When companies decide to invest in a supplier, it's usually because they feel the need to prop up an ailing vendor. But that wasn't the case with Neways Enterprises, a privately held company that makes and sells personal care, cosmetic, and nutritional products. It bought a stake in one of its key suppliers, Aseptic Solutions USA, not for financial reasons but for strategic ones.
Aseptic is a contract manufacturer based in Corona, California, USA. For Neways, what sets Aseptic apart from other contract manufacturers is its proprietary "flash sterilization" technology. Flash sterilization is a crucial part of the production of several of Neways' top-selling nutritional drinks. But Aseptic's production capacity is limited and in high demand. If Neways lost access to the technology, it would put its topselling products at risk.
So while Neways executives did believe that becoming a minority shareholder in Aseptic would provide financial benefits, its decision was primarily driven by a desire to strengthen its supply chain, says Neways President and Chief Operating Officer Brian Slobodow. By investing in the supplier, he explains, Neways could ensure access to this crucial technology, maintain its competitive advantage, and reduce a major source of supply chain risk.
A defensive move
Based in Springville, Utah, Neways was founded as a family-owned company in 1992 based on a desire to create personal care products and nutritional supplements that did not contain harmful chemicals. Now owned by a private equity firm, Neways primarily sells its product line through a network of independent distributors. The company currently sells more than 300 products in 28 countries.
Neways manufactures all of its personal care and household items—which constitute about half of the company's product line—at its plant in Salem, Utah. It supplements in-house production with about 15 contract manufacturers, including Aseptic. The outside manufacturers make pills, cosmetics, and liquid beverages. Five of those contract producers turn out the majority of these outsourced goods while the others manufacture a single item.
Neways' relationship with Aseptic began in 2005, when the company shifted production of its nutritional beverages from another contract manufacturer. Aseptic operates as a beverage co-packer that specializes in nutritional and dietary supplements and organic and premium juices. Aseptic was hired to produce Maximol Solutions, a juice-based mineral supplement that became a huge seller for Neways. Later, Aseptic started making another of the company's most popular products, a juice supplement called Neways Authentic Hawaiian Noni.
During its production process, Aseptic uses the flash sterilization technology that it developed, called MaxFlash. An alternative to pasteurization, flash sterilization kills microorganisms without compromising product freshness, according to Aseptic. Neways sees this technology as a key part of Aseptic's value as a contract manufacturer. "We assessed the technology—MaxFlash—as being unique," says Slobodow. "When we looked at other manufacturers in the U.S. we saw none that was comparable."
So in 2007, when Aseptic indicated that it was looking for a partner to help grow its business, Neways decided to step forward and invest in its supplier. "It was a number of factors that led us to this decision," recalls Slobodow. "You often get asked into these arrangements because the supplier is struggling financially. That was absolutely not the reason. It was not a financially motivated transaction because of the economy or anything like that."
Instead, Neways decided to invest because it wanted to safeguard access to Aseptic's beveragemaking technology. "We saw competitors trying to get into Aseptic and get them to make their products," says Slobodow. "And all of our top products were being made there."
In other words, Neways' investment was primarily a defensive move, driven by a concern that an outside investor might jeopardize its relationship with an important supplier and its technology. There are several reasons why that was a risk Neways wanted to avoid. For one thing, Slobodow says, "you can develop a product and find that there are only one or two manufacturers that can provide that product. If they are unable to supply in sufficient quantities, it can limit your ability to grow." For another, a company that does not have critically important technology inhouse and depends on an outside supplier can find itself shut out due to capacity or pricing restraints, he says. The need to maintain the highest product quality was also a factor. "All of our top products were made with [the MaxFlash] technology," Slobodow says. "And if suddenly Neways found itself without a [high-quality] manufacturer, we would have to go to a substandard manufacturer and put our top-selling products at risk."
In the three years since Neways bought an ownership stake in Aseptic and integrated the two companies' boards of directors, the arrangement has worked out well for both parties. Although Neways' original intention was to protect existing business, the infusion of capital into its supplier opened the door to new business for both Neways and Aseptic.
