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H 9B05A014

NEW CENTURY BREWING: MOONSHOT CAFFEINATED BEER

David Wesley prepared this case under the supervision of Professor Chris Robertson solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services is the exclusive representative of the copyright holder and prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 6613208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2005, Northeastern University, College of Business Administration

Version: (A) 2009-09-24

When Rhonda Kallman, chief executive officer (CEO) of New Century Brewing, came up with the idea for Moonshot, she was sure she had winner. Caffeinated energy drinks, such as Red Bull, had become extremely popular as alcohol mixers in bars. Why not offer the same benefit to beer drinkers?1 However, less than one year after launching Moonshot caffeinated beer, three large international brewers released their own caffeinated brands. To complicate matters, Anheuser-Busch’s offering, known as B-tothe-E, had a decidedly non-beer flavor that most beer drinkers found repulsive. In June 2005, after a disappointing first year, Kallman decided to relaunch Moonshot with a new label and more caffeine. This time around, almost all the company’s resources would go to support Moonshot. “This is a new category that is emerging, and we are at the crest of the wave,” Kallman explained. “Moonshot is going to be the engine that drives the company for awhile. I am devoting 90 per cent of my time to it and 95 per cent of my budget.” U.S. BEER INDUSTRY

The United States was both the largest beer market in the world and home to the world's largest brewer. In a typical year, Anheuser-Busch produced nearly as much beer as Germany’s entire national production. Other major brewers included SABMiller Brewing and Molson Coors. Together, the “big three” accounted for more than 80 per cent of total consumption. Anheuser-Busch (A-B) also owned vertically integrated non-brewing assets such as grain elevators, mills and can manufacturing. The resulting scale economies helped A-B achieve 75 per cent of the industry’s total operating profits.

1

Professor Chris Robertson would like to thank Evan Tesiny for background research in this case.

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Since the 1980s, the U.S. beer industry was characterized by flat consumption. However, consolidation, expanded market share, price increases and more efficient production all helped the big three achieve higher operating margins. One area of growth was light beer. In 1973, SABMiller (then known as Miller Brewing Company) introduced Miller Lite. Its success was immediate, accounting for nearly a quarter of Miller’s sales by the mid-1970s. Since then, the light beer category continued to grow year over year. By 2001, diet-conscious Americans2 helped propel Anheuser-Busch’s Bud Light ahead of Budweiser as the world’s top selling brand. At the same time, lighterbodied imports, such as Corona from Mexico, gained important market share in the United States.

Craft Beer Industry

A second area of growth was regional craft brewing. This segment consisted of small local brewers that offered unique European style beer. At the same time, mid-tier brewers, such as Stroh’s,3 experienced significant declines. These mid-tier brewers often leased excess capacity to craft brewers under contract, which allowed smaller companies an opportunity to enter the market without making costly investments in plant and equipment. Pabst Brewing Company, Boston Beer Company and New Century Brewing were examples of companies that produced beer through contracts with third-party brewers. The trend toward craft and specialty beers resulted in a near doubling of the number of breweries in the United States in the 1990s, most of which employed fewer than 20 people. Meanwhile, overall industry employment declined by seven per cent over the same period, mostly due to the demise of mid-tier brewers. By 2005, craft breweries numbered more than 1,500, even though their combined production accounted for little more than three per cent of total beer consumption in the United States. The success of the craft beer industry was also the downfall of new brands trying to enter the market. When Kallman began promoting Boston Beer’s Samuel Adams lager in the 1980s, the craft segment was relatively new and had few competitors beyond the leading imports of the time. In contrast, most liquor stores in 2005 sold products from more than 10 breweries, each with its own portfolio of brands. Advertising support, creative packaging, and product innovation were all key factors to gaining attention in this increasingly cluttered market. Distribution4

The repeal of prohibition in 1933 resulted in the formation of a three-tiered distribution system aimed at preventing control of alcoholic beverage industries by organized crime syndicates. This system divided distribution into brewers, distributors and retailers. Brewers generally transported products to distribution warehouses, where they were temporarily stored and then reloaded onto distribution trucks and delivered via a routing system to individual retailers. The law prohibited brewers from taking a direct interest in distributors or retailers and from selling directly to consumers.

2

In 2001, 21 per cent of Americans were obese, resulting in more than 300,000 premature deaths annually. Obesity in America: A Growing Threat, National Health Policy Forum Background Paper, July 11, 2003. 3 Between 1990 and 1995, Stroh’s national market share declined from 13.5 per cent to 9.1 per cent. 4 The following sections on Distribution and Demographics were summarized from The Brewers Handbook, by Ted Goldammer (KVP Publishers; 2000).

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Distributors were reluctant to carry lesser known independent brands with fewer than 20,000 cases a year. These often languished in warehouses and were thus more costly than established brands with guaranteed demand. As a result, smaller breweries were often prevented from distributing their products beyond regional markets.

Demographics

In 1984, the U.S. Congress passed the Federal Uniform Drinking Act, which encouraged states to prohibit the sale and consumption of alcoholic beverage products to persons less than 21 years of age. Legal drinkers under the age of 35 consumed approximately 54 per cent in bars and restaurants, while males accounted for more than 80 per cent of consumption.

