Brand Equity: Definition, Importance, Effect on Profit Margin, and Examples

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 their margin. The firm's brand equity enables it to make a bigger profit on each sale.

Key Takeaways

Brand equity refers to the value a company gains from its name recognition when compared to a generic equivalent.
Brand equity has three basic components: consumer perception, negative or positive effects, and the resulting value.
Brand equity has a direct impact on sales volume and a company's profitability because consumers gravitate toward products and services with great reputations.
Often, companies in the same industry or sector compete on brand equity.

Investopedia / Yurle Villegas

Elements and Importance of Brand Equity

Brand equity has a few 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. Intangible value is realized in 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.

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

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. Plus, 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.

The concept of brand equity was first introduced in the 1980s by David Aaker, a marketing professor at the University of California, Berkeley.

Real-World Examples of Brand Equity

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 that customers already have with Campbell's make the new product more enticing than if the soup has an unfamiliar brand name. Below are some other examples of brand equity.

Tylenol

Manufactured since 1955 by McNeil (now a subsidiary of Johnson & Johnson), Tylenol is a first-line treatment for mild to moderate pain. 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, Children's Tylenol, and Tylenol Sinus Congestion & Pain.

Kirkland Signature

Started in 1995, the Kirkland Signature brand by Costco has maintained positive growth, representing a growing portion of the company's overall sales. Signature encompasses hundreds of items, including clothing, coffee, laundry detergent, food, and beverages. 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.

Starbucks

Rated the sixth-most-admired company in the world by Fortune magazine in 2020, Starbucks is held in high regard for its pledge to social responsibility. With more than 31,000 stores around the globe in 2019, Starbucks remains the largest roaster and retailer of Arabica coffee beans and specialty coffees.

Coca-Cola

With a profit margins between 25-30%, Coca-Cola is often rated the most valuable 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

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 was the top luxury brand in 2020, 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, two top companies—Home Depot and Lowe's Home Improvement—consistently rank as the top two hardware and home store brands in the Harris Poll EquiTrend's brands of the year list. The 2020 survey found that Lowe's was the top hardware company in terms of brand equity and Home Depot came in second. However, in 2019, the roles were reversed, with Home Depot beating out Lowe's for the top spot.

A large component of brand equity in the hardware environment is consumer perception of the strength of a company's e-commerce business. Both Lowe's and Home Depot are industry leaders in this category. It was also found that, besides e-commerce, both companies have high familiarity among consumers, allowing them to further penetrate the industry and increase their brand equity.

Why Is Brand Equity Important?

Brand equity is important for a number of reasons. One reason is increased customer loyalty. A strong master brand equity can lead to increased customer loyalty, as consumers are more likely to choose a brand they know and trust. This can lead to repeat purchases and a more stable customer base. Another reason is higher perceived value. Brands with strong equity are often able to command higher prices for their products or services, as consumers perceive them as having greater value. A strong brand can also give a company a competitive advantage in the market, as consumers are more likely to choose a familiar brand over a lesser-known one. This can help the company gain a greater market share, as consumers are more likely to choose a trusted brand over competitors. Additionally, brands with strong equity often have a positive reputation and are able to provide high-quality products or services, which can lead to greater customer satisfaction.

What Are the Elements of Brand Equity?

The elements of brand equity include:

Brand awareness: This refers to the extent to which consumers are familiar with and recognize a brand.
Brand loyalty: This refers to the degree to which consumers consistently choose a specific brand over others.
Brand image: This refers to the perception that consumers have of a brand and its associated attributes, such as quality, reliability, and uniqueness.
Brand associations: This refers to the emotional or psychological associations that consumers have with a brand, such as feelings of trust, reliability, or nostalgia.
Brand value: This refers to the perceived benefits and overall value that consumers attribute to a brand, which can influence their purchasing decisions.

What Factors Affect Brand Equity?

There are several factors that can affect brand equity. One factor is the quality of products or services. Consumers are more likely to have a positive perception of a brand if they consistently provide high-quality products or services. Marketing and branding efforts are also important. Consistent and effective marketing and branding efforts can help build and maintain a positive brand image. Customer experiences also play a role in brand equity. Positive customer experiences can lead to increased loyalty and positive brand associations. The brand's reputation is also important, as consumers are more likely to choose a brand they perceive as trustworthy and reliable. Competition can also impact a brand's equity, as consumers may have multiple options to choose from. Finally, changes in consumer preferences or trends can affect a brand's equity, as consumers may shift towards different brands or products.

The Bottom Line

Brand equity refers to the value that a specific brand adds to a product or service. It is the positive perception or emotional attachment that consumers have towards a brand, which can influence their purchasing decisions and overall loyalty to the brand. It is created through consistent marketing efforts, positive customer experiences, and the overall reputation of the brand. Companies with strong brand equity often have a competitive advantage in the market and can command higher prices for their products or services.