147Table 5.3 The world’s most valuable brands

Brand Brand value ($ bn)

Coca-Cola 47.99

Marlboro 47.64

IBM 23.70

McDonald’s 19.94

Disney 17.07

Sony 14.46

Kodak 14.44

Intel 13.27

Gillette 11.99

Budweiser 11.99

Nike 11.13

Kellogg’s 10.67

AT&T 10.39

Nescafé 10.34

GE 10.29

Hewlett-Packard 9.42

Pepsi 9.32

Microsoft 8.99

Frito-Lay 8.99

Levis 8.17

such as New York and Sao Paulo. And they touch the lives of people living in remote rural communities across the globe. But global brands are about much more than logos and advertising campaigns.

Companies such as Coca-Cola, McDonald’s, Walt Disney, Sony, Body Shop and Mercedes-Benz have become world leaders through the strength of their brands.

By becoming synonymous with their products, they almost own their categories.

A well-established brand name can broaden a company’s ambitions, allowing it to introduce new products or move into new markets. Walt Disney has stretched its brand well beyond films to cover books, clothing, toys, games and holidays.

People do not have to pay 30 per cent more for a Disney T-shirt, but they do so because the brand means more to them than just a T-shirt – it embodies the Disney magic. With more choice between suppliers, business customers are looking for consistency and trust. IBM fell into the trap of just selling computers. Now it realises it needs an ongoing relationship trust with its customers which a single global brand can help build.

Most large companies with diverse consumer products follow similarly diverse branding strategies. Nestlé, for example, has multiple layers of branding. Its dried milk is always sold under the company name and Nescafé is clearly of Nestlé provision (sub-brand).

Even in less diverse businesses where global branding makes sense, attention must be paid to local preferences. McDonald’s, selling a US fast-food concept with a consistency that is almost chilling, serves wine and salads with its burgers in France. For the Indian market where beef products are taboo, it created a mutton burger: the Maharaja Mac.

Young urban professionals in London have more in common with their contempo-raries in Singapore than with middle-class families in Berkshire. The latter have more in common with people living in the affluent suburbs of Sydney.

The challenge for marketing professionals is to link their product to individual needs. One way is product proliferation – so that Coca-Cola becomes Classic Coke, Diet Coke and Cherry Cola. Coca-cola remains the brand, but it is delivered by a variety of means.

General Motors has chosen four global brands for its cars, in Saab, Cadillac, Opel and Chevrolet. A single brand could not stretch from the Opel Astra to a performance car such as the Saab 9000 or a luxury saloon such as the Cadillac.

Another is to create an idea for a single brand that transcends such differences by identifying it with an attitude rather than a particular lifestyle. ‘Good branding is about stirring emotions,’ says Peter Farnell-Watson, European managing director at Landor Associates, the US branding consultancy. ‘It sits in peoples minds and has an attachment in their hearts.’

Thus Nike is much more than a pair of trainers: it is about personal empowerment.

Body Shop, the cosmetics retailer, offers ethical consumption in a world where the environment is under threat. And IBM offers solutions for the planet – it is a company that can enhance your business performance.

But establishing just what the big idea is needs to be taken seriously at the highest level in the company. The companies which have managed their brands best are those led by chief executives who take the keenest interest in branding: Roberto Goizueta at Coca-Cola, Michael Eisner at Disney and Lou Gerstner at IBM.

Questions

1 What is the meaning behind the value of a brand in terms of assets and liabilities?

2 Provide the definition of hard equity following a company’s financial perspective.

3 What is the P/E multiplier developed by the Interbrand Group?

4 Discuss and elaborate on (i) the notion that brand names can function as signals in the marketplace as well as (ii) the argument that hard equity can be defined as the utility intrinsic to a brand.

(A) Problem 5.6 Financial methods used in the new product development process Introductory comments

A number of different financial methods are used to rank new-product projects and to decide whether they should be accepted to carry through in the development process and for inclusion in the capital budget of the organisation. Three of the most commonly used are as follows:

1 Payback (or payback period) This is the number of years required to return the original investment.

2 Net present value (NPV) This is the present value of future cash flows, discounted at the appropriate cost of capital, minus the cost of the investment. The NPV (and also the IRR) method is called a discounted cash flow (DCF) method.

3 Internal rate of return (IRR) This is the discount rate that equates the present value of the expected future cash flows to the initial cost of the new-product project. The IRR corresponds to the yield-to-maturity on a bond.

Future cash flows are, in all cases, defined as the expected annual net cash inflows from the investments.

Payback method

The payback period is defined as the number of years it takes a company to recover its original investment from net cash flows.

