed for impairment every year. These standards – while stopping short of allowing internally generated intangibles being put on the balance sheet – formally endorsed the idea that intangible assets have value and can be valued accurately.
How has Brand Valuation advanced recently?
The valuation standards from the International Valuation Standards Council (IVSC) from 2008 helped to formalise the various approaches to brand valuation which were then used to help create ISO 10668, the international standard in monetary brand valuation which was published in 2010. In conjunction with all of the main parties in brand valuation (including the Big 4 accountancy firms), ISO 10668 constitutes a meta-standard that lays down the general framework for doing brand valuations.
It states that brand valuations should be based in Behavioural Analysis (how brand reputation impacts behaviour), Financial Analysis (how that behaviour impacts business performance) and Legal Analysis (whether or not the supposed owner really has rights over that benefit).
ISO 10668: Brand Valuation
This standard is now being supplemented by ISO 20671 (Brand Evaluation), which looks more closely at the behavioural aspect of this analysis and the way this can be influenced. Other organisations are following suit with independent standards from the likes of MASB in the US and qualifications like the “Certified in Entity and Intangible Valuations” which was created by AICPA, ASA and RICS.
All of these are professionalising the industry and we at Brand Finance feel it is important for anyone involved in this area to support these initiatives for the benefit of all businesses as well as the reputation and credibility of the brand valuation industry specifically.
How do you identify a brand's value to a business?
Overarching these methods are the general “approaches” to the valuations which are common to any type of valuation – not just those of brands. ISO 10668 specifies 3 alternative brand valuation approaches - the Market, Cost and Income Approaches.
The purpose of the brand valuation; the premise or basis of value; and the characteristics of the subject brand dictate which primary approach should be used to calculate its value.
The market approach measures value by reference to what other purchasers in the market have paid for similar assets to those being valued. The application of a market approach results in an estimate of the price expected to be realized if the brand were to be sold in the open market. Data on the price paid for comparable brands is collected and adjustments are made to compensate for differences between those brands and the subject of the brand valuation.
As brands are unique and it is often hard to find relevant comparables this is not a widely used approach.
The cost approach measures value by reference to the cost invested in creating, replacing or reproducing the brand. This approach is based on the premise that a prudent investor would not pay more for a brand than the cost to recreate, replace or reproduce an asset of similar utility.
As the value of brands seldom equates to the costs invested creating them (or hypothetically replacing or reproducing them) this is not a widely used brand valuation approach.
The income approach measures value by reference to the economic benefits expected to be received over the remaining useful economic life of the brand. This involves estimating the expected future, after-tax cash flows attributable to the brand then discounting them to a present value using an appropriate discount rate.
As the value of brands stems from their ability to generate higher profits for either their existing or potential new owners this is the most widely accepted and used brand valuation approach.
When conducting a brand valuation using the income approach various methods are suggested by ISO 10668 to determine future cash flows.
The most widely accepted method is “Relief from Royalty” (also known as Royalty Relief) which estimates the value based on the royalties not given away by a company as a result of the company owning the brand and not having to licence it from a third party. This method fits with the “separability” criterion of the international financial reporting standards, its assumptions are based in real-world agreements and the number of assumptions is low. It is therefore easily auditable and easily replicable.
The royalty relief method is in almost three quarters of technical brand valuation methods according to Gabi Salinas and Tim Ambler’s report (A taxonomy of brand valuation practice: Methodologies and purposes in Journal of Brand Management 17(1):39-61 · September 2009).
However, it implicitly only identifies the value to a licensor – ignoring any benefit left within a licensee.
We therefore supplement this approach with an approach called “Incremental Cash Flow” which identifies the value of the business through a discounted cash flow method and then identifies how demand, free cash and therefore long term value will drop in the subject business if it were to have to use a generic brand. The difference between the value with the brand and the value without it is the brand value in this case or, as we call it, the “brand contribution”.
In order to identify this brand contribution, valuers need to identify how specific brand attributes are impacting people’s likelihood to purchase – a market research technique known as “Demand Driver Analysis”, sometimes referred to as “Brand Drivers Analysis”. This analysis is used in over 80% of valuations used for management purposes, according to Salinas’ and Ambler’s report.
The incremental cash flow method is best used for identifying incremental opportunities rather than the overall value of the brand because identifying what a generic brand is can be relatively subjective. For this reason, as well as the separability issue, the method is not used by technical valuers where assumptions on this supposed generic brand will have to be subject to intense questioning from the court.
Royalty Relief method
As explained, this is the most widely used method and assumes that the brand’s value is deemed to be the present value of the royalty payments saved by virtue of owning the brand.
The royalty rate applied in the valuation is determined after an in-depth analysis of available data from licensing arrangements for comparable brands and an appropriate split of brand earnings between licensor and licensee, using behavioural and business analysis.
The Royalty Relief Method is the most popular valuation methodology for a number of reasons:
- The assumptions are based on Verifiable Empirical Evidence
- It is grounded in commercial reality because royalties used are based on and benchmarked against real-world transactions.
- The asset is defined by specific Legal (trademark) Rights which are Separable and Transferable:
- These are essential points for determining the value of intangible assets according to accounting rules which are intended to avoid double counting.
- It Clearly Defines the Economic Benefits from a brand as broadly as necessary:
- As well as ensuring the separability of these benefits from other assets, the method also enables you to identify brand value when it is outside the core business (i.e. through licensing).
