Many Indian branded education firms enjoy strong brand equity but may have poor or even negative cash flows, thus precluding the use of methods such as Discounted Cash Flow method, Multiples based method or the Similar Transaction method. Thus, in this article we seek to explore the application of the premium profit method to value such firms. Let us take a HYPOTHETICAL Indian education firm (hereinafter X) and value its brand.
The Premium Profit Method is determined based on the value of the brand and the difference between the estimated cash flows that would be earned by a business using the brand with those that would be earned by a business that does not use the brand. This difference represents the additional cash flows related to the brand. The calculation of the brand value is effected by applying the appropriate discount rate to estimated future brand cash flows.
Thus, the premium profit method can be used to compute the differential cash flows between X and an unbranded or low-branded rival and then this differential is discounted at the opportunity cost of capital to arrive at X’s brand value.
X will have many unbranded competitors say individual tutors who provide coaching for exams such as ICSE, ISC, IAS, JEE etc. Thus, the tuition fee that they charge on can be compared with X’s fee per hour.
X’s unbranded rivals will have low costs perhaps only transportation from their residence to the student’s house. But X will have high costs viz. rent, advertisement, electricity etc. that will have to be deducted from the brand premium to arrive at the premium profit.
| X | Unbranded Individual Tutor | ||
|---|---|---|---|
| Fee charged per hour per student | 2000 | 500 | |
| X’s expenses per student (rent, advertisement, electricity etc.) per hour per student | 1000 | ||
| Expenses incurred by an unbranded tutor per hour per student | 100 | ||
| Profit | 1000 | 400 | |
| Premium Profit | 600 (1000 less 400) |
We then multiply the premium profit of INR 600 with the number of X’s students to arrive at an aggregate figure. Such analysis can be undertaken for a 5Y explicit forecast period and the aggregate figure can be discounted with X’s opportunity cost of capital to arrive at the present value of X’s brand.
While there are several limitations to the premium profit method as it relies on forecasting at least it can be done and comprehended in a simple and facile manner. Due to paucity of data, we do not know the state of X’s financials but from X’s website we can glean the fees X charges and this becomes an authentic starting point for the premium profit method. Obtaining the fees and costs of unbranded tutors is also quite easy. The only x-factor is the prediction of X’s costs but this is also not a big issue as one can easily ascertain costs such as rent, electricity etc. without much difficulty.
These arguments can be used to justify the use of the premium profit method to value the brand of large successful branded firms such as X.