The role of powerful brands in
creating shareholder value
By Professor Malcolm McDonald
LSBU 14th February 2013
1
The limited value of Profit and Loss
Accounts and Balance Sheets
“The information appearing in the majority of boardrooms
remains predominantly financial in nature. Without
(additional) information on value-creating activities
management are typically flying blind – when financials tell
them there is a problem management have already missed
the optimal point for taking appropriate corrective action”.
PricewaterhouseCoopers – ValueReporting™ Review 2003,
Transparency in Corporate Reporting, p.25
Page 2
Inter Tech’s 5 year performance
Performance (£million)
Base Year
1
2
3
4
5
Sales Revenue
- Cost of goods sold
£254
135
£293
152
£318
167
£387
201
£431
224
£454
236
Gross Contribution
- Manufacturing overhead
- Marketing & Sales
- Research & Development
£119
48
18
22
£141
58
23
23
£151
63
24
23
£186
82
26
25
£207
90
27
24
£218
95
28
24
Net Profit
£16
£22
£26
£37
£50
£55
Return on Sales (%)
6.3%
7.5%
8.2%
9.6%
Assets
Assets (% of sales)
£141
56%
£162
55%
£167
53%
£194
50%
Return on Assets (%)
11.3%
11.6% 12.1%
£205
48%
£206
45%
13.5% 15.6% 19.1% 24.4% 26.7%
Page 3
Why Market Growth Rates Are Important
InterTech’s 5 Year Market-Based Performance
Performance (£million)
Base Year
1
2
3
4
5
Market Growth
18.3%
23.4% 17.6% 34.4% 24.0% 17.9%
InterTech Sales Growth (%)
Market Share(%)
12.8%
20.3%
17.4% 11.2% 27.1% 16.5% 10.9%
19.1% 18.4% 17.1% 16.3% 14.9%
Customer Retention (%)
New Customers (%)
% Dissatisfied Customers
88.2%
11.7%
13.6%
87.1% 85.0% 82.2% 80.9% 80.0%
12.9% 14.9% 24.1% 22.5% 29.2%
14.3% 16.1% 17.3% 18.9% 19.6%
Relative Product Quality
Relative Service Quality
Relative New Product Sales
+10%
+0%
+8%
+8%
+0%
+8%
+5%
-20%
+7%
+3%
-3%
+5%
+1%
-5%
+1%
0%
-8%
-4%
Page 4
Quality of profits
%
Sales Revenue
Cost of Goods Sold
Profit Margin
Advertising
R&D
Capital Investment
Investment Ratio
Operating Expenses
Operating Profit
Key Trends
Virtuous plc (%)
100
43
57
11
5
7
23
20
14
Dissembler plc (%)
100
61
39
3
2
5
20
14
• Past 5 year revenue growth 10% pa
• Heavy advertising investment in new/
improved products
• Premium priced products, new plant, so
low cost of goods sold
• Flat revenue, declining volume
• No recent product innovation, little
advertising
• Discounted pricing, so high cost of
goods sold
3Note:
This table is similar to a P&L with one important exception - depreciation, a standard item in any P&L has been replaced by capital
expenditure, which does not appear in P&Ls. In the long-term, Capex levels determine depreciation costs. Capex as a percentage of sales in
an investment ratio often ignored by marketers, and it has been included in this table to emphasize its importance.
Factor
Profit on existing products over
3 years old
Losses on products recently
launched or in development
Total operating profits
The make-up of 14% Operating Profits
Virtuous plc (%)
21
Dissembler plc (%)
15
(7)
(1)
14
14
From Hugh Davidson’s “Even More Offensive Marketing” 1998
Justifying investment in marketing assets
Whilst accountants do not measure intangible assets, the
discrepancy between market and book values shows that
investors do. Expenditures to develop marketing assets
make sense if the sum of the discounted cash flow they
generate is positive.
Balance sheet
Assets
Liabilities
- Land
- Buildings
- Plant
- Vehicles
etc.
- Shares
- Loans
- Overdrafts
etc.
£100 million
£100 million
Balance sheet
Assets
- Land
- Buildings
- Plant
- Vehicles
etc.
£100 million
Liabilities
- Shares
- Loans
- Overdrafts
etc.
