Ecuador: Trademark Valuation

Without intention to sustain an eminently economics theory on the nature of the Intellectual Property rights, it is undeniable that its objective and defense lie mainly in factors of economic character. Since through the legal guardianship it is the goal to promote the creativity and the trade, to protect the investments and to the incumbents, to recognize the public and private interests, to favor the cultural, educational, technology, and commercial development in a given society, contributing in this way to its integral development, nowadays indispensable within the processes of integration and globalization, which has had as a consequence the need for strengthening the existing rights as well as the recognition of new rights and forms of exploitation, together with the existence of effective, fast, and economic measures for its effective protection and defense.

Being intellectual property rights a branch of the private law that studies and regulates the regimen of applicable protection to the intangible goods, perceptible through the intellect, that refer to the creations of the human talent or the ones that not necessarily are the result of a creative act; they ensure the progress of the culture and consolidate the freedom of trade and industry.

Several forms of Intellectual Property constitute the basis for the market domination and the continuous acquisition of gains, very often are the principal objective in mergers, procurements, and contracting; which means that, the Intellectual Property is the most important assets that a company can have.

The rights on patents, distinctive signs, and works of the talent are recognized by the economic benefits that from them are derived; at the world level, the companies are licensing, assigning, acquiring, and transferring technology, franchises, signing joint ventures, etc. The banks are accepting these assets as guarantees; the companies as contribution of capital and the Stock Exchanges accept in their markets these intangibles. Hence the importance of having duly assessed the Intellectual Property and within it, the Industrial Property, in its different forms, specifically the trademarks for purposes of the present study.

Basically it could be said that the value of the Industrial Property lies in the right to exclude third parties the use of the property protected on the basis of economic law enforcement, "the notoriety, the image, the confidence, the reputation, heavily obtained after many years, are the best guarantee of future sales and justify the high prices."¹; thus we have that the value of a trademark can consist in its capacity to generate flows of sale.

The trademark, object of legal protection of special interest in the present study, could be defined as that sign legally protected on the basis of economic law enforcement, that thanks to its perceptible external elements by the senses, should enjoy distinguishing feature concerning other signs, both for the identification of the product, so as to differentiate it of the other products in the market, thus facilitating the selective process of the consumer.

We can find more commercial definitions that refer to the value of the trademark, contained in sentences of some American Courts or Tribunals, such as:

"Trademarks help consumers to select goods. By identifying the source of the goods, they convey valuable information to consumers at lower costs. Easily identified trademarks reduce the costs consumers incur in searching for what they desire, and the lower costs of search the more competitive the market."

A trademark also may induce the supplier of goods to make higher quality products and to adhere to a consistent level of quality. The trademark is a valuable asset, part of the ‘goodwill’ of the business. If the seller provides an inconsistent level of quality, or reduces quality below what consumers expect from earlier experience, that reduces the value of the trademark. The value of a trademark is in a sense a ‘hostage’ of consumers; if the seller disappoints the consumers, they respond by devaluing the trademark."²

"The protection of trademark is the law’s recognition of the psychological function of symbols. If it is true that we lie by symbols, it is no less true that we purchase goods by them. A trademark is a merchandising short-cut which induces a purchaser to select what he wants, or what he has been led to believe he wants. The owner of a mark exploits his human propensity by making every effort to impregnate the atmosphere of the market with the drawing power of a congenital symbol … to convey, through the mark, in the minds of potential customers, the desirability of the commodity upon which it appears. Once this is attained, the trademark owner has something of value."³

We start from the fact that "value" should be understood as the expression in terms of a monetary quantity extended to a specific good, in a given time, responding to conditions and special circumstances in which it is utilized; well, concerning which it is hoped to receive a direct or indirect benefit and not necessarily economic.⁴

With regard to the valuation of trademarks we can then also say that the value unlike cost or price,⁵ is the representation of the future benefits to be perceived by the ownership or property of the rights, which is the reason why the value cannot be constant, but instead variable, since it is a relative and dynamic phenomenon that will continually change depending on the increase or reduction of the benefits through out the time.

