Mission Statement: Honest Tea creates and promotes delicious, truly healthy, organic beverages….

Mission Statement: Honest Tea creates and promotes delicious, truly healthy, organic beverages. We strive to grow with the same honesty we use to craft our products, with sustainability and great taste for all. Seth Goldman likes to say that Honest Tea got started because he was thirsty. Apparently, so were a lot of other people! Honest Tea grew from an operation with three employees and revenues of $250,000 in 1 998 to one with 98 employees and $4 7 million in sales in 2009. Along the way, exit strategies described in the 1 999 Honest Tea Business Plan have been executed. Seth and his co-founder, Barry Nalebuff, identified “investment by a strategic partner” and “complete acquisition” as potential exit strategies for investors. Honest Tea honestly followed these strategies in 2008 and 20 1 1, respectively, when the company concluded an installment sale to the Coca-Cola Company. This is a clear case of entrepreneurs planning for the harvest from the start, and doing what they set out to do.

The Honest Tea Story

During one of Seth's classes at the Yale School of Management, he and his professor, Barry Nalebuff, found they shared a passion for a less sweet but flavorful beverage while discussing a Coke versus Pepsi case study. While he liked the idea of creating the perfect beverage, Seth de

 

cided to follow his passion for social change and work for the Calvert Group, managing marketing and sales for this socially responsible investment firm. While doing so, he expanded his already keen interest in social enterprise. The entrepreneurial drive that began early in Seth's life became even stronger after a long run in Central Park, when he couldn't find any drinks to quench his thirst. Thinking back to the Coke versus Pepsi case study discussion, Seth emailed Barry, who had just returned from India where he had been studying the tea industry. Barry had learned that most U.S. beverage companies do not use whole tea leaves to make their bottled tea. Instead, they take whatever is left after the quality leaves have been packaged for products such as tea bags, leftover bits of tea described as “dust” or “fannings.” Seth and Barry had a sense that they were homing in on an opportunity. Even better, Barry had already come up with a name for a company that would make beverages using top-of-the-line tea leaves. The company would be called Honest Tea. Seth decided to leave the Calvert Group to pursue the idea, brewed batches of tea in his kitchen, and launched Honest Tea in February of 1 998. During their first meeting with the Whole Foods Regional Office, the buyer sampled teas that Seth brought with him in borrowed thermoses and placed an order for 1 5,000 bottles. Honest Tea made its first deliveries in June 1 998, offering five varieties of tea. Today, the product lines have expanded into Honest Tea (22 varieties in glass or PETE-1 [plastic] bottles,

Honest Ade [5 varieties], Honest Kids [5 varieties in pouches], Honest CocoaNova [3 varieties in glass bottles], and a zero-calorie line made with organic Stevia [2 varieties]. For most of the company's history, its products were distributed through independent beverage distributors with the greatest success in natural foods outlets. Exhibit 1 4-2 shows the growth of Honest Tea's revenues from 1 998 through 2009. The remarkable upswing in revenues between 2004 and 2005 is due in part to the company's teas becoming USDA certified organic. These remarkable revenue increases did not initially translate into profitability, according to Seth's blog. This is where financing options became critical.

Honest Tea's Competitive Advantages

The team at Honest Tea worked hard to define the brand around the features that make Honest Tea stand out from the competition. In Seth's own words, “Given that this is a highly competitive market, the most important factor in our favor is that we offer a differentiated product. What we are offering is a very strong brand that is consistent with what is in the package and very meaningful to customers.” For example, Honest Tea was the first brand to make a certified-organic bottled tea. What does this mean and why does it matter? When an item is labeled USDA certified organic, it confirms that chemical pesticides and fertilizers have not been used in growing or producing the ingredients. Increasingly, consumers, particularly the health-conscious, are seeking out organic goods in the marketplace. Honest Tea also uses up to two-thirds less sugar in its teas compared with competitors, such as Snapple and Arizona. Most varieties include

the phrase, “Just A Tad Sweet” on the label. This feature appeals to consumers who care about their health and diet.

Socially Responsible Business

Honest Tea's mission extends beyond using organic ingredients, whole tea leaves, and less sugar than most other beverages. The company goes to great lengths to educate customers about its ethical and socially responsible business practices. It wants them to know that when they buy Honest Tea, they are also doing something good for the community. As Seth puts it, “A commitment to social responsibility is central to Honest Tea's identity and purpose. The company strives for authenticity, integrity, and purity in our products and in the way we do business.”

Staying in the Game

The beverage market is highly competitive, but Honest Tea appears to be thriving because it is delivering a differentiated product that customers

feel good about buying, and it uses organic ingredients. However, this does not happen magically. The Honest Tea team has had to expend considerable efforts to secure the financial resources needed to fulfill their dream. Initially, Seth and Barry invested their own funds and those of friends and family to seed the company. This initial round of investors put in approximately $500,000 to get the business started. The money was primarily used to pay for the first production run. It was rapidly apparent that additional funding would be necessary to pay for more production and a sales staff was needed to support additional growth. Barry created an innovative financing structure, using warrants to protect the interests of the founders. The 1 999 Business Plan that appears in this text is the one that was developed to secure additional funding. By the end of 1 999, Honest Tea had raised in excess of $1.2 million in capital investment, primarily from small, private investors. Rather than going out to the venture capital community, as they expected to do, Seth was able to secure commitments from a number of consumers who had expressed an interest in investing in the company.11 He writes, “The hardest money to raise was the $1.2 million in 1 999, when we took in money from people we didn't know.”12 In the same year, Honest Tea jointly purchased ownership of Three Rivers Bottling, LLC, to have greater control over production and to eliminate potential problems of production shortfalls. The following year, the company secured additional funding from earlier investors. Over the following years the enterprise continued to grow, fueled in part by sales growth and additional equity raises.