£900 million
Balance sheet
Assets
- Land
- Buildings
- Plant
- Vehicles
Liabilities
- Shares
- Loans
- Overdrafts
etc.
Goodwill £800m
£900 million
£900 million
Asset Breakdown for the top 10 countries by Enterprise Value (US$ millions, 2011)
Intangibles
P and G paid £31 billion for Gillette, but bought only £4
billion of tangible assets
-
Gillette brand
Duracell brand
Oral B
Braun
Retail and supplier network
Gillette innovative capability
TOTAL
£ 4.0 billion
£ 2.5 billion
£ 2.0 billion
£ 1.5 billion
£10.0 billion
£ 7.0 billion
£27.0 billion
(David Haigh, Brand Finance, Marketing Magazine, 1st April 2005)
Brand Value
A brand may be an intangible asset for accounting purposes,
but the value of brands is hard to deny. The top 100 brands
increased by 2% to $2 trillion despite the global economic
turmoil.
Moreover, the stocks of those 100 brands have consistently
rewarded shareholders, outperforming the S & P 500 by more
than 30% between April 2006 and April 2010.
Brandz Top 100 Most Valuable Global Brands. Millward Brown Optimor. 2011 study
The substitution of physical assets by
intangible
In the past few decades there has been a transformation
in the production function of companies– the major
assets that create value and growth.
Intangibles are fast growing substitutes for physical
assets.
L.Baruch. Professor of Finance Stern School of Business. NYU
(reported by Haigh D in “Marketing Accountability” Kogan Page
2010 chapter 12 page 4)
Residual goodwill
International Financial Reporting Standard 3
(IFRS 3) recommended the identification and
disclosure of individual intangible assets on
acquisition. The residue paid on acquisition will
be referred to as “residual goodwill”. IFRS 3
also called for “impairment reviews” based on
discounted cash flows (DCF) valuation
techniques on each intangible asset included in
Residual goodwill.
Residual Goodwill
Residual Goodwill
Artistic Intangibles
Marketing Intangibles
Intangible
Assets
Customer Intangibles
Contract Intangibles
Enterprise
Value
Technology Intangibles
Working Capital
Tangible
Assets
Plant and Equipment
Land and Buildings
What does “Brand” mean?
A logo and associated visual elements
-to add value, trademarks need to have “associated goodwill” acquired by
superior product quality and service over a long period
l
A larger bundle of associated intellectual property rights
-product design rights, trade dress, packaging, copyright in smells, sounds,
advertising visuals, written copy etc. Many of these legal rights can be
registered and protected.
-e.g. Mercedes product design; Guinness recipe and production process
l
A holistic company or organisation brand
-the whole organisation: culture; people; processes etc.
-taken together, these create specific value propositions and create stronger
customer relationships
l
Hence, “brand” means one of the following:
-”trademark”; “brand”; “branded business”
l
Brand Equity
l
l
l
A financial term to denote that brands are financial
assets
A propensity of specific audiences for preferences
which are financially favourable to a good brand.
Brands with high equity are able to persuade people
to make economic decisions based on emotional
rather than rational criteria.
The Rational Consumer
20th century economics were based on the lunatic
assumption that humans are ‘rational’ i.e. They
calculate their maximum ‘utility’, using perfect
information to reach perfect decisions, i.e. A precise
point on a precise graph.
