Integrated Leadership Perspective - Part II

In week three of the Integrated Leadership Perspective course, Yale SOM students examined the challenges of running a rapidly expanding company through one crucial question: Why is Barry special?

Putting the query before the class was Sharon Oster, the Frederic D. Wolfe Professor of Management and Entrepreneurship, who oversees the course. ILP, as it is called by nearly everyone at SOM, is intended to apply what students have learned so far in the new core curriculum to real-world problems. The “Barry” she referred to was Barry Nalebuff, the Milton Steinbach Professor of Management, and more important for this lesson, the cofounder of Honest Tea, an organic tea and juice company founded by Nalebuff and Seth Goldman ’95 nearly a decade ago.

For the class, students analyzed the company, which Nalebuff and Goldman started to fill a gap they saw in the iced tea market. A decade ago, there were lots of sweet teas to buy, but few that were either unsweetened or only slightly sweetened. The pair launched Honest Tea in 1998 and set out to corral a part of the multi-billion dollar soft-drink industry.

As Oster pointed out, there were a couple reasons to doubt Honest Tea at first. One was the fact that what initially motivated the pair was the desire to create a drink somewhere between water and soda that they as consumers wished was available. This, Oster said, can be a dangerous thing on which to stake a company. “We wander through life engaged in our own little bubbles,” she said. “We’re not that great reflecting on what others want.” Then there was the potential fact that the reason there weren’t any products like Honest Tea, which contains little to no sugar, was that there wasn’t a market for them. This, she said, is what an economist would likely think.

“Or maybe Barry has seen something before other people,” she said. “Maybe the reason no one has filled the gap is that someone had to be first. The standard economist looks at the gap and says the reason is that no one wants it. The entrepreneur looks at the gap and sees opportunity.”

Barry replied that it was economics 101 reasoning that was the basic insight: declining marginal utility. "We teach that the first bit of something is always the best, and the next is not quite as good. Same thing for sugar. Why not a beverage with just a bit of sugar, but not too sweet?"

The students had studied a case about Honest Tea to prepare for the class, and Nalebuff spent over an hour discussing the company, outlining its struggles, and explaining its successes. Businesses, he began, almost never work out as expected. “I thought we’d be making money in a year or two,” he said. “I didn’t anticipate the fact that it would take $7 million in losses and eight years to get there.”

Manufacture and distribution of the product proved an early problem. The company initially invested in a bottling plant, which it later sold. The brand grew slowly, and then rapidly, and then slowly again. Recent growth has once again been brisk, as the company has become the largest seller of organic tea drinks in the nation. Honest Tea has operated in a market flooded with competition. “Several thousand beverages launched last year,” Nalebuff said, “of which maybe 100 will be on the shelf next year.

To raise money, Nalebuff devised an innovative method by which investors initially owned the entire company and the founders only acquired parts of it as the stock doubled, tripled, quintupled, and so on. All the while, sales grew, until things hit a major snag. In 2003, they had a recall due to defective glass bottles. “Ultimately nobody got hurt,” he said. “This happened during the busy season and we were taking products back. We lost shelf space. It could’ve killed the company.”

But the company righted itself and moved deeper and deeper into the market. Just last year, they signed a number of key contracts with distributors in California. “Think about it,” he said to the class. “All that growth has largely come without California, which is more like a country than a state. It’s warm there a large part of the year and people are thirsty and want good health.”

Now Honest Tea boasts 29 varieties and is valued at more than $30 million. It’s introducing a bunch of new products this year, including a kids’ line, an orange mango drink with the super-fruit mangosteen, and pomegranate white tea with açai, a wildly popular Brazilian berry.

The class ended with Nalebuff discussing other big names in the boutique soft drink industry, companies with much bigger sales and valuations, companies he thinks are within sight for Honest Tea. Which brought the class back to the question of the day: What has Honest Tea done to be successful?

Or as Oster put it: Why is Barry special?