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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
£254135
£293152
£318167
£387201
£431224
£454236
Gross Contribution- Manufacturing overhead- Marketing & Sales- Research & Development
£119481822
£141582323
£151632423
£186822625
£207902724
£218952824
Net Profit £16 £22 £26 £37 £50 £55
Return on Sales (%) 6.3% 7.5% 8.2% 9.6% 11.6% 12.1%
AssetsAssets (% of sales)
£14156%
£16255%
£16753%
£19450%
£20548%
£20645%
Return on Assets (%) 11.3% 13.5% 15.6% 19.1% 24.4% 26.7%
Page 3
Performance (£million) Base Year 1 2 3 4 5
Market Growth 18.3% 23.4% 17.6% 34.4% 24.0% 17.9%
InterTech’s 5 Year Market-Based Performance
Customer Retention (%)New Customers (%)% Dissatisfied Customers
88.2%11.7%13.6%
87.1%12.9%14.3%
85.0%14.9%16.1%
82.2%24.1%17.3%
80.9%22.5%18.9%
80.0%29.2%19.6%
InterTech Sales Growth (%)Market Share(%)
12.8%20.3%
17.4%19.1%
11.2%18.4%
27.1%17.1%
16.5%16.3%
10.9%14.9%
Relative Product QualityRelative Service QualityRelative New Product Sales
+10%+0%+8%
+8%+0%+8%
+5%-20%+7%
+3%-3%+5%
+1%-5%+1%
0%-8%-4%
Why Market Growth Rates Are Important
Page 4
%Sales RevenueCost of Goods Sold
Profit MarginAdvertisingR&DCapital Investment
Operating ExpensesOperating Profit
Investment Ratio
Key Trends
Virtuous plc (%)100
435711
57
2014
23
• 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
Dissembler plc (%)100
6139
3-2
2014
5
• 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3Note: This table is similar to a P&L with one important exception - depreciation, a standard item in any P&L has been replaced by capital expenditure, which does not appear in P&Ls.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.
The make-up of 14% Operating ProfitsFactorProfit on existing products over3 years oldLosses on products recentlylaunched or in developmentTotal operating profits
Virtuous plc (%)21
(7)
14
Dissembler plc (%)15
(1)
14
From Hugh Davidson’s “Even More Offensive Marketing” 1998
Quality of profits
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- Vehiclesetc.
- Shares- Loans- Overdraftsetc.
£100 million £100 million
Balance sheet
Assets Liabilities
£100 million £900 million
- Land- Buildings- Plant- Vehiclesetc.
- Shares- Loans- Overdraftsetc.
Balance sheet
Assets Liabilities
£900 million £900 million
Goodwill £800m
- Land- Buildings- Plant- Vehicles
- Shares- Loans- Overdraftsetc.
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 £ 4.0 billion- Duracell brand £ 2.5 billion- Oral B £ 2.0 billion- Braun £ 1.5 billion- Retail and supplier network £10.0 billion- Gillette innovative capability £ 7.0 billion
TOTAL £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
EnterpriseValue
Tangible Assets
IntangibleAssets
Technology Intangibles
Residual Goodwill
Customer Intangibles
Marketing Intangibles
Contract Intangibles
Artistic Intangibles
Land and Buildings
Working Capital
Plant and Equipment
EnterpriseValue
Tangible Assets
IntangibleAssets
Technology Intangibles
Residual Goodwill
Customer Intangibles
Marketing Intangibles
Contract Intangibles
Artistic Intangibles
Land and Buildings
Working Capital
Plant and Equipment
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 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 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 Hence, “brand” means one of the following:
-”trademark”; “brand”; “branded business”
Brand Equity
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
Brand
20%
OtherIntangible Assets
55%
TangibleAssets25%
Developed Markets
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
Intangible assets
Brand
Software
Patents
Distribution rights
Tangible assets
Assembled workforce
Business Goodwill
Marketing intangible
Technology intangibles
Customer intangible
Contract intangibles
Illustrative
Source: Brand Finance
Customer relationships
Government
Brands achieve this increased value by positively affecting different stakeholders
Partners
Employees
Suppliers
Bankers
Investors
• Lower borrowing costs • Better repayment conditions
• Lower prices and better terms
• Lower recruitment costs• Lower retention costs
• Greater willingness to partner• Partnership on better terms
• Higher price earnings ratio• Lower volatility
• More invitations to tender• Greater propensity to award• Higher share of fields awarded
Brand
Reputation
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
STAKEHOLDER BEHAVIOUR
FINANCIALIMPACT
SHAREHOLDER VALUE
Customers- individuals, businesses
Suppliers /
Partners- businesses, energy asset
ownersEmployees- current and
potential
Shareholders / Bankers
- individual and institutional
Other Stakeholder
s- government, media,
opinion formers, academics, public, environmentalists
• Pay price premium• Buy more
• Lower prices• Better terms• Willingness to partner• (more opportunities)
• Better retention• Lower salary expectations• Better qualified candidates
Revenues
CostsRevenues
CostsProductivity
CostsRisk
• Higher PE ratio• Lower volatility• Lower borrowing costs• Better repayment conditions
Influences business and brand value
Indirect influence on value
Tradem
ark
s
Brands Increasingly Drive Business Results
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.
