Jul 2010
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Can Honest Tea Say No to Coke, Its Biggest Investor?
HONEST TEA makes juices and teas with natural sweeteners, including the pouch drinks Honest Kids. In early 2008, Coca-Cola took a 40 percent interest in the Bethesda, Md.-based company, which had revenue of $47 million last year. Coke has an option to buy the whole company next year.

THE CHALLENGE Maintaining Honest Tea's integrity while adjusting to a new relationship with a financial backer that has a different way of doing business.

THE BACKGROUND Seth Goldman, now 44, left a mutual fund job in 1998 convinced that he could develop a wholesome alternative to sugary drinks that never seemed to quench his thirst. He joined forces with Barry Nalebuff, a professor he knew from the Yale School of Management, to start Honest Tea.

For Mr. Goldman, coming up with new products and flavors like Pomegranate White Tea or Black Forest Berry is the entertaining part of the beverage business. The grittier part is getting the product distributed on a profit-making scale. Mr. Goldman scored Honest Tea's first notable sale, to Whole Foods Market, by carting in several insulated containers of teas and a sample bottle — an empty Snapple container with a makeshift label — that persuaded the grocer to order several cases.

Then Mr. Goldman spent nearly a decade trying to build distribution. That meant lots of trade shows, cold calls and nights at modest motels, where he and other Honest Tea employees doubled up to save money while they marketed the company's drinks and signed up independent distributors. "You can build a great brand, but you can't ship this through the mail," he said. "Beverages have a high turnover, and you're out of the game unless your product is being restocked and on the shelf."

Then, in early 2008, Honest Tea sold a minority stake, for $43 million, to Coca-Cola's Venturing and Emerging Brands group, which was expanding Coke's ability to meet consumer demand for lower-calorie drinks. Honest Tea products soon got much wider distribution, through Coke, on grocery shelves and college campuses across the country.

But meshing Honest Tea's socially responsible, ecologically aware, small-company sensibility with the huge international brand of Coke has not always gone smoothly. A few months after the deal, Coke started vetting Honest Tea's ingredients to make sure they complied with federal requirements and noticed Honest Kids' packaging had prominent lettering that promised: "no high-fructose corn syrup."

Executives at Coke construed the phrase as an implicit rebuke of its products, some of which contained the controversial factory-produced syrup. "We got a strong request to change the wording," Mr. Goldman said.

THE OPTIONS Under its deal with Coke, Honest Tea retained control over its products and contents. Mr. Goldman believed that drawing attention to the absence of corn syrup was crucial to being true to the Honest Tea brand. The packaging, he said, was designed to highlight attributes — low sugar content and organic ingredients — that attract purchasers, typically parents, to buy this kind of product.

Honest Kids is expected to account for about one-third of Honest Tea's projected $70 million in sales this year. "We were not going to drop Honest Kids, so we had to figure out how to handle this," Mr. Goldman said.

At the same time, Coke had been facing declining demand for its soft drinks, which was why it had been investing in small beverage companies like Honest Tea and the fruit-smoothie maker Innocent Drinks. In late 2008, Mr. Goldman traveled to Coke headquarters in Atlanta to seek a solution. "I met with various people in the company who explained their belief that high-fructose corn syrup is comparable to sugar in its health impact."

Mr. Goldman decided against trying to resolve the scientific point. "Our point of view was that we were not going to get into the debate over whether high-fructose corn syrup is the same as sugar," he said.

One option Coke presented, he said, was simply to eliminate the "no high-fructose corn syrup" banner. But Mr. Goldman argued that including the notification was a key signal to buyers that there were no hidden ingredients in the drink, an important issue given the growing chorus questioning whether high-fructose corn syrup contributed to the risk of obesity in adults and children. (One Honest Kids competitor, Kraft Foods, announced in April 2008 that it was eliminating the syrup from its Capri Sun juice pouches.)

Coke also suggested that Honest Tea delete the corn syrup reference and substitute, "Sweetened with organic cane sugar." But that, Mr. Goldman said, went against Honest Tea's tenet that the consumer "does not want a product that is highly processed."

Another option Coke floated was adding the phrase "No fake stuff" to the packaging. Honest Tea rejected that, Mr. Goldman said, because it was subjective and would not persuade people to buy their products.

A Coke spokesman, Scott Williamson, said the company would not comment publicly on its differences with Honest Tea. He did note that the smaller company's "decisions were made on their understanding of their customers" and that Coke maintained that "sugar is sugar is sugar."

At the time Honest Tea's partnership with Coke was announced, some of the smaller company's customers complained publicly that its new financial ties would compromise the brand's integrity. On the other hand, Mr. Goldman understood that taking too combative a stance might damage Honest Tea's relationship with Coke. That relationship could culminate in a total sale of the company to Coke next year, an outcome that Mr. Goldman said is "very probable," but not guaranteed.

WHAT OTHER OWNERS SAY We solicited comments from several business owners who have had similar experiences:

Tony Hsieh, chief executive of Zappos, who has remained with the online shoe retailer since it was bought by Amazon:

"When Amazon acquired Zappos in 2009, we co-created a document that described our working relationship together, which we refer to internally as our ‘Five Tenets' document. It states that Amazon recognizes the value of the Zappos culture and will seek to protect it. More importantly, it explicitly states that we will make our own decisions independent of Amazon. The document has proven to be a helpful ongoing reminder of both sides' understanding."

Gary Hirshberg, chief executive of Stonyfield Farm, who has remained with the yogurt company since it was acquired by Group Danone (Mr. Hirshberg is a member of Honest Tea's board):

"My advice to C.E.O. Seth Goldman: Stick to your knitting. Keep the honest in Honest Tea. If you don't, you'll regret it. And so will Coke. I would argue that Honest Tea is providing more value to Coke by blazing its own trail than by adapting to Coke's."

Steve Munford, president of ActiveState, an antispam software development company, who stayed on after selling it to Sophos, an antivirus software maker. He is now chief executive of Sophos:

"Both Coke and Honest Tea bring value to this partnership, but they also have shortcomings. In fact, this is what probably encouraged them to join forces: Coke is seeing slumping sales in sugary drinks and wants to expands its portfolio, while Honest Tea needed a strong partner to grow their brand visibility and sales. The worst outcome is that both parties lock horns and refuse to come to a decision."