The answer lies in business valuation—both theory and practice. The methods used in valuing businesses can be applied to valuing intangible assets and intellectual property, including brands.

We must first determine: What does a “brand” encompass? A brand can include a trademark, logo, trade dress, packaging, marketing strategy, colors and all the elements that consumers associate with the brand image. We should also keep in mind that some brands have sub-brands, (e.g., Coca-Cola has Classic Coke, Diet Coke, Cherry Coke, Zero, etc). Furthermore, part of the value of a brand can be attributed to certain other intangible assets. In the Coke example, the special recipe (formula) is part of the brand’s success. We need to “zero-in” on exactly what it is we’re valuing (pun intended).

Continuing with the Coke example, Interbrand valued the Coca-Cola brand at an estimated $65.3 billion in 1997, assigning it the number one rank among brands worldwide. In comparison, the net book value of the intangible assets recorded on Coca-Cola’s financial statements was merely $3.7 billion, which shows that the brand’s value goes largely unrecognized on the balance sheet. What’s more, Coca-Cola’s market capitalization (i.e., the stock market’s valuation of the company) was an estimated $140 billion, which, when compared with the brand value of $65.3 billion, shows that the market attributed value to intangible assets well over and above the estimated brand value.

There are three fundamental approaches to be considered in valuing a brand:

• The cost approach;
• The income approach; and
• The market approach.

The cost approach is based on an accumulation of the costs incurred to build the brand since inception, such as historical advertising and promotion expenditures, campaign creation costs, trademark registration costs, etc. However, it is generally the least applicable approach in the valuation of brands because the cost of developing the brand usually bears little relationship to the brand’s income-generating potential. After all, investors are interested in the brand’s ability to generate future earnings.

The income approach is based on the net present value methodology, which seeks to measure the economic benefit of the brand to be generated from a stream of future earnings or cash flows. One possible application of this approach is the “incremental income” method, based on the premise that a branded item can command a premium selling price compared to similar, less well-known products. The branded item can also bring about economies of scale in production, due to larger volumes of sales from higher market demand.

However, the business valuator will offset the advertising expenses that are required to maintain brand awareness over and above that of a non-branded product. Forecasts and projections are made of the income stream to be generated from the increased sales and cost savings, net of additional advertising and promotional costs, specifically attributable to the brand. The net present value of the future incremental income stream generated by the brand would be determined by applying a discount rate. This discount rate is based on the rate of return that an investor would expect on an investment in the brand, based on its risk profile and characteristics. The higher the perceived risk, the higher the required return.

An alternative method that can be applied under the income approach is the projection of a stream of earnings or cash flows for the business as a whole, against which contributory charges are applied to recognize the contribution of other assets (e.g., working capital, fixed assets and other intangible assets) in generating the overall income stream attributable to the brand. The residual income stream attaching to the brand is then discounted to its present value as noted earlier.

The market approach estimates the value of a brand by reference to market transactions involving similar brands. The most common application is the relief-from-royalty method, which assumes that the user of a brand would have to license the rights to use it, if the user was not also the owner of the brand. In other words, if a company owns the brand, it avoids the payment of royalties for the use of the brand. The royalty rate is generally a market rate derived from an analysis of royalty or license agreements for similar assets (used as “guidelines”).

Adjustments are made, as appropriate, to reflect differences between the risk profiles, industry conditions, brand awareness and strength, geographical coverage, and other characteristics of the subject brand as compared with those of the “guideline” brands in the market. The estimated royalty rate is then applied to the forecasted net revenues to be generated by the brand, with the result discounted to present value using an appropriate rate of return as described above. The principal difficulty with the market approach is finding comparable and meaningful transactions from which to derive an applicable royalty rate, and making the appropriate adjustments to reflect differences between the brands under comparison.

In a nutshell, the valuation of a brand can be more of an art than a science—but it’s an exercise that can help management identify and develop the value drivers behind the brand. Professionals, such as Chartered Business Valuators and members of the American Society of Appraisers, can provide insight and assistance in the valuation of brands and other intangible assets.