Aseptic Solutions President Richard Alessandro has said that Neways' investment allowed his company to make the important capital acquisitions it needed to maintain its "state-of-the-art attitude." For example, Aseptic used some of the money it received in 2007 to purchase equipment to make "minishot" containers, which are less than six ounces and are often used for energy drinks. Neways, in turn, learned about the minishot marketing trend and subsequently decided to create two minishot products of its own. One is Beauty Nectar, a fruit drink with peptides, for the Japanese market; the other is Açai Action, an energy drink that contains a mixture of fruit juice and green tea. "I don't know that we would have gotten into minishots without this investment," says Slobodow, "because we had not seen [minishots'] coming popularity."
The strategic investment has also allowed Aseptic and Neways to combine their purchasing power for lower prices on packaging materials. "We are able to aggregate raw material packaging and get 'most favored nation' pricing that we weren't able to get prior," said Slobodow. "We have been able to save between five and ten percent in pooling packaging materials."
In addition, the two companies have begun sharing some warehouse space in the Los Angeles area of California. That move has allowed Neways to reduce some inventory and save on transportation costs because it no longer needs to ship product manufactured by Aseptic to its distribution center in Springville, Utah. Neways also uses the jointly managed warehouse to ship product made by Aseptic to Asian markets.
The relationship has even led Aseptic to assist Neways in expanding its own business. The co-packer is now helping Neways to market itself as a contract manufacturer to other nutritional products companies.
Resolving conflicts through cooperation
Although the companies' relationship has proved beneficial for both sides, it's not without difficulties. Initially, for example, some of Aseptic's customers had concerns about Neways' equity stake, especially since the co-packer did some contract manufacturing for Neways' competitors. "In most cases, we have been able to manage that successfully by assuring people that the management team [for Aseptic] is standalone and the formulas are kept in California and not shared with Neways in Utah," says Slobodow.
Out of concern for Aseptic's customer relationships, Neways owns only a minority stake in the supplier. "The outside world sees that if we don't own the majority, we can't force our way," Slobodow says. It is still a significant percentage, however, and Neways holds two of the five seats on Aseptic's board of directors.
It's not always easy for Aseptic to balance the demands of a customer that also happens to be a part owner with those of other large customers. Although Aseptic makes 30 to 35 percent of Neway's best-selling products, Neways is not Aseptic's largest customer. In fact, it is only Aseptic's fourth-largest customer, and its orders represent only about 20 percent of Aseptic's production volume. As a result, conflicts occasionally arise when Neways has a high-priority order that would require Aseptic to postpone production for one of its larger customers. "Those are the most difficult management issues we wrestle with," Slobodow observes.
Neways' board of directors has emphasized to the management teams at both companies the importance of cooperating to work out any problems that arise. If they are unable to find a solution, then they can pick up the telephone and call the board members. "It happens three or four times a year in the relationship," Slobodow says. "Those are stressful moments. There has to be some maturity to work through those situations."
Alessandro of Aseptic credits Neways for its fair-minded approach in those awkward situations. "We have an obligation to treat all our customers fairly," says the Aseptic president, "and Neways has respected that with a hands-off approach. We have occasionally had competing scheduling conflicts, but in the spirit of a good partnership, we have always worked together to satisfy our individual and mutual interests."
Despite occasional challenges and disagreements, Neways' investment in its strategic supplier has worked out well for both organizations. Aseptic's and Neways' businesses have both grown as a result of that investment. From a return-on-investment perspective, Neways' equity in Aseptic has appreciated because the supplier's profits are greater than they were three years ago. "Our capital investment is worth more today than if we had put it in a bank," Slobodow observes.
Slobodow advises companies that are thinking about a similar arrangement to study whether such a deal makes sense in terms of strategic sourcing. "How important is that supplier to your overall expenditure level?" is an important question to ask. Other questions he recommends considering include: Who are their competitors? What are the supplier's strengths and weaknesses? And do you have faith in the supplier's management team?
In Neways' case, the answers to all of those questions led to an investment decision that has proved to be a wise one. "We're happy with what we did," Slobodow says. "It was the right decision for us three years ago, and we would do it again."