COMPANY BACKGROUND Rhonda Kallman

When Rhonda Kallman was 19 years old, she became administrative assistant to Jim Koch, an enterprising partner at the Boston Consulting Group (BCG). She also worked part-time as a bartender and waitress. When Koch left BCG in 1984 to start the Boston Beer Company, one of the first craft brewers in the United States, he asked Kallman to join him. Koch believed that Kallman’s knowledge of local pubs and restaurants would help the fledgling company gain access to potential customers. The company’s Samuel Adams label was the first U.S. beer to compete with high-quality imported brands, such as Heineken and Beck’s. On the surface, the strategy was simple. Boston Beer Company (BBC) would employ traditional German brewing techniques and use only traditional ingredients. Instead of using fillers and preservatives to maintain freshness, as large U.S. brewers did, BBC would stamp a notch code (brewing date) on each bottle. Distributors and retailers were instructed to return bottles more than five months old for a full refund. The expired beer was then destroyed. Initially, the company did not own its own brewing facilities, but instead contracted production to thirdparty brewers with excess capacity to fill. This helped avoid the substantial upfront fixed costs of constructing a brewery and gave greater volume flexibility. Only when the company began to have substantial sales did it build its own breweries. Even then, contract brewing continued to fill much of the company’s production needs. As vice-president of sales and founding partner of the Boston Beer Company, Kallman became the primary link to customers and distributors. At first, distributors were hesitant to carry a small label with limited advertising support. Kallman instead focused on direct sales to Boston area pubs and restaurants. When Samuel Adams was voted the best beer in America in 1985, distributors finally took notice. Over the next 10 years, Boston Beer grew between 30 per cent and 60 per cent each year. Kallman became executive vice-president of Boston Beer in 1995, just as the company was nearing its peak with a strong national presence. By this time, Boston Beer had attracted numerous imitators with more than 600 craft brewers in the United States. In an effort to maintain growth, Boston Beer began introducing alternative alcoholic beverages, such as ciders and teas.

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After Boston Beer became a public company in 1995, Kallman felt that she had begun to lose touch with customers. With a sales team of more than 175 people nationally and 35 in-house marketing people, she had stopped working directly with distributors, bars and restaurants and instead spent most of her time in meeting rooms and behind one-way mirrors in dark rooms watching focus groups. Kallman explained, Being small means hard work, but being small is also interesting. As a company goes public, unfortunately the culture goes from being an entrepreneurial family enterprise to one that is less personal. The culture changes, and you start to bring in professional managers. The board of directors says things aren’t working when they really are, in a quirky sort of way. So you end up losing your quirkiness and the sense of family. For me, four years of that was enough.

New Century Brewing

Rhonda Kallman was inspired to start New Century Brewing in 2000 while on vacation in the Caribbean. A few days into her vacation, Kallman received a call from Dr. Joseph Owades, a world-renowned brew master and consultant, credited with creating the first American light beer in 1967 while employed by Rheingold Brewery in Brooklyn, New York.5 Owades called Kallman to ask whether she would be interested in starting another beer company. Kallman was initially hesitant, but the next day she called Owades back to discuss the details. “I don’t want to make another microbrew or craft beer,” she explained. “If I am going to do this, I want you to reinvent light beer. One out of two beer drinkers drinks light beer now and there is not much choice or variety for those drinkers.” Owades proceeded to develop a “light beer that would have a smooth flavor, light taste and be extremely easy to drink.” From then on, Kallman and Owades were in daily communication as she put together a business plan and he formulated the brew that would later be called “Edison, the independent light beer.” In 2001, New Century Brewing released Edison with great fanfare and national press coverage. Accolades poured in from across the country. An Atlanta Journal “blind tasting” ranked Edison first, above Amstel, Bud, Coors, Miller and even Atlanta’s own Kelly’s Light.6 But the market in 2001 was very different than 1985, when Kallman helped Boston Beer become the fastest growing brewer in America. Kallman explained, When Dr. Owades asked me to do this, I knew I couldn’t compete with Sam Adams. Corona and Bud Light were the fastest growing beers at the time, and I thought we could improve on that. Let’s create a beer that has the smooth taste of Corona, but only half the calories of Bud Light. Twenty years ago, it was a very different climate, especially in Boston. When we came in, we had something clearly different from the big brewers. It tasted different and it was from Boston. The timing was perfect. When I launched Edison, it was the day before the 9/11 terrorist attacks on the World Trade Center. That made it very difficult to get the capital I needed.

5

Rheingold’s light beer failed, and the company declared bankruptcy 10 years later. However, Owades went on to create other labels, including consulting on the development of Boston Beer’s Samuel Adams brand. 6 Light brew crew rates six entries, The Atlanta Journal-Constitution, June 20, 2002.