- It is capable of Consistent (i.e. reliable), Transparent valuation and revaluation:
- The basis of the valuation is revenue which is the least easily manipulable line of an income statement – easing comparability between businesses, years of business and individual valuer.
- Its other assumptions are either based on real-world transactions (royalties) or standard valuation assumptions used for the valuation of any other asset in the business.
- Also, whereas some methods base their assumptions on current year patterns in customer response, the Royalty Relief method explicitly takes a long term view since licence agreements typically last 5 years or more.
For all these reasons and a few more, the method is commonly used for balance sheet valuations, licensing agreements, law courts, and taxes. It is also a very good method for performance tracking since its assumptions do not vary wildly over time.
Price Premium and Volume Premium methods
The Price Premium method estimates the value of a brand by reference to the price premium it commands over unbranded, weakly branded or generic products or services.
In practice, it is often difficult to identify unbranded comparators. To identify the full impact on demand created by a brand the Price Premium method is typically used in conjunction with the Volume Premium method.
The Volume Premium method estimates the value of a brand by reference to the volume premium that it generates. Additional cash flows generated through a volume premium are determined by reference to an analysis of relative market shares.
The additional cash flow generated by an above-average brand is deemed to be the cash flow related to its ‘excess’ market share. In determining relevant volume premiums, the valuer has to consider other factors that may explain a dominant market share. For example, legislation that establishes a monopoly position for one brand.
Taken together with the Price Premium and Volume Premium methods provide a useful insight into the value a brand adds to revenue drivers in the business model. Other methods go further to explain the value impact of brands on revenue and cost drivers.
The income-split method starts with net operating profits and deducts a charge for total tangible capital employed in the branded business, to arrive at ‘economic profits’ attributable to total intangible capital employed. Behavioural analysis is then used to identify the percentage contribution of the brand to these intangible economic profits.
The same analysis can be used to determine the percentage contribution of other intangible assets such as patents or technology. The value of the brand is deemed to be the present value of the percentage of future intangible economic profits attributable to the brand.
Since brands’ primary role is to drive demand and therefore revenue, it is often unclear how using drivers analysis can directly identify proportion of profits without first looking at volume/price premiums although some methods don’t explicitly do so.
Multi-period excess earnings method
The multi-period excess earnings method is similar to the income-split method. However, in this case, the brand valuer first values each tangible and intangible asset employed in the branded business (other than the brand). He uses a variety of valuation approaches and methods depending on what is considered most appropriate to each specific asset.
Having arrived at the value of all other tangible and intangible assets employed in the branded business a charge is then made against earnings for each of these assets, leaving residual earnings attributable to the brand alone. The brand value is deemed to be the present value of all such residual earnings over the remaining useful economic life of the brand. This is despite the fact that other intangibles such as customer lists and goodwill (from cost synergies) would also be implicitly included in this figure.
Incremental cash flow method
The incremental cash flow method identifies all cash flows generated by the brand in a business, by comparison with comparable businesses with no such brand. Cash flows are generated through both increased revenues and reduced costs.
This is a more detailed and complex approach which tends not to be used in technical brand valuations but is extremely useful for strategic, commercial purposes. For example, when Virgin negotiates a new brand license with a new licensee. The incremental value added to the licensee’s business form’s the starting point for the negotiation.
There are even more methods used by various practitioners, as outlined in Gabi Salinas’ and Tim Ambler’s study, but for the purpose of brevity, I have focused on those set out in ISO 10668 which are by far the most commonly used.
Valuation in Practice
When establishing the impact of brands on business value, it is important to have this mix of expertise involved appropriately at the right moments of the process: strategic input and hypothesis creation right from the top (the CEO and/or corporate strategy team), close involvement on financial assumptions with the CFO’s team, and the close backing of marketing, brand and insights functions who understand what stakeholders are thinking and what is being done to support the brand right now.
Once the right team is created internally, the steps to follow are:
- Internal review: develop an understanding of where and how your business’ brands are used and what is being done internally to support them – including the amount spent on which activities relative to competitors. This step should also identify key objectives for any analysis and therefore the valuation approach to pursue.
- External review: conduct market research to understand awareness, customer perceptions of your brand(s) relative to competitors as well as any trends changing the direction of the market.
- Linkage Modelling: This step involves understanding either through management hypothesis and desk research or with in-depth statistical analysis the relationship between marketing activity, brand perceptions and business performance. Preferably, this would disentangle short term revenue effects from longer-term brand equity effects.
- Brand Strength Benchmarking: Creating a trackable scorecard of brand performance across various indicators with lead business performance. This step allows long-term objective and target setting and a clear comparison against competitors across all important factors.
- Valuation Modelling: Connect your understanding of the effects of brands to underlying business value drivers – profitability, growth and risk – in order to value the brand and understand how it fits within your business.
- Apply Your Value-Based Management: Valuation models can and should be used for a variety of applications. Valuation models are designed to be used as machines to understand the effect of actions. Don’t just look at them every year because you have to test for impairment or report to the board. Use them to make better decisions!
Taking the final step from brand research to investigate the effects of brands on business value enables you to maximise those effects and build moats around your business that protects from competition and maximises value growth. Increasingly, finance and marketing teams are working together to make better brand decisions by using valuation. Given that brands make up approximately 20% of global business value, it is about time!