Branding
“An extreme case has to be that particularly
scabrous class of drivel known as " skincare "
ads. Who on earth would believe the incredulous,
ludicrously pseudo-scientific, indigestible goulash
of molecules and meaningless polysyllables ? "
Baker N "Cynical consumer seeks brand for meaningful
relationship " Market Leader March 2009 ( pp 48-51 )
Brand Equity
Comparison of some Global Brands by the World’s Top Brand Valuation
Companies
(USD)
Interbrand (2010)
Millward Brown (2010)
Coca Cola
70.4bn
67.9bn
Walmart
-
-
IBM
64.7bn
86.3bn
Microsoft
60.8bn
76.3bn
GE
42.8bn
45bn
Google
43.5bn
114.2bn
McDonald’s
33.5bn
66bn
Brands are key intangibles in most businesses
Brands are estimated to represent at least 20% of the intangible value of
businesses on the major world stock markets. Brands combine with other
tangible and intangible assets to create value
Developed Markets
Brand
Brand
20%
Patents
Marketing intangible
Technology intangibles
Software
Intangible assets
Other
Intangible
Assets
Customer intangible
Distribution rights
Assembled workforce
55%
Tangible
Assets
25%
Customer relationships
Contract intangibles
Business Goodwill
Tangible assets
Illustrative
Source: Brand Finance
Brands achieve this increased value by positively affecting different stakeholders
•
•
•
More invitations to tender
Greater propensity to award
Higher share of fields awarded
Partners
•
•
Greater willingness to partner
Partnership on better terms
Employees
•
•
Lower recruitment costs
Lower retention costs
Suppliers
•
Lower prices and better terms
Bankers
•
•
Lower borrowing costs
Better repayment conditions
•
•
Higher price earnings ratio
Lower volatility
Government
Investors
Brands Increasingly Drive Business Results
Brands affect business value by influencing the behaviour of a wide range of Shell’s
stakeholders, some of which directly impact Shell’s P&L (and hence value)
STAKEHOLDER
PERCEPTION
Customers
- individuals,
businesses
Trademarks
Suppliers /
Partners
Brand
- businesses,
energy asset
owners
Employees
- current and potential
Reputation Shareholders /
Bankers
- individual and
institutional
Indirect
influence
on value
Other
Stakeholders
- government, media,
opinion formers,
academics, public,
environmentalists
STAKEHOLDER
BEHAVIOUR
• Pay price premium
FINANCIAL
IMPACT
• Buy more
Revenues
• Lower prices
• Better terms
• Willingness to partner
Costs
Revenues
SHAREHOLDER
VALUE
•(more opportunities)
• Better retention
• Lower salary expectations
• Better qualified candidates
Costs
Productivity
• Higher PE ratio
• Lower volatility
• Lower borrowing costs
• Better repayment conditions
Costs
Risk
Influences
business and
brand value
Successful brands
*
*
*
*
*
*
*
*
*
Have a clear customer benefit
Make a promise and keep it
Have simplicity, clarity and honesty
Have distinctive logos and design
Are widely available
Build trust
Have a price/quality trade off – win/win
Help consumers make good decisions
Result? Higher margins, higher volumes, innovation,
better quality
What went wrong with many brands?

Success led to smugness

Cutting corners/reducing costs

Economical with the truth (eg. ‘low fat’, but no mention of high
sugar content)

Add some gold to the packaging (illusion of quality)

Became the new commodities
27
SKIN-DEEP BRANDING
If your image-only re-branding exercise isn’t accompanied by
improvements in the core product or service, it is an image-wrapper
branding fiasco---- a great way to waste money and get marketing a
bad name.
If you improve the sizzle, don’t forget to improve the sausage
There are many products that pretend to be brands, but are not
the genuine article. As the Director of Marketing at TESCO said,
“Pseudo brands are not brands. They are manufacturers’ labels.
They are “me-toos” and have poor positioning, poor quality and
poor support. Such manufacturers no longer understand the
consumer and see retailers solely as a channel for distribution”
Marketing Globe Vol 2, No. 10. 1992.
* A brand is a name or a symbol on a product, service, person or place
* A successful brand creates super profits
* The brand is about the total experience, not the logo. Successful brands
offer consistently superior value that is delivered by fair processes.
Page 31
The route to Sustainable Competitive
Advantage (SCA)
Differentiation
High
Price
Sales Revenue
High
Volume
Economies
of Scale
Learning
Curve
Operations
Lower
Costs
Financial
Gearing
Interest Cover
Working Capital Ratio
Operational Leverage
From Keith Ward, Cranfield School of Management
Low Business
Risk
Low Financial
Risk
High Cash
Flows
Positive
NPV
SCA
The value proposition and the brand
“The customer is simply the fulcrum of the business
and everything from production to supply chain,
finance, risk management, personnel management
and product development all adapt to and converge
on the business value proposition that is projected to
the customer”.
