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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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BRANDS VALUATION : HOW TO
ESTIMATE THE RESPECTIVE VALUE OF
BRANDS AND TRADE MARKS
Presentation for the OECD
Meeting on the transfert pricing aspects of intangibles
Working party n° 6 of the committee on fiscal affairs
Paris 7-9 November 2011
Speaker
Maurice Nussenbaum - Professor of Finance, University Paris-Dauphine - Director, Sorgem Évaluation - Expert agréé par la Cour de Cassation
Sorgem Evaluation - 11 rue Leroux – 75116 PARIS
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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-A -
Introduction :
What are the differences between brands and
trade marks
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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a. For a lawyer (1)
The trademark is the legal dimension of the brand.
A brand is a distinctive sign whose holder has been granted
exclusive use :
- To identify that the products or services originate from a unique source,
- To distinguish the products or services from those of other entities,
- Typically : name, word, sentence, logo or a combination of these elements,
- A form of property : proprietary rights are established through registration to
prevent unauthorized uses and to negotiate payment for using the TM,
- Can be unlimited through renewal by paying the corresponding fees.
1. Brands do not have the same meaning
for each type of professional
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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A brand is an intangible asset i.e. a non
monetary asset without physical substance (IAS
38 ). It can be identifiable or unidentifiable :
- An identifiable asset can be separated, sold,
leased or licensed to a third party.
- An unidentifiable asset is generally known as
goodwill.
b. For the accountant
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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The economic definition of an asset relates to its
ability to generate identifiable future income.
As an asset, a brand generates identifiable
revenues (royalties, premium profits, excess
earnings, cost savings…).
c. For corporate finance
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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d. What is the difference between brand and
trademark ? (1)
Brand represents :
• Value added, image and symbolic elements
• A promise of value
• Distinguishing features
Brands are trademarks that have been loaded with social
and cultural meaning.
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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e. For marketing - what is the difference
between brand and trademark ? (2)
• A trademark is a pure legal entity operating in a
commercial context and brand is a crossover concept
• Brands build identity systems that encompass a
personality, a relationship and an image in consumer
minds.
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Brands are also defined by their missions
• What is the vision being advanced?
• What is the underlying necessity?
• What is the brand trying to change in the marketplace?
• What resources are at its disposal?
• What values does it convey?
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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The brand in its attributes
10 attributes by AAKER :
• differenciation
• satisfaction or loyalty
• perceived quality
• leadership or popularity
• brand personality
• organisation of associations
• brand awareness
• market share
• market price and destribution coverage
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There are differents kinds of brands:
• Mega or global brands: the same for all countries and
markets
• Local brands : specific per market or country
• Dedicated brands (to specific products)
• Brands specialized in certain niches/segments
• Tactical brands
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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Conclusion : trademarks and brands
Legal and business dimensions
1. Legal dimension : the trademark
Trademark as signs :
It is to easier to identifity the costs to replace or reproduce the
trademark than their specific revenues :
- replacement cost : current cost of producing or constructing
a similar new item having the equivalent utility
- reproduction cost : current cost of duplicating an identical
new item
But cost do not reflect the true potential to create value.
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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Conclusion : trademarks and brands
2. Business dimension : Brand
A brand is a differentiation tool used to create an attractive
system of values generating relevance, esteem and
knowledge.
Unlike the trade marks, brands have a capacity to create
financial value..
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• What are its competitive advantages?
• How big is the underlying market?
• Who might be the new entrants and what are the
risks for the brand’s potential?
3. The financial value of a brand depends on its position in
the value chain
Conclusion : trademarks and brands
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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4. The brand has also a specific positioning amongst the other
commercial intangible assets
• Examples of the intangible commercial assets: customer relationships
list, all types of agreements and contracts.