Now then, it is indispensable to know that the value does not exist in abstract and by itself, since it responds to the context of space and time, which there should be compounded by other elements as the buying potentials and selling, the circumstances of the negotiation, the market, the use that will provide, etc. Bearing in mind always the fact that the trademark will reach its greatest value in combination with other assets of the business.

The cornerstone of the valuation of trademarks is the calculation of the economic benefit that will bring the property of this intangible in order to obtain the fair market value, this is, the present value of the future benefits; it can be said then that it is not assessed to the property as such, but the rights concerning it, as a legally protected good that generates economic benefits.

The economic benefit implies two elements: the recovery of the investment and the income generated by that investment, for which it is also needed to determine the duration of assets or what we know as economic life, which, in trademarks turns out difficult. In order to calculate the amount of investment made or to be carried out in a trademark, there should be included the publicity, promotion, research and development of products and services, recruitment and training of personnel, among many others through out the years. It is necessary to take into account that the economic benefit to be obtained through an investment is variable, since it will depend on many external factors, as the economy of the country in which is developed, which faces us to an objective of continuous mobility, which involves a very complex process.

Now then, in order to simplify a little this complex process of valuation we should know that what basically concerns us is the future economic benefit and in order to have a starting point it would be necessary to obtain the capacity of income generation of the business, value to which if we deduct that income generated by the other assets, we will obtain the current economic benefit generated by the trademark.

One of the most obvious economic effects generated by a trademark is the fact that by its utilization, it is possible to put advantageous prices that is, higher than those of the competition (Rolex, IBM, Mercedes-Benz), which is caused by the enlargement of the demand for the products or services protected by that trademark, attributable all this to the magnetism of the same together with its quality, durability, guarantee, or backing, technology, among other factors.

Another alternative consists of the possibility of obtaining the economic benefit with the utilization of the trademark and the economic benefit without the utilization of the trademark, and the difference among these two values will be that attributable to the trademark as such.

We should understand for economic life the period during which the exploitation of assets is profitable, concept this that should not be confused with that of useful life of assets, that refers to its capacity of service in a given time and that does not turn out applicable to the trademarks since these do not suffer from deterioration or physical obsolescence by its utilization.

Now then, the intangible goods, in our case the trademarks, are not immunes to other types of obsolescence as the functional and the economic, that affect directly its value, which we will come to analyze before entering in what refers to valuation techniques.

Although it is difficult to accept that assets can have perpetual life, with regard to trademarks, these do not have discernible economic life, since the trademark will exist while it is utilized and maintained; however, even the most recognized trademark should continually be maintained through the publicity and promotion, being associated with a product or service that enjoy of acceptance by the public consumer; all of which requires a continuous investment of work, time, and money.

The trademark can disappear with the product if it is as closely identified with the same that it cannot be repositioned. They can also be abused by the imprudent extension of its use concerning inadequate products or the identification of poor quality products, which means that their value would be degraded. It is clear then, that the trademarks are not eternal due to nature, even though they can be perpetuated in their better condition, in view of a good management and the investments made in the same, counteracting thus the effects of the obsolescence.

In addition to the change of styles and tastes, the marks also change; in fact its change constitutes more the rule than the exception; this as a result of the continuous effort of its incumbents to remain an up-to-date trademark in force in the market, consonant with the reality of that moment or period.

Functional obsolescence: It refers to the degree in which assets can carry out the functions for which it was created with respect to one more modern, perhaps technologically superior. Intellectual goods do not suffer of this type of obsolescence, but perhaps indeed in matters of form and style, for this reason its incumbents are continually updating its presentation and using different logos, although always the essence will be the same; for example the obsolescence of an "unleaded" slogan to identify fuel, once currently almost no fuel contains lead, unlike earlier times in which the unleaded fuel represented a competitive advantage; or, the introduction of the slogan "the correct election" of AT&T, that had not had reason to be when there were no options in order to carry out long-distance calls, in times that the services of telecommunications still were not granted the private sector and were provided by a single state enterprise.

Economic obsolescence: Is the determinant of the value of intangible assets, since it constitutes a concept based on the fact that an intellectual good manages to reach its integrate value of market only when it is capable of contributing the profits of saying business and when said gains are capable of providing a rate of reasonable return.

