Many companies exhibit a discrepancy between their tangible book value and their market value. For example, global brand expert Kevin Keller cites PepsiCo, which had a net tangible book value of $6.5 billion but a market value of over $90 billion (Kevin Lane Keller, Strategic Brand Management: Building, Measuring, and Managing Brand Equity, third edition, Prentice Hall, 2008). Keller attributes about $83 billion of that market valuation to intangible assets, and more specifically, to PepsiCo’s brand equity.

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Branding is one of the most critical components of business strategy. Companies allocate significant resources to build brands, which in turn creates a community of loyal consumers. According to Lisa Stone, CEO of BlogHer, branding is about building a community and allowing the people who are part of the community to vouch for the product. In other words, a community of loyal customers not only builds sales, but also builds brand equity.

Goodwill

One of the controversies involving brands—a type of intangible asset commonly referred to as a component of “goodwill”—is that, based on FASB standards, valuations occur only when net assets are purchased; goodwill is then recorded in the financial statements as the excess paid for the net assets over their fair market value. As Mark Hogan and Linda Matuszewski note, “Goodwill is to be recorded only when a business is acquired. Internally generated goodwill, even if it is worth billions in economic terms, is not to be recorded” (“Good Will Come of Goodwill, but Accounting Depends,” CPA Journal, June 2015, http://bit.ly/2rif3Yj).

Shareholders want and need accurate financial information, and not reporting a large amount of a company’s value arising from brand equity on financial statements can be misleading. Such omissions, for example, make accurate comparisons between companies difficult. If two companies have the same net income, assets, liabilities, and equity, but one company has a much better known brand and thus more brand equity, an investor would be unable to see the difference.

Accountants are particularly interested in valuing brand equity; however, no universal method for quantifying brand equity exists. Vince Howe et al. note that FASB and others are reluctant to allow brand equity in financial reporting because of the “absence of verifiable costs, inability to verify a certain transaction or series of transactions (lagged effect of advertising), and uniqueness of each intangible brand and resulting difficulty in establishing criteria for relevancy and reliability” (Vince Howe, William H. Sackley, Frederika Spencer, David Mautz, and Justin Freed, “‘Accounting’ for Brand Equity – Value Relevance and Reliability: A Marketing and FASB Dilemma,” Society for Marketing Advances Proceedings, November 2013, http://bit.ly/2rirB1I).

Marketers have wrestled for years with various methodologies to quantify brand equity. This article presents four such methods, assesses their strengths and weaknesses, and offers insights for a possible path forward.

Marketers’ Approaches to Valuing Brand Equity

From a marketing perspective, brand equity is based on how customers perceive a company’s products relative to the competition. The four methods marketers use are largely based on what drives customer demand for a product:

  • The price premium method measures the willingness of customers to pay more for a branded product.
  • Customer lifetime value (CLTV) refers to the net present value of expected future cash flows arising from the customer base.
  • Brand consultancies, such as Interbrand or Millward Brown, have developed proprietary methods to quantify the role a brand plays in a customer’s purchase decision.
  • Company experts identify the various drivers of a company’s profitability, then categorize and weight those drivers to assess the percentage of economic profit attributable to the brand.

Exhibit 1 illustrates each method’s strengths and weaknesses.

EXHIBIT 1

Methodologies Used to Value Brand Equity

Method; Logic; Methodology; Pros; Cons Price Premium Method; Customers willing to pay more for branded product than similar, unbranded product; Sum all the premiums paid for branded products over nonbranded products; Straightforward approach that leverages current goodwill valuation Can be used for individual products or departments; Hard to determine if premium paid is due solely to brand For companies with many products, difficult to calculate premiums on all Customer Lifetime Value (CLTV); When customers buy same brand repeatedly over time, it captures notion of brand loyalty; Compute present value of future cash flows from retaining a customer's purchases over their lifetime, sometimes called customer equity; Well-established protocol for computing CLTV; Customer equity is broader than brand equity Portion of CLTV attributable to brand not clear Proprietary Methods from Brand Consultancies; Brand value computed by isolating amount of revenue and financial value due to brand; Varies; Combines financial metrics with market data; Methodologies are complicated and proprietary Methodologies produce highly discrepant values Expert Weighted Profit Drivers Due to Brand; Company experts know what drives profitability and how to determine role of brand in those drivers; Create a list of profit drivers for a company; use metrics to narrow down the list; weight each driver to capture influence on profit; assess impact of brand on each driver; compute brand value derived from brand impact on profit and on other profit drivers; Thorough analysis of profit drivers to derive brand impact Expert judgment can be reliable and valid given a clear process; Human bias could affect results

Price premium of branded products.