• Its value is conditional: it is a function of the excess profit which
remains after taking into account the costs off all other assets employed
(tangible and intangible assets)
• The increasing importance of the brand for the value of a company
is partialy due to the dematerialization of the economy: people buy
products and services full of symbolic associations
Conclusion : trademarks and brands
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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- B -
Different approaches used to value brands
and others intangibles assets :
3 basic approaches
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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Different
methods used for the
valuation of intangible
assets
Market Income Cost
Active Market Prices
Incremental Cash Flow
Reproduction Cost
Market / transactions Comparables
Relief-from-Royalty
Replacement Cost
Multi periods excess earnings
These methods have been detailed during the presentations made in March 2011 at
OECD working party n° 6.
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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1. Fiscal framework for the valuation :
Application of full competition principle
(OECD) recommendations
Transaction methods Transactional profit methods
Methods References Methods References
Comparable
Uncontroled
Price (CUP)
Prices applied between
independent companies
Transactional
Profts split
division of profits that would
have been between independent
enterprises
Resale
price Method
Price at which the good or
service is resold to an
independent company + margin
Transactional
Net margin
method
(TNMM) - net
profit earned un
comparable
uncontrolled
transactions
Comparaison between Net
profit from controlled
transactions with net profits in
comparable uncontrolled
transactions
Cost plus
method
Mark up on costs from
comparable uncontrolled
transactions
Importance of identifying comparable companies or transactions
Need for functional analysis = detailed examination of the functions assumed
by each company
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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2. The Sorgem Evaluation approach for brand
value (1)
As all assets, brands derive their value from the profits they are likely to generate.
It is however, difficult to directly measure a brand’s effect on corporate earnings.
Sorgem Evaluation approach for brand valuation proposes a frame work for :
-Analysing the risk of the brand
- separate the profits attributable to the brand from the profits attributable to all other intangibles used by the firm.
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Strategic analysis of the brand and its market
Profits directly
attributable to the
brand
Share of profits
attributable to
intangibles
Risk associated
with brand income
Growth scenarios
brand profits
Tool :
Based on royalties,
price premium or
margin
Tool :
Scenarios
Tool :
Class of risk
Tool :
Sharing matrix
Value of a brand = present value of its future earnings
This is an income based approach with marketing and strategic analysis.
2. The Sorgem Evaluation approach for brand
value (2)
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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2.1. Discount rate increases with the risk of the
asset :
Discount
Rate
low Average
(WACC)
High risk
Goodwill
Intangible
assets
Fixed assets
Working capital
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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2.2. Strategic analysis matrix for risk assessment
of the brand
Market criteria
Historical and forecast growth
Innovation
Structure of competition
Sensitivity to brands
Threat of new entrants
Brand criteria
Market share
Competitive position
Resistance to price variations
Satisfaction with quality/services
Brand image
Notoriety. Loyalty. Capability
of diversification into sub-brands.
Technical. Financial. Marketing.
Communications
Brand and
competitors
Brand and
customers
Brand levers
Potential expansion
of brand scope
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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2.3. Earnings allocated to intangible assets
Operating profits
Return on intangible assets
Return on tangible assets
and working capital
Corporation tax
(based on operating profits)
=
The return on intangible fixed assets and working capital
is considered as contributory asset charges.