This value proposition is represented by the brand
( The Customer Information Wars, Sean Kelly, Wiley, 2005)
( Professor McDonald February 2013 )
The Brand Iceberg
Symbol
Brand Name
Product
Key Assets and
Competences
What you
can see
Price
Efficient
Production
What you
can’t see
People
Low Cost Operations
High
Service Levels
Strong Supply
Chain Management
Effective
Selling
Brands Are Business Systems, Not Just Labels and Names
From “Even More Offensive Marketing” by Hugh Davidson
The overall purpose of strategic marketing is the
identification and creation of sustainable competitive
advantage.
Map of the marketing domain
Define markets
& understand
value
Monitor
value
Asset
Base
Determine
value
Proposition
Deliver
value
Page 36
In capital markets, success is
measured in terms of shareholder
value added, having taken
account of the risks associated
with future strategies, the time
value of money and the cost of
capital.
37
Shareholder value added
A branded business valuation is
based on a risk-adjusted cash flow
analysis
of
future
earnings
discounted at the appropriate cost of
capital
Shareholder Value Added (SVA)
*
What is it?
–
*
Profit after tax minus (net capital x cost of capital (%)
There are only 3 things you can do to influence SVA
1.
2.
3.
Increase revenue (sales)
Decrease costs (product costs/overheads)
Decrease the amount of capital tied up in the business
Economic profit
Operating profit after tax
Capital employed
Cost of capital
Economic profit
Operating profit after tax
less cost of capital
15,000 x 10%
Economic profit
£2,000
£15,000
10%
2,000
1,500
500
Risk and return
Required
returns
Perceived risk
Therefore
Expected volatility
in future returns
41
Financial Risk and Return
High
1
Return
2
3
Low
Low
Adapted from Keith Ward, Cranfield School of Management
Risk
High
Financial Risk
Low
High
High




Business
Risk
Low
What is Marketing Due Diligence?
Marketing Due
Diligence
Risk Assessment
Market Risk:
Is the market
there?
Strategy risk:
Will we get our
planned share?
Implementation risk:
Will we get our
planned profit?
Page 44
Market Risk Profile
l
Product Category Existence
The marketing strategy has a higher
probability of success if the product
category is well established
l
Segment Existence
If the target segment is well established
Sales Volumes
If the sales volumes are well supported
by evidence
Forecast Growth
If the forecast growth is in line with
historical trends
Pricing Assumptions
If the pricing levels are conservative
relative to current pricing levels
l
l
l
Page 45
Market Share Risk Profile
l
l
l
Target Market Definition
Proposition Specification
SWOT Alignment
l
Strategy Uniqueness
l
Anticipation of market change
The marketing strategy has a higher probability of
success if the target is defined in terms of
homogeneous segments and is characterised by
utilisable data
If the proposition delivered to each segment is
different from that delivered to other segments and
addresses the needs which characterised the target
segment
If the strengths and weaknesses of the organisation
are independently assessed and the choice of target
and proposition leverages strengths and minimises
weaknesses
If choice of target and proposition is different from
that of major competitors
If changes in the external microenvironment and
macroenvironment are identified and their
implications allowed for
Page 46
Shareholder Value Risk Profile
l
Profit Pool
The marketing strategy has a higher
probability of success if the targeted
profit pool is high and growing
l
Profit Sources
If the source of new business is
growth in the existing profit pool
Competitor Impact
If the profit impact on competitors is
small and distributed
l
l
l
Internal Gross Margin
Assumptions
Assumptions of Other Costs
If the internal gross margin
assumptions are conservative relative
to current products
If assumptions regarding other costs,
including marketing support, are
higher than existing costs
Page 47
Market segment objectives:
Directional Policy Matrix
Relative company competitiveness
High
Low
High
Segment
attractiveness
Analysis process
•Attractiveness of each segment
(ranked)
•Projected net free cash flow (3/5yrs) for each segment
•Key risk factors influencing cash flows
Strategic
invest/
build
Pro-actively
maintain
No
change
Selectively
invest
Manage for
cash
•Risk assessment for each segment
•Risk adjusted future cash flows per
segment
•Deduct risk-adjusted cash flows from
the capital x cost of capital
for each segment
•Aggregated positive net present value
Low
Present position
Forecast position in 3 yrs
Critical success factors
Cranfield University School of Management 1996
Strategies to
increase present value
•Increase future cash flows
•Cash flow happens earlier
•Reducing the risk in the cash flows
A great brand is the Holy Grail, the distillation of
years of creativity, sweat, ambition and investment.
