The notion of “brand equity” has long been of great interest to marketers, as evidenced by the number of books and articles on branding that have appeared both in the business press and on this very Web site.
The trickiest issue to date seems to be working through the nettlesome question of how brand equity should be measured. Estimating brand equity is important not only to marketing types but also to corporate and accounting types, since “the value of the brand” has been identified as one of the most powerful invisible assets that determine corporate value.
Valuing a brand is also becoming more important because FASB (the Financial Accounting Standards Board), the organization responsible for developing accounting standards in the US, has begun to consider public disclosures as well as capitalization of intangibles—including brands.
Criteria for a Good Measure
The solution to a good measure of brand equity should probably first describe the criteria that a good measure should meet. After combing through a lot of writing on the subject, we can identify multiple criteria.
In this article, the second of a four-part series on branding, we'll show you a brand equity measure that meets a number of these important criteria:
- Different people computing it can arrive at the same value.
- It is quantifiable and based on readily available data so that it can be monitored on a regular basis for multiple brands in multiple PCs.
- It meets the definition of an element of a financial statement.
- It is relevant to not only marketing valuation but also financial valuation as it pertains to a company's purchase price.
- It is in the form of a single number, to enable easy tracking and communication.
- It is intuitive and credible to senior management.
- It is relevant to the commonly understood definition of brand equity as worth (revenue minus costs).
- It is relevant to various levels of analysis (brand level; corporate level).
- Comparability—it is calibrated to include market and competitive effects.
- Allows for comparisons across industries.
- It is diagnostic, or able to flag downturns or improvements in the brand's value and provide insight into reasons for the change; it is relevant in terms of feedback value or information predictive value.
- It provides tactical guidance regarding the management of brand equity.
- It is able to capture future potential in terms of future revenue stream and brand extendibility.
- It provides strategic guidance regarding the management of brand equity.
These criteria are very important, because they help you gauge whether you are doing the right things to create brand equity.
Definition of Brand Equity
To develop a good measure of brand equity, we also need a clear definition of what brand equity is. This, too, has been tricky, and a lot of confusing definitions of brand equity exist in branding articles.
As we explained in our previous article, we define brand equity “as the financial value of brand reflecting its efficiency in attracting and retaining customers.” We define brand equity in terms of financial value and not things like “customer perceptions,” because our usage of “equity” is consistent with the common usage of the term, which is rooted in financial value, and because financial value is relevant to the primary users of the “brand equity” idea—namely, people like you.
The Brand Equity Measure
The Base Measure. The measure of brand equity that we have developed follows directly from the definition of “brand equity.” A very simple way of translating this definition (the financial estimation of the brand's value in terms of efficiencies in attracting and retaining customers) into a measure is to base the measure on assessments of the brand's revenue relative to the costs incurred to acquire and retain that revenue base.
Let's break this down into several very simple terms. After all, profit or value is simply revenue minus costs.
Let's dig deeper. First, revenue is a function of price times quantity demanded, right?
Therefore, a brand with strong brand equity should be able to attract (stimulate a large quantity of demand) for the brand among new customers (customer acquisition) as well as retain old ones (customer retention). But a brand with strong equity can also add value by its effects on price, too.
Logically, a brand that offers financial value to the company (entails equity) should be able to command a price premium without suffering a loss of revenue. A brand with high equity should also experience a larger market share at a given price than its competitors. It should also enjoy a disproportionate revenue increase at a lower price than its competitors. Therefore, a measure of brand equity should include price times the quantity demanded from new and existing customers.
In addition to the revenue side of the profit equation, though, brand value may also be influenced by the size of marketing costs incurred to (a) acquire and (b) retain customers. The more a company can acquire and retain customers at a lower unit cost, the more the brand should be worth to the company. Hence, as total revenue increases and unit marketing costs decrease, the equity or value of the brand to a company should increase. The difference between the two represents a preliminary measure of brand equity.
