An approach to assess the importance of brand equity in acquisition decisions

J PROD INNOV MANAG 1994; 11:221-235

221

0000

An Approach to Assess the Importance of Brand Equity in Acquisition Decisions Vijay Mahajan, Vithala R. Rao, and Rajendra K. Srivastava

Many firms acquire other firms with well-known and proven brands to hedge against the high costs and risks of new product development. A critical question in these acquisition decisions involves the assessment of the importance of brand equity to the acquiring firm. Since the brand equity benefits can vary by firm (and also by the decision maker within a firm) a critical question is how can one systematically decipher the effect of brand equity in acquisition decisions. Using the balance model [8,15], Vijay Mahajan, Vithala Rao, and Rajendra Srivastava present a methodology to determine the importance of brand equity in acquisition decisions. By capturing the idiosyncratic perceived importance of brand equity of every decision maker involved in acquisition decisions, the methodology enables members of a committee within a firm to understand and reconcile their differences in evaluating potential acquisitions. This methodology is applied in a pilot study for the all-suites segment of the hotel industry with data collected from senior executives of five major hotel chains. The authors also discuss benefits, limitations, and further extensions of the suggested approach.

Address correspondence to Vithala R. Rao, Johnson Graduate School of Management, Cornell University, 529 Malott Hall, Ithaca, N Y 14853-4201.

© 1994 Elsevier Science Inc. 655 Avenue of the America.s, New York, NY 10010

Introduction The rising costs and failure risks associated with developing and introducing new products from scratch have forced many companies to pursue new product strategies that are less costly and less risky than developing completely new brands. These new product strategies include licensing, brand extensions, developing me-too products, reviving old brands and acquiring new brands [11]. In the 1980s, many companies pursued the acquisition strategy to hedge against the high costs and risks of new product development. For example, R.J. Reynolds bought Nabisco, Philip Morris acquired General Foods and Kraft, Unilever obtained Chesebrough Ponds, Procter and Gamble acquired Richardson Vicks and Noxell, and Nestle picked up Carnation. Despite its high price tag (Philip Morris paid $12.6 billion for Kraft, R.J. Reynolds paid $4.9 billion for Nabisco, and Nestle paid $3 billion for Carnation), the acquisition strategy enabled these acquiring firms to buy well-known brand names and proven winners, gain access to new markets, or strengthen their positions in current markets. For example, the announcement of Procter and Gamble on April 10, 1991, that it would buy Max Factor cosmetics and Betrix, a German make-up and fragrance manufacturer, from Revlon for $1.12 billion in cash (twice the price that Revlon paid for these two businesses) was anticipated by industry analysts to offer the following benefits to Procter and Gamble [17,18]: instant access to major global markets with strong brand names, an opportunity to become a major global competitor, potential to attain high margins and 0737-6782/94/$7.00

222

J PROD INNOV MANAG 1994;11:221-235

BIOGRAPHICAL SKETCHES Vijay Maha[an is the John P. Harbin Centennial Chair in Business and the Associate Dean for Research, Graduate School of Business, The University of Texas at Austin. He has written extensively on new product diffusion, marketing strategy, and research. He serves on the Editorial Review Boards of several journals including the

Journal of Marketing, Journal of Marketing Research, Marketing Science, and Journal of Product Innovation Management. He has been selected by the American Marketing Association as the next editor of its most prestigious research journal, the Journal of Marketing Research, as of July 1994. Vithala R. Rao is the Deane Malott Professor of Management and Professor of Marketing and Quantitative Methods, Johnson Graduate School of Management, Comell University, Ithaca, New York He received a Ph.D. in Applied Economics/Marketing from the University of Pennsylvania. He has written extensively on application of multidimensional scaling and conjoint models for the analysis of consumer preferences and perceptions, role of price, product design, market structure analysis, evaluation of subsets of multiattributed items, product lx)sitioning and pricing, and new product acceptance by channel members. His articles have appeared in the Journal of Marketing Research, Journal of Marketing,

Multivariate Behavioral Research, Journal of Consumer Research, Decision Science, Management Science, Journal of Classification Society, Marketing Letters, and Marketing Science. He serves on the editorial boards of several journals including Journal of Marketing and Marketing Science. Ra.iendra K. Srivastava is Chairman and Sam Barshop Professor of Marketing at the Graduate School of Business, and the Charles A. LeMaistre Centennial Fellow at the IC2 Institute, The University of Texas at Austin He received a Ph.D. from the University of Pittsburgh. Professor Srivastava's research interests are interdisciplinary with articles spanning the fields of marketing, finance, economics, and international trade. Within marketing, his research interests include choice models, market structure analysis, and analyses of market dynamics. He is the recipient of several research awards, and his articles have appeared in such publications as Marketing Science, Journal of Marketing, and Journal of Market-

ing Research.

high growth rates, an opportunity to create strong global brands, and an ability to leverage its expertise in fragrances to create new brands. The surge in the mergers and acquisitions to acquire new brands in the late 1980s has brought into focus various issues in measuring the value of the acquired firm to the acquiring firm. It is fair to say that any firm can be conceptualized as a collection of individual brands it markets. Thus, the measurement system of a firm in the context of acquisition necessarily involves placing a monetary value on each of the brands (and associated assets) of the acquired firm [3]. The monetary value that the firm pays for a brand depends upon the perceived benefits that it can derive by acquiring the brand [1 ]. The acquiring firm derives

