working party n° 6 of the committee on fiscal affairs ... · transaction methods transactional...

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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



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-A -

Introduction :

What are the differences between brands and

trade marks

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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



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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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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



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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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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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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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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.



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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




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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


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- B -

Different approaches used to value brands

and others intangibles assets :

3 basic approaches



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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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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



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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)



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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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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



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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



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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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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.



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-C-

How to split the value created by

brands at a local and global level ?

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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 )



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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)



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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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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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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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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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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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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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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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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.

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