Brand equity resembles the industrial accounting system in which costs of goods sold are subtracted from total revenue to derive operating profit.
|
Industrial Accounting
System |
Marketing Accounting
System |
| Total Revenues | Total Revenues |
| - Cost of Goods Sold | - Total Marketing Costs |
| Operating Profit | Magnitude of Brand Value |
| - Marketing Expenses | - Cost of Goods Sold |
| Contribution Margin | Contribution Margin |
Although the difference between total revenue and total marketing costs is a reasonable approximation of brand equity, a better measure adjusts this figure by including a marketing efficiency (i.e., return on marketing costs) factor, which we will describe a few paragraphs from now. The reason we need such an adjustment becomes apparent when we consider these two examples:
|
CASE 1
|
Company A
|
Company B
|
| Total Sales |
$2,000,000 |
$3,000,000 |
| - Marketing Costs |
$1,000,000 |
$2,000,000 |
| Brand Value |
$1,000,000 |
$1,000,000 |
| Operating Margin |
$1,000,000 |
$1,000,000 |
| / Marketing Costs |
$1,000,000 |
$2,000,000 |
| Return on Marketing Costs |
1.0
|
.5
|
|
CASE 2
|
Company A
|
Company B
|
| Total Sales |
$2,000,000 |
$1,250,000 |
| - Marketing Costs |
$1,000,000 |
$ 500,000 |
| Brand Value |
$1,000,000 |
$ 750,000 |
| Operating Margin |
$1,000,000 |
$ 750,000 |
| / Marketing Costs |
$1,000,000 |
$ 500,000 |
| Return on Marketing Costs |
1.0
|
1.5
|
Notice that in case no. 1, the two companies have the same brand value ($1,000,000) but different return on marketing costs. In case no. 2, brand A has higher brand value but lower return on marketing costs than brand B. To incorporate these issues, we introduce another term, called marketing efficiencies. Very simply, marketing efficiency reflects the brand value metric divided by total marketing costs.
The difference between the magnitude of brand value and marketing efficiency is that while the former reflects the net difference between total revenue and total marketing costs, the latter reflects their ratio (total revenue divided by total marketing costs). The higher the ratio, the more efficient the brand's marketing is and the higher its brand equity becomes.
While the magnitude of brand value and marketing efficiency use the same input, they are not always positively related. To truly capture a brand's financial value to a company, you must adjust the brand value by the extent of marketing efficiency. In this way, you might think of a base metric of brand equity as…
Marketing Efficiency * Total Revenues
1 + Marketing Efficiency
Compare Brands in Different Industries. The base brand equity metric is useful in measuring the equity of the same brand over time. However, it can also be modified when one wants to compare the equity of one brand with the equity of a brand in a different industry.
If that's what you want to do, you may need to consider differences in the growth rates of the two industries, for example. When a brand's revenue in one industry is increased primarily from the industry-wide demand growth that has little to do with an individual brand's equity, while another brand's revenue in another industry shows no growth due to the negative growth rate in that industry, such differences should be reflected by modifying the brand equity measure to incorporate growth rates:
Marketing Efficiency * Total Revenues
1 + (1 + growth rate) * Marketing Efficiency
Modifying the Base Metric to Include Non-Marketing Costs. A company may also wish to consider the proportion of manufacturing costs over the total costs when comparing brands in two different industries. For example, if a brand in one industry has substantially higher manufacturing costs than a brand in another industry, adjustments to the basic model can be made:
Maximum Brand Equity * Marketing Efficiency
1 + Marketing Efficiency
Relating the Brand Equity Measure to the Criteria of a Good Measure
As we said earlier, a good measure of brand equity would meet the criteria that we mentioned at the beginning. The measure we have just described does a good job in meeting those criteria, and that makes it more useful to your company..
For example, it is objective, and can be calculated from readily available data like price, quantity demanded, and total marketing costs. It can be used not only for purposes of marketing, but also as an input to the financial evaluation of a company as is relevant to setting a purchase price.
It is a single number that allows for tracking and communication. For example, if the first year of a brand introduction serves as a referent, then brand equity measured in subsequent years allows for tracking the direction and magnitude of the brand health. The measure of brand equity is consistent with intuitive notions about value as based on revenue and cost and is relevant to the common definition of equity as worth. For these reasons it should be credible to senior management.
The metric can be aggregated across brands within the company, and is thus relevant to various levels of analysis. It also allows for comparisons with competitors as the equity of competing brands in the same industry would provide about the relative competitive status of a brand's health. Finally, it allows for a comparison of the equity of brands that operate in different industries.
We're only just beginning on our brand equity journey here, though. Stay tuned for the third and fourth articles, where we show how you can diagnose whether your brand's equity is likely to be high or low, based on consumer (as opposed to financial) input. We will also show you how you can build or leverage your brand's equity through different branding strategies.