Page 31
* 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.
The route to Sustainable Competitive Advantage (SCA)
Differentiation HighPrice
HighVolume
Sales Revenue
Low BusinessRisk
Low FinancialRisk
PositiveNPV SCA
Economiesof Scale
LearningCurve
High CashFlows
GearingInterest CoverWorking Capital RatioOperational Leverage
Financial
OperationsLowerCosts
From Keith Ward, Cranfield School of Management
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
What youcan’t see
What youcan’t see
What youcan see
What youcan see
Key Assets andCompetences
SymbolBrand Name
AdvertisingPresentation
Price
HighQuality
EfficientProduction
Low Cost OperationsExcellent
Database Strong R&DHighService Levels
Strong SupplyChain Management Effective
Selling
Product
People
Brands Are Business Systems, Not Just Labels and NamesFrom “Even More Offensive Marketing” by Hugh Davidson
The overall purpose of strategic marketing is the identification and creation of sustainable competitive advantage.
AssetBase
Define markets& understandvalue
DeterminevalueProposition
Delivervalue
Monitorvalue
Map of the marketing domain
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 SVA1. Increase revenue (sales)
2. Decrease costs (product costs/overheads)
3. Decrease the amount of capital tied up in the business
Economic profit
Operating profit after tax £2,000Capital employed £15,000Cost of capital 10%
Economic profitOperating profit after tax 2,000less cost of capital
15,000 x 10% 1,500Economic profit 500
Risk and return
Required returns
Therefore Expected volatility in future returns
Perceived risk
41
Financial Risk and Return
High
Low
Return
HighLow
1
2
3
Risk
Adapted from Keith Ward, Cranfield School of Management
LowHigh
Financial Risk
Low
High
BusinessRisk
What is Marketing Due Diligence?
Marketing DueDiligence
Risk Assessment
Market Risk:Is the market
there?
Strategy risk:Will we get ourplanned share?
Implementation risk:Will we get ourplanned profit?
Page 44
Market Risk Profile
Product Category Existence
Segment Existence
Sales Volumes
Forecast Growth
Pricing Assumptions
The marketing strategy has a higher probability of success if the product category is well established
If the target segment is well established
If the sales volumes are well supported by evidence
If the forecast growth is in line with historical trends
If the pricing levels are conservative relative to current pricing levels
Page 45
Market Share Risk Profile
Target Market Definition
Proposition Specification
SWOT Alignment
Strategy Uniqueness
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
Profit Pool
Profit Sources
Competitor Impact
Internal Gross Margin Assumptions
Assumptions of Other Costs
The marketing strategy has a higher probability of success if the targeted profit pool is high and growing
If the source of new business is growth in the existing profit pool
If the profit impact on competitors is small and distributed
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
High Low
High
Low
Segmentattractiveness
Relative company competitiveness
Selectively invest
Manage for cash
Strategicinvest/build
Pro-actively maintain
Cranfield University School of Management 1996
Analysis process• Attractiveness of each segment
(ranked)
• Projected net free cash flow (3/5yrs) - for each segment
• Key risk factors influencing cash flows
• 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
Strategies to increase present value• Increase future cash flows• Cash flow happens earlier• Reducing the risk in the cash flows
Critical success factors
Nochange
Present position Forecast position in 3 yrs
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
* KraftPhillip Morris bought Kraft and its portfolio of food brands for $12.9billion – four times the value of Kraft’s tangible assets
* Grand MetBought Pillsbury for $5.5billion – a 50% premium on Pillsbury’s pre-bid value and several times the value of its tangible assets
* NestlePaid $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
contractual-legalControl
Future economic benefit
Identifiability
Flow of future economic benefit to entity probable
Cost reliably measurable
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 Customer Contract
• 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
• 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 lists• Databases• Sales or production
backlog order books• Customer contracts
and related customer relationships
• Non-contractual customer relationships
• 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
Technology Artistic
• Illustrations• Artworks• Films• Pictures• Cartoons• Photography• Personality
rights
Marketing Customer Contract
• 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
• 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 lists• Databases• Sales or production
backlog order books• Customer contracts
and related customer relationships
• Non-contractual customer relationships
• 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
Technology Artistic
• Illustrations• Artworks• Films• Pictures• Cartoons• Photography• Personality
rights
Shareholder value-adding strategies
57
Excellent Marketing Customer insights that lead
to the development of genuinely new products.
Clear positioning and branding.
Clear, honest marketing communications that make for easy access and availability.
Confusion Marketing ‘New, improved’ products
that pretend to be different. 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.
Co. name plus grade
eg. Mercedes
DifferentSimilarDifferential Advantage
Unique brand
names eg. Tide, Bold
Co. name eg. ICI,
Standard Bank
Co. name plus product
name eg. Cadbury
Flake
Similar
Different
TargetMarket
60
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
Branding as Customer Service
Great brands do not differentiate just for the sake of differentiation
( Professor Malcolm McDonald, January 2011 )