Why brands must come before profit

Just imagine a world where, instead of being judged by their bottom line, companies were assessed on the success of their brand management; a world where changes in a company’s brand values were focused on by City analysts, financial reporters and shareholders, rather than oscillations in pre-tax profit; where newspaper headlines trumpeted “Values up again at X” instead of “Profits at X rise by ten per cent”.

Unthinkable? Perhaps. Yet most people agree it would be a good idea if financial markets paid more attention to directors’ stewardship of the underlying, long-term value of the assets they are managing, rather than short-term profit fluctuations. Now, we may be beginning to move in that direction.

As far as marketers are concerned, the issue of brand valuation has been a dull diversion, an accountant’s obsession. It has been backward looking, offering no help to brand managers wanting to do their job better. And, thanks to the contortions imposed by current accounting conventions, it has ended up focusing on the issues that matter least.

The current state of play, for example, allows companies to place the value of brands on the balance sheet, but only if they have been acquired and not home-grown. Yet, when it comes to measuring marketing prowess, it’s how good companies are at creating and nurturing home-grown brands that really matter. As Procter & Gamble’s UK chief Paul Polman recently pointed out, the difference between the value of its assets as measured by accountants – $12bn (8bn) and its market value of about $55bn (37bn) – is mostly accounted for by the value of its (home-grown) brands.

Likewise, the accountants’ preoccupation with the issue of separability (the degree to which a brand can be separated out from other assets and therefore valued in its own right) means that only standalone brands can be valued. Yet, increasingly, what marketers (and shareholders) really want to know is the extent to which corporate brands like Sony or British Airways (which are inseparable from the business) add, or don’t add, value.

Brand valuation nudges a little closer towards practical relevance when companies start using valuation techniques for internal purposes. These techniques can offer useful checklists of key considerations. IDV, for example, has developed a colour-coded sheet to measure shifts in its brand performance by factors such as distribution penetration, price premium, brand awareness and so on. Interbrand has core measures of leadership, stability, market (volatility), internationality, trend (in terms of performance) and marketing support.

New developments may, however, place brand values and valuation closer to centre stage, as movers and shakers in the world of corporate reporting start looking for new ways to tackle modern accounting’s increasing irrelevance. Thus Steven Wallmann, commissioner of the US Securities & Exchange Commission, has warned that “financial statements are measuring less and less of what it is that is truly valuable in a company… (and if that happens) then we start to eliminate the ability of that integrity check to be as useful as it has been”.

The European Commission is funding research into an alternative form of financial reporting, revolving around a Statement of Intellectual Capital to assess the performance of a company in managing intangible assets, including brands, patents, copyright, databases, supply contracts, management contracts, recipes and formulae, registered designs, software and licences.

What’s interesting about such a beast, should it ever grow into anything more than a research project, would be the spotlight it would throw on marketers and their skills. According to research by Interbrand, the proportion of the UK FTSE 100 companies’ total market value, represented by intangibles, has risen from about 40 per cent in the Sixties to 63 per cent by the mid- Nineties – and brands are tending to account for a growing slice of these intangibles.

For example, at one time, airlines’ most valuable intangible assets were landing rights. But landing rights have a finite life and in airlines the pendulum seems to be swinging towards brands. Interbrand’s Raymond Perrier suggests that while branding would have represented only five per cent of an airline’s total market value in the Sixties, by 2010 it will represent 45 per cent. Similar trends can be seen in cars, financial services, retail, pharmaceuticals and so forth.

A Statement of Intellectual Capital would create an annual discussion of marketers’ (and other managers’) handling of such intangibles. It would also focus minds, both externally and internally, not just on the importance of brands and marketing generally, but on the underlying dynamics shaping the business’ development.

To tease out the relative values of intangibles, Perrier argues in Interbrand’s new book, Brand Valuation, that a business needs to analyse carefully its key business drivers – the things that really contribute to its competitive success – and ask itself to what extent these drivers are brand-dependent. For example, are petrol stations valuable to oil companies primarily because of the brand name that’s plastered over them or because of their location? According to Perrier, industries’ “brand-dependency” varies greatly. For luxury goods, brands accounts for about 70 per cent of total corporate worth, he suggests, compared with food and drink’s 55 per cent, financial services’ and cars’ 30 per cent, retail’s 15 per cent and utilities’ – zilch.

An assessment like this is sobering: many brands may turn out to be less important than their marketers like to think. On the other hand, it could also be very useful, as debate around the issue helps turn the production of a rear-view mirror reflection of business performance into something that actually clarifies future priorities.

A statement of intellectual capital would not completely close the gap between financial report and business reality. As Perrier admits: “There will always be elements [of intellectual capital] which cannot be clearly identified or cannot be appropriately valued.”

Indeed, arguably the most important intangible in any business nowadays is not brands themselves, nor even brand management skills, but marketers’ ability to keep them fresh – their ability to adapt, to learn, to create. And we are still as far away from measuring that as we have ever been. Nevertheless formally recognising the value and importance of intellectual capital in all its forms is an overdue, and much needed, reform.