Not so much a logo, more a way of life, a way of
being, a way of doing business: a great brand
conveys everything that in your finest dreams you
want your customers to understand about your
business and product.
“Great stars shine brightest when the sky is darkest. In
austere times, great brands bestow pleasure,
maintain their premium and take a long view”
Mark Ritson, Marketing Magazine
3rd December 2008 (p.20)
APPENDIX 1
Brands as Assets
* Kraft
Phillip Morris bought Kraft and its portfolio of food brands for $12.9billion – four
times the value of Kraft’s tangible assets
* Grand Met
Bought Pillsbury for $5.5billion – a 50% premium on Pillsbury’s pre-bid value
and several times the value of its tangible assets
* Nestle
Paid $4.5billion, more than five times Rowntree’s book value
Intangible Assets: driving
corporate value in the 21st century
Analysis of the world’s 35 largest stock
markets
(11,000
companies,
total
capitalisation $41 trillion) representing 99% of
all quoted companies in the world by value,
revealed that 63% of all enterprise value is
made up of intangible assets. Only a small
proportion was disclosed or explained in
published accounts.
Global Intangible Tracker 2008. Brand Finance
Identification & Recognition Criteria of
Intangible Assets
separable
Control
Future economic benefit
Identifiability
Flow of future economic benefit to
entity probable
Cost reliably measurable
contractual-legal
An intangible asset shall be
recognized as an asset
apart from goodwill if it
arises from contractual or
other legal rights or if it is
capable of being separated
from the acquired entity and
sold, transferred, licensed,
rented, or exchanged.
(SFAS 141, par. 39)
Valuing trademarks and brands
Historic cost to create
Costs to replace
Market value
“economic use”
-price premium/gross margin
-earnings split
-royalty relief
Marketing
• Trade names
• Trademarks
• Trade dress
• Service marks
• Collective marks
• Geographic Indicators
• Certification marks
• Internet domain
names
• Newspaper
mastheads
• Non-competition
agreements
• Design rights
• Packaging designs
• Copyrights over
descriptors, logotypes,
advertising visuals and
written copy
Customer
• Customer lists
• Databases
• Sales or production
backlog order books
• Customer contracts
and related
customer
relationships
• Non-contractual
customer
relationships
Contract
Technology
• Licensing agreements
• Franchise agreements
• Advertising contracts
• Lease agreements
• Construction permits
• Operating and
broadcasting rights
• Servicing contracts
(mortgage contracts)
• Mineral, water, air usage
rights
• Employment contracts
• Assembled workforce
• Distribution rights
• Landing slots
• Production or import
quotas
• Government permits and
authorizations
• Raw materials supply
contracts
• Patents (compounds,
processes, technology)
• Unpatented technology
• In process R&D
• Product trials data and
research
• Manufacturing process
controls
• Computer software
• Trade secrets such as
formulas and recipes
• Templates and castings
• Positive and negative
knowhow
• Manufacturing and
operating guides
Artistic
• Illustrations
• Artworks
• Films
• Pictures
• Cartoons
• Photography
• Personality
rights
Shareholder value-adding strategies
57
Excellent Marketing
Confusion Marketing
Customer insights that lead
to the development of
genuinely new products.
‘New, improved’ products
that pretend to be different.
Clear positioning and
branding.
Clear, honest marketing
communications that make
for easy access and
availability.
Confusing, emotional
communications to justify
price premiums for parity
products.
Pricing strategies designed
to make comparisons
impossible.
Distribution strategies that
out obstacles in the way of
choice.
Differential Advantage
Different
Similar
Different
Target
Market
Similar
Co. name
plus grade
eg.
Mercedes
Co. name
eg. ICI,
Standard
Bank
Unique
brand
names eg.
Tide, Bold
Co. name
plus product
name eg.
Cadbury
Flake
Branding as Customer Service
Great brands do not differentiate just for the sake of differentiation
They innovate around core category benefits
They make the brand famous and distinctive (easy to recognise)
They make it easy to buy ( distribution and penetration )
In other words, they get the basics right
( Professor Malcolm McDonald, January 2011 )
60