Brand Valuation In the new economy where value drivers are shifting from tangible to intan- gible resources, brands are the most familiar asset. They are well known by consumers, perceived as a critical component of enterprise value, and often motivate large mergers and acquisitions. Yet brands are a complex intangible asset, and their valuation is a difficult task requiring a variety of expertise: legal, economic, financial, sector-specific, and marketing. Using rigorous methodologies, an analysis of the world of the new econ- omy, and an inquiry into the limits of modern valuation technics, this book offers empirical and theoretical background to the key issue of brand valu- ation. It provides answers to the many questions that arise when attempting to value a brand: How to understand the origin of brand value? How to assess its value objectively? Why valuations of some brands by consulting firms differ so widely? How to understand that some brands are valued at millions of euros when the companies that own them are losing money? Brand Valuation explains the economics and finance factors explain- ing the value and volatility of brands and presents the most commonly used methodologies to value brands, such as the cost methods, the excess earnings approach, the relief-from-royalty method, or the excess revenue approach. The methodologies covered are illustrated with numerous exam- ples, allowing the reader to grasp the advantages and limits of each valua- tion technique. The book presents the relevant context of brand valuation, including the applicable existing accounting and valuation standards and also discusses the models developed by consulting firms. Luc Paugam is an Associate Professor at ESSEC Business School, France. Paul André is a Professor at HEC Lausanne at the University of Lausanne, Switzerland. Henri Philippe is a Partner at Accuracy in Paris, a corporate finance consulting firm, and teaches finance at the Université Paris-Dauphine, HEC Paris, and École Nationale des Ponts et Chaussées, France. Roula Harfouche is a Fellow of the Institute of Chartered Accountants in England and Wales and a Partner at Accuracy London, UK. Routledge Studies in Accounting For a full list of titles in this series, please visit www.routledge.com 9 Law, Corporate Governance, and Accounting: European Perspectives Edited by Victoria Krivogorsky 10 Management Accounting Research in Practice Lessons Learned from an Interventionist Approach Petri Suomala and Jouni Lyly-Yrjänäinen 11 Solvency in Financial Accounting Julie Margret 12 Accounting and Order Mahmoud Ezzamel 13 Accounting and Business Economics Insights from National Traditions Edited by Yuri Biondi and Stefano Zambon 14 The Nature of Accounting Regulation Ian Dennis 15 International Classification of Financial Reporting, Third Edition Chris Nobes 16 Fraud in Financial Statements Julie E. Margret and Geoffrey Peck 17 Auditing Theory Ian Dennis 18 Brand Valuation Luc Paugam, Paul André, Henri Philippe, and Roula Harfouche Brand Valuation Luc Paugam, Paul André, Henri Philippe, and Roula Harfouche First published 2016 by Routledge 711 Third Avenue, New York, NY 10017 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2016 Taylor & Francis The right of Luc Paugam, Paul André, Henri Philippe, and Roula Harfouche to be identified as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data Names: Paugam, Luc, author. Title: Brand valuation / by Luc Paugam, Paul Andrâe, Henri Philippe, and Roula Harfouche. Description: New York : Routledge, 2016. | Series: Routledge studies in accounting ; 18 | Includes bibliographical references and index. Identifiers: LCCN 2016000105 | ISBN 9781138933828 (hardback : alk. paper) | ISBN 9781315677347 (ebook) Subjects: LCSH: Brand name products—Valuation. | Intangible property—Valuation. | Brand loyalty. | Branding (Marketing) Classification: LCC HD69.B7 P39 2016 | DDC 657/.7—dc23 LC record available at http://lccn.loc.gov/2016000105 ISBN: 978-1-138-93382-8 (hbk) ISBN: 978-1-315-67734-7 (ebk) Typeset in Sabon by Apex CoVantage, LLC Contents List of Tables and Figures vii Acknowledgments xi About the Authors xiii Introduction xv 1 What Is a Brand? 