Niche drinks gain traction in U.S. market

NEW YORK (Reuters) - Nine years ago, Seth Goldman walked into a Whole Foods Market Inc. store with an empty bottle bearing a mocked-up label and five thermoses of iced tea he brewed in his kitchen.

He walked out with a purchase order for 15,000 bottles, the first step of a journey that has transformed him from the marketing manager of a social investment fund to the chief executive of Honest Tea, a beverage company he said will have sales of nearly $25 million this year.

Honest Tea is one of many independent drink makers carving out space in the increasingly fragmented U.S. nonalcoholic drinks market, worth about $105 billion a year, to the detriment of established companies.

With hits including Glaceau's vitaminwater, which comes in rainbow hues, and Red Bull's energy drink, agile start-ups are gaining traction as consumers seek alternatives to the traditional soft drinks sold by the industry giants.

"Unfortunately, the consumer is not cooperating with big brands the way they have in the past," said Charles Frenette, a former chief marketing officer for Coca-Cola Co. and Miller Brewing Co..

He was referring to consumers' recognition that they have many options and that different drinks suit different occasions. "The consequence is they become more promiscuous -- people are now drinking dozens of brands."

Goldman Sachs analyst Judy Hong said the beverage industry is shifting from a small number of hit products toward a huge number of niche products, which often come from start-ups that rely on word-of-mouth or viral marketing, mediums that resonate better with young consumers than the television spots long favored by their deep-pocketed rivals.

"We have thousands of brands that are introduced in one year and some of them will stick," Hong said. "That's part of why we have been seeing strong growth from some of the upstarts at the expense of the larger competitors." She added that excess production capacity and third-party distribution made the drinks industry particularly welcoming for entrepreneurs.

ROOM FOR START-UP SUCCESS

The big three soft drink makers -- Coca-Cola Co., PepsiCo Inc., and Cadbury Schweppes Plc -- together control about 78 percent of the U.S. market for bottled drinks, according to trade publication Beverage Digest. But they have been outmaneuvered in some of the fastest-growing segments, such as ready-to-drink tea and energy drinks.

"Sometimes big companies don't have the patience to stay with something for year after year, when it hasn't caught on," said Gil Cassagne, chief executive of Cadbury Schweppes Americas Beverages, the maker of Dr Pepper and 7UP. Cadbury also bought Nantucket Nectars and Snapple, the hit iced tea Cassagne called "an eight-year overnight success."

"The beverage industry presents an interesting paradox in that it is highly consolidated ... yet time after time, small companies with entrepreneurial savvy and energy can still break through and create tremendous value," said Beverage Digest editor John Sicher.

After decades of growth, traditional carbonated soft drink sales volume has fallen in the last two years in the United States. A growing health-consciousness is pushing many consumers to choose bottled water or drinks they view as having a functional benefit, such as antioxidants in tea, electrolytes in sports drinks or caffeine in energy drinks.

Hong said U.S. energy drink sales topped $6 billion in 2006 and could double in five years, since it accounts for less than 2 percent of consumption of all caffeinated drinks.

Privately-held Red Bull GmbH controls 30 percent of the energy drink category, closely followed by another independent company, Hansen Natural Corp., with 27 percent, according to Beverage Digest.

The market for ready-to-drink tea, which Morgan Stanley analyst William Pecoriello said is nearly three-quarters controlled by Coke, Pepsi and Cadbury, has also given rise to such strong brands as Arizona and Fuze, which was recently acquired by Coke, the world's biggest soft drink company.

The Atlanta-based giant, which is trying to boost its noncarbonated offerings, also said in May that it would buy Glaceau for $4.1 billion, proving that a little entrepreneurial persistence and creativity can go a long way.