Risk Analysis in Brand Valuation

F. Beccacece1 , E. Borgonovo1 and F. Reggiani2

1
IMQ, Bocconi University,
20135 Viale Isonzo 25, Milano
2
IAFC, Bocconi University,
20135 Piazza Sra¤a 11, Milano

Abstract
After an empirical start, brand valuation has attracted the interest of both
accounting practitioners and academicians. Several methods for the assessment
of brand value have been developed. However, a major critique shared by these
models has been the lack of objectivity. In view of such criticism, the Japanese
Ministry of Economy, Trade and Labour created a dedicated Committee with
the twofold task of rigorously de…ning brand and of developing a methodology
for brand valuation based on publicly available balance sheet data. The result
goes under the name of the Hirose methodology. The methodology, however,
while achieving the above two mentioned key-merits, does not allow a …nancial
interpretation of the valuation results. We propose a brand valuation model which
merges objectivity with robust underlying quantitative structure thus sharing a
direct …nancial interpretation and providing risk analysis insights. An empirical
analysis allows us to compare both numerical results and …nancial insights derived
by analysts from the utilization of the Hirose Methodology, the Royalty Method
and the proposed model.
Keywords: Brand Valuation, Hirose Methodology, Risk Analysis, Brand De-
fault Probability.

Acknowledgments: We would like to thank Mauro Bini for precious suggestions

and support throughout the development of this work. We would also like to thank
Francesco Momenté and Emanuel Bagna for useful comments and discussion.

1 Introduction
The recent development of brand value assessment for accounting purposes has an em-
pirical start. It can be seen to originate in Britain in the late 1980s. In those years,
Guinness, Reckitt and Colman, Grand Metropolitan and United Biscuits reported the
brand values of …rms acquired in take-over activities in their balance sheets. In 1988,
Ranks Hovis McDougall took this innovative …nancial accounting practice one step fur-
ther by capitalizing internally-developed as well as externally-acquired brands. In 1995,

1
the Accounting Standards Committee published Exposure Draft 50, Intangible Assets,
(see [11]), allowing balance sheet inclusion of intangible …xed assets under the condi-
tions: i) the historical cost is ascertainable, ii) assets are distinguishable from goodwill,
and iii) the cost is measurable independently of goodwill, other assets and earnings.
Indeed, points i)-iii) have been “strongly criticized on grounds that very few assets
would be able to qualify for recognition with such restrictive requirements [Canibae no et
al (1999)].”. In the meantime, the academia was urging a deeper understanding of the
…nancial value of brands. A growing body of empirical literature (see for example Barth
et al (1998) [1] and Seethamraju (2003)[17]) was indeed supporting the hypothesis that
brand assets are value relevant, i.e. associated with market values.
In 2004, the Accounting Standard Board published IFRS 3 Business Combinations
(see [14]). In accordance with IFRS 3 Business Combinations, if a brand is acquired in
a business combination, the cost of that brand is its fair value at the acquisition date.
This reporting standard has therefore formally introduced in accounting practices the
discipline of brand valuation.
Several methods, in fact, had been developed by …nancial analysts and practitioners
to assess brand value.1 The methods can be classi…ed broadly into cost, market and in-
come approaches. The cost approach utilizes the cost spent in developing the brand as a
measure of brand value (Reilly and Schweis (1999) [16], Ch. 8, pp. 118-145.) Reilly and
Schweis (1999) [16] distinguish the “historical cost approach,” which values the brand
based on the sunk costs associated with brand maintenance and management, from the
“replacement cost approach,”which values the brand based on the expected total cost
required to recreate the brand. Shortcomings in the cost approach are highlighted in
Reilly and Schweis (1999) [16], which mention that the relationship between spent costs
and brand value is not always clear, as in the cases in which high costs did not result in
a success brand. The market approach, also referred as “sales comparison approach”,
values brand by making reference to the actual price of similar brands traded in the
market [Reilly and Schweis (1999) [16], Ch. 9, pp. 146-158.] Reilly and Schweis (1999)
[16] note that it may not be appropriate to assume that similar brands will be priced
alike, since brands are by nature somewhat unique. Perrier (1997) [15], Ch. 4, and
Reilly and Schweis (1999) [16], Ch. 10, discuss the income approach. This approach,
which may also be called “economic value approach,” values brands based on the net
present value (NPV) of the excess pro…t or future cash ‡ows generated by the brand.
The three most common variations of this approach are the Royalty Rate Analyses2
[see Reilly and Schweis (1999) [16], pp. 194], the Premium Pricing Technique [Perrier
(1997) [15], pp.21-22] and the Pro…t Split Analyses [see Reilly and Schweis (1999) [16],
pp. 193]. In formulae, all the methodologies share the view that:

XN
E[Xi ]
V = (1)
i=1
(1 + r)i
1
Stobart (1991) [20] and Keller (2002) [9] provide a through overview of brand valuation techniques.
2
We shall refer to this method as “Royalty Method.”