This obsolescence reflects the effect of factors that are found outside the property in itself, this means that the market value of assets can be significantly degraded on the basis of the economy of the business on which exists, to its capacity to generate benefits and to the fact that intangible assets have little functionality in a different area from the business where are developed.⁶ In this regard, in the valuation of an industrial property right there should be considered the characteristics of who requests the assessment or of the selling and buying potentials in a specific market.

For example, the value of an intellectual good in a prosper business whose success guarantees economic benefits that justify a certain level of investment, will be higher than the value of that same intellectual good in case the business is not sufficiently profitable and very superior in case that business generates losses and is in the process of liquidation, in which case the tangible goods are more important and valuable.

It can be concluded then that the economic obsolescence is the determinant of the value, since a business should be capable to produce reasonable profits on the investment and its value will be determined by such capacity or generation power. With this background we come to analyze the factors that involve the applicability of different types of economic obsolescence to the intangible goods, especially trademarks.

Event obsolescence: This term is used to describe the potential reductions of value of a trademark by any event outside what represents normal life of the same, such as the poor negotiations or its poor management. We find a clear example in the case of the tennis player René La Coste who in 1930 initiated the line of production of sports clothes of cotton of excellent quality identified with its name and an alligator; in 1970 the company General Mills acquired the production permit generating a great economic benefit due to its massive exploitation, which deteriorated the image of the trademark which was associated with products of massive production of medium quality whose purchase fever in the consumer had disappeared. Thus, General Mills sold the rights to Crystal Brands who despite its efforts did not manage to reposition the trademark as quality synonym and luxury article, therefore the rights were sold to the French company, Devanlay Inc. who removed the trademark from the market for a long time, until when in 1994 introduced it again to the market with its original characteristics as an article of excellent quality; thus the time has shown that this repositioning has been successful.⁷

In 1976, Kuon-TV and Nebraska Educational Television Network sued the NBC Television Network for the use of its logo of letter "N" with the colors red, white and blue, introduced into the Super Bowl of 1976, to be similar to the point of producing confusion with that of Nebraska. This no intentional act cost the NBC millions of dollars in equipment, services and cash, in addition to the deterioration of its image. ⁸

Technological obsolescence: The vertiginous technological advances means that every minute is developed something new, better, more versatile, more complete, smaller, with greater capacity, speed and resolution; it is enough to cite as an example the integrated circuits that revolutionize day to day our lives, which means that every minute even the computers most modern are being turned obsolete.

Thus, we ask ourselves: What happens with the trademarks that identify these products? although every producer what searches is that its product is related directly to the trademark and that this is immediately identified by the consumer, this constitutes a double-edged weapon concerning products susceptible to the technological obsolescence.

Everything depends on that a trademark is too related to a product that has fallen into this type of obsolescence, because that will drag this to the disregard. This does not always occurs, since some trademarks are well positioned that can move through broad technological gaps, as the case of IBM that has been able to developed through time.

By the symbiosis between trademark and technology it has often been achieved that even a trademark achieves an effect opposite to the technological obsolescence of the product and promotes it or at least maintains it stable in the market, even though it is technologically obsolete, as long as one technologically competitive that replaces it is developed.

Product Obsolescence: A product simply can come out of use or decline in importance and as a result, as long as a trademark also joins together only and directly to this product it will disappear. In the years 1940 and 1950, the automatic transmission in a vehicle was uncommon, associated with the best and more luxurious models; in fact the automatic transmissions had their own trademarks, which were reason for publicity regardless of the vehicle, the same that shown a chromium plated medal in its mudguard or body if they were equipped with this type of transmission. Today the automatic transmissions are considered as a part of the standard equipment of any vehicle, no longer it is considered an element of added value whose distinctive and uncommon characteristics justify an independent trademark that identifies them.⁹

Cultural obsolescence: We should know that although trademarks should be striking, shining, attractive, versatile, with recordation power and consonant with the trends, these should be also politically neutral; since its utilization is likely to generate controversies concerning different standpoints with respect to religious issues, ethnic, racial, environmental, of health and other related cultural genders. Thus in some states of the United States, the descendants of "Crazy Horse" an old leader of the Indian Oglala Sioux who opposed consumption of alcoholic beverages, fought against the utilization of the denomination Crazy Horse in order to identify a beer. Thus, also as example, labeling one case of vegetables as harvested and packed by Mercury Fertilizers, Inc. would not be a good idea no matter how healthy its content is.¹⁰

We have countries as Italy in which the soft drinks for example the Coca Cola, have very small per capita consumption despite being the beverage more sold in the world, this simply by cultural reasons of feeding, since its nationals prefer the water, the wine, the juices and other beverages preferably natural, thus certain soft drinks obviously not as positioned as the Coca Cola suffer from absolute cultural obsolescence in this country.

