The spark for Goldman and Nalebuff’s partnership came during a discussion Goldman had with Nalebuff about the lack of unsweetened, healthy beverages in an American market dominated by sweetened products. This discussion ultimately shaped the vision for the company they would start together - a beverage company that supplied tea made with all natural, organic ingredients and operated around the principles of social responsibility and environmental sustainability. The company was called Honest Tea. In the span of a decade, Honest Tea has grown from a one-man business operating out of Seth Goldman’s kitchen to an enterprise boasting 52 employees and annual sales of $23 million in the space of a decade.

Like many emerging brands catering to environmentally-conscious consumers, Honest Tea has established itself in a market dominated by conglomerates using a unique, differentiated product and marketing
scheme. Honest Tea products are either low in sugar or sugar-free. Beverages are made from organic ingredients, free from antibiotics, pesticides, and bioengineering. Honest Tea purchases produce from suppliers that engage in fair trade practices and show “respect for individual workers and their families.” Goldman and Nalebuff created Honest Tea to cater to ‘active and engaged’ consumers who seek an alter-native to unhealthy beverages. The company presents a corporate philosophy distinct from competitors, some of whom have developed reputations for ethically dubious
and environmentally unsustainable business practices.

Economists often employ the terms ‘negative externality’, ‘free-rider’ and ‘public good’ when describing consumers who choose to support ‘honest’ or ‘green’ companies like Honest Tea. Such consumers recognize that during the production process, firms often inflict costs on workers or the environment that are not borne by the producer or consumer. Economists characterize the insufficient quantities of public goods that arise from such behavior as market failures, and the costs borne by workers or society as ‘negative externalities’.

Most are free-riders, in that they refuse to correct for negative externalities generated in the production process. However, a small but growing consumer base is reversing this trend by paying a premium
for products from firms that correct for the negative externalities by providing ‘fair’ wages and committing to environmentally sustainable production.
Consumers are becoming more open to voluntarily contributing to maintaining the quality of the environment and supporting responsible business practices.

HONEST TEA’S IMPACT ON THE
 BEVERAGE INDUSTRY

HONEST TEA’S founders believe the firm’s responsible business practices help to correct some of the negative externalities in the production process. More recently, Seth Goldman proposed that Honest Tea’s industry presence may provide positive externalities shaping the wider market for organic produce. Goldman states that when “When we buy
Honest

Tea 2.5 million pounds of organic ingredients, as we did in 2007, we help create demand for a more sustainable system of agriculture.” Further, Goldman claims that the increased demand facilitated by Honest Tea can create a market for organic
produce “that multiplies far beyond its own purchases.”

Claims like Goldman’s have captured the interest of some economists. Do firms that purchase large quantities of organic produce help to decrease of the price of such produce in the wider market? While evidence supporting an affirmative response is sparse, some economists believe that firms can lower prices of the inputs for their products through two avenues - establishing price stability and encouraging technological progress.

Economists conceptualize this effect in terms of calculating cost. Given that the market for a product is unstable, producers are subject to an additional cost of providing a product on the market. Increased demand from companies like WholeFoods and Honest Tea has two effects. First, it increases both the price and quantity of the product supplied in the market. But economists suggest that the increased quantity can have an additional effect on the probability that produce will be sold, in effect stabilizing the market. This decreases the costs of providing the product, which shifts the supply curve outwards, leading to a decrease in price and an increase in supply. In the short term, the increased price of purchasing green inputs is passed onto the consumer, who is willing to pay a premium to sponsor the use of green technology. The second effect can be an increase in the quantity supplied in the market and a decrease in the price, helping green products to become more competitive in the wider market for produce.

Large-scale purchase of green products may also spur technological progress. Gary L. Nakarado from the U.S. National Renewable Energy Laboratory believes that a thriving market for green technology or produce can also accelerate the pace of technological innovation. “The principle of the learning curve,” Nakarado writes, “is that reductions in cost accompany increased production, and a doubling of the cumulative production of a product will bring with it a reduction in unit cost by a fixed percentage.” A growing, predictable market for sustainable agriculture can encourage producers to enter the market, each of whom compete to implement the most cost-effective production techniques and drive production costs down. The consumer
group Commodities Now believes that the increased demand “‘attracts suppliers to the field and ultimately leads to the development of newer and better products and services.” It can also “benefit both the environment and “companies’ bottom lines.” 3
Nevertheless, start-up costs for emerging brands that cater to consumers that demand green and ethical
products are formidable. Richard Norgaard, Professor of Energy and Resources at the University of California at Berkeley, contends that companies like Honest Tea have to expend significant marketing costs “to inform Connie Consumer about their product and convince her to switch - and stay switched.” 4 Goldman and Nale-
buff have been remarkably successful in doing so.

HONEST TEA'S MARKETING STRATEGY

GIVEN THE DEMAND for green practices in the marketplace, the question remains: how do emerging brands convince consumers to pay a premium for a product that exhibits the characteristics of a public good? Ryan Wiser and Steven Pickle from the Ernest Orlando Lawrence Berkeley National Laboratory believe that three specific marketing techniques can enhance the perceived value of a public good.
First, companies should appeal to community and social dynamics in order to place pressure on consumers
to avoid free-riding. In contrast to traditional beliefs about the rational consumer in a neoclassical model, behavioral economists have shown that consumer choice is influenced by social norms and values. Economists James Walker and R. Mark Isaac have conducted experiments that show that reducing the number of consumers who consume a public good and increasing the opportunity for non-binding communication between consumers decreases the incidence of free-riding.
Honest Tea attempts to increase community communication by marketing its products to specific communities and geographic regions. Honest Tea also reinforces communication between consumers by encouraging customers to participate in community programs affiliated with Honest Tea. One recent initiative, Bethesda Green, encouraged the community of Bethesda, Maryland to “promote environmentally conscious living for residents, employees and businesses.” Honest Tea also provides an avenue for consumers to develop relationships over social networking sites Facebook, Twitter, and MySpace, in an effort to engender a sense of community and common purpose among its patrons.
Second, companies that market green products can decrease the incidence of free-riding by focusing on customer retention. Davis and Holt believe that two of the most important factors affecting free-riding are repetition and experience. Their experiments illustrate that “in a single-shot game, 40-60 percent of individuals
are willing to contribute to a public good.” However,
in subsequent games, “contributions decline with repetition, and sometimes dramatically.” Economists hypothesize that decreased participation is a result of “learning effects,” where consumers learn that free-riding is profitable after observing others free-riding.
Thus, firms like Honest Tea should provide incentives for customers to continuously purchase its goods over time. A Massachusetts green energy pilot program, for example, offers special discounts, in the form of gift certificates, to consumers who make a five-month commitment to purchasing green energy. In addition, companies engaging in environmentally sustainable and ethically responsible practices should establish an ongoing dialogue with customers, so that customers are informed of the public goods they are purchasing. Honest Tea provides consumers with regular newsletters, field reports from producers in developing countries, and information on conferences that address issues of socially responsible business practices.

The success of Honest Tea indicates that at least some consumers are willing to pay a premium in order to compensate for unforeseen consequences of the production process. Other companies can learn valuable lessons from Honest Tea’s approach to marketing and convincing consumers to support ethically and environmentally responsible business models. Honest Tea, despite catering to an initially small market, has had a wide ripple effect on behavior of other firms by decreasing the cost, and thus increasing the demand, for sustainable inputs.

Reflecting on Honest Tea’s humble beginnings and recent success, Goldman notes that, “Sometimes even the most thoughtful consumers can forget how much power they possess.” As Goldman and Nalebuff have shown, the honest consumer may hold much more power than one might initially expect.