What Is Brand Equity?

Brand equity refers to a value premium that a company generates from a product with a recognizable name when compared to a generic equivalent. Companies can create brand equity for their products by making them memorable, easily recognizable, and superior in quality and reliability. Mass marketing campaigns also help to create brand equity.

When a company has positive brand equity, customers willingly pay a high price for its products, even though they could get the same thing from a competitor for less. Customers, in effect, pay a price premium to do business with a firm they know and admire. Because the company with brand equity does not incur a higher expense than its competitors to produce the product and bring it to market, the difference in price goes to margin. The firm's brand equity enables it to make a bigger profit on each sale.

[Important: Brand equity is an extension of brand recognition - but more-so than recognition, brand equity is the added value in a particular name.]

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Brand Equity

Understanding Brand Equity

Brand equity has three basic components: consumer perception, negative or positive effects and the resulting value. Foremost, consumer perception, which includes both knowledge and experience with a brand and its products, builds brand equity. The perception that a consumer segment holds about a brand directly results in either positive or negative effects. If the brand equity is positive, the organization, its products and its financials can benefit. If the brand equity is negative, the opposite is true.

Finally, these effects can turn into either tangible or intangible value. If the effect is positive, tangible value is realized as increases in revenue or profits and intangible value is realized as marketing as awareness or goodwill. If the effects are negative, the tangible or intangible value is also negative. For example, if consumers are willing to pay more for a generic product than for a branded one, the brand is said to have negative brand equity. This might happen if a company has a major product recall or causes a widely publicized environmental disaster.

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.

Key Takeaways

  • Brand equity refers to a value premium that a company generates from a product with a recognizable name when compared to a generic equivalent.
  • Brand equity has three basic components: consumer perception, negative or positive effects and the resulting value.
  • Often, companies in the same industry or sector compete on brand equity.

Brand Equity Examples

A general example of a situation where brand equity is important is when a company wants to expand its product line. If the brand's equity is positive, the company can increase the likelihood that customers might buy its new product by associating the new product with an existing, successful brand. For example, if Campbell's releases a new soup, the company is likely to keep it under the same brand name rather than inventing a new brand. The positive associations customers already have with Campbell's make the new product more enticing than if the soup has an unfamiliar brand name.

Here are some other examples of brand equity: Manufactured since 1955 by McNeil (now a subsidiary of Johnson & Johnson), Tylenol ranks above average in the pain relief category, according to the Mayo Clinic. EquiTrend studies show that consumers trust Tylenol over generic brands. Tylenol has been able to grow its market with the creations of Tylenol Extra Strength, Tylenol Cold & Flu, and Tylenol Sinus Congestion & Pain.

Since 2009, the Kirkland Signature brand by Costco has maintained positive growth. Signature encompasses hundreds of items, including clothing, coffee, laundry detergent and food and beverages (one study shows that Costco sells more wine than any other brand in the country, despite state laws that restrict it from selling alcohol in certain areas). Costco even provides members with exclusive access to cheaper gasoline at its private gas stations. Adding to Kirkland's popularity is the fact that its products cost less than other name brands.

According to a Starbucks consumer case study, customers choose its brand of coffee over others both because of its quality and because of the company. Rated the fifth-most-desirable company in the world by Fortune magazine in 2014. Starbucks is held in high regard for its pledge to social responsibility. With more than 21,000 stores around the globe, Starbucks remains the largest roaster and retailer of Arabica coffee beans and specialty coffees.

With a brand value in the ballpark of $72 billion, Coca-Cola is often rated the best soda brand in the world. However, the brand itself represents more than just the products – it's symbolic of positive experiences, a proud history, even the U.S. itself. Also recognized for its unique marketing campaigns, the Coca-Cola corporation has made a global impact on its consumer engagement.

Porsche, a brand with strong equity in the automobile sector, retains its image and reliability through the use of high-quality, unique materials. Viewed as a luxury brand, Porsche provides owners of its vehicles not only with a product, but an experience. In comparison to other vehicle brands in its class, Porsche ranks number three, above brands such as Mercedes and BMW, according to U.S. News & World Report.

Tracking a Company's Success with Brand Equity

Brand equity is a major indicator of company strength and performance, specifically in the public markets. Often, companies in the same industry or sector compete on brand equity. For example, an EquiTrend survey conducted on July 14, 2016, found that The Home Depot was the No. 1 hardware company in terms of brand equity. Lowe's Companies, Inc. came in second, with The Ace Hardware Corporation scoring below average. A large component of brand equity in the hardware environment is consumer perception of the strength of a company's e-commerce business. The Home Depot is an industry leader in this category. It was also found that, besides e-commerce, The Home Depot has the highest familiarity among consumers, allowing it to further penetrate the industry and increase its brand equity.