After more than a century in the food business, RHM knows a thing or two about what it takes to make a brand a household name. Thanks to catchy advertising and years of careful management, many of RHM’s brands are so well known in Britain they have become part of the social fabric—to say Bisto gravy in the company of Britons is to evoke the “Bisto kids,” characters that appeared in advertising for the better part of the twentieth century; while RHM advertising campaigns in the early 1970s not only launched the Hollywood careers of film directors Ridley Scott (Gladiator) and Alan Parker (Mississippi Burning), but also made its Hovis bread into a brand that is as British as Chanel is French or Coca-Cola is American.
But RHM not only became part of advertising history, it also was the central player in a recent chapter of financial history. Back in 1988, when it was called Rank Hovis McDougall, the firm famously became the first publicly listed company to record non-acquired brands as intangible assets on its balance sheet, sparking off years of discussion, government studies and accounting-standards pronouncements in the UK and elsewhere.
While accounting for brands and other intangibles has been receiving plenty of attention lately, the experience at RHM since the late 1980s reflects how finance chiefs in many companies have come to use brand valuation for practical purposes, transforming it into a common language for finance and marketing
According to Michael Schurch, current CFO of RHM, the company didn’t expect the attention it received in 1988. More than anything else, the original exercise to assign numeric values to its brands was part of its bid to fend off an unwelcome advance from an Australian asset-stripper, Goodman Fielder Wattie (GFW). “There is a bit of a strange history at RHM, going back to the Goodman Fielder Wattie bid,” says Schurch. “It was a defensive mechanism in a takeover situation … and it worked.”
GFW’s bid came at the tail end of a wave of deals in the 1980s in which asset-strippers had acquired companies with strong brands at bargain-basement prices. One such deal was closed shortly before GFW’s bid for Rank Hovis McDougall. In 1986 Hanson Trust paid £2.3 billion for Imperial Group, then promptly sold off the new acquisition’s undervalued food portfolio for a total of £2.1 billion. It was left with a tobacco business that was hugely cash generative, having paid a net price of just £200m for it. It signalled to many managers of highly branded businesses at the time that accountants and stock analysts were undervaluing their greatest assets.
To avoid that “valuation gap” problem in the GFW bid, RHM turned to Interbrand, a consulting firm specialising in brand building. Having never been asked to value a portfolio of brands before, Interbrand began working with academics at the London Business School to develop an early set of metrics based on brand strength.
With hindsight, Jan Lindemann, currently managing director of Interbrand’s global brand-valuation practice, says the metrics were unsophisticated, but they were a start. They came up with a figure of £678m for RHM’s portfolio of brands—the tangible assets already on the balance sheet had been valued at less than £400m.
The market value of RHM soared as investors re-evaluated its business, and GFW eventually withdrew its bid. Thus was born the brand-valuation consulting industry.
A Brand Bond
Later, in 1992, RHM was bought by UK conglomerate Tomkins, it came off the stockmarket and Tomkins wrote off all RHM’s intangible assets. Brand valuation no longer had a use at the firm. Fast-forward to 2000. Tomkins agreed to sell RHM to Doughty Hanson, a private equity fund, for £1.1 billion in a highly leveraged deal. It was then that brand valuation was ready for a comeback.
“One of the first things I had to do was work on a refinancing of the group,” recalls Schurch, who moved after the Doughty Hanson deal from his post as managing director of the food unit at Tomkins to become RHM’s CFO. “During that work, we had to identify what were the underlying assets that would support the business—what assets could lenders come and take over for security.” The firm was carrying assets on the balance sheet at the time totalling just £300m. “If you are offering that as security, you are not going to get £650m financing” (the amount required by Doughty Hanson to pay off a bank loan that it had taken out to acquire RHM).
So Schurch and his bankers decided to structure a financing package in such a way that they put all of the brands into separate intellectual property companies, effectively licensing the brands back to the RHM operating divisions. The result was a unique bond issue in 2001—dubbed the “Brand Bond”—which securitised five of the company’s oldest brands, those with the most reliable cash flow, including its Hovis bread and Bisto gravy. It was structured in tranches of investment-grade and junk bonds, for a total of £650m, the largest-ever sterling corporate bond issue at the time. The bonds leveraged the earnings of the brands—running at an annual Ebitda of £150m—by a factor of more than 4.3. The £650m paid off the bank loan, and annual financing costs dropped to £80m from £93m.
An essential part of the bond financing was another brand-valuation exercise, for which Interbrand was brought back in. But unlike the seminal effort in 1988, the brand valuation this time round would not be a one-off exercise. It would become an important part of the com-pany’s day-to-day management.
“Having paid Interbrand nearly half-a-million pounds for their work, my aim was to make sure we really exploited that and built upon that work,” says Schurch. “It gave me a tool to say to marketing, ‘You are charged with protecting the value of these prize assets, the brands. You need to demonstrate year on year that you are protecting and growing them.’”
