What it means
Two products can be almost identical in function, yet one sells for far more because of the name on it. That difference is brand equity.
It is built from awareness, perceived quality, loyalty and the associations customers link with the name. Brand equity matters in finance because it drives cash flows.
A strong brand can support higher margins, lower marketing costs per sale, faster launches of new products and greater resilience in a downturn. Investors and acquirers pay close attention to it.
Measuring it is difficult. Marketers use surveys of awareness and preference, while finance teams use methods such as the price premium approach, which values the extra price customers will pay, or the relief from royalty approach, which estimates what the company would pay to license the brand from someone else.
The accounting treatment surprises many people. A brand built internally is generally not recorded as an asset, because its cost cannot be reliably separated from ordinary spending.
A brand bought in an acquisition is recorded as an intangible asset at its fair value (what it would sell for between willing parties) and then tested for impairment. Brand equity can also be negative.
A scandal, a product recall or poor service can make customers actively avoid a name, and the business may have to discount to sell. Protecting the brand is therefore part of protecting earnings.
Managers influence brand equity every day. Pricing, product quality, customer service and advertising all add to or subtract from it, so it is not only the marketing department's concern.
In practice
Real-world examples
Example 1
A sports shoe maker charges $30 more per pair than a rival with a similar design. Customers pay the premium because they trust the name. The finance team uses the extra margin to estimate the worth of the brand when planning a licensing deal.
Example 2
A regional bank has a long record of fair treatment and customers stay with it even when a competitor offers a slightly higher savings rate. The retention lowers the bank's cost of funding and marketing. The board regards this loyalty as an asset even though it never appears on the balance sheet.
Example 3
A food company is hit by a product safety recall. Sales fall for several quarters and it has to offer discounts to win shoppers back. The loss in brand equity shows up as lower margin. Management tracks the recovery through survey scores and the size of the discounts needed to hold sales.
Think of it
Brand equity is the value your brand name adds-what customers will pay extra just for your name.
Formula
Calculation
Annual price premium value = (Branded price - Comparable unbranded price) x Units sold
Suppose a branded water bottle sells for $32 while a similar unbranded bottle sells for $20. The company sells 50,000 bottles a year.
Price premium per unit = 32 - 20 = $12. Annual premium = 12 x 50,000 = $600,000.
This $600,000 is the yearly cash flow attributable to the brand. If it is expected to last for five years, the undiscounted value is 600,000 x 5 = $3,000,000.Case study
Seen in the real world
Silverline Audio is a fictional headphone maker that built a loyal following over twenty years. When it considered selling the company, an adviser estimated that customers paid an illustrative premium of about $25 per unit compared with similar headphones.
With annual sales of 400,000 units, the premium was worth $10,000,000 a year in extra revenue. The buyer valued the brand as a major intangible asset, and the purchase price reflected it.
After the sale, the buyer recorded the brand at fair value and set up an annual impairment review. The finance team now watches the price premium as a sign of brand health. If the gap between its prices and those of similar rivals narrows, the team treats it as an early warning that customer loyalty is weakening, and it raises the matter with the marketing director before the next budget round.
Watch out
Common mistakes
- Assuming brand equity is always on the balance sheet. Internally built brands are generally not recorded, while purchased brands are.
- Equating brand equity with advertising spend. Money spent does not guarantee value, because customers decide whether the brand deserves a premium.
- Believing it can only be positive. Poor reputation can create negative equity and force a business to discount.
Questions
People also ask
How can brand equity be measured?
Through surveys of awareness and preference, and through financial methods such as the price premium or relief from royalty approach.
Why do acquirers care?
A strong brand supports pricing power and customer loyalty, which raise future cash flows and the price a buyer will pay.
Can brand equity be lost quickly?
Yes, a serious scandal or quality failure can damage it fast, although rebuilding it usually takes much longer.
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