Brand equity refers to the value of a brand name. If customers are willing to pay more for a product from a particular company than for a generic product, that company has brand equity. An example of brand equity is the clothing manufacturer Lacoste. A golf shirt festooned with the Lacoste alligator typically retails for much higher than a similar shirt with no alligator; many customers happily pay the premium because they associate Lacoste with prestige and sophistication.

Brand equity can also be negative. If a brand has a huge product recall, for example, or is involved in a highly publicized environmental disaster such as the 2010 BP oil spill, some customers actively avoid that brand, and the brand name becomes a liability rather than an asset. Brand equity impacts profit margins by affecting profit margin per customer, sales volume and customer retention.

A Big Effect on Profit Margins

When customers attach a level of quality or prestige to a brand, they perceive that brand's products as being worth more than products made by competitors, so they are willing to pay more. In effect, the market bears higher prices for brands that have high levels of brand equity. The cost of manufacturing a golf shirt and bringing it to market is not higher, at least to a significant degree, for Lacoste than it is for a less reputable brand. However, because its customers are willing to pay more, it can charge a higher price for that shirt, with the difference going to profit. Positive brand equity increases profit margin per customer because it allows a company to charge more for a product than competitors, even though it was obtained at the same price.

Brand equity has a direct effect on sales volume because consumers gravitate toward products with great reputations. For example, when Apple releases a new product, customers line up around the block to buy it even though it is usually priced higher than similar products from competitors. One of the primary reasons why Apple's products sell in such large numbers is that the company has amassed a staggering amount of positive brand equity. Because a certain percentage of a company's costs to sell products are fixed, higher sales volumes translate to greater profit margins.

Customer retention is the third area in which brand equity affects profit margins. Returning to the Apple example, most of the company's customers do not own only one Apple product; they own several, and they eagerly anticipate the next one's release. Apple's customer base is fiercely loyal, sometimes bordering on evangelical. Apple enjoys high customer retention, another result of its brand equity. Retaining existing customers increases profit margins by lowering the amount a business has to spend on marketing to achieve the same sales volume; it costs less to retain an existing customer than to acquire a new one.

Negative brand equity has the opposite effect on customer retention and, as a result, profit margins. After the BP oil spill, the company lost many customers. Its profits immediately dipped, and BP had to pour millions of dollars into an exhaustive advertising campaign to restore its image.