V. MAHAJAN ET AL.

benefits from a brand by capitalizing on its brand equity. Brand equity defines the power that a brand may command in a market by means of its name, symbol, or logo [7,13,20,23]. The benefits derived from brand equity result from three sources. As summarized in Figure 1, these sources are: 1. enhanced performance (for example, increase in market share or increase in revenues due to the firm's ability to charge a premium price) and/or marketing efficiency (for example, reduced advertising and promotional expenditures) associated with the brand, 2. longevity (or vulnerability) of a brand due to its loyal customer base and distribution relationships, and 3. carryover potential (or extensibility) to other brands and markets of the acquiring firm. The benefits offered by a brand are not necessarily equally valuable to all firms. Therefore, the brand equity and hence the monetary value of a brand is specific to a particular owner. Depending upon their assessment of the perceived potential and current benefits offered by a brand, two acquiring firms may place different monetary values on it. Even within the same firm, different members of the committee responsible for evaluating acquisition decisions may also place different monetary values on the brand equity offered by a brand, based upon their individual assessments of the perceived potential and current benefits offered by the brand. In these situations, a critical question is how can one determine the perceived importance of brand equity of a potential acquisition candidate? This article proposes a methodology to deal with this question and presents a preliminary explorative application. When implemented across acquiring firms, the approach helps to decipher the relative importance of different brand equity factors of a potential acquisition brand candidate (Figure 1) to the individual acquiring firms. Similarly, the methodology will enable one to understand the idiosyncratic perceived importance of various brand equity factors among members of a committee in an acquiring firm evaluating a potential acquisition. Of course, the specific factors (Figure 1) and measures used to operationalize these factors will vary by application. The organization of this article is as follows. The approach suggested to evaluate the impact of brand equity on acquisition decisions is briefly summarized

BRANDEQUITYINACQUISITIONDECISIONS

J PRODINNOVMANAG 1994;11:221-235

Extensibility Growth ] potential

Brand Equity

I=

Longevity [ Vulnerability ]~

F

I Performance [ Profits (share/margins)

223

Carryover of brand benefits across products and markets

Brand loyalty Switching cost Distributor loyalty Customer services Positioning

Recognition Quality Perceived value Customer base Positioning

Figure 1. Determinants of brand equity. in the following section. Next, empirical results for the all-suites segment of the hotel industry are presented. Finally, the article concludes with limitations and further extensions of the empirical work.

The Approach Strategic management literature is replete with studies that have examined the success of an acquisition by examining projections made with regard to the financial viability (for example, ROE, ROI) of the new (or altered) entity (see [14,16,19]). Recent studies, however, suggest that success of an acquisition cannot be fully explained by merely examining financial projections, and an explicit consideration of strategic variables that characterize the type of acquisition is required to evaluate the success of an acquisition [10,12,22]). Using the balance model developed by Farquhar and Rao [8], Rao et al. [15] have demonstrated that nonfinancial variables can significantly contribute to the acquisition evaluation decisions. We revisit the approach used by Rao et al. [15] to assess

the importance of brand equity in acquisition decisions. Rao et al. [15] have suggested that the acquisition process can be conceptualized similar to that of brand choice: the acquiring firm (its decision makers) evaluates the attributes (characteristics) of different alternative candidate companies that could be acquired, using some type of preference-choice model. In evaluating alternative candidate companies, the acquiring firm may prefer the candidate firms to be similar to it on some dimensions and be different from it on some other dimensions. That is, in its evaluation of candidate firms, the acquiring firm may seek a balance between itself and the acquired firm. Because the pair of firms (acquiring and acquired) can be thought of as a subset (size 2) of multiattributed items (where each firm can be described as a multiattribute item), the firm evaluating n number of potential acquisition candidates needs to evaluate n subsets (of size 2) of multiattributed items for its acquisition decision. The balance model or the preference-choice model [8] captures these dynamics by describing the preferences of decision maker(s) for subsets so as to

224

J PROD INNOV MANAG 1994;11:221-235

reflect the degree of balance among items in a subset. Arguably, merger and acquisition decisions are such a high-involvement type that complex cognitive models such as the balance model may actually work better than for many areas of consumer choice. In describing a decision maker's preferences for subsets, the balance model postulates that attributes that have nonzero influence on preferences for subsets can be grouped into two classes. These two groups of attributes (described using a terminology slightly different from that originally suggested in [8]) are summarized in Table 1. The attributes in each group are those for which means and dispersions of items in the subset are optimized. These are briefly, described below: *

Table 1. Attribute Classification in the Balance Model

Optimize Attribute Means

OptimizeAttribute Dispersions

Desirable: maximize means

Complementary: maximize dispersions

Profits/returns Market share Price/premium Brand loyalty Undesirable: minimize means

Risk/vulnerability Debt/equity ratio Relative cost

Optimize Dispersions: These are the attributes

for which the decision maker wishes to optimize the dispersion (similarity or complementarity) of the items in the subset for these attributes. The attributes with a lower preferred dispersion are called "similar" and the attributes with a higher preferred dispersion are called "complementary." For example, in an acquisition choice, a decision maker may prefer the two firms (acquiring and acquired) to be similar to each other on certain attributes such as product

Distribution of coverage across channels Seasonality/cyclicity Similar: minimize dispersions Insider share ownership Product quality Distribution clout

quality, distribution clout, etc. The decision maker may also wish the two firms to be dissimilar to each on some other attributes (i.e., the counterbalancing attributes) such as seasonality/cyclicity, distribution coverage across channels. Therefore, in selecting an acquisition candidate, the decision maker will look for a candidate that will optimize the similarity (low dispersion) and complementarity (high dispersion) across attributes for the acquiring and the acquired firms.

Optimize Means: These are the attributes on

which the decision maker wishes to optimize the mean of the items in the subsets for these attributes. The attributes for which the mean is maximized are called "desirable" and those for which the mean is minimized are called "undesirable." For example, while evaluating acquisition candidates, a decision maker may look for an acquisition candidate that will increase the overall average value of the acquiring and the acquired firms on certain attributes (the desirable attributes) such as profits, market share and brand loyalty. At the same time, the decision maker may also wish to decrease the overall average value of the two firms (acquiring and acquired) on some other attributes (the undesirable attributes) such as debt/equity, risk, and relative manufacturing/selling costs. Therefore, in evaluating the acquisition candidates, the decision maker will look for an acquisition candidate that will optimize the mean values across both the desirable and undesirable attributes. *

V. MAHAJAN ET AL.

Given the above classification of attributes, the modeling problem in the balance model is to assess a decision maker's preferences for subsets of items by examining his or her trade-offs on the means and dispersion measures for various attributes. The utility (or value) of a subset is a weighted combination of means and dispersions of the various essential attributes. In the absence of prior categorization of the attributes, empirical estimates of weights of means/dispersions provide an indirect mechanism to infer categorization of the attributes (see Appendix for details). For example, if an acquisition is being evaluated on p number of attributes, for each pair of firms (acquiring and acquired), an acquirer's utility or the overall preference for the pair of firms can be stated as: Preference (pair) = w0

+

o Z wit (mean value of the attribute t for the pair) t=l p

4-

(1)

Z w2t (variance of the attribute t for the pair) t=l

where wit and w2, are the weights for the means and variances and w o is a constant.

