‘Why?' is a commonly asked question when talking about brand valuation. Why do you value brands? Why is brand valuation useful? Why would a brand valuation benefit me?

Brands are generally a company's most valuable asset and the means through which income and profit is generated. Identifying what drives this value enables management to increase a brand's performance, resulting in increased revenue, larger market share and higher profits. Brand valuation helps analyse and plan for this, which is what makes it useful.

The final value figure which is usually banded about is by itself, largely uninteresting. Look behind the headline number and the interest and usefulness soon becomes apparent. It hides a number of factors which illustrate the health of the business. Think of it like a tiered iceberg or a pyramid, the tiers of which are connected by a series of formulae. The top tier contains only the final figure and is the most visibly attractive element, but largely useless in itself. Tier two contains performance measures such as a brand's profitability, income, tax and discount rates. Tier three contains measures of brand strength and market conditions. There are then a series of similar tiered pyramids for each market, segment or territory the brand operates, all of which are connected to the main pyramid. All this information can be collated in one spreadsheet.

So, for example, at a glance you can see marketing's impact on brand value in each sector or country; which means the brand valuation model can be used as a return on investment tool. Or by amending a marketing budget, you could see how it could impact the brand's value and business profitability; so the brand valuation model can be used for forecasting and scenario planning.

How do you value brands?
The most common approach is the relief-from-royalty methodology which calculates how much a brand owner is relieved from paying for the use of the brand, by virtue of owning it. This uses the traditional licensing arrangement whereby the brand owner receives a royalty on income generated by the brand. Future brand earnings (sales times royalty rate) are discounted to reflect the time value and risk attached to those future cash flows and tax is deducted. Forecasting revenue and calculating a royalty rate are therefore two key components.

Building a brand valuation model
Most information required to build a brand value tracker, to monitor the value of a brand, is already held internally by the brand owner: historical sales and profitability, sales forecasts, brand research, competitor research, market trends, future plans and strategies. The task is therefore neither daunting nor unmanageable. It simply requires the assimilation of all the information with an understanding of how the pyramid fits together.

Case study: valuing Coca-Cola's UK brand value

Tier Three: brand and market performance
Understanding the strength of the brand relative to the competition is a key element of determining the royalty rate. A number of measures are drawn up against which the brand and competitive set are scored. Such measures could include perception measures such as awareness, understanding, perception, heritage, propensity to buy, and harder measures such as market share, market and brand growth and price positioning. This is used not only to construct the royalty rate but as benchmarks for performance.

Take Coca-Cola as an example. Using similar measures, Coca-Cola's brand score, in recent research Intangible Business carried out, ‘The UK's Most Valuable Grocery Brands 2006', was 76%. Coca-Cola can see how it performs against these set criteria relative to its competition. For example, it scores well for awareness, 100%, but underperforms for relevancy, 74%. Communications can therefore be focused to increase consumers' capacity to relate to the brand and increase their propensity to purchase.

This brand score is then positioned within a royalty rate range, which for soft drinks such as Coca-Cola is between about 0% and 20%. With a brand score of 76%, Coca-Cola's royalty rate is therefore about 15% at retail level. If communications could effectively increase Coca-Cola's relevancy to say 85%, this would have a positive effect on the royalty rate resulting in a more valuable brand. Likewise if it were to fall yet further, so would Coke's value.

Tier Two: Financial performance
With an appreciation of historical sales figures and future trends for the brand and sector as a whole, as referenced in tier one, future sales growth can be forecast. Coca-Cola's UK sales have declined by approximately 2% since 2003 and the market trends are moving away from sugary, carbonated drinks towards healthier alternatives. Coca-Cola's sales are therefore forecast to continue below inflation. Profitability remains high though due to the sheer volume of distribution and low manufacturing costs.

Future earnings are then multiplied by the royalty rate established from the criteria in tier three. These earnings are discounted by 9%, as these are relatively low-risk cash flows, and a tax rate of about 30% is applied.

Tier one: The brand value
The sum of the future cash flows as calculated in tier two add up to £1,057.3m which is the value of the Coca-Cola brand in the UK. If Coca-Cola constructed a similar valuation programme in every country it operates in, it would be able to identify where the value is coming from and in which markets it is underperforming and why. Resource could therefore be quickly be deflected from over-performing areas and allocated to remedy the decline in underperforming areas, with a full picture of what impact the new resource allocation is likely to have.

Conclusion
While this is a simplified version of a complicated procedure, it does demonstrate that there is more to knowing the value of a brand then the simple headline number. The headline number is all that is normally seen but, like the tip of an iceberg, it is supported by a huge volume of weight beneath. And if this is understood properly, then rather than asking ‘Why?' people say, ‘Wow.'