2
where V is the brand value, Xi is the expected brand generated excess pro…t or cash
‡ow at year i and r is the proper discount rate.
The main conceptual di¤erences among the methods lie in the way E[Xi ] is esti-
mated. For example, the pro…t split method starts with the company forecasted pro…ts
and derives the pro…t fraction which can be attributed to a certain brand. The clearest
example of this type analysis is the yearly publication of brand values in Business Week
(see [10]). The price premium technique measures the brand generated excess pro…t (or
cash ‡ow) by the present and future price premium of branded products compared with
products without brand. One considerable application of this technique is described
in Section 2. Instead, the Royalty Method estimates the brand generated cash ‡ow as
follows:
E[Xi ] = E[Si ] R
where Si are the sales of the company at year i, and R is the appropriate royalty rate.
There follows that the brand value determined by the Royalty Method (VR ) equals:

X
N
E[Si ] R
VR = i
(2)
i=1
(1 + r)

In principle, R is found from a market analysis looking at the fees (expressed as

percentage of sales) that a …rm required to licence its brand. The determination of the
appropriate rate is not always straightforward, especially for …rms that do not licence
(or have not licensed yet) their brand. Since it is beyond the scope of this paper to
explore how to determine the appropriate royalty percentage, in the empirical analysis
presented in Section 5 we have used the values published annually in “Licensing royalty
rates”[Battersby and Grimes (2005) [5]]3 .
The most delicate issue in the use of these methods is the arbitrarity in the iden-
ti…cation of which part of a …rms’pro…ts (or cash ‡ows) is attributable to the brand.
Thus, many valuation approaches made use of qualitative statements and not veri…able
data in measuring the value of brands, leading to results which relied on …nancial an-
alysts’ subjective interpretation. In so doing, the methods failed in satisfying two of
the principles required by fair value estimates: objectivity and no-arbitrarity (Treynor
(1999) [21].) Let us quote directly from Treynor (1999) [21]: “the data should be veri…-
able, at least in principle. When data are veri…able, ‘objectivity’ceases to be an issue”
and (Treynor (1999) [21], p. 27) “the data should not depend on arbitrary decision by
anybody (Treynor (1999) [21], p. 27).”
To overcome the shortcomings of many valuation approaches, the Japanese Ministry
of Economy, Trade and Labor …nanced a project aimed at de…ning a brand valuation
model solely based on public data [Hirose et al (2002) [6]]. Starting point of the report
is a rigorous de…nition of brand, and output of the Japanese study is a valuation model
3
The volume is a reference tool that provides detailed royalty rates for 1,500 products and services in
ten di¤erent licensed product categories: art; celebrity; character/entertainment collegiate; corporate;
designer; event; music; nonpro…t; and sports. The royalty rates generated by brand names are under
the category “corporate”.

3
(known as the Hirose methodology) based only on publicly available …nancial data
directly extracted from the …rm Annual Reports. This makes the valuation results
very well grounded “empirically”, and capable of meeting the objectivity requirement
mentioned above. However, while having solved the problem of “objectivity,”the model
is exposed to criticism as far as the …nancial interpretation of the results is concerned,
which we illustrate.
We then advance an alternative model that merges the objectivity of the Hirose
methodology with a robust underlying quantitative structure that o¤ers a clear …nancial
interpretation of the results. The model also enables one to perform risk analysis
of brand generated cash ‡ows, allowing to estimate brand default probabilities from
balance sheet data.
The above general discussion is followed by an empirical analysis in which we apply
the new model, the Hirose methodology and the Royalty Method to estimate the brand
value of a sample of 10 companies operating in di¤erent sectors. Results of the analysis
will enable us to compare not only the numbers, but also the information that an analyst
can derive from the use of the various models. We shall show that discrepancies in the
Royalty Method and the Hirose methodology results are attributable to the di¤erent
cash ‡ows which are inputs of the two methods. We shall also show that applying
the newly proposed method in conjunction with the other methods, an analyst derives
insights not only on the brand value, but also on the riskiness of its cash ‡ows.
The remainder of the paper is organized as follows. Section 2 is devoted to a review
of the Hirose methodology, highlighting its merits and discussing its (lack of) …nancial
interpretation. Section 3 introduces an alternative brand valuation model. Section 4
presents the empirical analysis results. Conclusions are o¤ered in Section 5.