B R A N D EQUITY IN ACQUISITION DECISIONS

The role of the weight for variance, w2t, is illustrated in Figure 2 which shows the strengths of two brand acquisition candidates B1 and B2, and a brand A already owned by the acquirer in two different channels---department and drug stores. If the acquirer is interested in increasing clout in department stores, then lower variance (i.e., negative w2t's) and option B2 are desirable. However, if the acquirer is interested in enhancing market coverage across the two channels, then B1 and higher variance (positive w2t's ) are desirable. The weights in equation (1) can be estimated using regression methods with judgmental data on pairs of firms (as described in the Appendix). In fact, once these weights have been estimated for each decision maker (usually on a set of hypothetical acquisition candidates), they can be used to evaluate potential acquisition candidates and to draw inferences regarding the desirability of the various attributes in an acquisition candidate. Such analyses enable one to determine the perceived impact of brand equity on acquisition choices.

An Application The proposed approach to assess the perceived impact of brand equity on acquisition decisions is illustrated here for the all-suites segment of the hotel industry. All-suite hotels, pioneered by Embassy Suites, represent the fastest growing segment of the lodging and hospitality industry. This growth has been spurred by the willingness of guests to pay more for suites relative to rooms and their growing loyalty to suites as an alternative of choice. Survey findings indicate that as many as 20% of travelers would prefer an all-suite hotel if one were available [6]. Virtually every recognizable name in the hotel industry (Marriott, Hyatt, Sheraton, Radisson) has entered this segment in an effort to increase (or avoid losing) market share. New entrants such as Lexington Hotel Suites and Pickett have also joined the fray, resulting in a capacity growth of 20%-30% per year in the mid to late 1980s, compared to only 3%-4% for the industry as a whole [4]. This growth in competition, coupled with the recent slowdown in the lodging industry, has led to growing consolidation and acquisition of smaller players (such as Pickett by Guest Quarters in 1990) in the market. This activity is expected to continue with the growing importance of national reservation systems as well as fundamental changes in capital markets.

225

J PROD INNOV MANAG 1994; 1 1:221-235

]~ ~[ ACQUISITION ]~-BAI.ANCE- --I OPTIONS(nI,B21

ACQUIRING FIRM (A)

B2 IZ

INCREASES POWER/CLOUT IN DEPT. STORE CHANNEL

ZIIIIOZiXZZZ}Z2ZZ \

k.~d

\ \

.................................................................. ;:ID ...............

B1 ENllANCESMARKET COVERAGE

SlIARE OF DRUG STORE CHANNEL

F i g u r e 2. The balance model.

Given the importance of brand recognition and customer loyalty in this industry, the question now is how much does brand equity contribute to acquisition decisions for this industry. Alternatively, how can one determine the importance of brand equity in a decision maker's preference for acquisitions. Using the seven steps of the balance model outlined in the Appendix, we report here results of an exploratory study that was conducted to study the effect of brand equity on acquisition choices for the all-suites segment of the hotel industry. It should be noted that because brand value is owner-specific, the answer to the question as to how much brand equity contributes to acquisition decisions will depend upon the particular firm evaluating the candidate firms. Therefore, in order to ascertain this effect, senior executives from various hotel chains were contacted to participate in the study. Five of these executives (from five different chains) agreed to participate in the study. Two of these respondents were from large hotel chains with a presence in the all-suite segment of the hotel industry. All of these respondents were amply familiar with merger/acquisition issues in the hotel industry. We will discuss this application in the sequence of the seven steps indicated in the Appendix.

Step 1: Identification of Attributes Rao et al. [15] have suggested that in identifying potential candidates for acquisition, an acquiring firm may focus on their financial performance, productmarket characteristics, and marketing strategy-related variables. Relevant attributes in these categories were identified based both on trade articles (for example,

226

J PRODINNOVMANAG 1994;11:221-235

V. MAHAJANET AL

Table 2. Variables Considered in M&A Decisions and Profiles of "All-Suites" Firms Considering Merger Options Existing All-Suites Hotels Decision Variables (Hypothetical Levels)

Embassy Suites"

Residence Inn by Marriott ~

Quality lnn

Lexington Suites Inn

Guest Quarters

Radisson Suites

34

68

61 12%

Financial Variables 1. Revenues (across units; in $ Mil) b 2. Net income before taxes (% revenues) (4%, 7%, 10%) 3. Debt/equity ratio (1.0, 2.0, 3.0)

507

265

45

13%

11%

8%

6%

12%

2.5

3.0

2.2

0.5

0.4

2.0

3%

15%

0%

100%

21%

22%

12%

2%

5. Ownership structure (% franchised) (0%, 50%, 100%)

40%

50%

100%

67%

6. Number of properties (20, 40, 80)

81

108

22

21

14

12

245

120

145

147

221

220

4. Average return on equity (5%, 10%, 20%) Property Management Characteristics:

7. Average suites/property ( 150, 200, 250) 8. Average occupancy rate (55%, 65%, 75%) 9. Average age of properties (2, 5, 8 yrs.) 10. Planned increase in number of properties (20%, 50%, 100%)

70%

70%

65%

55% 15

5

8

10

10%

23%

150%

15%

75%

63%

8

2

15%

30%

Market characteristics: I 1. Market segment served (up-scale, midrange, economy) c

Up ($100)

Mid ($80)

Econ ($60)

Econ ($55)

Mid ($80)

Up ($100)

12. Brand loyalty (% return intent) (50%, 65%, 80%)

80%

80%

64%

68%

90%

48%

13. Brand recognition (unaided recall) (10%, 20%, 60%)

60%

20%

4%

8%

10%

2%

14. Customer focus (business, all) d

All

All

Bus

Bus

Bus

Bus

15. Geographic scope (national/regional)

Nat

Nat

Reg

Reg

Reg

Reg

a These two firms were chosen as the two acquirers in the design. b Multiplicative function of number of properties, average Suites/Property, Occupancy Rate, and Suite Rate/Night. Therefore, revenues [attribute 1] were not included in developing the fractional design as they are a multiple of number of properties, average number of suites, occupancy rate and average suite rate per night [attributes 6, 7, 10, and 11, respectively]. c The corresponding average suite rates per night were: $100, $80, and $60. d "All" means both business and resort.