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The situation became more difficult when a number of larger competitors launched their own light beer brands, such as Corona Light, Sam Adams Light and Mich Ultra. “The window of opportunity closed quickly,” recalled Kallman. “Within 12 months, everybody had a light beer.” Four years later, Edison remained a niche product carried by upscale restaurants and boutique stores7 primarily in and around New England and Georgia. And New Century Brewing had yet to make a profit. Despite its slow start, Kallman remained optimistic about the potential of Edison. I honestly believe this can be a $100 million brand. Edison is a high-quality alternative to the mainstream and it tastes good. It just needs some marketing work and some advertising.

The Rise of “Energy Drinks”

Despite the trend toward more healthy food and drinks, one of the fastest growing beverage categories was “energy drinks.” These were typically high in calories and other substances, such as amino acids and caffeine. Energy drinks were not known for tasting good and were expensive. Their average selling price of $37 a case (24 cans) was five times that of carbonated soft drinks, such as Coca-Cola. Nevertheless, in 2004, energy drink revenues grew by more than 70 per cent to $2 billion. Soft drinks, by comparison, grew by only one per cent.8 The first and best known energy drink was Red Bull, the sole product of an Austrian company founded in 1984. It contained a mix of vitamins, amino acids, sugar and 80 milligrams of caffeine. According to the company, Red Bull “was made for moments of increased physical and mental stress and improves endurance, alertness, concentration and reaction speed. In short: it vitalizes body and mind.” After a slow start, Red Bull began exporting its products in 1992. Within a few years, Red Bull became a popular alcohol mixer in night clubs. Soon afterward, imitators began to flood the market with a wide variety of similar products. By 2004, more than 200 energy drinks were available in the United States alone.9 Large soft drink manufacturers quickly entered the fray with their own offerings. PepsiCo alone offered several dozen energy drink flavors under its SoBe label as well as Amp Mountain Dew and Gatorade. Moonshot Caffeinated Beer

In early 2004, Kallman attended a rock concert. After drinking some Edison, she ordered a Mountain Dew. “I was dancing and feeling good. The sensation was wonderful,” she recalled. That’s when I came up with the idea of putting caffeine into beer. Even though we were undercapitalized at the time, I decided to launch Moonshot anyway with a budget of less than $100,000. Kallman contacted Dr. Owades to ask him to come up with a recipe that would contain caffeine but would taste like ordinary beer. Owades was at first incredulous, refusing to develop the product. “There’s not 7

This category included Trader Joe’s, a boutique grocery chain with 28 stores located in Chicago east. 8 The buzz on energy drinks; Coke, Pepsi and tiny firms vie for sip of caffeine-packed beverage market, The Atlanta JournalConstitution, April 8, 2005. 9 Ibid.

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much innovation in the beer industry,” argued Kallman. “A beer with caffeine is something new.” With a little prodding, Owades finally agreed to develop a light-bodied Pilsner that had slightly more calories than light beer and 45 milligrams of caffeine (equivalent to half a cup of coffee or a can of coca-cola, see Exhibit 1).10 Shortly after its launch in the summer of 2004, Kallman learned that drinkers of Moonshot represented a different demographic than drinkers of microbrews. Most consumed domestic beer, not high-end craft beer, and many were women. We found that 23 years is really bull’s-eye for our target market. Twenty-three is when people have just gotten out of college. They have jobs, apartments, girlfriends and boyfriends. They have moved up from Old Navy to Banana Republic, because they have more money to spend. Kallman first created a label for her new brand featuring a retro style reminiscent of the 1940s and 1950s (see Exhibit 2). However, the young 21 to 25-year-old target market saw the label as “old” (as in oldfashioned), not the new and exciting message that Kallman wanted to portray. However, once the product hit the shelves, there was little she could do, other than wait until the current batch sold out. In early 2005, Kallman contacted Arnold Worldwide to create a new image for Moonshot in exchange for equity in New Century Brewing. A new Moonshot with 69 milligrams of caffeine was launched in June 2005 in Boston and New York. Bottles and labels were redesigned to feature a modernistic image of a rocket on front and 24 different beer related witticisms on the back (see Exhibit 2). Promotion focused on providing samples to consumers in night clubs and bars. New Century hired college students in the Boston area to visit different clubs each night, particularly high-energy clubs where adventurous drinkers were more open to new products. After trying the beer, Kallman hoped that they would tell their friends and create “a buzz” around the product.

B-to-the-E

In January 2005, a few months after Moonshot debuted, Anheuser-Busch launched a caffeinated beer with ginseng and other additives. At first, Kallman thought that Budweiser’s offering (BE), commonly known as “B to the E,” would create awareness for Moonshot. After all, about a third of the news articles about BE also mentioned Moonshot. The only problem was that BE did not taste like beer. In fact, most drinkers disliked it. Noted one, Once I get past the initial gag reflex, I’m stunned at how complex the fruit character is. It tastes chock full of hexenes, amines, tetras and other words that only petroleum and chemical engineers use in polite conversation.11 That was certainly not the impression that Kallman wanted to create for caffeinated beer. In addition to the initial resistance to try a beer with caffeine, she would now have to contend with the negative impression created by BE. Beer drinkers wanted to drink beer, not a bad tasting ener...