2 The Hirose methodology for Brand Valuation: the Japanese

Model
The brand valuation model we discuss in this Section, is the one developed by the
Committee on Brand Valuation (Chairman: Dr. Yoshikuni Hirose, Professor at Waseda
University), a consultative body organized under the Japanese Ministry of Economy,
Trade and Industry. It is contained in the corresponding report, released on June 2002
entitled, “The Report of the Committee on Brand Valuation (Hirose et al (2002) [6]).”
The Report is considerable for two main reasons:

it has developed an objective brand valuation model using public …nancial data
extracted from the Annual Report;

the methodology it provides is quite general and might be easily extended to the
valuation of intangibles other than brands.

The Report de…nes “brands”as “emblems including names, logos, marks, symbols,
package designs and etc. Used by companies to identify and di¤erentiate their products
and services from those of competitors” and presents a brand valuation model (from

4
now on the “Japanese model”) using the income approach, a valuation approach based
on pro…tability.
The Japanese model can be summarized as follows. The brand value (V ), is assumed
to be function of several factors:

V = f (P D; LD; ED; r)
The implied factors are:
P D: “Prestige Driver”(Price advantage of the brand)
LD: “Loyalty Driver”(Stability of the brand)
ED: “Expansion Driver”(Brand expansion capability)
r : risk-free interest rate.
We now examine the …rst three factors in details.
P D is a factor of brand value that focuses on the price advantage created by the
power of the brand that enables the company to sell its products constantly at higher
prices than those of its competitors. P D is represented by cash ‡ows attributable to
the price advantage of the brand. The proportion of advertising expense, or brand
management cost, to total operation cost is used as the attribution rate. Formally, P D
is given by:
1X
0
Si Si Ai
PD = C0 (3)
5 i= 4 Ci Ci OEi
where :
S = Sales
C = Cost of sales
S = Sales of a Benchmark Company
C = Cost of sales of a Benchmark Company
A = Advertising and promotion cost
OE = Operating cost
LD is a factor that focuses on the capability of the brand to maintain stable sales
for a long period based on the stable customers or repeaters with high loyalty. LD is
represented by the stability of the cost of sales. It is calculated by the formula:

c c
LD = (4)
c

where:
c = 5-term average of cost of sales;
c = 5-term standard deviation of cost of sales.
ED focuses on the fact that a brand with high status is widely recognized, and
therefore, is capable of expanding from its traditional industry and markets to similar
or di¤erent industries as well to overseas, expanding market geographically. ED is
explained by an average of the growth rate of overseas sales and growth rate of sales

5
from non-main businesses. The formula to calculate ED has been stated as follows:
" #
1 1 X SOi SOi 1 1 X SXi SXi 1
0 0
ED = +1 + +1 (5)
2 2 i= 1 SOi 1 2 i= 1 SXi 1

where :
SO = Overseas sales;
SX = Sales from non-main businesses.
The brand value V can be easily interpreted as a non decreasing function f of the
factors. In particular, the Japanese model provides a very simple form for the function
f , given by:
P D LD ED
V = (6)
r
We note that from a practical point of view the brand value is estimated as follows:
one gathers the past 5 years balance sheet data, estimates the three terms in the numer-
ator of eq. (6) and discounts them at the risk free rate. From a …nancial point of view,
eq. (6) measures brand value as a perpetuity with cash ‡ow given by (P D LD ED).
In the remainder of the work we refer to eq. (6) as either the Hirose methodology or
the Japanese model.
Although the Japanese model shares the advantage of objectiveness and data ac-
cessibility, it does not o¤er a clear interpretation of the …nancial aspects of the brand
value, as we are to discuss.

1. Discounting at the risk-free rate: brand cash ‡ows are risky. The Report un-
derlines how, in accordance with the IAS 36, Appendix A [12], the uncertainty
(and consequently the riskiness) of the cash ‡ow generated by the brand, must
be handed by using one of the two methodologies:

a. adjusting the interest rate with a risk premium and using the cash ‡ow we can
estimate by considering a single scenario (the most likely one);
b. considering the expected cash ‡ow and maintaining the risk-free rate for dis-
counting the future cash ‡ows

and it follows the latter methodology, determining the expected cash ‡ow as the
average cash ‡ow of the last period (…ve years for P D and two years for ED).
With respect to (w.r.t.) this point we move our …rst critique to the Japanese
model in that the followed approach is risk neutral4 since it simply provides
the present value of the expected cash ‡ow, with no adjustment for the risk, in
contrast to standard principles in evaluation theory and practice (see Smith J.
K. and Smith R.L. (2000) [19], Brealey and Myers (2000) [3].) One could remark
that the factor LD may be interpreted as the correction of the present value of
the expected cash ‡ow, in accordance with the certainty equivalent form (CEQ)
4
On the concept of risk neutral valuation, please see Hull (1998), p. 237.

6
 of the Capital Asset Pricing Model [see Smith J. K. and Smith R.L. (2000) [19].]
Our second critique is just devoted to show that this is not true.

