Brand Finance is an interesting consultancy. Founded in 1996 and based in the U.K., they advise “strongly branded organisations on how to maximise their value through the effective management of their brands and intangible assets.” They have offices around the world (including Toronto) and produce reports on the most valuable brands by country and by sector. I think it is useful to understand the basics of their methodology because it is a good example of bringing more rigor to what often is a very subjective exercise, and might also give improvement professionals ideas on how to create better metrics for other “soft” areas of business.
I don’t pretend to fully understand their algorithm but in essence, among other things, they estimate an annual “royalty rate,” that is, they ask the question given the strength of the brand in terms of awareness, profitability, market share etc. what royalty rate would a company have to pay each year to licence the brand. They then use discounted cash flow (DCF) approach to arrive at a net present value of the cash stream, deriving an estimate of the value of the brand. I like this approach because it is more than just consumer awareness, but also takes into account profitability as well. A brand might have high awareness and even market share, but if it isn’t making money, it a lot less exciting to me as a business person.
By the way, below are the most valuable brands in Canada, using this approach, as of September, 2011:
- TD Bank
The following material is from the Brand Finance website, which is: http://www.brandfinance.com/home
The methodology employed in this BrandFinance® Global 500 listing uses a discounted cash flow (DCF) technique to discount estimated future royalties, at an appropriate discount rate, to arrive at a net present value (NPV) of the trademark and associated intellectual property: the brand value.
The steps in this process are:
1. Obtain brand-specifc financial and revenue data.
2. Model the market to identify market demand and the position of individual brands in the context of all other market competitors. Three forecast periods were used:
- Historical financial results up to 2010. Where 2010 results are not available forecast using Institutional Brokers Estimate System (IBES) consensus forecasts are used.
- A five-year forecast period (2011-2015), based on three data sources (IBES, historic growth and GDP growth).
- Perpetuity growth, based on a combination of growth expectations (GDP and IBES).
3. Establish the royalty rate for each brand. This is done by:
- Calculating brand strength – on a scale of 0 to 100, according to a number of attributes such as financial, brand equity, market share and profitability, among others.
- Use brand strength to determine ßrandßeta® Index score.
- Apply ßrandßeta® Index score to the royalty rate range to determine the royalty rate for the brand. The royalty rate is determined by a combination of the sector of operations, historic royalties paid in that sector and profitability of the company.
4. Calculate future royalty income stream.
5. Calculate the discount rate specific to each brand, taking account of its size, geographical presence, reputation, gearing and brand rating (see opposite).
6. Discount future royalty stream (explicit forecast and perpetuity periods) to a net present value – i.e.: the brand value.
Royalty Relief Approach
Brand Finance uses the royalty relief methodology that determines the value of the brand in relation to the royalty rate that would be payable for its use were it owned by a third-party. The royalty rate is applied to future revenue to determine an earnings stream that is attributable to the brand. The brand earnings stream is then discounted back to a net present value. The royalty relief approach is used for three reasons: it is favoured by tax authorities and the courts because it calculates brand values by reference to documented third-party transactions; it can be done based on publicly available financial information and it is compliant to the requirement under the International Valuation Standards Committee (IVSC) to determine Fair Market Value of brands.