In addition we have trademarks that in despite being vulnerable are not been affected by this obsolescence, for example we can ask to ourselves if the Marlboro cigarettes trademark is affected by the warning that is forced to carry out in each one of its packets as to be a harmful product for the health.

As we have previously sustained the value of the rights on an intangible good such as the trademarks is due to factors of temporary nature, circumstances of the market and of the business that is developed under such distinctive sign, among others; which causes that the value is variable to the extent that vary these factors, without detriment that the problem to resolve is the certainty that the property is not overestimated or undervalued, without mentioning that although buyer and seller can agree in the value, this not necessarily should be exactly the same for each of them since it obeys to subjective appraisals, but it suffices that exists an agreement which obviously will be the result of certain certainty concerning the valuation process and its end result. Thus there exist different valuation techniques that make it possible for us to avoid or to reduce the margin of error concerning this type of drawbacks, seeking thus an valuation certainty.

It constitutes the technique most direct and easy to understand, since it quantifies the present market value of a good, through the comparative analysis of the exchange of equivalent goods in a given time period with circumstances that permit this comparison, for which an active and public market is required.

The existence of several exchanges of equivalent goods is understood by active market since a single sale does not constitute an active market; unfortunately, there does not exist an active market concerning the exchange of trademarks rights. By public market we should consider that the related information of the transactions should be known or accessible, which is also difficult since by reasons of competition the parties try to maintain the confidentiality of certain details of the transaction.

When these two conditions do not exist will be required greater subjective judgment of the particular case and as a result would become a less reliable technique. The market of real estate is a good example through which there is observed the existence of these two requirements in a given market (geographical area) in which the prices are public and reasonable comparisons can be carried out.

Even in the market of real estate it is necessary to carry out certain adaptations or adjustments that permit an adequate comparison, since usually it is difficult to find an absolutely comparable good, as a result it is necessary to quantify the differences such as its size, form, geographical location, topography, time of the sale, among others. Obviously, practicing this exercise concerning the trademarks is almost impossible.

We have then that the greatest problem of the applicability of a market approach for trademark valuation lies in the comparability. Not only by the fact that a trademark is rarely negotiated individually, but the value of the same will be determined to a great extent by the industry in which evolves, as a result if transactions are used as a basis in order to estimate the value, it will be necessary that these have been carried out within the same industry and subject to the same influences of exogenous factors and risks.

If there is possible to obtain the necessary data, as it has been previously explained, it does not necessarily means that these can constitute comparable transactions, since the profitability of the good is of relevant incidence in the value of the same; thus the profitability of the trademark and its participation in the market should be also comparable. Since, obviously, a trademark that generates a growing source of income will be more valuable concerning that which maintains a source of constant income or ultimately diminishing.

We can conclude that this is a technique little utilized for the valuation of intellectual goods and especially trademarks, due to the unique and symbiotic relation of these with a given product or service; what requires the existence of transactions concerning trademarks that by their similar characteristics to the assessed trademark, permit a reasonable comparison.

4.2 Cost Approach

As mentioned earlier, cost is not just like value, which is the reason why the market value of a trademark can be significantly greater than the costs involved in its creation and development, as well as said value can be significantly reduced by the economy of the business in which the trademark plays its role; since the trademarks, upon having little functionality outside the business for which they have been developed, constitute assets whose value will depend a great deal of the economic conditions of the business or industry in which they are utilized.

The technique of the cost approach tries to assess the future economic benefits through the quantification of the quantity of money required to replace the capacity of service that has the intellectual good; what is known as reproduction cost.

To this point it is advisable to clarify certain terminology and differentiation between what should be understood for reproduction cost, replacement cost and original cost.

