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Dr Pepper’s Bai Deal Highlights the Risk and Reward of Acquiring Upstart Brands

By
John Kell
John Kell
Contributing Writer and author of CIO Intelligence
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By
John Kell
John Kell
Contributing Writer and author of CIO Intelligence
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April 27, 2017, 3:22 PM ET
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Dr Pepper Snapple paid $1.7 billion last year to scoop up the fast-growing Bai Brands. Now, the soda giant needs to figure out how to boost sales for the antioxidant-infused startup without diluting the brand.

The nation’s largest food and beverage companies—an industry collectively known as Big Food—have posted slim sales increases in recent years as consumers ditch legacy brands and increasingly favor startups that are coming to market with innovative products and disruptive branding. Decades-old brands are being stung in the process, hurt by mistrust about ingredients and also shifting consumption preferences. Take the example of the soda industry: sales have slipped for 12 straight years as consumers increasingly favor waters, flavored waters, and teas.

All those changes have put pressure on Dr Pepper Snapple (DPS), which relies heavily on the sale of carbonated soft drinks like Dr Pepper, Canada Dry, and 7UP. Because consumers are broadly ditching the sugary stuff, Dr Pepper Snapple’s reported net sales increased just 2% for the first quarter, even when factoring some contribution from the Bai deal, which was completed at the end of January.

Dr Pepper Snapple bought Bai because that it’s more on trend with what consumers want today. It sells drinks that contain only five calories and is marketed as an “enhanced” water—alluding to the beverage’s better-for-you proposition. The portfolio also includes carbonated flavored water, coconut water, and ready-to-drink teas. It also is closely affiliated with pop superstar Justin Timberlake, who invested in Bai just before it was acquired.

Dr Pepper says it wants to innovate more and extend the brand into new categories, as well as ship it to markets abroad. Those are all classic Big Food moves after scooping up a startup. In fact, Dr Pepper is already testing the brand in the United Kingdom.

But Dr Pepper alarmed Wall Street when it tempered expectations for how well Bai would perform in 2017. After doubling in sales for the fourth quarter of 2016, the expectation was Bai’s sales would soar 80%-90% this year. Now, growth is pegged closer to the 40%-50% range. The problem Dr Pepper is trying to address: Bai built a lot of the brand’s business in club stores, where bulk packages of water are often steeply discounted. About a third of the business is done at those retailers, and Dr Pepper wants to change that.

“We have recently done some research on Bai and learned that while trial is low on the brand, repeat rates are higher than we have historically experienced,” CEO Larry Young told analysts during a conference. What that means, CFO Martin Ellen later explained, is Dr Pepper needs to rely less on bulk packs (which aren’t a good way to get people to try the brand) and more on accounts like grocery and convenience stores. “We got to go back and think about how we build the brand sort of more one bottle at a time and get the trial going so we can get the repeat purchases,” Ellen said.

The conundrum that vexes Dr Pepper is a problem that all Big Food companies face: how do you manage growth for an upstart brand you have acquired? Campbell Soup (CPB) recently admitted it tripped up when it tried to expand the Midwestern-based Garden Fresh Gourmet brand into a national salsa. Campbell didn’t differentiate the recipes enough to meet the needs of consumers in different parts of the country. The food company is promising new flavors and packaging will be better received.

Hershey (HSY) this week also conceded it is still trying to figure out how to best expand the recently acquired Krave and Barkthins brands. “In some cases, we overextended distribution,” CEO Michele Buck told investors this week. “We’ve right-sized that a bit.” She promised that Hershey would figure out how to get the right food in front of the right customers.

The classic cautionary tale is what Kellogg (K) did with Kashi, a cereal brand it acquired for just $33 million in 2000. Revenue has soared since then, but many felt that Kashi lost its way when Kellogg extended it aggressively into new categories like frozen pizzas. In response, Kellogg is pivoting to focus Kashi more on what it is known for: cereal. CEO John Bryant earlier this year, while speaking at a food industry conference, said Kashi’s cereal sales should increase this year.

“On Kashi. I’m feeling quite happy about where we are on the cereal business right now,” Bryant said. And as for the rest? “If you think about things like Kashi pizzas or breakfast drinks, these are all exiting our portfolio as we speak.”

Wall Street still loves the Bai deal—analysts broadly supported the changing distribution plans Dr Pepper has enacted. But if Dr Pepper messes up the brand, once-loyal customers will have no problem saying “bye, bye, bye.”

About the Author
By John KellContributing Writer and author of CIO Intelligence

John Kell is a contributing writer for Fortune and author of Fortune’s CIO Intelligence newsletter.

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