Schurch and Ginny Knox, the joint chief operating officer of consumer brands, set up a review process for the company’s 20 brands based on seven metrics that were used in Interbrand’s valuation. They comprise statistical measurement of: 1) how the overall market segment has changed; 2) the brand’s stability; 3) market share and other “leadership” qualities; 4) long-term trends for the brand; 5) advertising spending, sales promotions and related activities to “support” the brand; 6) geographical distribution; and 7) trademarks and other legal protection.
Schurch explains that it’s a “spreadsheet-driven process,” which quantifies the metrics and assigns them different weightings. The most important metric, Schurch says, is brand support and how it relates to the metrics addressing trends. He says that analysis has helped shift the finance department’s perception of brand support, helping them to view spending on advertising and the like more as an investment than an expense.
“Traditional finance directors would look to reduce costs all the time—’We can always improve short-term profitability by turning off the support tap.’ But we assess it as an investment. It is about encouraging the right behaviour in the business,” he says.
Into the Future
At least once a year now, RHM’s finance department assesses each brand’s value. To do so, Schurch uses a forecast of a brand’s annual economic value added (EVA) for five years. “The EVA figure is then adjusted to discount it for things like ‘technical functionality’—such as, a cake might be the only one of its type in the market—to distil what EVA is due purely to brand reputation,” he explains. This adjusted EVA forecast is discounted back to a net present value (NPV) using a discount rate based on a brand’s strength as calculated with the seven metrics. In practice, the discount rate usually ranges from 7% to 15%. Finance also assesses likely returns on advertising before any funding is committed, using classic discounted cash flow techniques treating advertising spend as a long-term investment.
“You are only as good as your assumptions, but you do have a rigorous framework,” says Schurch. “I use the results to test for deterioration in the brands. If there has been any, then I’ll jump all over marketing.”
A recent example he cites is Bisto. With a market share of 62% in the UK and annual sales of about £90m, it’s one of the company’s oldest and strongest brands. A brand-valuation exercise last year showed some deterioration in its scores, leading to the conclusion that RHM had been taking it for granted and not giving it sufficient support. The result was a decision to increase the annual support budget by 30%, or £1.5m.
Schurch says that he, like other CFOs, has little interest in the debate about finding a static value so that brand assets can be put on the balance sheet. “I’m much more interested in corporate value, and a lot of reporting standards seem to be going that way. We think with our system we’re at a place where the financial community can understand what we’re doing.”
The Tough Questions
Not everyone is a fan of the brand valuation concept. Patrick Barwise, professor of management and marketing at the London Business School, has long argued against putting intangible values on the balance sheet. He contends that the essence of brand value is like reputation, and is not something that can be separated properly from the business as a whole and quantified. If a company isn’t buying or selling a brand, he says, putting a theoretical value on it requires forecasting the future, which itself depends on a whole range of hard-to-quantify variables.
Though he is a critic of theoretical brand valuation, he does believe that using metrics as a management tool, as RHM does, is a good thing, but prefers the term “brand evaluation.“
“The learning that comes from brand evaluation forces you to ask the tough questions about where you are making your money and future trends in the market,” he says. “I don’t think we’ll ever be at the stage where it is fully treated as an investment, but there is more pressure for marketing people to provide more hard data.”
Whatever the accounting arguments, says David Haigh, chief executive of Brand Finance, as brand valuation moves increasingly into the domain of finance, it’s becoming less “airy fairy waffle” and more about hard numbers. “Brand valuation has really come of age. You are now talking to real people about real numbers.”
A Call for Creativity
Though consumer-goods companies have been at the forefront in adopting brand valuation, other sectors are catching up. Take Telefónica, Spain’s €28 billion formerly state-owned phone company. Having hired FutureBrand, a consulting firm, to do its first global brand valuation in 1999, it launched its first annual brand measurement programme last year.
“This is not a food company where the market is fairly stable year to year,” says Marisa Guijarro, vice general director of marketing at Telefónica. “Technology and the markets we operate in are changing all the time. The only thing that doesn’t change is your brand. You need to know very well how your brand is performing to make strategic decisions.”
Telefónica’s initial brand valuation—covering seven countries and six business sectors—helped the company identify and act upon a number of strategic risks and opportunities. Hence its decision to reduce the number of company-owned brands in the mobile telephony market. The ongoing brand-measurement programme—a software-based scorecard, employing economic value added (EVA) evaluations—brings finance and marketing together to assess a number of key topics, including budget allocations, M&A analysis and co-branding decisions.
The result at Telefónica and other companies undertaking similar exercises is nothing short of a revolution, says Sebastian Shapiro, New York-based head of brand evaluation at FutureBrand. Before brand-management metrics began taking off, he says, “you’d get the marketing manager coming in to tell the board about an improved aspect of the ‘hipness’ of a brand, and the finance guy talking about the ROACE spread, and nobody would understand what the other was talking about. We’re trying to put it in more of a common business and strategic planning language.”
Though it is no small feat, Guijarro is in favour of such a effort. Arriving at hard numbers through brand-valuation exercises “has meant finance understands what we are doing and that it is very important to us strategically as a company.”