Prior to the 1960s, the payback was the most commonly used method for screening capital expenditure proposals. It is still widely used, but generally only for smaller replacement projects or as a risk indicator for larger projects. Some features of the payback, which indicate both its strengths and its weaknesses, are listed below:

1 Ease of calculation The payback is easy to calculate and apply. This was an important consideration in the pre-computer, pre-calculator days.

2 Ignores returns beyond payback period One glaring weakness of the payback method is that it ignores cash flows beyond the payback period. Ignoring returns in the distant future means that the payback method is biased against long-term projects.

3 Ignores time value of money The timing of cash flows is obviously important, yet the payback method ignores the time value of money. A pound in year 3 is given the same weight as a pound in year 1.

NPV Method

As the flaws in the payback method were recognised, managers began to search for methods of evaluating new-product projects that would recognise that a pound

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received immediately is preferable to a pound received at some future date. This led to the development of DCF techniques to take account of the time value of money.

One such DCF technique is called the NPV method. To implement this approach, find the present value of the expected net cash flows of an investment, discounted at an appropriate percentage rate and subtract from it the initial cost outlay of the new-product project. If its NPV is positive, the project should be accepted; if negative, it should be rejected. If two projects are mutually exclusive, the one with the higher NPV should be chosen.

The equation for the NPV is

Here, CF₁, CF₂and so forth, represent the annual receipts, or net cash flows; K is the appropriate discount rate or the project’s cost of capital; C is the initial cost of the new-product project; and n is the project’s expected life. The cost of capital, K, depends on the riskiness of the project, the level of interest rates in the economy and several other factors.

Present value of £1: PVIF_K,n1/(1
K)ⁿ The IRR

The IRR is the discount rate that equates the present value of the expected future cash flows, or receipts, to the initial cost of the project. The equation for calculating this rate is:

Here we know the value of C and also the, CF₁, CF₂, . . . , CF_n, but we do not know the value of R. Thus, we have an equation with one unknown and we can solve for the value of R. Some value of R will cause the sum of the discounted receipts to equal the ini-tial cost of the project, making the equation equal to zero: this value of R is defined as the internal rate of return. In other words, the solution value of R is the IRR.

C F₁(PVIF_R,1)
C F2(PVIF_R,2)
…·
CFn(PVIF_R,n) C  0



T1

CF_T

(1
R)^T C  0 CF₁

(1  R)¹
CF₂

(1  R)²
....
CF_n

(1  R)ⁿ C  0

 CF1(PVIF_K,1)
CF2(PVIF_K,2)
…·
CFn(PVIF_K,n) C

_T1



NPV



(1
K)²
…·
CF_n

(1
K)ⁿ



Notice that the IRR formula is simply the NPV formula, solved for the particular discount rate that causes the NPV to equal zero. Thus, the same basic equation is used for both methods, but in the NPV method the discount rate, K, is specified and the NPV is found, while in the IRR method the NPV is specified to equal zero and the value of R that forces the NPV to equal zero is found. Because IRRs can be calculated very easily by computers, many companies have computerised their capital budgeting processes and automatically generate IRRs, NPVs and paybacks for all projects. Even some hand-held calculators are programmed to compute IRRs.

Thus, business firms have no difficulty whatever with the mechanical side of capital budgeting.

Problem

The example used is taken from the files of a major industrial firm, Miller Chemical Co. Miller’s cash flow analysis for the compound X project is typical of that used in all types of business with sales in excess of about £10 million.

It is assumed that the annual sales volume will be 100,000 tons by the third year.

This is 10 per cent of projected industry sales. These estimates are based on the results of a test marketing programme for the newly patented compound X and the market potential as projected for the next 15 years by the market research department. The net sales price will be £40 per ton. This estimate is based on present competitive price levels as determined by the marketing department. Selling and advertising expenses, which were estimated by the marketing department, are based on other products sold to the textile industry. An inflation rate of 8 per cent in labour and materials cost is expected. Sales prices will increase at this same rate. The capital needed to undertake the project can be raised at an average cost (average of debt and equity) of 10 per cent.

Cash flow data are shown in Table 5.4 for projects S and L. The S stands for short and the L for long: project S is a short-term project and L a long-term one in the sense that S’s cash inflows tend to come sooner than L’s. For now, the company assumes that the projects are equally risky. Note that cash flows consist of both after-tax profits and depreciation, not profits alone. Also, most projects require both fixed assets and an addition to net working capital as in the compound X case; the investment outlays in Table 5.4 include any necessary working capital and the cash flow in the past year includes the return of these funds.

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