2. LD cannot be interpreted as a correction term in accordance with CEQ. We show

now that LD is not a correction term entailing the cash ‡ow riskiness. Let us
consider the CEQ expression for the present value of a single cash ‡ow Ct that
will be received at time t. It is:
(Ct ;rm ) Ct
Ct m
RPm
P Vt = (7)
1+r
where:
rm and m are the expectation and the standard deviation of the market return,
respectively;
Ct is the standard deviation of the cash ‡ow;
is the correlation coe¢ cient;
RPm is the risk premium of the market.
In order to …t the Japanese model [eq. (6)] in the CEQ framework, one needs
…rst to identify the cash ‡ow and adjust it for the correction term. Based on
what we have discussed till now, if LD has to be interpreted as a risk correction
factor, it must hold that P D = Ct (for the sake of simplicity, the factor ED is
omitted). Hence, equating eq. (6) and (7), one obtains the condition:
(Ct ;rm ) Ct
Ct (1 c
) Ct RPm
c m
= (8)
r r
After a …rst algebraic manipulation, one gets:

c (Ct ; rm ) Ct
Ct = RPm (9)
c m

This condition has in itself no direct …nancial interpretation. However, let us try
and dig in the meaning of eq. (9) by utilizing some conditions on the elements of
eq. (9) that …nd usual ground in the practice. The …rst condition is that, from a
c c
practical point of view, one can assume ' t . Inserting in eq. (9), one gets:
c ct

Ct (Ct ; rm )
= RPm (10)
ct m

Ct
Now, since = 1 by de…nition, one is left with:
ct

(Ct ; rm )
1= RPm (11)
m

7
 RPm
Finally utilizing the often empirically veri…ed fact that 2 = 1, condition (9) is
m
equivalent to requiring :
1
(Ct ; rm ) = (12)
m

Eq. (12) suggests that, in order LD to be a risk correction coe¢ cient, the corre-
lation coe¢ cient between the brand generated cash ‡ow and the market should
always equal the inverse of m . This is a strong condition that is not going to be
veri…ed in the practice. Hence, one cannot but infer that the CEQ interpretation
of the Japanese model, via Capital Asset Pricing Model, leads to an unacceptable
conclusion.

3. Relationship between value drivers and parameters used to compute them. If,
from one hand, it can be fully shared the role attributed in the model to the
value drivers as factors which are strictly linked with the brand value, from the
other one, the suitability of the parameters used in order to compute them is not
immediate.

4. Analytic form of the brand value function and correlations among the factors
used for explaining it. The last weakness of the Japanese model is the possible
inconsistence between the structural form of the brand value function and the
correlations among the factors. In fact, the product of the factors proposed in
the model as brand value function, even if it shows the advantage of a very
simple analytic form, is valid when the factors are thought of as uncorrelated.
Unfortunately, this is not the case, since the some of the parameters used in the
model for determining di¤erent value drivers are correlated. For example, it is
evident that sales and cost of sales, which are present in both P D and LD, cannot
be thought of as completely uncorrelated.

A …nal note. After analyzing the main advantages and some of the limitations of
the model, we would like to draw some remarks on the approach of measuring the value
drivers by the means of a benchmark company. In our opinion, the use of a benchmark
is justi…ed in the model, since brand value is essentially determined by the advantage
that the brand guarantees over competitors. On the other hand, this makes crucial the
choice of the benchmark company, which, in the most cases can be interpreted as the
worst of the sector.

3 An Alternative Model
This Section introduces an alternative brand valuation model. Our purpose is twofold.
On the one hand, the model is aimed at preserving the key merits of the Hirose method-
ology, i.e. brand cash ‡ow estimation from public data. On the other hand, we aim at
overcoming the di¢ culties in the …nancial interpretation of the Hirose methodology5 ,
5
See the end of Section 2.