Hotel and Motel Management) and inputs from industry experts and managers. Experts and managers were provided a copy of Figure 1, which describes brand equity factors, to stimulate their thinking of the relevant brand equity attributes. This resulted in fifteen attributes listed in Table 2. These attributes include four that describe financial performance, six that relate to property characteristics, and five that describe positioning and market performance. The last category includes two measures--brand loyalty and brand recognition--that were identified by the experts as indicators of brand equity. Further, these experts suggested that the hotel industry use of frequent guest programs is intended to increase brand loyalty.l

Step 2: Attribute Profiles for All-Suite Hotels Data were assembled to fully describe six existing all-suite chains (see Table 2) on the fifteen attributes. In addition, profiles for twenty-seven hypothetical all-suite hotel chains were constructed based on a fractional factorial design (see [2,9]) taking into account the attributes and corresponding attribute

J It should be emphasized that our measures of brand equity are based on input from industry experts. In empirical studies, specific measures used to operationalize brand equity can influence its relative importance to the acquisition decisions. In that respect, Figure 1 suggests a framework to unfold brand equity variables (see also [l ]).

BRAND EQUITY IN ACQUISITION DECISIONS

levels indicated in Table 2. In order to make sure that profiles of hypothetical hotel chains were realistic, attribute levels were chosen to reflect the distribution of these variables in the industry. (The issue of whether or not the attribute profiles used fully describe the real firms is an open one. It is possible that other factors such as the personality of CEOs, specific company cultures, capital structure, interest in takeover, etc., may be needed to completely characterize a real firm.)

Step 3: Evaluation of Profiles To evalute the acquisition desirability among the six all-suite chains listed in Table 2, each respondent was asked to evaluate ten combinations of real firms (two acquirers, each potentially acquiring one of the remaining five) and fifty-four combinations of realhypothetical firms (two acquirers, each potentially acquiring one of twenty-seven hypothetical firms). Thus, a total of sixty-four judgments were provided by each respondent. Examples of the industry scenario and firm profiles are provided in Figure 3. For each pair of firms, the respondents were asked to indicate: (1) the desirability of merger on an 1 l- [0--10] point scale; and (2) the probability of merger taking place on a 0 [not at all likely] to 100 [certain] scale.

Step 4: Model Estimation The two dependent variables (desirability and probability of merger) were highly correlated (average correlation across respondents --- 0.93). However, respondents were more prone to use the entire range of the desirability [0--10] scale and tended to restrict themselves to the lower half of the range on 100-point probability scale. Hence, desirability of merger was selected as the dependent variable in order to utilize the greater variability on that dimension. 2 The balance model was estimated separately for each of the five respondents using desirability of merger as the dependent variable with thirty predictors (means and variances for each of the fifteen attributes) based on fifty-four data points for combinations of real-hypothetical hotel-pairs. While such a regression analysis seems to suggest limitations in terms of degrees of freedom, the

2 It should be noted at the bottom of Table 3 that the respondents were asked to provide their opinions on the desirability as well as the probability of the merger taking place. A probable event is not necessarily desirable. In the reported study, the high correlations between the two measures suggest that respondents view the desirable mergers also to be highly probable.

J PROD INNOV MANAG 1994; I 1:221-235

227

fractional factorial design ensures orthogonality among variables and therefore enables reasonable standard errors for regression coefficients. Table 3 presents (unadjusted and adjusted) R-square values for each of the five respondents. In all cases, the model fit decreased significantly with the exclusion of marketing as well as brand equity variables from the analysis (variables 11 through 15 in Figure 3). In terms of incremental adjusted R-square, brand equity variables (brand loyalty and brand recognition) accounted for 5%-30% of explained variance across the five respondents.

Step 5: Identification of Important Attributes Table 4 summarizes the regression coefficients obtained for the balance model for each of the five respondents. For brevity, only significant variables (at p -- 0.10 or better) are included. Further, in Table 5, we have inferred the ways in which the significant attributes were used by each of the respondents in forming their judgments. The attributes are categorized into two classes of "optimize means" (both desirable and undesirable) and "optimize dispersions" (both complementary and similar) attributes according to the balance model. The following observations are warranted from these tables: 1. The respondents are not similar in their use of attribute information. They tend to use different attributes to develop their preferences for acquisition candidates, although some attributes such as brand recognition or brand loyalty were used by four out of the five respondents. The only attribute used in a consistent manner (as a similarity effect) across four of the five respondents was the market segment served (as measured by the suite rate per night) suggesting that these respondents would like the acquiring firm and acquired firm to be serving the same market segment in this industry. This clearly confirms the idiosyncratic nature of acquisition decisions and supports such conclusions drawn in an earlier study of the cosmetic industry [15]. 2. The respondents use only limited information (especially respondents 3 and 4) in evaluating potential candidates. For example, whereas respondent 1 was more attentive to brand equity (brand loyalty and brand recognition) and property management attributes, respondent 2 appeared to be utilizing several attributes (financial, property management, and marketing) in both groups of attributes (means and dispersions).