Sunil Gupta and Donald R. Lehmann define brand equity as “the premium a customer would pay for one product over another when economic and functional benefits are the same” (Managing Customers as Investments: The Strategic Value of Customers in the Long Run, Wharton School Publishing, 2005). Instead of waiting until it is purchased, a company could find the premium paid for each individual product over a competitor’s product; the sum of all such price premiums paid for all the company’s products projected into the future, discounted at a rate of return that would be required by a purchaser, would equal a company’s brand equity.

This approach to valuing brand equity mirrors the way accountants currently value goodwill; the value of goodwill appears as the premium that someone would pay for specific net assets over other similar assets. The accuracy of this approach depends upon the non-branded equivalent product. Thus, in order for this method to be accurate, other benefits from the product would have to be eliminated from the premium, leaving only the value of the brand equity.

Moreover, this approach could be difficult for large companies that sell numerous goods. Rather than making the calculation based on individual products, determining premiums based on product lines or departments would be both more realistic and required by GAAP where possible when the assets are being valued in a business combination (i.e., acquisition).

Customer lifetime value.

CLTV is “the discounted future income stream derived from acquisition, retention, and expansion projections and their associated costs” (Gupta and Lehmann 2005). More simply, it is the present value of the profit from retaining a customer over the life of the customer’s purchase stream. For example, the cost of acquiring a customer includes the total costs of advertising, promotion, and personal selling. The company then continues its efforts to retain that customer through loyalty programs and customer service. Depending upon the average length of time customers remain loyal to a company, which varies by type of product, a company can then calculate the total revenue stream expected, less the total costs of acquiring and retaining the customer, and adjust that amount for net present value.

The sum of all current and estimated future CLTV for a company is called “customer equity” (Geoffrey N. C. Bick, “Increasing Shareholder Value through Building Customer and Brand Equity,” Journal of Marketing Management, February 2009, http://bit.ly/2rx1W4P). Customer equity, as calculated by CLTV, is similar to, but not the same as, brand equity; Roland Rust et al. state that brand equity “is the portion of customer equity attributable to the customer’s perceptions of the brand” (Roland T. Rust, Katherine N. Lemon, and Das Narayandas, Customer Equity Management, Prentice Hall, 2005). Thus, customer equity measures all factors that affect customer retention, such as product quality, customer service, and distribution/product availability—some of which correlate to brand equity, but not perfectly. Accounting for what portion of customer equity is directly attributable to a brand—and vice versa—is difficult; in theory, the greater the retention of consumers, the greater the brand loyalty, which in turn leads to greater brand equity. Given the correlation between customer retention and brand equity, disentangling brand value from CLTV remains unexplored.

Proprietary methodologies.

Recognizing the tremendous value of brands in market valuations, various brand consultancies have developed proprietary methodologies to quantify the value of companies’ brands and rank the world’s top global brands. Two of the leaders in this space are Interbrand and Millward Brown; their rankings of the top 10 brands in 2014 and 2015 are shown in Exhibit 2.

EXHIBIT 2

Top 10 Valued Brands in 2014 and 2015

Interbrand; Millward Brown 2014; 2015; 2014; 2015 1; Apple; Apple; Google; Apple 2; Google; Google; Apple; Google 3; Coca-Cola; Coca-Cola; IBM; Microsoft 4; IBM; Microsoft; Microsoft; IBM 5; Microsoft; IBM; McDonald's; Visa 6; General Electric; Toyota; Coca-Cola; AT&T 7; Samsung; Samsung; Visa; Verizon 8; Toyota; General Electric; AT&T; Coca-Cola 9; McDonald's; McDonald's; Marlboro; McDonald's 10; Mercedes-Benz; Amazon; Amazon; Marlboro

Combining marketing, accounting, and law, Interbrand’s Brand Valuation Methodology is “based on the cash flow that the brand can be expected to generate in the future” (Keller 2008). Essentially, Interbrand quantifies economic profit (after-tax operating profit minus a charge for the capital used to generate revenue and margins) and then accounts for the role that the brand plays in customer purchase decisions. The value of the brand is “the net present value of the forecast brand earnings discounted by the brand discount rate” (Keller 2008). The brand discount rate is calculated by benchmarking a company’s strengths and weaknesses against other companies in the same industry.

