Part 3. How Brand Equity Increases the Value of a Company

In the first part of the SCIENCE + BUSINESS ™ series, we found that neither its marketing function nor the position of marketing director enjoys overestimation in companies. In the second part of the series, we looked at whether there is a margin for this marketing space and found that the situation is that marketing is an essential part of a company’s success. Or at least when marketing is done according to our definition:
“Marketing is a group of primarily future-building, fundamental principles that offer a durable competitive advantage to the company and coordinates an integrated and purposefully direction for the operations of the entire company to evoke cognitive and emotional reactions in the customers to measurably increase the demand so that the value of a company is enhanced.”
Figure 15. The three most important marketing tools for increasing the value of a company listed by elasticity.
Marketing must therefore guide the company’s operations as a whole, as well as activities that comprehensively utilize the entire marketing mix, which thus primarily aims to increase the company’s value.
In the previous section, we also found that, based on the analysis of nearly 500 scientific research results, from all the tools of the different marketing mix, customer equity, marketing capabilities, and brand equity are the most effective in increasing a company’s value (Figure 15) . Of these three, we will take brand equity into more detail in this section.
BRAND EQUITY – #3
The role of a brand in increasing a company’s value, primarily in increasing sales, has been studied for decades. In the first phase, brand research focused on measuring awareness and customer awareness, it was considered that information about the origin of the product allowed for a higher price premium. This was followed by the “era of attributes”, where the focus was, as the name implies, on combining different attributes into a brand. Especially in the 1970s and 1980s, a conjoint analysis was often preferred in brand research, which seemed to be well suited for elucidating the relative order of importance of different attributes. This era also saw the emergence of a new and important concept value for marketing. Although attribute research flourished, research studies, began one after another to show that measuring attributes alone did not predict people’s (purchasing) behavior. A better concept was needed.

Brand equity was needed, defined in several different ways, the most famous of which are probably the definitions of Aaker and Keller. As definitions became more consistent, brand equity was approached from three different perspectives:

1. Customer experience, i.e., which variables (e.g., awareness, attitude, loyalty) contribute to the development of brand equity positively or negatively, and how these variables vary as different moderators (e.g., industry or competitive situation) change.
2. Business outcome, i.e., what is the effect of brand equity on sales, profitability, and market share change, or price premium.
3. Business outturn, i.e., how brand equity is quantified as an asset.
Due to their evolutionary development path, those working in marketing quite often have a very clear view of what brand equity is and what it means. This would otherwise be an excellent basis for a discussion of brand equity, but unfortunately, often that definition varies from respondent to respondent, which makes discussing and measuring brand equity a bit challenging. For this reason, we define brand equity according to scientific studies as follows:
“Brand equity is the business value generated by the brand of a product or service to the company that owns it, compared to an identical product or service without the impact of the brand.”
As stated in our definition of marketing, marketing is basically a constructive activity for the future. This is also perfectly true in brand building. Where short-term profitable marketing measures (e.g., promotional advertising) can, ideally, quickly impact sales through cash flow (and generally negatively to profitability), brand equity increases marketing inventory value (Figure 16), which by its nature cannot be seen by short-term retrospection or reached by accounting-based metrics (e.g. sales, margin, and market share) alone.
Unfortunately, the effectiveness of brand equity, and marketing in general, is often measured primarily through cash flow: how have marketing measures increased short-term sales, what costs have arisen from marketing, and how is all this reflected in this year’s accounts? Thus, for example, building customer loyalty is basically only reflected as an expense in cash flow, even if in the long run its effect on the value of the company is positive.
Regrettably, measurement often focuses solely on advertising, and measurement methods vary by consultant, from time-to-time, or for whatever reason. The actual inventory value (brand equity) created by marketing is then completely ignored, but the credit for the increase in the value of the company is certainly shared between the various functions in the company or its management team.
A comparison to product development and production should open the core of the idea. Product development works in the long run and therefore requires investment, the return on which will only be visible in the company’s cash register after a long time. Thus, if, for one reason or another, a company decided to reduce its investment in product development and instead divert resources in pursuit of a short-term advantage to optimize production, this would quickly translate into a clear improvement in profitability. The company would do well for a while, but in the long run, the lack of product development would force the company into a dead end. Indeed, far-reaching competitors would develop new, more attractive alternatives for customers, which the company’s customers would increasingly move to buy. In addition to the decrease in sales, the margin would suffer. Obsolete products would no longer receive similar margins, instead, customers would pay a higher price for new features they find useful from competing products. Therefore, in the long run, a company cannot build its operations solely on optimizing short-sighted production assets, no matter how exciting they are.
Similarly, if a company sees marketing as subordinate to the sales function, and does not build brand equity for the future, neither from the operations of the marketing department nor from the future of the company, one can’t even expect an awful lot. However, according to our previous definition, brand equity is a way to elicit measurable cognitive and emotional reactions in a company’s customers to increase demand. These reactions materialize at different times and affect not only sales but also the desire to pay a higher price for the product compared to the competitors.
A good example of this is Martha Stewart’s company ImClone, which became mixed in a scandal in early 2002. Stewart and her company were accused in the media of lying to the authorities, and ImClone’s brand equity fell historically in a year. Nevertheless, the effect was hardly reflected in sales in 2002, or more notably in turnover in 2003, although it did not, for example, increase advertising. The change only began to show between 2003 and 2005, when sales fell and profitability eventually fell to dramatically negative. Good brand equity absorbed the attacks and the company lasted commercially a couple of years longer than a company in a similar situation, but with poor brand equity.