228

J PROD INNOV MANAG 1994; 11:221-235

V. MAHAJAN ET AL.

INDUSTRY SCENARIO Since the mid-1980's, the "all-suites" segment of the hotel industry has climbed steadily in market share relative to traditional hotels in all sub-segments (upscale, midscale and economy) of the hotel industry. In 1986, all suites represented 1.4 percent of all domestic hotel rooms. In 1989, all-suites represented 4 percent of capacity, with an average occupancy rate of 72.8 percent (versus 68 percent for the rest of the industry), and an average room rate of $12.66 over the industry average. Hotel industry analysts estimate that all-suites will enjoy a 10 percent market share by the year 2000 in an industry which is overbuilt, intensely competitive, and lacking in investor interest. Given the growth opportunities offered by all-suites, some firms in this industry are trying to grow through acquisition of (or mergers with) other f'm'ns in order to compete more effectively through consolidation. In this study, you will be asked to make several judgments on the desirability of mergers, and the value placed by f'umas on merger (or acquisition) with various candidate Firms. Assume that the candidate firms being considered for merger/acquisition have been initially screened. The firms being considered as merger/acquisition options are profiled on a variety of dimensions, including financial, property management and marketing variables (a glossary defining these variables is included). The firm considering the merger is also described on the same dimensions. Given this information, please provide your judgments as indicated on two packages. In one package Firm "A" (profiled on a pink sheet) is considering merger with (or acquisition of) candidate firms profiled on yellow sheets. Similarly, Firm "B" (green sheet) is considering merger with firms described on blue sheets. PROFILE OF "ALL-SLYrrES" FIRM CONSIDERING MERGER OPTIONS

PROFILE OF "ALL-SUITES" FIRM BEING CONSIDERED FOR MERGER

FINANCIAL VARIABLES:

FINANCIAL VARIABLF~:

1 2 3 4

Revenues (From All Units: in Million $'s) Net Income Before Taxes as % of Revenues Debt/Equity Ratio Average Return on Equity

1 2 3 4

36 $M 6% 1.0 4%

Revenues (From All Units: in Million $'s) Net Income Before Taxes as % of Revenues Debt/Equity Ratio Average Return on Equity PROPERTY MANAGEMENT CHARACTERISTICS:

PROPERTY MANAGEMENT CHARACTERISTICS: 5 6 7 8 9 10

507 $M 13% 2.5 21%

Ownership Structure (% Franchised) Number of Properties Average Number of Suites per Property Average Occupancy Rate Average Age of Properties Planned Increase in Number of Properties

5 6 7 8 9 10

0% 20 150 55% 2 Yrs. 10%

Ownership Structure (% Franchised) Number of Properties Average Number of Suites per Property Average Occupancy Rate Average Age of Properties Planned Increase in Number of Properties

40% 81 245 70% 5 Yrs. 10%

MARKET CHARACTERISTICS:

MARKET CHARACTERISTICS: 11

Market Segment Served and Average Suite Rate/Night

Economy 60 $'s

11

Market Segment Served and Average Suite Rate/Night

Upscale 100 $'s

12

Geographical Scope

Regional

12

Geographical Scope

National

13

Brand Loyalty (% Return Intent)

50%

13

Brand Loyalty (% Return Intent)

80%

14

Brand Recognition (Unaided Recall)

10%

14

Brand Recognition (Unaided Recall)

60%

15

Customer Focus

Bus +Resort

15

Customer Focus

Bus +Resort

1.

In your opinion, how desirable is a merger with the above firm for the firm considering merger options? (Circle number). 0

1

2

3

4

5

6

(Least) 2.

7

8

9

10 (Most)

Provide an estimate of the probability of the merger taking place. Give a number between 0 (not at all likely) and 100 (certain) Probability of Merger

%

Figure 3. Examples of hypothetical profiles of firms in the all-suites study.

BRAND EQUITY IN ACQUISITIONDECISIONS

J PROD INNOV MANAG 1994;11:221-235

229

Table 3. Summary Regression Results: Hotel ("All-Suites") Industry (Dependent Variable: Desirability of Merger) Fit of the Balance Model (R-SQ. & ADJ. R-SQ.) Variables Included

Resp 1

Resp 2

Resp 3

Resp 4

Resp 5

All (financial, prop. mgmt., marketing)

0.84 0.71

0.80 0.64

0.69 0.56

0.71 0.57

0.87 0.79

All except marketing b

0.65 0.48

0.62 0.46

0.62 0.48

0.39 0.15

0.82 0.74

All except brand loyalty/recognition (measures of brand equity)

0.68 0.50

0.65 0.49

0.65 0.47

0.67 0.57

0.83 0.75

Variance accounted for by brand equity

30% a

23%

16%

10%

5%

Resp. = Respondent "(0.71-0.50)/0.71 = 0.30 (30%). b Excludes marketing variables 11 through 15 included in All-Suites profiles in Table 4.

Step 6: Evaluation of Candidates for Acquisition The regression coefficients in Table 4 estimated from fifty-four combinations of real-hypothetical profiles can be used to predict preferences for ten combinations of real firms. For illustrative purposes, the results of such an analysis are presented in Table 6 based on respondent 2's balance model (similar evaluations can be done for other respondents). As indicated earlier, the desirability of merger between two acquiring hotel chains (Embassy Suites and Residence Inn by Marriott), each potentially acquiring each of the five remaining acquisition candidates, was obtained. These ratings, which were not used in the estimation step and hence represent a holdout sample, and their implied rank order preferences are presented in the column labeled A in Table 6. The remaining columns were obtained by predicting the desirability rating and implied rank order preference (within each set of five merger pairs) by using the model with all attributes (column B), only return on equity and debt/equity ratio (column C), all except brand equity attributes (loyalty and recognition) (column D), and only brand equity attributes (column E). The effect of attributes on the desirability of merger among hotel chain pairs is better understood by examining the data of return on equity against the debt/equity ratio for the six chains in question as shown in Table 2. Tables 4 and 5 indicate that respondent 2 viewed higher mean on the attribute of return on equity and lower mean on the debt/equity ratio attribute. This individual also preferred similarity (or negative weight for dispersion) on the attribute of return on equity and complementarity (positive weight