Reproduction cost: It corresponds to the one that will be incurred at the date of realization of the valuation to create one it replicates of the property. With regard to trademarks, the reproduction cost would be represented for the costs of planning, creation, and design, research, legal advisory services, publicity, and promotion incurred to develop the trademark matter of analysis.

Replacement cost: It corresponds to the one that will be incurred at the date of realization of the valuation in order to obtain an equivalent property with regard to its objectives but that does not constitute a retort since it will fulfill the same profits required but more efficiently.

The clearest example to elucidate the difference between reproduction and replacement cost would be that of a computer program. In the first case it refers to the cost to create an identical software, in the same language of command, flow charts, modifications, patches, codes, etc. while in the second case will be the cost of a software in the newest and efficient language, that adjusts to the current configurations of hardware, as a result it will fulfill with the same profits that the previous one but utilizing a different process.

Original cost: It corresponds to the cost incurred under specific circumstances, at a given time, that will be that of the purchase or creation of assets, usually agrees with the value registered in the accounting books. It could be said that there is related to the value concept only by coincidence since the costs incurred in a time and specific circumstances could have been high or low, which is the reason why cannot reflect a true value; above all in the valuation of intangible assets, especially trademarks one should be very careful upon utilizing this type of cost, which instead should turn out only referential and as starting point.

Returning to the cost approach, this is sustained in that the price of the new property should be proportional to the economic value of the service that the property can provide during its productive life. Now then, a trademark does not reach its maturity as a direct result of a single investment, but instead should grow gradually in its value as a result of many years of investment, which means that in this approach should be considered the depreciation that results from the functional and economic obsolescence applicable to these intellectual goods.

To be able to carry out the previous operation it will be necessary primarily to obtain the original cost of the trademark, that is the historical costs of all the investments carried out in its development during the different years, then this cost must be updated to the present value of the currency through a system of monetary correction that makes it possible to revalue the categories, taking into account inflation indexes to the consumer,¹¹ which will make it possible for us to know how much it would currently cost what was spent during the years. The complexity in this operation is to determine when it began and when it finished the development of the assessed trademark, to which is added the fact that the investments in publicity and promotion are also designed to incentive the sale of products and there are not carried out exclusively in order to construct the trademark.

In the event that there are no records that make it possible to know the historical costs of the investments made, there is the possibility of carrying out a comparison, whenever this is reasonable and the cost of creation of the same is known, for which there must be taken into account, among other aspects, the size of the market in which the trademark competes, the participation of market of the trademark, prices of the products, or services identified with the trademark, advertising support, profitability of the product or service, research of market concerning the recognition by the public consumer, extension of the knowledge of the trademark outside the sector of consumers and geographical sector of market.

It is also said that it is possible to obtain an estimate of the value of the trademark analyzing the cost involved in the necessary works to be carried out for the change of same. The change not only includes the printing of new stationery and replacement of labels, but also involves primarily, the entire consultancy related to the new name which is very important today with the globalization of the economy, including research on the use of similar trademarks or easily confused, a linguistic search in order to determine its possible meaning in other languages, the analysis of the name by psychologists, associates, and experts of the industry, the market studies analyzing the reactions of the consumer, shareholders and stock exchange in general; in order to then enter to preliminary tests of acceptance in the market, design of packages and presentations, publicity campaigns and promotion in radio, television and press, etc. Thus, we can explain ourselves how the change of name of "Esso" by that of "Exxon" is estimated had a cost of approximately 150 million dollars.¹²

Although the cost approach contains the necessary elements to be able to determine the market value of assets, this results from difficult application in trademarks since one of those important elements is the quantification of the economic obsolescence of these intangible assets in which can also affect social factors, cultural, demographic, ethnic, among others, as it has been already explained.

As an example let us take two trademarks with the following characteristics: trademark A is associated with high profitability products in a growing industry with little competition, with a considerable recognition by the consumer and a potential capacity to be extended to new products. While trademark B is related to products of low profitability in a diminishing industry with a great deal of competition; with reduced recognition by the consumer and the impossibility of being extended to new products.

