The evasive & baffling A&P ROI
Investment in a brand is like any other investment. An organization either has enough cash in its kitty to be able to invest it in building the brand quity or the organization borrows from the bank. The ultimate objective of any investment is to generate return. How much the required rate of return is varies from market to market and form environment to environment.
These are times of economic recession. Even the BRICs are now coming to around 7% GDP growth (with the exception of Russia which itself is heavily dependent on International Gas prices). Recessionary times are the true litmus test of marketers. Getting growth and developing market and categories are not easy. These are times of high interest rates in Pakistan with the discount rate being 10.5% and 1 year KIBOR at 12%. This means that an organization investing in the brand could alternatively invest in the risk free Banking sector and obtain a 12% return with the principal intact. So the investment in the brand should result in a return that is greater than 12% keeping in account that there is greater risk in trading as compared to just keeping the finds in the bank. This risk premium in my estimation should be around 6% considering historic risk premiums internationally and adjusting for factors in Pakistan’s environment.
One way to go about is to assume that the entire principal of the A&P spend gets absorbed in building the brand equity and since the brand is an asset, it increases in value over time. With this assumption, one would atleast want an annual return of 12%+6%=18% on the brand meaning at the least that with an investment of 100 MM in a brand which has a 35% margin, one would require incremental sales of approx 54 MM on an annual basis. This incremental return would be based on the fact that there would be a natural fade rate also on the brand so “incremental” would be over and above the declining sales level, if you DO NOT advertise.
If take the example of a hypothetical toothpaste brand that has roughly 500MM of annual sales, a 100 MM investment returning in an additional PKR 4 MM of sales is quite possible but a bit steep.
However, the critical assumption in this whole calculation has been that that the entire marketing spend would go straight away to add to the brand equity. This is a difficult assumption to justify unless you have already means of evaluating the size of the brand equity. One way of valuing the brand would be the Royalty Relief Method according to which
- you determine as to what royalty rate the brand would give you if you license it out to another organization.
- Applying this royalty rate to projected future sales value of the brand and
- then finding the net present value of the resulting stream of income, net of taxation, discounted at the Weighted Average Cost of Capital of the brand would give you the value of the brand.
In this entire methodology, the sales value of the brand is driven by determining the present value on the basis of future net sales. So unless the principal of the A&P spend affects the royalty rate %, it will not have any effect in determining valuation of the brand. How and whether the A&P spend influences positively the royalty rate of the brand is a matter of another discussion.
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