8
by introducing an approach that enables to extract information on brand risk directly
from balance sheet cash ‡ow estimation.
We then consider the brand generated cash ‡ow composed of a risk-free component
and a risky component. The rationale below this choice is the following. As we men-
tioned in our critique to the Hirose methodology in Section 2, since the brand generated
cash ‡ow is, in its entirety, an uncertain/risky quantity, not all the cash ‡ow can be
discounted at the risk-free rate. However, we consider that the brand is capable of as-
suring a minimum cash ‡ow equal to x0 2 R, which is risk-free and therefore represents
the portion of the cash ‡ow that can be discounted at the risk-free rate as in eq. (6).
In addition to the sure cash ‡ow, we consider the capability of the brand to generate
a risky cash ‡ow. We model the additional cash ‡ow as ranging from 0 to its highest
value, denoted by q. More formally, the risky cash ‡ow is a …nite support random
variable X 2 [0; q] ; X FX , where FX is the cumulative distribution function for X.
Hence we have that the cash ‡ow generated by the brand is the random variable:
Y = x0 + X (13)
In the current model, we still want to maintain input data on the same basis as in the
Hirose methodology, since it is the main advantage of the Japanese model to enable
brand evaluation based on accessible book data. Nonetheless, keeping the economically
signi…cant time span of 5 years used in the Hirose methodology, one can get from 5
to 10 data per …rm (10 data would be gotten if one considered mid-year and end-year
…nancial statements. However, mid-year …nancial statements are not as reliable as
end-year statements for valuing brands associated to products with a high seasonality
in sales). Such a sample size is unfortunately not enough to guarantee a statistically
accurate …tting of the distribution FX . We then utilize an alternative approach. In
order to characterize the risk associated with the brand, we consider that the …rm can
be hit during each time period by a shock. Due to this external or an internal event,
the brand looses the capability to generate the additional bene…t X (we call this event
a “partial default”) with probability p. We note that if one …xes x0 at zero, then p
is the brand (total) default probability, while when x0 > 0, p is denoted as “partial
default probability.”
We now introduce an auxiliary variable (T ) that shall enable us to characterize the
default probability p utilizing the same database as in the Hirose methodology. To do
0
so, we de…ne T = , with the discrete probability mass function
q
P (T = 0) = p
T (14)
P (T = q) = 1 p
and we impose the condition that
E[T ] = E[X] (15)
This condition preserves the expected value of the brand generated cash ‡ow. In fact,
it holds
E[x0 + T ] = x0 + E[T ] = x0 + E[X] = E[Y ] (16)

9
Let us then compute the value of the bene…t generated by the brand utilizing the
auxiliary random variable T . We now show that the introduction of T enables the
computation of the brand value (V ) through the following expression.

Proposition 1 Considering an in…nite time horizon, the risk-free cash ‡ow x0 and the
additional risky cash ‡ow X, the brand value V equals:

x0 E[X]
V = + (17)
r r+p

where r is the risk-free rate and p the partial default probability after a shock [eq.(14)].

Proof. Let us study what can happen at period 1. The expected number of shocks,
as we mentioned, is 1. If the shock at period 1 does not result in brand default, then
the brand shall generate the bene…t q at the end of the period. Let us now de…ne the
periods such that the revenues and costs are scheduled at the period end. The expected
Net Present Value (NPV) of T at period 1 is:

p 0 + (1 p)q (1 p)q
E[T1 ] = = (18)
1+r 1+r
The presence of r at the denominator is due to the fact that we assume that all risks
associated with q are contained in p.
The brand is able to generate the bene…t in the second period only if it has not
default in period 1. This means that P (T2 = q jT1 = 0) = 0. Given that the brand
has not defaulted in period 1, then if the brand does not default in period 2, the brand
shall be capable of generating again the bene…t. Then, the probability of getting the
bene…t q at the end of the second period is:

P (T2 = q) = P (T2 = q jT1 = q )P (T1 = q) + P (T2 = q jT1 = 0)P (T1 = 0) = (19)

= P (T2 = q jT1 = q )P (T1 = q) = (1 p)2 q (20)

The presence of (1 p)2 is justi…ed by the assumption of independent shock arrivals.
Hence:
(1 p)2 q
E[T2 ] = (21)
(1 + r)2
Following the same logic, one can show that

(1 p)n q
E[Tn ] = (22)
(1 + r)n

The expected present value of the cash ‡ow generated by the brand at year n is, then:

x0 (1 p)n q
E[Yn ] = n + (23)
(1 + r) (1 + r)n

10
As a consequence, the total NPV equals:
X
1 X
1
x0 X (1 p)n q
1
V = E[Yn ] = + (24)
n=1 n=1
(1 + r)n n=1 (1 + r)n

which equals eq. (17), thanks to the properties of the geometric series.
Eq. (17) requires as inputs the minimum (x0 ) and the average of the cash ‡ows
EF [X]: These two quantities can be computed from the cash ‡ows generated by the
brand over n past periods, where n is an appropriate time span for the analysis. For
example n = 5 years in the Hirose methodology [eq.(3)]). The default probability p can
be either inserted by the analyst, or inferred from historical data. In fact:

E[X]
E[T ] = E[X] =) (1 p)q = E[X] =) p = 1 (25)
q

In eq. (25), E[X] is found from the average of the past N years brand generated cash
‡ow, and q is the highest cash ‡ow that the brand can generate. Hence, brand value
can be directly quanti…ed by means of available balance sheet data through eqs. (17)
and (25) as in the Hirose methodology. However, eq. (17) shares a more transparent
interpretation in terms of brand risk w.r.t. the Hirose methodology.
In the next Section the quantitative comparison of the results of the three models
is proposed.