+
+
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a- Brand’s positioning in a risk class
2 Brand D
3
4
2
1
3 2
1
O
Market / other markets
Brand / other brands
+
=
-
- = +
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Minimum risk class = 10 year OAT = 3 %
Medium risk class 2 = 10 year OAT + 4.5 % = 7.5 %
Maximum risk class 4 = 10 year OAT + 2 x 4.5 % = 12 %
Funding structure: 1/3 debt; 2/3 equity
Debt rate: 6 % (pre-tax)
b- Calculating the discount rate : risk free rate + risk premium
The risk premium depends on the risk class :
Discount rate for class 2 = 2/3 x 7.5 % + 1/3 x (6% x 0.66) = 5.4 %
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2.4. The sharing approach to assess the contribution of
each intangible to value creation (Sorgem Evaluation)
1. Identification of the different intangible assets affected by the sharing 2. Identification of key success factors (or drivers) and assessment of their
relative weights. 3. Assessment of the contribution of each intangible to a achieve the success
factors effectueness (relative weights)
strategic analysis + judgement to ascertain each of the assets’
respective weightings
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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Assessment of the relative weight of the brand
Identification
of the firm
or BU’s drivers
Relative
weight of the
brand
compared
to other
intangible
assets
Relative
weight of each
intangible
asset
for each driver
Relative
weight
of the
drivers
Identification
of the firm
or BU’s
intangibles
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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Illustration
Success Factors
(drivers) Innovation
Marketing
efficiency
Price /
promotion Total
Relative Weights 30% 40% 30% 100%
Brand 10% 40% 30% 28%
Technical
knowhow 70% 20% 10% 32%
Marketing
knowhow 20% 40% 60% 40%
Total 100% 100% 100% 100%
The relative weight of the brand is 28%.
This means that 28% of the excess earnings will be allocated to the brand.
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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-C-
How to split the value created by
brands at a local and global level ?
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Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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1. Respective appeal of global and local brands (1)
Context of global brands Advantages and disadvantages of global brands
Same consumer behavior for all countries
Homogeneous tastes
New technology
Associated with origins (ex Coronas beer)
Luxury goods (made in France)
Ex. of global brands : APPLE NIKE :
same product
same name
same positioning
same distribution network
Low autonomy for local entities management of the
global brand
Advantages
strength of global image
coherence and recognition through countries
scale economies (production and distribution)
better access to distribution network (easier negotiation
and lower marketing costs)
quicker identification and integration of innovations
increasing international media reach(through internet)
disadvantages
grey markets(management of distribution network)
coping with cultural differences
coping with different competitive sets and marketplace
conditions
threat of international image attacks
Ex : PERRIER – KIT KAT ( NESTLE )
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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Contexts of local brands Advantages of local brands
• Cultural and linguistic differentiation
• Differentiation of product quality
• Different legal and regulatory
environments
• Different consumption patterns and
tastes
Examples : food with DANONE
Or BONDUELLE (Vegetables)
Advantages
satisfaction of each specific market
Disadvantages
no international recognition
low economies of scale (distribution
and advertising)
low international media reach
fuzzy image
1. Respective appeal of global and local
brands (2)
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Consequences:
• Local brands are local intangible assets. The profit may
be split through the analysis of the legal distribution of
property rights.
• It is also possible to economically identify the local
contribution to profit generation.
1. Respective appeal of global and local
brands (3)
Brands and Trademarks : How to split their Financial value – OECD – 8th november 2011
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2. Functional analysis and profit split
Case 1 : The local entity uses a local brand
belonging to another entity of the MNE :
• all the value is created locally
• costs may be split between the local entity and the other
entities
• but there is a potential conflict between economic reality and
property rights if the brand belongs to another entity : the
profit split through legal arrangements may be different from
the economic split.
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Case 1 : The local entity uses a local brand belonging
to another entity of the MNE (2)
The local entity will have to support a royalty fee.
The royalty rate should follow the TP rules :
• arm’s length standard
• functional analysis
• risk sharing
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Case 1 : The local entity uses a local brand belonging
to another entity of the MNE (3)
Consequently, the split between the local entity and the owning
entity cannot be done by solely observing the relative burden of
present costs :
• cost is not a good criteria to value brands: one should rather rely
on benefits generated than on costs
• present costs are just one aspect in a functional analysis: they
may have been borne by the licensor in the past to create the
brand and are no more borne now.
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Case 1 : The local entity uses a local brand belonging
to another entity of the MNE (4)
How to infer the split from TP guidelines :
One basic idea : the local entity should support the same costs
charged by the MNE that what would have been charged to an
independent party in comparable circumstances
Therefore all 4 TP methods can be used depending on the
circumstances : CUP, TNMM, PS or CP.