1 2 Brand Value 27 3 Brands and Accounting Standards 40 4 The Excess Earnings Method 66 5 Revenue Premium Method 84 6 The Relief-From-Royalty Method 92 7 The Market-Based Approach 103 8 The Cost-Based Approach 111 9 Brands and Valuation Standards 120 10 Ad Hoc Valuation Models 136 11 Volatility of Brand Values 151 Conclusion 163 Appendix 1 167 Appendix 2 172 Appendix 3 174 Appendix 4 176 Index 179 This page intentionally left blank Tables and Figures Tables 1.1 Details of fixed assets on the balance sheet of Barbara Bui (2013–2014) 7 1.2 Top-ten S&P 500 firms by advertising expense in 2014 7 1.3 Advertising expenses by sector (Global Industry Classification Standards)—S&P 500 companies from 2004 to 2014 8 1.4 Relationship between advertising expenditure, operational performance, sales growth, and market return (for S&P 500 companies with positive advertising expenditure from 2004 to 2014) 9 1.5 Brand life cycle and probable life expectancy (LE) 16 1.6 Lifespans used in accounting valuations of brands in the United States 17 2.1 Balance sheet of Fashion 22 at 31/12/20×4 30 2.2 Income statement of Fashion 22 for year 20×4 31 2.3 Cash flows generated by Fashion 22 for year 20×4 31 2.4 Income statement of Fashion 22 for year 20×4 with the effects of the brand 33 2.5 Estimated cash flows of Fashion 22 and incremental brand- related cash flows 34 3.1 Uncertainty as to the amounts of expected cash flows generated by a brand in year n + 1 51 3.2 Uncertainty as to the timing of cash flows generated by a brand in the years n + 1 to n + 3 52 3.3 Recognition of intangible assets by FTSE 100 companies 60 4.1 Historical income statements of Consultancy Inc. 72 4.2 Forecast income statement of Consultancy Inc. 72 4.3 Historical balance sheets of Consultancy Inc. 72 4.4 Forecast profitability and ROCE of Consultancy Inc. 73 4.5 Estimation of annual excess earnings 74 4.6 Estimated excess earnings of the Consultancy Inc. business 77 viii Tables and Figures 4.7 Value of Consultancy Inc.’s workforce 79 4.8 Estimated excess earnings from the Consultancy Inc. brand 80 5.1 Revenue per consultant 86 5.2 Operating profit generated by the Consultancy Inc. brand 87 5.3 Discounted cash flows and value of the Consultancy Inc. brand 88 6.1 Forecast revenues 2015–2019 95 6.2 Forecast revenues 2015–2022 95 6.3 Study of brand awareness in the leather goods sector 96 6.4 Estimated gross royalties of the Traveller brand 96 6.5 Net royalties of the Traveller brand 97 6.6 Present value of net royalties of the Traveller brand 97 6.7 Value of the Traveller brand 98 6.8 Ranges of royalty rates by sector and brand type—as a per cent of revenue 100 7.1 Trading multiples of companies in the luxury apparel sector (7 October 2015) 105 7.2 Transaction multiple on recent sports apparel companies 106 8.1 Creation and development costs of the “Acajou” brand 114 8.2 Valuation of the “Acajou” brand at capitalised historical costs 115 8.3 Reproduction costs of the “Acajou” brand 116 9.1 Available data and valuation methods applicable to brands 128 10.1 Advantages and disadvantages of ad hoc brand valuation models 137 10.2 Factors impacting the Interbrand discount rate 139 10.3 Interbrand ranking of the ten highest-value brands (2005–2014) 139 10.4 Definition of BrandFinance ratings 146 10.5 BrandFinance (2014) ranking and comparison with Interbrand ($ billion) 146 10.6 Criteria included in the Brand Equity Evaluation System to determine the pre-tax profit multiple 148 11.1 Similarity between options and brands 156 11.2 Validity of additive and combinatory models 158 A.1 Median beta by industry sector (GICS) 172 A.2 Median cost of capital by industry sector (GICS) 174 Figures 1.1 The brand life cycle 15 1.2 Sporting goods brands ranked by brand awareness amongst US consumers in 2014 24 2.1 Mapping of the different brand valuation methods 37 3.1 Decision tree for an impairment test under IAS 36 49 Tables and Figures ix 3.2 Evolution of the book-to-market ratio of FTSE 100 companies 58 3.3 Evolution of shareholders’ funds and market capitalisation from 1990 to 2014 59 3.4 Other intangible assets of FTSE 100s as a per cent of total assets (average) 62 3.5 Recognition of intangible assets by the five most intangible- intensive companies (as a per cent of total assets) 62 4.1 Cost of capital by asset category 81 7.1 Purchase price allocation of the Reebok acquisition 107 7.2 Purchase price allocation of the Umbro acquisition 108 9.1 Variation in 2005–2010 in the number of companies with a higher book value than market capitalisation (as a per cent of the number of companies making up the two indices) 122 10.1 Movements in Apple brand value and market capitalisation (Base 100 in 2001) 141 10.2 Movements in McDonald’s brand value and market capitalisation (Base 100 in 2001) 141 10.3 Movements in Coca-Cola brand value and market capitalisation (Base 100 in 2001) 142 10.4 Movements in GE’s brand value and market capitalisation (Base 100 in 2001) 142 11.1 Standard valuation model and representation rule 159 11.2 Valuation reflecting the combinatory nature of intangible assets 160 A.1 Balance sheet and cost of capital 170