4 Quantitative Investigation and Results

This Section details the application of the three models to the valuation of the brands
of a sample of 10 …rms listed in Figure 1. The study is based on publicly available
…nancial statements data.
Figure 1 displays the results of the computation of the brand values produced by
application of the Hirose methodology [eq. (6)] and the Royalty Method [eq. (2)]. The
yellow horizontal bar of Figure 1 (…rst bar in each group) reports the corresponding
value as published in Business Week’s traditional annual review of the top one-hundred
brands6 [see ref. nr. [10]].
Figure 1 evidences that some disagreement among the brand values assigned by
the three methods. We investigate the results …rst examining the degree of agree-
ment/discrepancy, and then investigating the …nancial meaning of the results.
As a synthetic measure of agreement, we compute the correlation coe¢ cients on
the values. In fact a correlation coe¢ cient close to 1 would signal a trend towards
agreement/disagreement. The correlation coe¢ cients for our sample of 10 …rms are
reported in Figure 2.
Figure 2 shows that the highest agreement is found between the values of the Hirose
methodology and the Interbrand one (84:9%). The agreement between Royalty values
6
The values are Interbrand’s estimates, whose evaluation methodology belongs to the Pro…t Split
Analyses (see Section 1).

11
 McDonald's

Kodak

Gillette

Disney

Colgate

Budweiser
Business Week
Nike Royalty
Hirose

Tiffany

Pepsi

CocaCola

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000

Figure 1: Brand Values estimated with the Hirose Methodology [eq. (6)], the Royalty
Method [eq. (2)] and by Interbrand as published on Business Week.

Hirose Royalty Interbrand

Hirose 1
Royalty 52.8% 1
Interbrand 84.9% 43.2% 1

Figure 2: Correlations among the brand values estimated by the Hirose Methodology,
the Royalty method and by Interbrand as published on Business Week.

12
 Company Our Model Hirose p
CocaCola 21,407 22,846 53%
Pepsi 13,147 13,739 51%
Tiffany 2,693 3,376 42%
Nike 376 477 59%
Budweiser 5,591 6,017 50%
Colgate 8,928 9,334 54%
Disney 7,935 11,015 66%
Gillette 6,751 7,479 59%
Kodak 3,477 4,064 49%
McDonald's 9,683 12,320 45%

Figure 3: Brand values utilizing our model [eq. (17)] and the Hirose Methodology.
Column p contains the partial default probabilities intrinsic in the Hirose Methodology
cash ‡ows.

and the Hirose methodology is intermediate (52:8%), while the lowest agreement is
registered between the Royalty Method and the Interbrand Method (43:2%).
As we are to show, the reason of the discrepancies lies in the di¤erent cash ‡ow
basis of the methodologies.
Figure 3 shows the brand values that one obtains by eq. (17) when one utilizes as
input the cash ‡ows of the Hirose methodology.
More speci…cally the values in Column 2 of Figure 3 are obtained utilizing as cash
‡ow in eq. (17) the values:
xi = P Di ED (26)
where the term
Si Si Ai
P Di = C0 (27)
Ci Ci OEi
is one of the summands in eq. (3), and represents the cash ‡ow generated by the brand
price advantage at year i; while ED is interpreted as a constant growth factor.
We detail the calculations of the brand value for the …rst …rm in the list (Coca-Cola).
S
Figure 4 shows CSii and Ci for the …rm.
i
The …ve years cash ‡ows obtained from book values are reported in Figure 5. From
this Figure it is also possible to see that the minimum cash ‡ow generated by brand
equals 1047M U SD. Choosing this value as x0 , then the expected additional risky cash
‡ow is E[X] = 270M U SD, and the maximum cash ‡ow equals

max xi = x0 + q = 1617M U SD (28)

i

Figure 5 also shows the value of the partial default probability, p, computed as the
complement to unity of the ratio between the average and the maximum cash ‡ow [eq.

13
 S/C and S/C*

4.50
4.00
3.50
3.00
2.50 CocaCola
2.00 Benchmark
1.50
1.00
0.50
0.00
1999 2000 2001 2002 2003
Year

Si Si
Figure 4: Ci
and Ci
for Coca Cola from 1999-2003

xi for Coca Cola

1700
1600
1500
1400 xi
1300 E[xi]
1200
1100
1000
1999 2000 2001 2002 2003

x0=1047
p=0.53 V=21407MUSD
q=570
Figure 5: Brand Valuation according to eq. (17).

