What it means
Two bottles of water from the same spring, one with a well-known label and one without, sell at different prices. The difference is brand equity.
It is built over years through product quality, consistent marketing, customer experience and reputation, and it can be destroyed quickly by a scandal, a quality failure or neglect. Marketers describe brand equity in terms of its sources: awareness (do customers know the brand exists and recall it when they need the category), associations (what the brand means to them: reliability, luxury, value, ethics), perceived quality (whether they believe it is better) and loyalty (whether they buy again and resist switching).
Finance describes it in terms of its effects: price premium, volume premium, lower marketing cost per sale, lower customer churn, easier distribution, and the option to extend the brand into new categories. Measuring brand equity ranges from survey-based scores to financial valuation.
The price premium method compares the price the branded product commands with a comparable unbranded or private-label product and multiplies the difference by volume. The royalty relief method asks what the business would have to pay to license its own brand from a third party if it did not own it, and values the brand as the present value of those avoided royalties; this is the method most commonly used for acquisition accounting and for published brand league tables.
The excess earnings method attributes to the brand the profit remaining after a fair return on all the other assets. Accounting treats brand equity cautiously.
A brand built internally is not recognised as an asset, because the cost of building it (advertising, product development, service) cannot be reliably separated from ordinary operating expense, and it is written off as incurred. A brand acquired in a business combination is recognised at fair value as an intangible asset, usually with an indefinite life, and tested annually for impairment.
The result is that two companies with equally valuable brands can show very different balance sheets depending on whether they built or bought them. For managers the practical point is that brand equity is an asset that requires investment and can be run down.
Cutting marketing to meet a quarterly target, discounting to hit volume, stretching the brand onto products that do not fit it, or tolerating a decline in quality all draw on the equity without showing an immediate cost. The cost appears later as a lower price premium and higher churn.
In practice
Real-world examples.
Example
A sportswear company licenses its name to a sunglasses manufacturer for 8% of sales, receiving income from brand equity without making the product.
Example
A supermarket chain launches a premium own-label range that sells at 70% of the branded price, having judged that its own name carries enough equity to support the gap.
Example
A regional bakery is acquired for three times its net assets; the buyer records $6 million of the excess as a brand intangible.
Think of it
“Brand equity is the value your brand name adds-what customers will pay extra just for your name.
Formula
Calculation
Price Premium Value = (Branded price minus Unbranded price) x Annual volume
Brand Value (royalty relief) = Present value of (Brand revenue x Royalty rate x (1 minus Tax rate)) over the forecast period plus terminal value
Worked example, price premium. A branded coffee sells at $9.50 per pack against a private-label equivalent of the same quality at $6.50. Annual volume is 4 million packs.
- Price premium = $3.00 per pack
- Annual premium = $3.00 x 4,000,000 = $12,000,000
- Additional marketing to sustain the brand: $4,000,000 a year
- Net annual brand contribution = $8,000,000
Worked example, royalty relief. The same brand has revenue of $38 million a year ($9.50 x 4 million), expected to grow 3% a year. Comparable licence agreements in the food sector carry royalties of 5% of revenue. Tax rate 25%, discount rate 10%.
- Year 1 royalty saving after tax = $38,000,000 x 5% x 0.75 = $1,425,000
- Treating the saving as a growing perpetuity: value = $1,425,000 / (10% minus 3%) = $20,357,000
The brand is worth about $20 million on this method, roughly 2.5 times its net annual contribution. If the company were acquired, the buyer would record an intangible asset of about that amount. On the company's own balance sheet, the brand appears nowhere, although it accounts for most of what a buyer would pay.
Sensitivity: if a quality problem cut the sustainable price premium to $2.00 and volume to 3.5 million packs, annual premium would fall to $7,000,000 and the brand's revenue base to $33,250,000; at the same royalty rate the brand value would fall to about $17.8 million. A single bad year can remove years of investment.Case study
Seen in the real world.
A family-owned paint manufacturer had built a reputation over forty years for durability, and its products sold at a 20% premium to national brands in its home region. A new chief executive, under pressure to grow, reformulated the range with cheaper resins, cut the advertising budget by half, and extended the brand onto a low-price range sold through discount stores. Sales rose 12% in the first year and profit rose more, because costs had fallen.
In year two, complaints about peeling increased, professional decorators, who had been the brand's most loyal customers, moved to competitors, and independent retailers began to ask why they should stock a brand that was also in the discounters at 60% of their price. By year three the premium had gone: the company was selling at parity with national brands, volume was below the starting point, and profit was 30% lower than before the changes.
The board reversed course, restored the original formulation, withdrew from the discounters and rebuilt advertising, but it took five years to recover the premium. The finance director's post-mortem valued the brand equity lost in the first two years at more than the total profit gained, and the company now reports a brand health score (unprompted awareness, price premium and decorator loyalty) to the board alongside its financial results.
Watch out
Common mistakes.
- Treating marketing purely as a cost to be cut when profit is short. It is also the maintenance spend on an asset that does not appear on the balance sheet.
- Extending a brand onto products or price points that contradict what it stands for, which dilutes the associations that give it value.
- Reading the absence of a brand asset on the balance sheet as evidence that the brand has no value.
Questions
People also ask.
Why does an acquired brand appear on the balance sheet but a built one does not?
Accounting rules recognise intangibles only where their cost can be measured reliably, which is possible in an acquisition but not for internal spending.
How is brand equity different from goodwill?
Goodwill is the residual of an acquisition price over identifiable net assets, which include the brand. The brand is a specific, separable asset; goodwill is what is left.
Can brand equity be negative?
Yes. A brand associated with poor quality or a scandal can sell for less than an unbranded equivalent, which is why companies sometimes retire damaged brands.
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