Honest Tea and Coca-Cola-A Marriage Made in Beverage Heaven?

In February 2008, Honest Tea celebrated its tenth anniversary and announced another milestone. The company had accepted a 40 percent investment from the Coca-Cola Company that could help expand production and distribution, just as the founders had suggested in the 1 999 business plan. At the time, Seth stated, “We started Honest Tea ten years ago with five thermoses and an ambitious vision for offering a new type of beverage-a delicious healthier drink produced with a consciousness about the way the ingredients are grown. As more consumers become aware of how their decisions impact the health of the planet and themselves, we are thrilled to receive this investment from the world's largest beverage company to help take our brand and our mission to a larger scale and wider audience.”13 As part of the investment, Coca-Cola North America's Venturing and Emerging Brands (VEB) Business Unit retained an option to purchase the remaining ownership in 201 1. There was considerable concern among loyal Honest Tea customers as they became aware of the investment by Coca-Cola. Many were unhappy that this mission-driven company with a focus on health and organics would be subsumed by a large, multinational corporation with a different agenda. At the time, Gary Hirshberg, president and “CE-Yo” of Stonyfield Farm, and mentor and advisor to Seth, responded with the following: “The knowledge and access that Coca-Cola North America and its distribution system can provide comes at a perfect time as Honest Tea is at an exciting inflection point. I look forward to helping Seth and the team continue to build the business the right way in the years ahead.”14 Barry added, “This is our chance to bring organic beverages to the mainstream.”15 In his February 5, 2008 blog, Seth addressed the customer questions head on: “So how do we move from the ideal to the real without screwing up what we've created? The world of missiondriven business is littered with entrepreneurs whose companies lost their soul or at least lost their leadership …. I am determined to make sure that never happens with Honest Tea. Our challenge is to find a partner who wants to 'buy in' to our mission, rather than one who wants us to 'sell out.' Any partner that we consider must understand that the 'Honest' brand stands for great-tasting, healthier beverages that are produced in a more sustainable manner. As long as that partner buys into our approach, we welcome the opportunity to expand the scale and reach of Honest Tea.” From the initial investment in 2008 until early in 201 1, the number of distributors of Honest Tea grew, as did the number of outlets selling Honest Tea. In 2010, Honest Tea worked with CocaCola to create a tea-brewing system inside a Coca-Cola bottling plant. Seth wrote, in an April 2010 blog posting, “There's no more visible way to communicate the level of commitment Coke is making in our brand's future than to show a picture … of the Big Brewer-not only because it is a financially significant investment (more than $1 million) but because it takes up such a large piece of real estate in the middle of a production plant where space is limited and quite expensive …. The payback on such an expensive system is at least three years, far beyond the investment timeframe that Honest Tea could make on its own-we're rarely in a position to make capital investments beyond the next two months.” The company had been growing, but still had not become profitable. It needed to expand distribution and reach more people to fulfill its mission. As Seth noted in his blog posting on March 1, 201 1: ” … 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 … ” In the same blog entry, he added, “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.” Honest Tea needed to give back to its patient investors. Seth suggested, “The only way we were able to stay in business was because our investors believed they would gain a return for the investments. Given our margins, dividends weren't going to be an option, so an exit would have to come either via acquisition or IPO.” Although the team at Honest Tea briefly thought that an IPO would be an option, it reconsidered in 2007. Recognizing that “distribution is the key to winning in the beverage industry,” and that the current network of independent distributors could not yield the necessary reach, it was determined that discussions with Coca-Cola made sense. Honest Tea continues to operate as a separate division within Coca-Cola. Seth elected to reinvest the majority of his proceeds from the sale back into Honest Tea. The company has the opportunity to help fulfill the dream of bringing organics into the mainstream marketplace. In fact, in one of Seth's most recent blog posts, he wrote: “I can't imagine walking away from the business now that we finally have a national

footprint in place and the chance to democratize organics in a way that's never been done. This tea party is just getting started.”

Case Study Analysis

1. What are Honest Tea's competitive advantages?

2. Look at the list you generated. Which is most important to you as a consumer and why?

3. Given what you already know about Honest Tea's business philosophy and practices, if you were Seth's business advisor, what additional competitive advantages would you encourage him to develop? 4. What does it mean for a company to engage in “socially responsible business practices”?

5. What methods of capital acquisition did Honest Tea employ? Why?

6. How did the sale to Coca-Cola impact Honest Tea's investors?

7. What are the arguments for and against selling equity to Coca-Cola?

 

 

 

 

 

 

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