Riddle of the brands: the secret formula of kudos
5 March 2012 | Updated: 5 March 2012 8:34 am | By Joshua Freedman
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The value of a firm’s brand is tough to put a figure on, but a system used by other industries claims to be able to do just that.
Now, get out your calculators. Punch in the revenue you expect your firm to bring in next year. Press the memory button, or if you are a bit out of touch with technology, just write it down.
Make sure you know your firm’s net revenue, forecast growth as a percentage, profit margin, total and average deal size. Each should have a weighting of 8 per cent of the final total. Add the lawyer headcount, which has a weighting of 10 per cent of the final total. Throw those figures in a super number-churner by adding them together according to their weighting, and remember the result - a score out of 50.
Then go to strategy consultants Huron Consulting (who happen to provide the financial data too) and get them to give you their score for your firm’s reputation and reputational growth. It is based on interviews with the market. You will get another score out of 50. Write down that number too.
Add the two scores together, giving an index out of 100 for the quality of your firm’s brand. Let’s call this the brand index. Brand valuation consultancy Brand Finance calls it the BrandBeta Index.
Turn this into a royalty rate - the proportion of revenue another firm would have to pay to use your brand. Typical rates in the professional services sector are around the 1 per cent mark - much lower than the 10 per cent you will get with global consumer mega-brands. Less branded sectors will have royalty rates of more like 0.5 per cent. Whether you are above or below the 1 per cent mark will depend where you come on the 0-100 brand index spectrum.
The number you first thought of
Now, remember that number you saved on your calculator at the beginning? You will need that now. In fact, you will need the predicted revenue figure for each of the next five years. For each year, calculate how much that percentage of revenue (the royalty rate) is. Remove the amount of tax you would expect to pay on this, depending on where you are.
You are left with a figure for royalty earnings for each of the next five years after tax.
Still following? Hopefully, because here comes the clever bit. You need to calculate the ’discount rate’, which is basically how much you save by owning your own brand rather than buying the rights to use it from someone else. This figure is calculated using a remarkably complex formula, taking into account risks and costs associated with the jurisdiction.
The final number is the ’discounted royalty earnings’.
Baffled? So were most of the people interviewed by The Lawyer. Brand Finance, which came up with the methodology, claims it is an accredited system that has stood up in court. They have applied it to all sorts of industries before but were commissioned to look into the legal profession by the Managing Partners’ Forum (MPF), which says the five top brands in the legal market are the magic circle excluding Slaughter and May, plus DLA Piper. (DLA Piper co-CEO Sir Nigel Knowles is the MPF’s chairman, incidentally.)
The MPF and Brand Finance even compare their system to the Standard & Poor’s indices. On the plus side, it uses hard data and produces hard numbers for potential acquirers to consider. But this is the first time it has been applied to the legal profession, which is a bit of a challenge, as the main factor it uses for estimating royalty rates is the value of licensing agreements, which only exist in other sectors. It has got around this by looking at agreements in other professional services sectors.
“This approach has been adopted and used in M&A deals,” says Richard Chaplin, founder and executive director at MPF. “People have recognised that you’ve got to be able to build a firm around a brand and client relationships.”
That is all very well, but does the market take any notice of numerical brand values?
“I’m quite agnostic towards brand valuation, because obviously brands have value, but whether they have a value of £12.50 or £12.47 - that’s very difficult,” says Stephens. “It’s tough enough to value hard things, but putting a tangible value on intangible things like brands… Yes, you can put them in a machine that comes up with a number. It’s not damaging - it’s a sport, it doesn’t harm anyone.”
It might harm your eyes trying to understand the formula for determining the weighted cost of capital (WCC) (see above equation). And
the impression is that people in the business of acquiring law firms post-deregulation are not going to take that much notice.
Iain Kennedy, UK support services head at Duke Street, which has made an investment in insurance firm Parabis, describes himself as ”massively cynical” about numerical brand valuations for the legal sector. He says the private equity house did not hire anyone to value the target’s brand when it did the deal.
Kennedy points out that Parabis itself has gone through a number of name changes over the years and currently has four brands - Argent, Cogent, Parabis and Plexus.
“When you talk about the provision of legal services, the people element’s massively important,” he asserts. “The value of Parabis is first and foremost in the people within the organisation; second with the customer relations, many of which are contractual - there are forward lines of future revenue; and third with the systems and knowhow embedded in its operations. Brand’s almost irrelevant.”
Paul Rawlinson, an IP partner at Bakers, says that a firm’s brand is its “stickability factor” - its clients’ tendency to keep using the firm rather than anything you can measure with numbers.
“What you’re dealing with here is a collection of services around engagement rather than a business model that’s uniform,” he continues. “It’s more to do with the stickability factor and the retention rate of clients.”
Charles Lloyd, head of IP and advertising at Taylor Wessing, has a similar view.
“There are no doubt formulae based on revenue streams that will get you to an overall value for the firm,” he concedes. “You’d have to take off the value of fixed assets and discount the value for the potential movement of people or clients away from the firm, say, if half the partners leave with clients - something it’s very hard for a firm to protect against. But it’s all subjective, and it’s the sometimes surprising value of business that stays with a firm when partners leave that reflects the true brand value of the law firm.”
In other words, you cannot just use a formula.
The basic problem with Brand Finance’s methodology is that half of it is just the usual business metrics - profitability and the rest - and the other half, the reputation testing, is hardly objective. In fact, this bit is hardly different from the reputation-based brand valuation surveys carried out by competitors such as Acritas, which interviews general counsel to discern ’top-of-mind awareness’ of firms - ie which firms general counsel think of and which they would recommend.
“[A] numerical [method] is an important way of doing it, but I don’t think it should be just based on financials,” says Acritas CEO Lisa Hart Shepherd.
Brand Finance’s method is not - it also takes reputation into account. But can you put a number on this?
“It’s a little like hearing a vicar and an atheist talking about human values,” says Stephens. “Are they talking about the same thing?”