MARKETING FOCUS: Raising brands’ stock in the City - New accountancy rules should assist companies in valuing their brands, but will it do the same for the marketing effort that lies behind them?

The City long ago realised that brands have value. It knows that when the economic going gets tough, a brand’s equity and strength can help maintain consumer confidence and support its share price.

The City long ago realised that brands have value. It knows that

when the economic going gets tough, a brand’s equity and strength can

help maintain consumer confidence and support its share price.



But many in advertising and marketing feel that the red braces brigade

in the City think about brands in the same way as their next

Porsche.



They like what they see, but don’t always appreciate what’s under the

bonnet. So whereas the brand has a clear value for them, the marketing

and advertising which drives it does not.



Industry bodies such as the Institute of Practitioners in Advertising,

along with individually listed companies, are busily trying to change

this perception of marketing as a cost, rather than an investment.



They have their work cut out. Financial Times chairman David Bell,

speaking at the IPA’s Effectiveness Awards earlier this month, said

there was still strong evidence that the value of marketing and

advertising went unrecognised by City institutions.



’Nothing highlights this better than the different approaches of the

City to pharmaceutical companies and branded goods companies,’ he

said.



’A review of this year’s company results reveals a strong focus on

patents, new product trials and overall spend on R&D in the comment

about pharmaceutical companies. And the City tends to mark these

companies down if they reduce spend in these areas.’



He adds: ’By comparison, the comment about branded goods companies

highlights almost none of this information. The focus is much more on

the short-term performance and cost-cutting initiatives.’



Bell went on to point out that successful brands can have ’amazing

longevity and profit streams’, citing Coke as an example. ’Coke first

appeared in 1886 ... it goes without saying that (its) market value is

many thousand times its tangible assets.’



But Bell was preaching to the converted. The members of the IPA and the

clients at the Effectiveness Awards know good marketing and advertising

can make its mark on a company’s bottom line. The challenge, as Bell

made clear, is to convince the City, which is still resistant to the

charms and claims of brand marketing.



’The value of brands as shareholder assets has been widely recognised,

but the crucial role of marketing and advertising in building this brand

equity, and so enhancing these assets now on the balance sheet, is still

not fully recognised. We will have to change this. We will need to

continue to develop the vocabulary and widely accepted measures of brand

equity if this situation is to change.’



Some in the marketing industry argue that a forthcoming change in

accountancy law could help the development of a vocabulary that the City

understands.



Next month, two new innocuous-sounding rules, Financial Reporting

Standards (FRS) 10 and 11, will come into force. One senior marketer

calls it ’the most significant event in branding in the last

decade’.



The reason for this enthusiasm is that, for the first time in the UK,

acquired brands (termed ’purchased goodwill and intangible assets’) will

have to appear on a company’s annual accounts.



In the past, intangibles, such as brands, goodwill and patents, were

simply written off, but as intangibles have become more valuable, large

companies found they were having to write off increasingly huge sums

with unpleasant and misleading consequences on the balance sheet.



The new accounting measures bring Britain into line with what’s been

happening in the US for years, and what most brand-heavy companies

started doing in the 1980s, which is to put a value on the brand and

include it in the annual accounts.



More importantly, however, many in the industry hope this official

recognition will ensure the City recognises the value of building

brands, and thus the contribution of marketing, to the share price

These minor changes in accounting rules could have a very significant

effect on marketers around the country.



What FRS 10 says is that items in the intangibles category must be

written off over a maximum of 20 years (compared with 40 years in the

US) unless that presumption can be rebutted. A company with a strong,

newly acquired brand, for instance, may claim its useful life is forever

(for example BMW acquiring the Rolls-Royce brand) in which case it will

have to do a discount cash flow valuation annually to support its

claim.



David Haigh, managing director of Brand Finance, is an accountant whose

company is at the forefront of a rapidly developing business in

evaluation accountancy. Haigh is excited about FRS 10 and 11 because, he

says, the rules will be a catalyst for a dramatic change in the way

accountants view and invest in the marketing function.



Haigh claims that annual discount cashflow analysis on the brand will

mean finance departments will have to think in terms of long-term

investment in marketing. ’Marketing and financial management will have

to dovetail, and the accountants will have to be far more mindful of

brand investment,’ he says.



According to Ray Perry, marketing director at the Chartered Institute of

Marketing, this process will, if nothing else, give marketing

departments an annual indicator of their effectiveness. And, although

the rules only relate to bought-in brands, Haigh claims it makes no

sense to limit the process. Once companies have set up a template for

valuing acquired brands, they will use it for their entire brand

portfolio.



Of course, FRS 10 and 11 don’t give companies that template; they have

to determine their own method of evaluation and be able to justify its

formula. Haigh says it is important to be clear about what assumptions

are being made and that they are fully disclosed. Just as pension fund

managers must disclose that their forecasts are based on a certain yield

and growth in salaries, so brand valuation will have to be equally

transparent, revealing profit margins, market share and other key

indicators.



Shell’s global head of brand and communication, Raoul Pinnel, welcomes

the FRS 10 change. He argues that not only will it encourage the board

to take care of the brand, but it will open a dialogue about investing

in its value. ’Marketing people won’t just be preaching on the basis of

belief, but on the basis of hard facts and quantitative research and

that will speak much more loudly to the board,’ he says.



