What’s in a Shape?

 

The valuation of intangible assets has long been a complicated area, for both commercial and financial reporting purposes.  Historically, financial reporting regulators sought to improve the transparency of acquisitions reporting through requiring IFRS reporting companies to separately recognise intangible assets acquired in business combinations on the balance sheet.  This was eventually followed in the UK by FRS 102 (though recent announcements look to significantly reduce the number of intangible assets that will be identified going forward for accounting periods starting after 1 January 2019). 

Understanding intangible asset values and value drivers should improve how businesses are run and operated, by highlighting factors which can create as well as destroy intangible value. 

Brand building

There is an old adage that it is harder to build brand value than it is to destroy it.  This is particularly true in industries where the company / products brand is one of the most important (intangible) assets a business can have. 

For manufacturing or business facing service companies the brand or the trade name can be an important factor in helping to maintain customer loyalty and stickiness, but typically customer relationship and technology intangible assets tend to be of higher value.  While changing a name can have an impact on such companies, other factors tend to reduce the impact.

For other industries, such as consumer-facing businesses, the brand tends to be the key intangible asset. 

The most common approach to valuing a brand for accounting purposes is a future cash flow approach known as the relief from royalty approach.  This approach estimates a hypothetical future royalty (based on a percentage of revenue) charged by a hypothetical owner of the asset over its useful economic life, where the after-tax royalty stream is discounted to its net present value using an appropriate cost of capital.  The key assumptions are what revenue is attributable to the brand, over what period and what hypothetical royalty rate one should apply.  There are various factors that impact what might be an appropriate (hypothetical) royalty rate, such as whether the product / company is a market leader, the level of competition in the sector, the level of profits that can be generated from the use of the brand etc.

There are many examples in the past (and present) where the wrong thing said can significantly impact a business (for example the comments by the chief executive of Ratners’ in the 1990s). Getting legal protection (for example through trademarking) can help to protect brand value, much in the same way as having patent protection can protect proprietary technology.

In the food and drink sector brand names can change but not often – the best historic examples being the ‘Marathon’ name changing in the 1990s to ‘Snickers’ in the UK, to bring it in line with the global operations and for similar reasons ‘Opal Fruits’ being renamed ‘Star Bursts’.

Another example where brand value may be difficult to maintain is in the highly competitive soft drinks sector.  In response to the UK Governments introduction of a sugar levy on soft drinks, Scotlands’ most popular soft drink announced that it was reducing its sugar content by half.  The news seemingly has not gone down well, particularly as there is already a sugar-free version.  It is too early to say whether changing the recipe has damaged the brand long term, but it is fair to say that it certainly has not enhanced it.

The ease with which a name can be changed without impacting a product / businesses sales would indicate a low value to the brand, but in each of the above cases the changes were more strategic rather than required due to some damage to the existing brand.

The name of a product or brand is one aspect of a brand.  For some products, the shape can be just as important, particularly when it becomes synonymous with a product.

What's in a name?

What’s in a name, William Shakespeare once wrote.  Perhaps he should have written ‘what’s in a shape’, agreeing with the European Court of Justice who recently dismissed an attempt to overturn a ruling in December 2016 that the four-finger shape of a KitKat did not deserve legal protection on an EU-wide basis.  

The case goes back to 2006 when the European Union Intellectual Property Office (EUIPO) registered the three dimensional four-finger KitKat shape, in respect of ‘sweets, bakery products, pastries, biscuits, cakes, waffles’.  In 2007 an application was made for a declaration of invalidity of the registration.  This was rejected in 2012 by the EUIPO, who took the view that it had acquired distinctive character through the use that had been made of it in the EU.

This decision was then annulled in December 2016 by the General Court when it was found that the EUIPO had erred in law in finding that the mark had acquired distinctive character through the use in the EU, when it had only acquired distinctive character through use in only ten countries in the EU. The ruling was appealed to the European Court of Justice, who ruled to uphold the General Court’s judgement in July 2018.

The food and drinks sector in the UK has faced increasing pressures and uncertainty in recent years including, as recently noted in the BDO Food and Drinks Report 2018, uncertainty around the UK’s exit of the EU and what that might finally look like.

One immediate impact of the announcement to leave the EU was a fall in exchange rates which has led to the cost of imported ingredients rising in the UK.  As noted in the BDO Food and Drinks Report, 39% of respondents had experienced a decrease in operating margins in the last year, so it is fair to say that for some margins are ‘wafer-thin’. An example of this recently was Walkers Shortbread, which saw pre-tax profits decline 60% as the wholesale butter price has risen, even though group sales increased by 3.2%.

With margins under pressure, companies in the sector have had to be innovative in how they can maintain and grow revenues whilst keeping rising costs in check to protect margins.

Many have gone down the route of ‘shrinkflation’ offering less for the same price.  As noted in the BDO Food and Drinks Report, according to industry bible The Grocer, shrinkflation is now endemic in the food and drink industry, as manufacturers face pressure on prices.

Changing chocolates

Back in late 2016, the makers of Toblerone decided to reduce the weight of this iconic product by changing its shape.  This change in shape (increasing the gap between each triangle) was a significant change, and one quickly noticed and commented on by consumers.

In response, Poundland were quick to look to take advantage of the situation by looking to introduce a copycat bar called the ‘Twin Peaks’.  Unlike KitKat, the triangular prism shape of the Toblerone was registered as an EU trademark in 1997, and so a claim was made in the High Court against Poundland for damages on the basis of trademark infringement of its registered shape and image marks.

Three months of legal wrangling followed and delayed ‘Twin Peaks’ launch, and a deal was eventually struck to stop the launch of this product.  However, it appears this was not because a case could be made to legally protect the Iconic shape. It was announced recently that the shape of the Toblerone would be restored, a seeming victory for the consumer.

Other high profile cases where shape trademarks have not been registered include Lindts’ chocolate bunny and the Rubik’s Cube.

Arguably the KitKat bar is synonymous with the four-finger shape in the UK and many countries in the EU (albeit the product has changed over time and also has added further varieties to broaden its appeal).  However, in Norway there is the similarly shaped four finger chocolate bar Kvikk Lunsj, a Norwegian snack first manufactured in 1937 (2 years after KitKat (then known as Rowntree’s chocolate crisp) first appeared).

The owners of KitKat may seek to apply to the EUIPO again, with fresh evidence, for an EU-wide registration.  The product is also currently protected in several countries in Europe at the national level (though not in the UK: a 16,000-word ruling in May 2017 found that it had “no inherent distinctiveness”.)

The impact of losing the battle to protect the shape could have a double impact on brand value – with increasing copycat competition, potentially taking chunks out of its future revenues and growth, and potentially a lower hypothetical royalty rate due to the brand being less attractive due to the existence of copycat products.

What this all goes to show is that while brands are key intangible assets for a business, maintaining brand value can be tricky, particularly when companies are faced by intense competitive pressures, such as in the Food and Drinks sector.  Such factors should be reflected in the valuation of brands and trade names acquired as part of a business combination, but will require greater consideration going forward.