14
 Company Our Model Royalty p
CocaCola 27,457 23,604 58%
Pepsi 29,015 27,960 46%
Tiffany 2,960 2,952 58%
Nike 12,375 11,697 59%
Budweiser 17,733 16,928 50%
Colgate 14,626 12,723 62%
Disney 47,130 43,146 50%
Gillette 13,629 11,852 50%
Kodak 23,218 19,694 47%
McDonald's 26,804 26,345 56%

Figure 6: Brand valuation results with our model [eq. (17)] and the Royalty method.
p is the partial default probability intrinsic in the Royalty method cash ‡ows.

(25)]. In this case, p = 0:53. According to eq. (17), the brand value is given by the
0
sum of the sure part xr = 20940 and the risky portion E[X] r+p
= 467.
Following the same method, the brand values for the other companies have been
obtained and are shown in Figure 3. The comparison of the values obtained with our
model and the Hirose methodology shows the following (Figure 3.) The correlation co-
e¢ cients on the values is 0:999, meaning that there is a systematic relationship between
the results of the two methods. The high correlation is the consequence of the choice
of the cash ‡ows basis, which is the same for the two evaluations. The resulting values
of p shown in the third column of Figure 3 are the partial default probabilities (see
Section 3) implied by the cash ‡ows of the Hirose methodology.
If instead of utilizing the Hirose methodology, one made use of the Royalty Method,
one would obtain the results of Figure 6.
In order to understand the results of Figure 6, let us illustrate the valuation of Coca-
Cola with the Royalty Method …rst. The cash ‡ows are reported in Figure 7. They
are found by multiplying the sales times the royalty rate extracted from the annual
publication “Licensing royalty rates” [Battersby and Grimes (2005) [5]] (7% in this
case.) Capitalizing the average cash ‡ows at 6% 7 one …nds the value of 23600M U SD
displayed in Figure 6.
The same cash ‡ows can be utilized to compute brand value and the brand default
7
The formula utilized in this analysis is the perpetuity equivalent of eq. (2), i.e.:

R E[S]
VR =
r g

with r = 8% and g = 2%.

15
 1,500,000
1,480,000
1,460,000
1,440,000
1,420,000
E[X]+xo
1,400,000
xi
1,380,000
1,360,000
1,340,000
1,320,000
1,300,000
1999 2000 2001 2002 2003

x0=1370
p=0.58 V=27500MUSD
q=103
Figure 7: Cash ‡ows for Coca Cola employing the royalty method in MUSD.

probability according to the model introduced in this work [eq. (17)]. Figure 7 displays
the cash ‡ows and the values of x0 , E[X] and q. One has: x0 = 1370M U SD, q =
44
103M U SD, E[X] = 44M U SD, and p = 1 104 = 0:58. Substituting into eq. (17), one
…nds that the sure portion of the brand values would amount at 27350M U SD, while
the extra amount, E[X]
r+p
amounts at around 100.
Let us now discuss the overall ranking agreement. As one can compute from Figure
6, the correlation coe¢ cient among the brand values estimated with our model and with
the Royalty Method equals 0:985. This result evidences the presence of a systematic
relationship. Such relationship is again due to the fact that the two values share the
same cash ‡ows basis. However, it is immediately apparent the discrepancy of the
royalty cash ‡ows and the cash ‡ows derived by the Hirose methodology (reported in
Figure 5.) As far as risk analysis is concerned, the partial default probabilities implied
by the Royalty Method are reported in the third column of Figure 6. Let us now
investigate whether the risk views implied by the Hirose methodology and the Royalty
Method coincide. Figure 8 compares the partial default probabilities obtained with the
two methods.
It is immediate to note that Hirose methodology and the Royalty Method can lead
to a di¤erent view on the brand partial default probability. The reason lies in the fact
that in this analysis p is extracted out of the cash ‡ows, so it is the partial default
probability “implied” by the valuation method. The fact that the cash ‡ow basis is
di¤erent explains the di¤erence in the p’s.
We now show that one can also derive the default (with no more “partial”) prob-
ability straightforwardly using eq. (25). It is enough to choose as minimum cash ‡ow

16
 McDonald's

Kodak

Gillette

Disney

Colgate

Budweiser

Royalty
Nike Hirose

Tiffany

Pepsi

CocaCola

0% 10% 20% 30% 40% 50% 60% 70%

Figure 8: Comparison of partial default probabilities (p) implicit in the Hirose Method-
ology and the Royalty Method cash ‡ows.