Being both national trademarks and with the same characteristic with regard to the intensity of their advertising campaigns, the elements of the cost approach upon calculating its cost of reproduction very probably yield the same value for both trademarks; the costs of research development, publicity and promotion will probably be the same; however, it turns out obvious, that the market value of the trademarks will be considerably different. This difference will be due to the economic obsolescence present in each trademark, whose quantification demands us to apply an income approach considering the value of other assets related to the turn of the business. This is precisely what makes it possible for us to put emphasis on the preeminence of the income approach, in the valuation of trademarks.

However, the cost approach provides an indication of value to be utilized as starting point for the later application of other approaches, since its potential margin of error induces to the use only as referential value unless a recently created trademark is assessed in which case constitutes one of the most practical and methodologically adequate tools.

The foregoing is explained upon knowing that there exist certain important factors that are not directly reflected in the methodology of application of this approach and that as a result, they need to be considered independently, these factors include;

1) The not incorporation of information referring to the quantity of economic benefits associated with the trademark, those which are outlined by the existing demand for the product or marked service and the generated profitability.

2) The not consideration of information on the economic trend of the benefits, explained previously to comparing the trademark productivity through the example of the signs A and B.

3) The period during which it is expected to receive the economic benefits constitutes another element unincorporated directly and that presents great importance in the valuation.

4) The risk associated with the reception of the programmed benefits has not been considered as a calculation factor and in fact affects the value. A high risk causes that the income expectations are speculative.

5) The adjustments necessary for reflecting the economic effects of the obsolescence should be calculated separately and usually are difficult to quantify.

We depart from the point that market value of intangible assets can be expressed as the present value of the future economic benefits that will be derived from the property of this during its productive life. There is then as a basis in this approach, a monopolistic position in which a business is capable of receiving an excess or greater profit margin with respect to the standardized costs of similar products, being achieved this through the intellectual property for example trademarks and what they represent on the basis of its positioning, and to which are attributed this income.

This causes that the income approach is a strong calculation tool. Thus, an IBM computer can cost more than one technologically identical but identified with a less known trademark and the consumer will be willing to cover this difference.

The three principal ingredients of the income approach are: a) The quantity of income flow that can be generated by the good, b) To assume a given duration of the income flow, c) To assume the risk related to the income flow expected. These elements can be related by a simple formula¹³

Where

V= Value of the gain flow attributable to the property.

I= Income derived from the utilization of the property, representative of the net income flow and payments.

r= Risk associated with the utilization of the property and the acquisition of the expected gains. It technically constitutes the rate of deduction that makes it possible to know the current value of future benefits taking into account the risk of carrying out a given business.

For example, if an annual earning of $100 dollars is received to perpetuity, and its rate of deduction is of 10%, then the value of that income is of $1000. Now, this is really the simplest of the examples and that rarely happens in real life, since usually it cannot be expected that a good produces income to perpetuity; as a result the calculation will be more complex and the determination of a rate of deduction turns out even more complex too.

It is necessary to make clear the concept and application of what constitutes the discount rate that with regard to investments it is comparable to the opportunity cost as component of indispensable assessment within an income approach.

Therefore, we have that this component measures the economic compensation of an investor by its commitment to given capital investment. It is precisely this commitment, which causes that the investor renounces other opportunities for investment and assumes the risks with which it is committed. The factors that affect this component of value include inflation, the liquidity, real interest rate, and measurement of the relative risk. As mentioned before, the discount rate is utilized to transfer the future economic benefit to present value, whose formula applied for the industrial property is presented in the following equation:¹⁴

Where,

V = Value of the Intellectual property

CF = The amount of net cash flow during each successive time period

i = The required rate of return on the intellectual property

If it is expected that the future cash flows increase at a constant rate, the introduction of this factor in the formula aforementioned, through algebraic methods, provides us the following useful equation:

Where,

g= Constant growth rate expected

Following the words of Smith and Parr, our authors guiding in this matter, when the growth rate is expected to be higher than the discount rate (i), the equation turns out useless, and a specific projection for every year will be required.

Precisely by the fact that the property of a business or assets has as a purpose the acquisition of a return by the investment that this requires, the income approach constitutes the better indicator of value for this type of intangible assets, such as the trademarks; without ruling out, of course, the applicability of other adequate systems of trademark valuation as that of the residual method, the method of advantageous prices, the method of exemption in the payment of royalties, the financial method, and that of the global income.