Is Herbalife A Pyramid Scheme? New Evidence Suggests Not.

Convershaken Staff
February 24, 2017
 

Herbalife's days of being labelled a pyramid scheme may finally be over. The nutritional supplements giant, which coughed up $200m and agreed to restructure its business in a settlement with the Federal Trade Commission (FTC) last summer, assured analysts during a recent earnings call that its business is the real deal.

CEO Michael Johnson highlighted the fact that 300,000 people, or half of Herbalife's US members, have converted to or signed up to be 'preferred members' - who receive discounts on products but can't sell them or earn commissions - since October. That alone "should leave no doubt in anyone's mind" and "put to rest all doubt" that there are "real customers" for Herbalife products, he argued.

Prior to the settlement, Herbalife - like other 'multi-level marketing' groups - freely peddled a 'business opportunity' to people, encouraging them to buy then flog its products and paying them a commission for every additional seller they recruited. The strategy generated product sales without requiring actual consumer demand. However, many sellers ended up losing money: they splurged on Herbalife products they couldn't sell, paid to attend classes and conferences, and shelled out on real estate to open 'Nutrition Clubs' as recruiting venues.

The FTC's investigation found that half of Herbalife’s distributors or ‘sales leaders’ earned less than $5 a month from selling its products. It pointed to a survey conducted by Herbalife, which revealed that 57% of owners of Nutrition Clubs - which cost around $8,500 to open - reported making no profit or losing money. It concluded that Herbalife primarily incentivised sellers to recruit more sellers, rather than sell products to consumers.

As part of the settlement, Herbalife agreed to rejig its business. It now distinguishes preferred members from its distributors. At least two-thirds of the rewards it gives to sellers will soon be based on verified retail sales, and only a third can reflect sales to other distributors for their personal consumption. Starting in May, verified consumer sales must account for at least 80% of Herbalife's total US sales, or the rewards it offers sellers will be capped at 10% of their sales. 

Other concessions include Herbalife agreeing not to have sellers stomach the costs of opening Nutrition Clubs until they finish their first year as a distributor and complete a business training programme. Moreover, it has agreed to pay for an Independent Compliance Auditor (ICA) for seven years to ensure it complies with the new rules. It's also barred from exaggerating the potential earnings from working as a seller, or marketing it as a way for people to quit their jobs and live a lavish lifestyle. Finally, Herbalife agreed to pay $200m to the FTC, which it has distributed among nearly 350,000 people who lost at least $1,000 by joining Herbalife.

Johnson's repeated assurances that Herbalife has genuine customers were likely intended to reassure investors and rebuild the company's reputation. However, they came across as defensive and could fuel further skepticism. Still, assuming Herbalife's preferred members are sticking to the rules and not selling the discounted products, the company has shown it isn't built on sand.