But a single example is always just a single example, and one should, of course, never rely too much on it. Fortunately, there is no need because the impact of brand equity can be looked at through scientific studies, of which one monitored 444 brands for ten years. A time-series analysis was performed using a three-factor model and brand equity results were related to the total return on equity (ROA), market capitalization, sales, and operating profit. Its main result was positive, i.e., brand equity affects the above variables: for example, when brand equity increases/decreases by one variance on average, the return on capital increases/decreases by 6.8% (statistical certainty >99%) and earnings per share increase/decrease by 7.6% (>99%).

However, despite the comforting results described above, perhaps the most important finding of the study is here: based on 10 years of monitoring of more than 400 brands, on average only 3% materializes from brand equity to operating profit in each fiscal year. As many as 97% will not appear in the annual reports until the following years (>99%). The ratio naturally varies from industry to industry, in some the current financial year may be negative, in which case the investment in the brand will not make a profit for a year or two, in others “up to” 20% of the brand’s additional sales may materialize during the current financial year.
Numerous other scientific studies reach a similar conclusion, such as the study in England of 222 companies, where the analysis revealed that the short-term marketing focus does not have a statistically significant effect on the achievement of internal goals or the defeat of competitors. The long-term focus, in turn, increased the company’s probability of beating its competitors by as much as 115% (>95%).
So brand equity clearly matters, as numerous other scientific studies show, but how is it built so it increases the value of a company like the one mentioned above? And as you might guess, the answer, of course, is not simple, there is no miracle-working silver bullet, even if the prevailing hype claims there is one.
Brand equity consists of four dimensions: consciousness, significance, valuation, and differentiation. We will delve into more detailed building instructions later, as we will first highlight the last member of the quartet.
Differentiation, building your own brand to stand out clearly from other competing alternatives, is a concept in marketing, a mantra that everyone who has ever studied or used marketing knows. That is why it is necessary to get acquainted with the matter a little better.
Let’s start with a study of 25 product categories that analyzed 290 fast-moving consumer goods brands over ten years. The brand in the study was a single brand (e.g., Diet Coke) and not just the parent brand (e.g., Coca-Cola). The study examined the impact of price, discounts, distribution, and advertising, as well as the functional risk of the product, the competitive situation of the product category, the social value, and the hedonic/utilitarian nature of the product as moderators. The analysis yielded numerous findings, but the impact of brand components on the sales and market share was most relevant to the present topic. Where consciousness, significance, and valuation were strongly related to sales and market share (r = .39 – .55,> 99%), the differentiation actually correlated negatively with sales and market share (r = -. 14 and -.08,> 99%). In principle, therefore, brand equity is not built through differentiation, although, of course, it also has a place to increase sales and market share if certain boundary conditions are met.
