The first time Seth Goldman went to see a buyer at the Fresh Fields natural-food supermarket in Rockville, he brought five thermoses filled with tea that he and Barry Nalebuff had brewed in Goldman's kitchen in Chevy Chase. He brought an empty Snapple bottle and replaced the Snapple label with his own. Nalebuff called their new low-sugar beverage Honest Tea.
That was six years ago. Honest Tea went on to become the leading organic tea, according to SPINS, a natural foods market research firm. This year, the Bethesda-based company with 18 employees is on track to reach sales of $7 million and turn its first profit, Goldman said. It has attracted investors such as "Bloom County" cartoonist Berkeley Breathed, Timberland Co. chief executive Jeffrey B. Swartz, and Gary Hirshberg, chief executive and president of organic yogurt maker Stonyfield Farm.
Honest Tea Inc. is no threat to beverage industry giants Coca-Cola Co. and Pepsico Inc., whose combined annual revenue is about $50 billion. But Honest Tea may soon spend more time alongside the big guys. In June, the company introduced a plastic bottle, which will allow Honest Tea to enter territories such as schools, health clubs and airplanes, where plastic is preferred for weight and safety reasons.
The plastic Honest Tea bottles were aboard the first flight of Independence Air, the new low-cost airline that took off from Dulles International Airport in May. Independence Air settled on Honest Tea after months of research, which revealed that travelers hankered for iced tea. "[Honest Tea] is keeping with our brand promise of being different, being independent . . . being a little bit surprisingly better than people expect," said Rick DeLisi, an Independence Air spokesman.
For Goldman, 38, and Nalebuff, 46, Honest Tea's recent foray beyond the organic-beverage aisle is only the beginning. "We'd love to be sold in Wal-Mart and Target and the Price Clubs," Nalebuff said. "We want to be the first real mainstream organic beverage."
Launching a beverage brand in today's crowded marketplace is a feat even for the likes of Coke and Pepsi. The model most often cited model is Snapple, which was created by three friends from Long Island who started off selling their tea in New York delis. The founders eventually sold Snapple to Quaker Oats for $1.7 billion. Quaker botched marketing and distribution and unloaded Snapple for less than a quarter of what it paid for it. At its peak in the late '90s, Snapple Beverage Group had annual revenue of more than $700 million.
Snapple, now part of Cadbury Schweppes PLC, retains a dominant 28 percent share of the premium beverage sector.
"Snapple was the right product at the right time in the right venue -- New York City -- where lots of the media is located," said beverage industry analyst Emanuel Goldman (no relation to Seth Goldman), an independent consultant in Hillsborough, Calif. "Most products aren't that lucky. Remember Clearly Canadian? It's still there, but barely. Even Coca-Cola's Fruitopia fell on its face. It's very difficult to start from scratch as Snapple did and become successful."
"The biggest bottleneck for growth is distribution and capital," said Tazo Tea chief executive Tal Johnson. Tazo, a subsidiary of Starbucks, and Honest Tea have gone head-to-head in the natural food arena. (Tazo has never released sales figures.) In April, Tazo sealed a major distribution deal with Kraft Foods Inc., giving it an edge in the race to supermarket shelves.
Seth Goldman called distribution "a real estate war fought every day." He has gone to stores to find Honest Tea's shelf space taken up by Snapple.
Natural foods and beverage industry veterans say winning the distribution battle is much harder these days because of consolidation among distributors, bottlers and supermarkets.
"Nantucket Nectars had the benefit of getting involved with mom-and-pop [stores] through third-tier soda companies and beer distributors. Now there are fewer distributors and a lot of them own brands and are more hesitant to take on a small brand," said Jim Crooks, brand manager for Nantucket Nectars.
"Distributors will look at small brands. They want to be in on the next big thing, the next SoBe" -- South Beach Beverage Co., sold to Pepsi in 2000 for $370 million -- "but they're impatient. So they churn small brands. That may be good for the gambler, but not if you're one of the chips," Johnson said.
To get Honest Tea into the refrigerator case, Goldman has come up with some creative arrangements. He worked with a corned beef distributor, a cheese vendor and a charcoal dealer. In the past two years, Honest Tea has signed more conventional deals with Canada Dry distributors on the East Coast and a Snapple distributor in Washington state, Goldman said. "It's like a minor league player getting the call to go the majors."
Honest Tea has also branched out to chains such as Sheetz Inc. convenience stores. And it will soon be in Rite Aids in the Washington area, its first foray into drugstores.
Wider distribution brings new problems. A gasoline station in Altoona, Pa., for example, doesn't give Honest Tea the same platform as Whole Foods, Honest Tea's biggest account. And in the mainstream marketplace, Honest Tea will compete against Arizona Iced Tea, Nestea and, of course, Snapple.
