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The Honest Tea Story and the Next Chapter With Coca-Cola

Sixteen years ago when I graduated from the Yale School of Management, I was eager to continue my career path as a non-profit activist.  If a fortune teller could have looked into my future and told me I would end up running a mission-driven organization that 1) Helps eliminate billions of empty calories from the America diet; 2) Protects thousands of acres of agricultural land and surrounding ecosystems from chemical toxins and; 3) Creates economic opportunity in the developing world, I would have asked, “What’s the non-profit creating all this exciting change.

The surprising answer is that the enterprise helping to make all this happen isn’t a non-profit, but is in fact a beverage company, quite an unexpected twist for me since my only prior beverage experience was a lemonade stand in elementary school.  And yet the story of Honest Tea’s evolution as well as the next chapter in its growth, which starts next month, provides a window into how change happens in corporate America.

Back in 1998 it didn’t take focus groups to understand that consumers were buying sweet drinks.  Yet my co-founder Barry Nalebuff and I were thirsty for something different, and we suspected that despite the millions being spent on market research, the big corporations were missing the opportunity for a less-sweet alternative.  We brewed five thermoses of tea in my kitchen and brought them, along with a repurposed Snapple bottle with a label pasted on it to the local Whole Foods office near my Bethesda, MD home.  The buyer placed an order for 15,000 bottles, and we were in business — provided we could figure out how to make that much tea!

Our less-sweet taste profile made it more challenging for us to grow.  We received more than our share of rejections from distributors and retail buyers who didn’t think we were peddling what the public wanted.  So instead of getting to stores via beverage trucks, we had to arrange/beg for our drinks to be delivered through own alternative distribution channels – natural food distributors to the natural channel, cheese distributors to gourmet stores, corned beef distributors to delis, and charcoal distributors to reach supermarkets.  Our patchwork distribution network certainly made for a slower path to growth, but it meant that when we did finally gain some traction, we had a clear point of difference on the beverage shelf.

We started to gain some momentum just around the time the rest of the population was beginning to pay attention to what they were putting in their bodies.  Though the low-carb craze started to fade in 2000 – even an all-bacon diet eventually loses its appeal — it helped train consumers to read nutrition panels.  In addition to our lower-calorie profile, our commitment to organics also resonated with consumers increasingly interested in products that emit fewer toxins into the ecosystem, not to mention into their bodies.  So we kept growing through the dot-com bust and even the Great Recession, sustaining an average annual compound growth rate of 60%.

But even with our aggressive pace of growth, we kept losing money.  Our margins were thin because our buying power was weak compared to the big brands, and we needed to hire more people to keep building the brand up and down the street.  In order to stretch our limited funds, we’ve always been very frugal – we share hotel rooms when we travel and cram quite a few people into a big office space filled with used desks.  Our ability to survive on fumes was critical because there were more than a dozen bottled tea brands that came and went during our first five years, many of them well-funded, including Coke’s own Mad River, a brand they bought in 2001 and discontinued a few years later.

But more importantly, we were fortunate to develop a group of angel investors who helped us stay in business by continuing to support us financially with equity and debt investments.  Why did those investors keep writing us checks, even though we were bleeding cash?  Some did it because they liked our drinks and wanted to keep their fridges stocked with our organic, lower-calorie drinks.  Most supported us because they believed there was a good long-term investment opportunity in making and marketing healthier beverages as Americans became more health conscious and environmentally aware.

The only way we were able to stay in business was because our investors believed they would gain a return for their investment.  Given our margins, dividends wasn’t going to be an option, so an exit would have to come either via acquisition or IPO.  For a few months in 2007, it seemed like going public was a viable path for an emerging beverage company.  Jones Soda Company, which had sales of $40 million had a market capitalization of more than $700 million.  But the 2008 market correction brought that notion, and several companies, including Jones, back down to earth.  There are a handful of beverage companies, such as Arizona (private) or Hansens (public) that have managed to stay independent while gaining national scale.  But their offerings are modeled after the prevailing sugary drinks that predominate the beverage shelves, rather than challenging them.

Ultimately, distribution is the key to winning in the beverage industry, and Jones struggled to grow with a patchwork of independent distributors, which made it challenging to gain and keep grocery chain accounts.  So when Honest Tea was approached by the Coca-Cola Company in 2007 as a prospective investor, and possible acquirer, we knew this was a partner worth talking to.

Given our small size and prospects for continued fast growth, we weren’t interested in exploring an acquisition with Coke.  Instead we negotiated for them to make a minority investment with an option to buy the rest of the company three years later.  As we were preparing to announce the Honest Tea-Coke transaction back in 2008, some suggested that perhaps we wouldn’t want to disclose the relationship – there was a concern that the Honest brand might suffer a backlash from loyal fans who loved our mission-driven approach, but would boycott a brand connected to a large multi-national not known for its commitment to organics.  But I argued that if we genuinely believe in our mission of democratizing healthier and more sustainable drinks, then we are obligated to find a way to take it to scale and Coke is the best partner to help make our drinks are available wherever beverages are sold.

The only way Honest Tea could operate as a non-profit, both in terms of mission, and in terms of financial performance was because there was a partner out there who would make the investment opportunity worthwhile to our investors. And now that we’ve reached national scale, Honest Tea has the potential to deliver meaningful margins to Coke, while continuing to expand our impact.

I have already heard from some of our hardcore loyalists (there are people out there with Honest Tea tattoos) who threaten to stop supporting Honest Tea if Coke does purchase the rest of the company. I would hate to lose those consumers because we wouldn’t have been able to build our company without them.  But I’d like to pose two challenges to them – if we are still selling a lower-calorie, organic, Fair Trade beverage, don’t we deserve your support? And second, to the extent you are concerned about the role that big food companies play in our society, isn’t it better to have them investing in solutions like Honest Tea?

There is a Chinese proverb printed underneath our bottle caps that also appears as both a greeting, and a warning, on the front wall of our office.  It speaks to the skeptics who thought we’d never make it as well as to those who argue there is no way a mission-driven company will survive inside the walls of a publicly-traded company judged quarterly on its ability to extract profits.  It reads, “Those who say it cannot be done should not interrupt the people doing it.”

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