17
 Company Hirose Royalty
CocaCola 19% 4%
Pepsi 21% 11%
Tiffany 17% 16%
Nike 25% 11%
Budweiser 9% 9%
Colgate 5% 5%
Disney 43% 7%
Gillette 16% 7%
Kodak 18% 4%
McDonald's 34% 13%

Figure 9: Brand (total) default probabilities implicit in the cash ‡ows of the Hirose and
the Royalty methodologies.

x0 = 0. In fact, if x0 = 0, p measures the probability of the brand not generating more

than 0, i.e. the brand default probability. Figure 9 shows the default probabilities
implied by the Royalty Method and the Hirose methodology cash ‡ows.
First of all, a comparison of the values of the default probabilities of Figure 9 and
the partial default probabilities of Figures 3 and 6, shows that the default probabilities
are lower than the partial default probabilities. This is consistent with the fact that it
is more likely that a brand generates more than 0, rather than it generates more than
a minimum cash ‡ow x0 > 0.
As far as the risk views implied by the Royalty Method and the Hirose methodology
are concerned, Figure 9 shows that they are not linked by a systematic relationship. In
fact, the default probabilities practically coincide for Budwiser and Colgate, while little
agreement is found on the brand default probabilities of Disney, McDonalds’, Kodak
and Nike. Hence, one ought to conclude that the Royalty and the Hirose methods
not only lead to di¤erent brand values, but also give rise to a di¤erent underlying
interpretations of brand risk.
Finally, let us see how an analyst can pro…t from the joint use of the di¤erent models.
Suppose one is assigned the task of valuing, say, Coca-Cola’s brand. Then one can say
that the value of Coca-Cola is in a range between the minimum and the maximum
value estimated by the four methods8 . In the case of Coca-Cola, the brand value would
range between 22000 — with eq. (17) and the Hirose cash ‡ows — and 67000. One
can also gain insights on the brand risk. The riskiness of the brand cash ‡ows can
8
On a more general line of thought, the reason for the discrepancy among the values can be seen as
highlighting to the fact that brand market is not complete. We also recall that in the case of incomplete
markets also the valuation of real options does not lead to a unique value, but to a range [Smith and
Nau (1995)].

18
then be summarized as follows. Probability of Coca-Cola not to generate more than
the sure portion (say of around 21000) is 53% according to the Hirose method and 58%
according to the Royalty Method. The default probability, i.e. the probability that its
brand looses any value varies between 4% (according to the Royalty Method) and 19%
according to the Hirose methodology.

5 Conclusions
In this paper, we have dealt with the problem of assigning brand value. We have seen
that, after an empirical start, brand valuation has attracted international attention
with the publication of the IFRS 3 Business Combinations. Such publication has lead
to the development of several valuation methods that have been envisioned by …nancial
analysts and practitioners. We have brie‡y reviewed such methods, highlighting that
most of the criticism against them stems from their lack in objectivity and arbitrariness,
as underlined in Treynor (1999) [21].
We have seen that, in order to counterbalance the criticism against current methods,
a recent model has been developed by the Japanese Ministry of Economics and Labor, as
a result of a research project aimed at de…ning brand value based on publicly available
data. Such method, named the Hirose methodology, has the key-merit of solving the
historical problem of objectivity and arbitrarity in brand valuation, since its cash ‡ow
estimation scheme relies solely on publicly available …nancial reports.
However, we have seen that the Japanese model presents some drawbacks. The …rst
one is the di¢ culty in reconciling the model with traditional valuation results. This
prevents one from assigning a meaningful …nancial interpretation to its terms and in
particular to its loyalty driver portion. In addition, the model foresees discounting of
brand cash ‡ows at the risk free rate, while, again due to the structural de…ciency, no
model term can be seen as an indicator of the cash ‡ow riskiness. To overcome these
limitations, we have then o¤ered an alternative model, with the purpose of providing
a brand valuation tool supported by a more robust underlying quantitative structure
and allowing a more direct …nancial interpretation of the results, while preserving the
key merit of the Hirose methodology — i.e. to use publicly available information. The
model allows to estimate a brand default probability from balance sheet data which
re‡ects brand risk. Speci…cally, it allows to set a threshold, i.e. a minimum brand
generated cash ‡ow, and to assess the capability of the brand of not generating more
than such threshold. Since the minimum cash ‡ow can be greater than or equal to 0, the
model then allows to estimate both a partial or a total default probability, respectively.
We have illustrated the above …ndings through an empirical analysis based on a
sample of ten companies. First subject of investigation has been the agreement among
the valuation results of the Royalty Method, the Hirose methodology and brand values
published yearly on Business Week and estimated by Interbrand. We have seen that
the correlation between the brand values is low, signalling the absence of a systematic
relationship among the valuation methods.
We have then estimated the brand values utilizing the alternative model proposed

19
in Section 3, using …rst the cash ‡ows of the Hirose methodology, and then the ones
of the Royalty Method. Consistent results have been obtained. Moreover, though the
application of our approach, we have determined the brand partial and total default
probabilities implied by the Royalty Method and the Hirose methodology. The es-
timated values of the probabilities demonstrate the di¤erent view on the brand risk
implicit in the two models.
Finally, we have discussed that the joint utilization of the methods allows analysts
to determine valuation boundaries and to obtain …nancial and risk analysis insights.

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21