One of the key steps in Interbrand’s methodology is the role of branding index (RBI), where many drivers of demand for a specific branded product are ranked and weighted. This ranking and weighting is done by primary research, historical review of the brand’s role in that industry, or an expert panel. The goal of RBI is to find “the degree to which each driver [of demand] is directly influenced by the brand” (Keller 2008). Multiplying cash flows by the RBI yields the overall earnings specifically attributable to branding; this allows brand equity to be separated from the other factors that can persuade people to purchase products.

In 2014, Interbrand valued Apple’s brand at $118.8 billion, a 21% increase from 2013 (Michael Kraten, “Reimagining the Financial Statements,” CPA Journal, April 2015, http://bit.ly/1SSQXz7).

In contrast, the Millward Brown methodology focuses more on the core value of the brand rather than the financial components. It begins by evaluating the corporate earnings from brands in companies; in some cases, a company may have only one brand, but others may have to separate out the earnings attributed to each brand they own. To find the portion of earnings attributed to each brand, Millward Brown uses annual reports and other sources of financial information. This analysis yields a metric called the attribution rate, which is multiplied by the total corporate earnings of the company to find the earnings for each brand. Millward Brown also uses financial information, such as Bloomberg stock market data, to evaluate the brand multiple, which is multiplied by the brand earnings to find the brand’s financial value.

Millward Brown then assesses brand uniqueness and how a brand gains customer loyalty. In the final step, Millward Brown uses this consumer research to find what they call brand contribution, which is multiplied by financial value to find total brand value. Using this methodology, Millward Brown found that Apple’s brand was worth $147.9 billion in 2014, a 20% decrease from 2013. Note that these two brand consultancies valued Apple’s brand very differently. This discrepancy highlights problems with proprietary methods and reinforces the call for more formalized guidance in accounting for brand value.

Though these proprietary methods are complicated, they combine marketing and accounting concepts that can be used across many different industries for many different companies.

Expert-weighted profit drivers.

A fourth option uses company experts to develop a measure of the economic profit attributable to the influence of the brand on various profit drivers. Experts on all major functions from within the company create a list of such drivers, including brand, supply chain management, cost and margin management, and human resources. “Through an iterative process during which group members vote, rank, and rate resources, they gradually narrow down the list” (Keller 2008) to approximately five to eight drivers. The experts then weight each driver in terms of its impact on profitability and assess the influence that brand has on each driver. Averaging across experts, this process yields brand premium profit, or the profit that results from a brand through both its direct influence on profit and its indirect influence through other resources.

Companies increasingly compete on intangible assets, and their investments in brands are a key part of this strategy.

Some argue that a reliance on company personnel to determine and weight the different resources that drive profit is subjective and susceptible to bias. In general, however, techniques using expert judgment have been shown to be highly credible and reliable with the right experts and a solid process (Victoria Story, Louise Hurdley, Gareth Smith, and James Saker, “Methodological and Practical Implications of the Delphi Technique in Marketing Decision Making: A Reassessment,” Marketing Review, Winter 2000, http://bit.ly/2stXFnV).

Insights for Accounting

Accounting for the value of brand equity is not a new issue for the accounting profession; however, the topic likely will increase in importance over time. Companies increasingly compete on intangible assets, and their investments in brands are a key part of this strategy; thus, the problems arising from both the inability to value brands and the lack of consistency in which companies can report brand value will be magnified. Given the sizeable amounts attributed to brand valuations, this asset must be accounted for.

Because protocols exist to value brand equity, accounting professionals could partner with marketing professionals to develop a brand valuation process. For example, the Marketing Accountability Standards Board (http://www.themasb.org) has a project “Brand Investment & Valuation” to assess brand strength and validate a practical model for brand valuation. In addition, the Six Capitals framework of the Integrated Reporting Initiative would consider brand value to be a major component of intellectual, human, social, and relationship capital (http://integratedreporting.org). Much like integrating sustainability reporting with financial reporting, including the value of brand equity in financial statement disclosures would be a first step. The ultimate objective would be to determine the economic value of a company that can be attributed to its brands.

Lindsey Trent is a graduate with a Master’s of Accountancy (2017), at the University of Montana, Missoula, Mont.
Jakki Mohr, PhD is the Regents Professor of Marketing, at the University of Montana, Missoula, Mont.