for dispersion) on the attribute of debt/equity ratio. The inferences on these two attributes when jointly looked at make much sense. The predicted preferences for potential partners of Embassy Suites and Residence Inn by Marriott are given in column (C) in Table 6. In each case, based on these two attributes alone, the two chains are best suited for each other and the least likely merger candidate is Lexington Suites Inn. Notice that although Radisson Suites is predicted to be the second most desirable merger option for Embassy Suites, it conflicts with the actual rating (least desirable). Similarly, consider the data on return intent (brand loyalty) against brand recognition for the six chains and the model weights on these attributes for respondent 2 who treats brand recognition as desirable and return intent as similarity-seeking (preference for low dispersion on this attribute among merger candidates). Given this respondent's interpretation, it is not surprising that Residence Inn by Marriott and Guest Quarters--which get similar ratings to Embassy Suites on return intent--are predicted (based on brand equity attributes alone; see column E in Table 6) as the two most suitable merger candidates for Embassy Suites. Interestingly, Radisson Suites, the second most desirable option for Embassy Suites based on return on equity and debt/ equity ratio, is the least desirable when evaluated in terms of brand equity attributes. This illustrates the moderating effect of variables upon one another. As can be seen by comparing the first and last columns of Table 6, the two brand equity variables alone contain valuable information for predicting the actual ratings; (the average correlation between predicted and actual ratings for brand equity variables was 0.52 compared with 0.71 for all fifteen variables and

230

J PRODINNOVMANAG 1994;11:221-235

V. MAHAJANET AL.

Table 4. Regression Coefficients of Acquisition Balance Model Respondent Hotel ("All-Suites") Industry

I

2

-1.027

1.079 -4.904 0.992

3

4

5

Effects due to means:

Financial variables: 1 Revenues 2 Net income before taxes 3 Debt/equity ratio 4 Average return on equity Property management characteristics: 5 Ownership structure (% franchised) 6 Number of properties 7 Average number of suites per property 8 Average age of properties 9 Planned increase in # of properties Market characteristics: 10 Average occupancy rate 11 Market segment served (suite rate/night) 12 Brand recognition (% return intent) 13 Brand recognition (unaided recall) 14 Customer focus (business, resort) 15 Geographical scope (national, regional)

-0.039

-2.517 -4.675 1.261

0.033 -0.077

-0.018 -0.341

-0.437

-0.170 0.021 0.021

-0.051 0.071 0.018

0.012 0.013 0.020

0.346 0.042 -1.990

Effects due to dispersions:

Financial variables: 1 Revenues 2 Net income before taxes 3 Debt/equity ratio 4 Average return on equity

0.006 1.937 -0.481

Property management characteristics: 5 Ownership structure (% franchised) 6 Number of properties 7 Average number of suites per property 8 Average age of properties 9 Planned increase in # of properties Market characteristics: 10 Average occupancy rate 11 Market segment served (suite rate/night) 12 Brand loyalty (% return intent) 13 Brand recognition (unaided recall) 14 Customer focus (business, resort) 15 Geographical scope (national, regional)

corresponding average Kendall's Tau values were 0.4 and 0.6).

Step 7: Resolution of Differences The methodology proposed offers a way to discuss individual committee members' evaluations of various

-0.019

0.026 -0.030

-0.012 0.024

-0.044

-0.043 -0.033

-0.051

-0.119 -0.096

-0.016 -0.963 -1.509

attributes by forcing a common setting and data collection procedure. We now illustrate how results obtained from our application can be utilized by a firm. For this purpose, the five respondents may be thought of as members of a hypothetical committee of an acquiring firm in the All-Suites industry. Table 7 summarizes how these individuals evaluate the two

BRAND EQUITY IN ACQUISITION DECISIONS

J PROD INNOV MANAG 1994; 11:221-235

231

Table 5. A Summary of Inferences on the Categorization of Attributes (All-Suite Hotel Chains) Types of Attributes

Respondent 1

Respondent 2

Respondent 3

Brand recognition Brand loyalty

Net income Average Return on equity Brand recognition Percent franchised

Return on equity Brand loyalty

Respondent 4

Respondent 5

Optimize Means: Desirable Positive weights for means

Undesirable Negative weights for means

Debt/equity ratio Debt/equity ratio Percent franchised Customer focus Suites per property Average age of property Average occupancy rate

Number of properties Average number of suites/property Average occupancy rate Suite rate/night Brand loyalty

Average age of prop- Debt/equity ratio Percent franchised erties Number of properties Net income before taxes

Optimize Dispersions: Complementary Positive weights for dispersions

Similar Negative weights for dispersions

Revenue Debt/equity ratio

Suite rate/night Brand recognition Customer focus

Average return on equity Percent franchised Suites per property Suite rate/night Brand loyalty Geographical scope

brand equity variables. The following differences can be gleaned from Table 7. •

Respondent 4 views that brand equity is not important for the acquisition decisions.

•

Respondents 1 and 2 feel that the mean value of brand recognition of the two firms should increase after acquisition. Respondent 1, however, also feels that the two merging firms should be similar to each other on brand recognition.

•

Respondents 1, 3, and 5 feel that the mean value of brand loyalty of the two merged finns should increase after acquisition. Respondents 2 and 5, however, would like the two firms to be similar to each other on brand loyalty.

Percent franchised Planned increase in properties

Suite rate/night

Number of properties Brand loyalty Suite rate/night

Based on the above observations, Table 8 summarizes the areas of agreement and disagreement among the respondents. Whereas the horizontal axis represents their views on the importance of brand loyalty, the vertical axis represents their views on the importance of brand recognition to the acquisition decisions. The majority opinion (four out of five, exception being respondent 4) among the respondents posits that the acquired firm should have brand loyalty either equal to the brand loyalty of the acquiring finn or greater than its brand loyalty to increase the overall brand loyalty of the merged firms. The majority of them (three out of five; exception being respondents 1 and 2) also view brand recognition to be unimportant to the acquisition decisions. The previous analyses are clearly an important input to the committee discussions on the evaluation of