It is a view backed by Leslie Butterfield, chairman of Partners BDDH,

who wrote in the IPA’s Understanding The Financial Value of Brands:

’This sort of research process is good news for the marketing community,

and for advertising agencies, too. The rigour that it implies will force

a positive revaluation by the board and by the financial community of

the role and value of brands, and of the marketing and advertising

support for those brands. As a result, the better clients and their

agencies will prosper and may one day even see their remuneration and

fees linked to changes in the brand values.’



Frazer Thompson, Heineken’s international marketing manager, also thinks

the changes are good news and will help change the mindset of finance

and marketing departments. ’Brand managers are increasingly aware of the

intangible asset value of the brand and what they can do to increase

that value. The implications of FRS 10 and 11 are that non-marketing

managers will appreciate that too.’



But some in the industry think the impact of the new rules has been

overestimated. One sceptic is Tim Ambler, senior fellow at the London

Business School. ’There’s a huge amount of baloney about this which is

profoundly misleading,’ he says. Ambler claims that nothing will appear

on balance sheets that wasn’t there before. ’It isn’t a template, it

doesn’t tell you how do it, it’s simply clarifying the rules for

companies who have for many years put acquired brands on the balance

sheet. From that point of view, it’s most welcome, but for marketers or

company structure, there’ll be no spin-off at all.’



Ambler was at Grand Met in 1988 when it was among the first to include

new brands - worth pounds 608m - in its accounts. At the time this was

seen as a radical move, but Ambler says it had ’no impact on the use of

brand equity internally’.



While many welcome the changes in accountancy rules, they argue that

this is not the real battleground. The issue is about convincing the

City of the value of advertising and marketing, using language that both

the City and marketers can share.



One recent notable effort was a paper by Orange and its advertising

agency, WCRS, which won the IPA Charles Channon Award for the best

contribution to new learning this month. It set out not only to prove

the effectiveness of advertising on sales, but to show how it added

value to shareholders in terms of share price. WCRS worked with Lehman

Brothers on developing a spreadsheet methodology that sought a

quantitative comparison of advertising with stock value.



The paper reports: ’Lehman Brothers’ sophisticated spreadsheet

methodology puts the current implied value per share of Orange at 528p

(compared with the current market value of 443p). We then asked them to

re-work their valuation on the assumption that advertising’s effects on

net subscriber growth, customer revenue, and churn had not applied. The

implied value per share plummets to 279p.’



The paper concludes: ’With the help of Lehman Brothers we have been able

to calculate advertising’s capacity to increase Orange plc’s implied

value per share by pounds 2.49. This is equivalent to an increased

market capitalisation of pounds 3bn.’



There are few marketers who today would accept the old Lord Leverhulme

complaint that half of their advertising was working, they just don’t

know which half. Metrics for measuring advertising and media

effectiveness are being refined and improved all the time. But the

industry must ensure that its claims about measurability and

accountability are made in a language the City can understand and agree

with.



HOW IS BRAND EQUITY WORKED OUT?



New accountancy rules should theoretically make it easier to put a

figure on the value of acquired brands on the balance sheet. But Steve

Waring, partner at specialist marketing accountants Willott Kingston

Smith, says the process is fraught with problems. As yet, there is no

consistent framework for working out the value, he says, or apportioning

how much of total value is assigned to a company’s brands.



’Comparative allocation is the difficult bit and will differ from year

to year,’ says Waring. ’It’s hard to say, for example, if a brand has

suffered reversible losses.’ Evaluation will therefore be a matter of

analysing how the brand was acquired, together with its sales, and

discussion with company directors.



According to David Aaker’s Building Strong Brands, this analysis should

embrace the following areas of evaluation: price premium,

satisfaction/loyalty, perceived quality, leadership/popularity,

perceived value, brand personality, organisational associations, brand

awareness, market share, market price, and distribution coverage.



Brand Finance managing director David Haigh is so confident that he’s

found a way to do this he has registered his brand valuation formula as

a trademark : Brand Value Added (BVA). It involves traditional research,

questionnaires and face-to-face interviews and includes the following

analyses:



Economic Value Added (EVA) A brand’s background and revenues, costs and

capital are calculated to produce a five- to ten-year cashflow forecast.

The EVA is the fully absorbed earnings of the brand after the allocation

of central overhead costs.



Elimination of private label production



The earnings in the discounted cash flow calculation must relate only to

the brand being valued, not to other unbranded goods which may be

produced alongside the brand, but aren’t sold under its name.



Remuneration of capital employed



To avoid over-valuing the brand, a fair charge must be made for the

value of the business’s tangible assets, such as the distribution

system, manufacturing plant and stock. The brand is only adding value to

the business once a fair return has been made on the fixed assets and

working capital.



Taxation



The discount rate is applied to post-tax earnings, giving an assessment

of the historic and prospective Economic Value Added attributable to the

intangible assets of the branded business.



Calculating BVA



Different businesses rely in varying degrees on branding to stimulate

demand and support price. By identifying what it is that drives demand

in the specific market, Haigh argues it is possible to estimate the

contribution made by the brand.



Assessing brand risk: Brand value reflects its income-generating

potential - an appropriate discount rate takes into account economic,

market and brand risks.



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