The study’s finding has since been replicated in several studies, such as a study analyzing 39 car brands also over ten years. The brands involved accounted for 97% of U.S. car sales, and, unlike the previous study, were parent brands (car brand), not model-specific brands. More than 6,000 people over the age of 18 participated in the survey each year, and the focus was on the impact of brand equity on new customer acquisition, repurchase, and margin. The relationship was analyzed with both the direct effect of brand equity and the effect through the customer’s life cycle value on the above variables. The study also examined the impact on both brand equity and customer lifecycle value formation of various marketing activities (advertising, new model launches, discounts, and other offers, price. and distribution).
Figure 17. Basically, car brand differentiation reduces sales and increases profitability.
Of course, the analysis again produced many interesting results, but the most important thing in this context is that as awareness, importance, and appreciation increased sales and profitability, differentiation, on the contrary, reduced sales, although it clearly increased the margin in this declining customer segment (Figure 17).
BRAND EQUITY AND FINANCIAL RISKS
Properly built brand equity thus clearly increases the value of a company as sales and profitability increase. However, a slightly less frequently raised point is how brand equity decreases financial risks. Increased sales and profitability are naturally associated with lower cash flow volatility risk, but high brand equity also reduces uncertainty related to credit rating, total equity risk, market risk (systematic equity risk), and company-specific risk (unsystematic equity risk). For this purpose, the brand equity connections of 252 companies were examined, using databases such as Standard & Poor’s and CRSP databases for seven years. The analysis checked the company’s size, long-term and short-term liabilities, return on asset and its volatility, P/B value, level of diversification, age of the company, and industry. The analysis did not take into account companies operating in the financial sector due to the numerous regulations affecting their operations. According to the results of the study, brand equity has a clear effect on a company’s financial risks, i.e., as it increases, it reduces risks and as it decreases, risks increase, as shown in Figure 18.
Figure 18. The change in a single variance in brand equity is reflected in risk classification, capital risk, market risk and equity risk, respectively.

A similar conclusion was reached by another study analyzing the relationship between the brand equity of 155 companies and financial resources and the credit margin over eight years. According to the study, the direct elasticity of brand equity on the financial resources available to a company is .29 (>99%) in the short term, but already .48 (>99%) in the longer term (Figure 19). And when indirect mechanisms of action are added to the equation, a very significant elasticity value of .61 (>95%) is already reached. Similarly, based on databases of Bloomberg and Standard and Poor’s, brand equity diminishes corporate financial risk in the form of lower credit margins (-.2 and -.33; >95%, and -.35; >99%). The study examined the company’s sales, sales growth, asset size, asset growth, R&D investments, non-debt tax shield, industry concentration, beta, pretax interest coverage, and EBITDA.

Figure 19. Direct short-term (DS) and long-term (DL), and total (T) effects of brand equity on financial resources and credit margin, as well as effects of advertising on brand equity and financial resources.
SUMMARY
Properly constructed brand equity thus clearly has the effect of increasing financial success, but also the effect of reducing financial risks. These build on the elasticity mentioned at the beginning of the paper, i.e. each percentage increase in brand equity construction increases the value of the company by an average of 0.33 percentage points. Pretty good from marketing, but we can do better, right? For this reason, in the next series SCIENCE + BUSINESS ™, we will address Marketing Capabilities with an even better elasticity of Brand equity: 0.55.