232

J PROD INNOVMANAG 1994;11:221-235

V. MAHAJANET AL.

Table 6. Stated and Predicted Rank Order Preferences (for Respondent #2) Actual

Acquiring Firm

Acquisition Candidate

Predicted Based on (Variables): All

Only ROE & D/E

All but Brand Equity

Brand Equity Only

A

B

C

D

E

8.0 2.0 2.0 3.0 1.0 8.0 7.0 3.0 1.0 5.0

8.6 4.0 1.6 4.0 6.5 8.3 3.4 1.3 2.5 4.3

8.1 2.7 1.1 2.1 5.5 7.3 2.0 0.3 1.3 4.7

7.8 3.4 0.8 3.1 6.4 7.5 2.8 0.5 1.5 4.2

7.9 4.3 4.6 7.2 0.9 8.6 3.7 3.9 5.5 1.6

1 3 3 2 5 1 2 4 5 3

1 3 5 3 2 1 3 5 4 2

Rank order desirability (0-10) Embassy Suites Embassy Suites Embassy Suites Embassy Suites Embassy Suites Residence Inn Residence Inn Residence Inn Residence Inn Residence Inn

Residence Inn Quality Inn Lexington Suites Guest Quarters Radisson Suites Embassy Suites Quality Inn Lexington Suites Guest Quarters Radisson Suites

Rank order desirability (l--best) Embassy Suites Embassy Suites Embassy Suites Embassy Suites Embassy Suites Residence Inn Residence Inn Residence Inn Residence Inn Residence Inn

Residence Inn Quality Inn Lexington Suites Guest Quarters Radisson Suites Embassy Suites Quality Inn Lexington Suites Guest Quarters Radisson Suites

prospective acquisition candidates. To summarize, these analyses show a way of using the estimated model to make predictions of the desirability of hypothetical mergers among pairs of all-suite hotel chains. Further, they show that the merger and acquisition evaluations based on financial variables alone can be quite different from those using the brand equity attributes. In that respect, the perceived impact of brand equity on acquisition choices is clearly shown. As shown in Tables 3 through 5, the perceived importance of brand equity varies by respondent. These tables enable one to understand the idiosyncratic perceived importance of brand equity factors among members of a committee in an acquiring firm evaluating a potential acquisition. Implementation of our approach for evaluating potential acquisition candidates by a company will naturally involve committee members from the same company, who represent different "functional" backgrounds and responsibilities. Such a composition of a committee may lead to different factor perceptions in an acquisition decision; for example, a committee

1

1

1

3 5 4 2

3 5 4 2

4 3 2 5

1

1

1

3 5 4 2

3 5 4 2

4 3 2 5

member with financial responsibility may focus more on variables such as net income before taxes and debt/equity ratio, whereas a member with marketing responsibility may focus more on brand equity variables and market segments covered. Further, the estimates from the balance model can be utilized to evaluate real acquisition alternatives for each committee member. Thus, our approach offers an efficient procedure for gathering informed opinions of multiple evaluators regarding possible acquisitions in order to accomplish a "new products" strategy through acquisition and provides a basis for informed discussion of various viewpoints expressed by different evaluators.

Conclusions

This article has presented a methodology to measure the impact of brand equity in acquisition choices and has empirically demonstrated its use in hypothetical merger decisions. In the context of the all-suites segment of the hotel industry, it was demonstrated that, for these five

BRAND EQUITY IN ACQUISITION DECISIONS

J PROD INNOV MANAG 1994; 11:221-235

Table 7. Use of Brand Equity Variables by Members of a Hypothetical Committee

Committee Member Respondent l

Brand Equity Variables Brand Recognition

Brand Loyalty

Mean value of the two Mean value of the two firms should increase firmsshould increase after merger after merger The two merged firms should be similar to each other on brand recognition

Respondent 2

Mean value of the two The two firms should merged firms should be similar to each other increase after merger on brand loyalty

Respondent 3

NS

Mean value of the two firms should increase after merger

Respondent 4

NS

NS

Respondent 5

NS

Mean value of the two firms should increase after merger The two firms should be similar to each other on brand loyalty

Abbreviation: NS, not significant in the model.

respondents in this pilot study, brand equity as measured by brand loyalty and brand recognition accounted for between 5% and 30% of the explained variance in perceived desirability of hypothetical mergers. Clearly, a study among a defensible larger sample of relevant decision makers is called for to enable any generalization of the impact of brand equity in the merger decisions in the hotel industry. The study, however, clearly demonstrates that the perceived impact of brand equity on acquisition decisions is idiosyncratic. Hence, the value assigned to a brand will vary depending upon who (across firms as well as individuals within a firm) is evaluating the brand for acquisition. In order to obtain a generalized impact of the effect of brand equity across various industries, the balance model approach can be implemented for other settings and industries. Such a study, though ambitious, will clearly assist in our understanding of the importance of brand equity in the brand evaluation of the merger process. Nevertheless, this exploratory study suggests that one must recognize that contribution of brand equity to

233

acquisition decisions is specific to the decision maker (or in general specific to the owner of acquiring firm). When applied to a real-life problem context, the balance model is a promising approach to: (1) evaluate the possible candidates for acquisition, (2) decipher various attributes, including brand equity attributes, that may be perceived important by a decision maker(s) to determine the desirability of acquisition candidates, and (3) assess the contribution of brand equity variables in determining the acquisition choices. Such analyses could also be performed for a firm's competitors to assess their options and alternatives. The balance model approach can be utilized in various other inter-organizational decisions such as licensing technology, strategic alliances, franchising, strategic market partnerships in a distribution system, and choice of distributor agents or advertising agencies. As interest in inter-organizational marketing relationships increases, we expect that these substantive topics will be fruitful areas for academic investigation. Finally, we point out the limitations of this approach. First, because acquisition decisions are generally based on group judgment, there is a need for a process (or model) that enables integration of distinct viewpoints. For a committee responsible for acquisition decisions of a firm, the proposed methodology yields information on areas of agreement and disagreement among the decision makers in the group as a starting point for discussion and resolution of any differences among the various decision makers involved in the acquisition process, hence, helping in the creation of a "shared mental model" [5]. Next, there is

Table 8. Agreement/Disagreement on Brand Equity Variables by Members of a Hypothetical Committee

Brand yalty Recognition Not important for merger Firms should be similar or increase overall value when merged

Not important for merger Respondent 4

Firms should be similar or increase overall value when merged Respondents 3 and 5

Respondents 1 and 2

234

J PROD INNOVMANAG 1994;I 1:221-235

clearly a need to demonstrate that information obtained from our methodology does in fact improve corporate decision making regarding mergers and that this methodology can in fact predict actual mergers in the industry.