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Case 2 : The local entity uses a global brand (1)
The same observations can be made to demonstrate that the
relative burden of costs between the local and the other entity is
not a good approach to split the value created.
A global brand is a global intangible and it is difficult to identify
the local contribution for profit generation.
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Case 2 : The local entity uses a global brand (2)
Several issues will have to be addressed but the answers may partly lie beyond the
scope of economic analysis :
• Does the increase in value of the global brand achieved locally with costs borne
locally belongs to the entity which is the legal owner of the brand ?
• Do the economies of scale achieved through the use of a global brand belong to
its legal owner ?
• Does the increase in value achieved through organizational optimization of the
brand management totally belong to its legal owner ?
• In case of transfer of value from a local entity to another entity within the MNE,
should the local entity be entitled with a payment corresponding to an
indemnification ?
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Case 2 : The local entity uses a global brand (3)
Is it possible to split the value creation between the local and the
global level?
Knowing the costs suffered by the local entity from using the global
brand, it is possible to determine the value created at the local level
by projecting the business plan and discounting the cash flows.
By adopting the TP guidelines, the local entity should, at least,
benefit from a fair rate of return from its investments in the global
brand.
It may lead to the determination of an arm’s length royalty rate
charged by the legal owner.
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Case 2 : The local entity uses a global brand (4)
The royalty rate should be estimated through :
• analysis of comparable transactions between independent parties
• economic analysis of the extra-profit generated by the user of the
brand. If the local entity bears the costs of sustaining the brand, it
will be charged a lower royalty rate. The valuation of the brand
will be made by sharing the extra profit between the different
intangible assets.
The local firm will benefit from some part of the extra-profit if
some of the intangibles legally belong to it : for example, the
customer relationships.
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Case 3 : The business restructuring case : how to
apply the general TP considerations ? (1)
Business restructuring may imply transfer or waiving rights on
local or global brands from the local to the other (see § 9190 -
chapter 9 of transfer pricing guidelines p45-46).
In this example the economic substance of the local firm may differ
from its form through legal arrangements .
It is possible to estimate the transfer of value through a but for
analysis by comparing the old DCF with the new one for the local
entity and therefore to value the impact of the transfer arrangement.
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Case 3 : The business restructuring case : how to
apply the general TP considerations ? (2)
But if the brand does not belong to the local entity, the right to use
the brand cannot always remain attached to the local entity. .
Therefore, only one part of the transferred value could be
attributable to the local entity.
Which part ? At least, the local entity should recover a fair rate of
the return for the efforts (or expenses) it has incurred so far.
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Case 3 : The business restructuring case : how to
apply the general TP considerations ? (3)
Should it get more ? The answer depends on the relative extent of
the property rights belonging to the local entity …
Can the answer only rely on the economic analysis ?
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CONCLUSION
1. Brands must be valued on the basis of their
expected income, whether price premiums or
future cash flows.
2. Brand valuation depends as much on
marketing and strategic analysis than on
financial analysis.
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3. The border between the effects of a brand
or the effect of other intangible assets is
often blurred by the fact that these effects
are not additive in nature but
interdependent. This means that an
extensive approach to brands is more
pertinent than a restrictive one.
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4. The royalty rate is the simplest expression
of the profits that can be directly attributed
to a brand and does not directly depend on
the costs borne by the owner (1)
The rate level is a function of the extra profit from using
the brand by the licensee.
It is also a function of the lost profit for the owner
(licensor) by not operating himself.
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4 . The royalty rate is the simplest expression
of the profits that can be directly attributed
to a brand and does not directly depend on
the costs borne by the owner (1)
It also depends on the respective roles that the brand and the
other intangible assets play in the creation of value : getting
a fair share for the brand among all intangibles.
The royalty rate is largely independent of the costs incurred
by the brand’s owner.