So far Snapple regards Honest Tea mainly "as a regional player," said Steven Jarmon, a spokesman.
Going mainstream, though, is "worth the risk," Johnson said. "When it works, the payoff is huge."
Nalebuff and Goldman didn't start out with the goal of quenching Middle America's thirst. The two met in the mid-'90s at Yale University, where Goldman was an MBA student and Nalebuff was one of his professors.
Before going to business school, Goldman had held a variety of jobs: deputy press secretary for Sen. Lloyd Bentsen (D-Tex.), director of an AmeriCorps demonstration project in Baltimore and vice president at Calvert Group Ltd.
At Yale, Goldman promptly began hunting for a business venture.
"Seth was clearly entrepreneurial," Nalebuff said. While discussing a case study of the cola wars in class at Yale one day, Nalebuff mentioned a problem that had been plaguing him as a consumer for years: Why did all the beverages out there have either no sugar or lots of sugar and nothing in between?
"There are many variations on cola. There's grape, ginger, caffeine, no caffeine, but there's no variation on how sweet it is," Nalebuff said. "Most of beverage companies have not catered to adults but 16-year-old boys with big bladders. We're thirsty, too."
Nalebuff the economist figured that the price of a beverage you'd find in your supermarket aisle reflected mostly the cost of packaging and distribution. So to be affordable, a beverage had to cost pennies per bottle to make -- hence the corn syrup and carbonated water formula that prevailed for so long. For years, Nalebuff said, "I was stuck on the idea of mixing orange juice and club soda, or cranberry juice and club soda. But that is not a business."
The puzzle of the low-sugar drink remained unsolved until Nalebuff went to India in 1997 and sampled some tea at a tea estate. Premium tea, he learned, cost about 5 cents a cup to produce.
Goldman quit his job with the Calvert Fund. He and Nalebuff, their friends and family put some of their own money -- about $500,000 total -- into the venture. They quickly began boiling and brewing.
"Seth and I just went crazy in our kitchens, and we would torment our friends, students and colleagues with all sorts of different teas to try," Nalebuff said. They didn't focus on organic ingredients until they became affordable.
The pair came up with five flavors, which they tested on focus groups. Nalebuff said one of the respondents who sampled a genmai green tea responded, " 'I know you're paying me to drink this, but do I have to?' "
"We realized that Americans are in the early stages of their appreciation of tea," Nalebuff said. In other words, more consumers know their espresso machiatto from their espresso con panna, but not their sencha from their assam. "It's important not to get ahead of the customer," he said.
Nalebuff and Goldman threw in flavors such as mint, lemongrass and blood orange to make the teas more palatable. Honest Tea hit market shelves in June 1998 and sells for about $1.29 a bottle.
Goldman and Nalebuff admit they weren't quite ready for mass production. "Some of the early batches had about an inch of sediment on the bottom. Some tea tasted better than others," Goldman said. Goldman and Nalebuff started production in Buffalo. They now brew and bottle tea at three plants, on the East and West coasts.
Honest Tea comes in 12 flavors, such as Moroccan Mint Green and Peach Oo-la-long. Goldman still experiments in the back of the company's one-room headquarters in Bethesda. And he still goes out to supermarkets to offer samples of tea.
Goldman seems determined to run Honest Tea as a perpetual start-up. His executive suite consists of a desk behind a divider. And he prefers to go by "TeaO" rather than CEO.
Recently, while in Landover for an unveiling of the new plastic bottle, Goldman ended up spending four hours in the back of a truck, unloading and reloading scores of overturned cases of Honest Tea so they could be delivered.
If Honest Tea reaches the shelves of Wal-Mart Stores, it may be harder for Goldman to keep up the scrappy routine.
Growth could attract big-name corporate buyers. With organic brands growing well beyond industry averages, a rising number of small companies are being bought up by large food conglomerates. In 1999, General Mills Inc. bought Small Planet Foods Inc., owner of the Cascadian Farm and Muir Glen brands. In 2000, Kraft bought Boca Foods Co., maker of Boca Burgers. In 2001, Coca-Cola bought Odwalla Inc. and its juice line.
Honest Tea already has one big-name investor: Groupe Danone, the French yogurt company. In 2001, Groupe Danone bought a stake in Stonyfield Farm, the organic yogurt maker, and signed off on Stonyfield's investment in Honest Tea. Stonyfield's Hirshberg is on the Honest Tea board.
Goldman said selling Honest Tea to a larger company "doesn't preoccupy me."
"We're not out there seeking those conversations," he said "It's contradictory to building a brand."
Nalebuff said that so far Honest Tea's move toward the mainstream hasn't generated accusations of "selling out" from their customers, though some viewed the plastic bottle with apprehension. He said other customers were happy to find Honest Tea in more convenient locations. "They're always upset we're not available enough."