V. MAHAJANET AL.

18. Schiller, Zachary. Procter and Gamble is following its nose. Business Week 28 (April 22, 1991). 19. Singh, Harbir and Montgomery, Cynthia A. Corporate acquisition strategies and economic performance. Strategic Management Journal 8:337-386 (July-August 1987). 20. Smith, Gordon V. Corporate Valuation: A Business and Professional Guide. New York: John Wiley & Sons, 1988. 21. Time. The beauty past. 61 (April 22, 1991).

The authors would like to thank the Marketing Science Institute for their support. Helpful comments were provided by Professor George Day of the Wharton School, Professor Donald Lehmann of Columbia University, Gregory C. Crown of Embassy Suites, Mark C. Wells of Hampton Inns, Inc., Marsha Scarbrough of Mariott Corporation, Professor Jukka Laitamaki of Fordham University, Professor Rick Staelin of Duke University and Executive Director of the Marketing Science Institute, Professor Patrick Barwise of London Business School, and Professor Barry L. Bayus of the University of North Carolina.

References I. Aaker, David A. Managing Brand Equity. New York: The Free Press, 1991. 2. Adelman, S. Symmetric and asymmetric fractional factorial plans. Technometrics 4:47-58 (February 1962). 3. Barwise, Patrick, Higson, Christopher, Likierman, Andrew and Marsh, Paul. Accounting for Brands. London, UK: London Business School and the Institute for Chartered Accountants, 1989. 4. Daniele, D. W. All-Suite players project major growth. Hotel and Motel Management 52 (May 30, 1988). 5. de Geus, Arie P. Planning as learning. Harvard Business Review 66:70-74 (March 1988). 6. DeLuca, M. Suites are "hot" in all price levels. Hotel and Motel Management 53-58 (May 30, 1988). 7. Farquhar, Peter H. Managing brand equity. Marketing Research 1:24--33 (September 1989). 8. Farquhar, Peter H. and Rao, Vithala R. A balance model for evaluating subsets of multiattributed items. Management Science 22:528-539 (January 1976). 9. Green, Paul E. On the design of experiments involving multifactor alternatives. Journal of Consumer Research 1:61-68 (1974). 10. Hopkins, H. Donald. Acquisition strategy and the market position of acquiring firms. Strategic Management Journal 8:535-548 (November-December 1987). 11. Kotler, Philip and Armstrong, Gary. Principles of Marketing. 5th edition, Englewood Cliffs, NJ: Prentice-Hall, 1991, chap. 11. 12. Lubatkin, Michael. Value-Creating mergers: Fact or folklore. Academy of Management Executive 2:295-302 (November 1988). 13. Penrose, Noel. Valuation of brand names and trademarks. Brand Valuation: Establishing a True and Fair View, John Murphy (ed.). London, UK: The Interbrand Group, 1989, chap. 4. 14. Porter, Michael E. From competitive advantage to corporate strategy. Harvard Business Review 65:43-59 (May-June 1987). 15. Rao, Vithala R., Mahajan, Vijay and Varaiya, Nikhil P. A balance model for evaluating finns for acquisition. Management Science 37:331-349 (March 1991). 16. Salter, Malcolm S. and Weinhold, Wolf A. Diversification Through Acquisition. New York: The Free Press, 1979. 17. Schiller, Zachary. P&G is turning into quite a makeup artist. Business Week 66-459 (April 8, 1991).

22. Walter, Gordon A. and Bamey, Jay. Management objectives in mergers and acquisition. Strategic Management Journal 11:79-86 (January 1990). 23. Winters, Lewis C. Brand equity measures: Some recent advances. Marketing Research 3:70-73 (December 1991).

Appendix For a mathematical explication of the balance model to assess the importance of brand equity in the acquisition decisions, let p denote the number of attributes on which the acquiring and acquired firms can be described. Let X = (xol, Xo2. . . . . X0p) be the acquiring firm a n d Xj --- (Xjl , xj2 . . . . . Xjp) be the j-th firm to be acquired, j -- 1. . . . . n. Let the mean and variance of

t-th attribute for the pair (0, j) of the acquiring firm and j-th firm to be acquired be respectively denoted by mjt and Vjr, for each attribute t. These are computed as mjt=(xjt + Xot)/2 v j t = ( x j t - x0t)2/2

Then the overall preference, U0j, of a pair (0, j) can be described as p P U0j = w0 -[- ~ wltmjt -1- ~ w2tvjt, t=l t=l

(A1)

where wit and w2t are the weights for the means and variances and w 0 is an intercept to accommodate the idiosyncratic use of the scale by the decision maker. The use of the balance model for the purposes of evaluating acquisition candidates by an executive committee of an acquiring firm requires implementation of the following seven steps: (1) identification of characteristics or attributes to design profiles of acquiring and acquired companies, (2) construction of profiles of firms according to a conjoint-type design (Green [9]), (3) evaluation of subsets of profiles of acquiring and acquired firms by the members of the executive committee, (4) estimation of the balance model, equation (A1) for each member of the committee, (5) identification of important attributes for each committee member, (6) evaluation of actual candidate firms for acquisition by means of equation (4) separately for each committee, and (7) resolution of

BRAND EQUITY IN ACQUISITION DECISIONS

differences among the committee members to reach a final decision. Once the balance model has been implemented, the perceived importance of brand equity can be determined by: (1) assessing the fit of the balance model with and

J PROD INNOV MANAG 1994;11:221-235

235

without brand equity variables (to assess the perceived contribution of brand equity) and (2) using the balance model with and without brand equity variables to rank order potential acquisition choices (to assess the impact of brand equity on acquisition choices).