There’s no accounting for the value that people bring

New accounting rules that demand acquired brands be recognised as assets will, contrary to popular opinion, erode the value of marketing, says Alan Mitchell

From now on, the value of brands will increasingly appear on corporate balance sheets, as newly introduced international accounting standards begin to take effect. The rules require companies to recognise acquired intangible assets separately from the blanket term “goodwill” and ban the amortisation of goodwill and intangible assets that have “indefinite useful lives”. Instead, these assets must be “tested for impairment” annually.

“Hurrah!” has been the overwhelming response among marketers: at last, investors’ and accountants’ attention is being drawn towards brands. Now that boards are being required to report publicly on how successful their management of these brands has been, things can only get better.

Really? Here’s a view to the contrary. For a start, the new accounting standard perpetuates a breathtaking absurdity. It only covers “business combinations” (that is, acquisitions), not home-grown brands, the net effect being that the balance sheets of companies that acquire brands look stronger than those that grow their own. Of course analysts should know better, but this naturally biases investors’ minds in favour of asset-shufflers and against asset-builders. This is not good news for marketers. But there’s more.

Is it a positive thing that the standard makes brand valuation a part of financial reporting? Technically speaking, there are many ways to value a brand. How much would people be prepared to pay for it as an asset? What are its likely future cash flows? What premium can it levy within the market? They all lead to different numbers because they all serve different purposes.

One particularly common approach is to take the stock market value of an organisation, subtract the value of tangible assets such as buildings, plant and machinery, and analyse the remaining intangibles into different forms of asset such as “brands” or “copyrights”. It’s seductive because of its public relations value, but it’s disastrously misconceived.

Every man-made tangible asset you see around you is a form of crystallised intangible value. The can of baked beans you ate for tea is the product of the insight, imagination, skill, organising ability and motivation of the company that made it. So is the productivity of the factory it came from. The value of a tangible asset (including how well your factory performs), is the product of the intangible qualities of the people who created and manage it. The same asset in the hands of different people would generate different amounts of value.

But if you start all your calculations with tangible assets in isolation, you quickly generate a Marie Celeste picture of the business. Its people mysteriously disappear from view, and that quickly creates a mystery of how to account for the difference between the value of these isolated things with the people and their value without the people. Having framed the mystery in this way you can never solve it (which is good for consultants but nobody else).

It gets worse: as a special “high-level committee of experts” told the European Union two years ago, every organisation’s assets fall across a wide spectrum from easily separable and tradeable to virtually impossible to separate and trade. Assets such as brands fall somewhere in the middle. But what really matters – what determines the organisation’s success or failure – is a whole series of people attributes, such as creativity, openness to new ideas, enthusiasm, flexibility, vision, empathy and so on.

If you line up the usual-suspect list of intangible assets such as brands, patents, copyrights, licences and databases and place them against these “intangible competencies”, you can’t neatly translate one into the other. Creativity, leadership and insight build brands and drive innovation and improve productivity and, and, and…

And these underlying value drivers can never – I repeat never – be valued as separate assets, for two fundamental reasons. First, the organisation doesn’t own these assets like it owns buildings. It shares them with people who take them home to bed at night. Second, it cannot command or control their use either. It can only elicit and encourage people to contribute them.

So what’s the alternative? Here’s a hint from a recent speech by Tesco chief executive Sir Terry Leahy. In free markets every company is subject to a continual stream of “shocks” from customers delivering their verdict on its value delivery, he argued. “The impact of these shocks is acute because there is a strong multiplier at play. Consider this fact. In our industry, retailer ‘A’ who gains one per cent more customers a year can double his market value compared with retailer ‘B’ who loses one per cent of customers a year. And on that, fortunes are made or lost, careers crowned or curtailed, pensions swell or shrivel, jobs develop or disappear.”

What Leahy seems to be talking about is not brand or any other intangible asset. It’s the business’s overall value-creating momentum: people making the right connections, consistently, year in, year out. Meanwhile the valuation bandwagon treats assets as things, separated out one from another, shoehorned into artificial time periods.

Confuse these two approaches and you generate a fundamental category error. It pops up all the time. Recently, for instance, the president of the Institute of Chartered Accountants of Scotland explained the benefits of the new accounting standard with the following question: “Would you rather I tell you there are three cupboards, a table and a few chairs in this room, or would you prefer just to know there is some furniture?”

Replace “some furniture” with “a human being” and the error becomes obvious. Would you prefer to have two lungs, a heart and a brain neatly laid out on a slab, or would you prefer to understand the living being? To see a business as a collection of separately identifiable tangible and intangible assets is to miss the very thing that makes it tick – the people competencies that generate Leahy’s multiplier.

Unfortunately the Marie Celeste mindset is gaining ground. Just look at the quest to “prove” marketing’s and advertising’s return on investment (ROI). Invariably, the method adopted is to isolate other variables so that “effectiveness” as a separate activity can be demonstrated. You might as well ask, “What’s the ROI of breakfast?” If you take Leahy’s multiplier on the other hand, the real challenge becomes painfully clear. What are the intangible competencies (to use the EU phrase), and the connections between them, that build the organisation’s momentum? How can marketing help?

William Edwards Deming, the quality pioneer, once dismissed most corporate metrics as mere “accident statistics”. They tell you that an accident has happened, but they tell you nothing about why or how the accident happened or how to improve the situation in the future. Except in a few specialist circumstances, such as business combinations, brand valuation is an intellectual dead end. What we really need to do is focus on the secrets of organisational momentum. Which is, by the way, what stock markets really value.

Alan Mitchell, asmitchell@aol.com

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