Protecting Honest Tea's brand under Coke's big bureaucracy

Washington Post Staff Writer
Saturday, March 5, 2011; 7:20 PM

Gary Hirshberg likes to joke that he can "count on one finger" the number of entrepreneurial companies that manage to thrive after they have been sold to big corporations.

It's no joke. The continued success of his yogurt company, Stoneyfield Farm, eight years after its sale to Groupe Danone is the rare exception to the rule that big corporations invariably screw up their entrepreneurial acquisitions, first by overpaying for the hot young companies, then by driving away their key employees and finally by sucking all the innovation and promise out of them by imposing their bureaucratic ways of doing business. It's not uncommon for the founders to wind up buying the battered firms back at a fraction of what they sold it for.

Seth Goldman, however, is confident he can buck the odds. The youthful founder and guiding hand behind Bethesda-based Honest Tea completed the sale of his organic drink company to Coca Cola last week after a three-year experiment in which the soda giant took on the role as distribution partner and minority investor.

The courtship has not been without some of the usual stresses and strains, most notably over Honest Tea's proud boasting that its products contain none of the corn syrup that is the favored sweetener of the makers of soda pop. But any reservations that Goldman might have had about consummating the relationship were more than offset by the considerable power of Coke's production and distribution system, lowering costs for ingredients and bottles and helping to increase the number of outlets carrying its products from 15,000 to 75,000.

As a result, Honest Tea's annual sales have tripled to $72 million, gross profit margins have more than doubled, and Goldman has become more convinced than ever that the best way to drive unhealthy drinks from the American diet is from inside Coke's formidable vending machine.

In fact, Goldman is so convinced that he insisted on plowing most of his proceeds from the sale back into a minority stake in Coke's newest brand, an unusual arrangement that he insisted on as a condition for staying on to manage Coke's newest brand. The structure was modeled after one that Hirshberg, a member of Honest Tea's board of directors, struck with Danone.

That Coke agreed to the ownership stake is an indication that it appreciates how much Goldman is the Honest Tea brand - not just its chief spokesman but the person who best understands the product, its customers and the relationship between them. But it's also a measure of Goldman's maturity and wisdom to understand how important it is for Honest Tea and for Coke that he continue to have serious skin in the game.

"The business world is riddled with tales of entrepreneurial brands that lost their spark after they were acquired," Goldman wrote earlier this month in a revealing post for Inc. magazine. "Once the founder loses ownership, his or her motivation to keep building, inspiring and sacrificing diminishes, and as a result, the rest of the team transforms into managers instead of entrepreneurs."

Goldman's immediate challenge is to convince Honest Tea's loyal and crunchy customers that the sale to the sultans of sugar water will in no way change the company's commitment to producing health drinks in an environmentally sensitive way through fair and honest dealings.

Like the chief executive of any hot young company, however, his more serious challenge is to prove he can finally turn Honest Tea from a fast-growing company into a profitable one. He long ago concluded that, in an industry so thoroughly dominated by just two companies, there was little chance that Honest Tea could become a billion-dollar brand on its own.

As it happens, Coke needs Honest Tea as much as Honest Tea needs Coke. It is not only that soda companies have come in for public criticism and regulatory scrutiny as perpetrators of childhood and adult obesity, and that Honest Tea provides it with some welcome political cover. It's also that, in markets such as the United States, sales of traditional soda have been flat for more than a decade as a result of changing demographics and shifting consumer taste, particularly among younger and more affluent consumers. Across the beverage industry, much of the growth now comes from healthier products.

Honest Tea is hardly Coke's first foray into the category, but most of the earlier acquisitions have not ended well. Failure tended to follow a pattern. Coke would try to use its powerful distribution network and exclusive contracts to re-launch its new brand on a national scale, placing it in as many supermarkets, convenience stores, restaurants and vending machines as it could as quickly as possible. To generate sales, it offered deep discounts and invested heavily in expensive national advertising campaigns. When it didn't work, embarrassed headquarters executives moved quickly and quietly abandoned their new brand. "Boom-splat," as one industry official put it.

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