Since the Federal Trade Commission revealed that it is seeking an injunction against Vemma, there have been numerous stories about whether that case will have any impact on Herbalife. We saw something similar happen with the BurnLounge case last year. It’s only natural to wonder whether there will be a broader impact on the multi-level marketing industry as a whole when regulators target one specific company.
But what the issue boils down to is retail / consumer demand for a company’s products and whether the so-called 10 customer, 70% rules could have an impact on Herbalife, just as they had on Vemma.
What are the 10 customer, 70% rules?
Although the FTC noted several problems in Vemma’s business model, one thing of interest in the case pertains to those 10 customer, 70% “rules.” Indeed, a weak area in Vemma’s case, according to the FTC, relates to these rules. It should be noted that these are not technically rules, per say, but rather guidelines set forth by a judge in a precedent-setting case the FTC filed against Amway in 1979.
The guideline states that a distributor for a multi-level marketing company must have 70% of their sales resold at wholesale or retail price (to prevent “inventory loading”) and sell products to at least 10 different retail customers per month. A key defense for Amway in that case was that requirement for its distributors.
Because of that requirement, the judge ruled that the company was not a pyramid scheme but rather a legitimate multi-level marketing company. The point was to make sure product was being moved “through a wholesale and eventual retail network.” Amway later weakened its interpretation of these very same policies which saved it from being branded a pyramid scheme by regulators, but that’s a separate issue.
Big problem for Vemma
As this pertains to the Vemma case, according to the court documents, is that the company’s compensation scheme puts “little emphasis on selling to customers outside its network.” The court document further states that there is “minimal” likelihood of Vemma affiliates earning profits on retail sales. In other words, a big issue we saw last year in the BurnLounge case came back to haunt Vemma. The FTC said Vemma’s business model focuses more on compensating distributors for recruiting new distributors rather than selling product.
For Vemma distributors to retain active status, they must sell at least 120 personal volume points and have at least one active customer or affiliate on each of their two teams. Qualifying personal volume points can come from the distributor’s own purchases. Needless to say, a distributor buying product for himself does not push products outside the Vemma network, but in order to stay active, the distributor must have that minimum amount of volume points per month.
So why does this matter for Herbalife?
Bill Keep, PhD., an expert on pyramid schemes and dean of the School of Business at The College of New Jersey, tells ValueWalk that a key weakness in the 10 customer, 70% rules is allowing companies to interpret the term “retail customer” however they like. Indeed, the documents from the Bostick versus Herbalife class action case in California (which was settled) indicate that Herbalife has a very loose interpretation of those rules.
The company does recognize that “retail customers” exist, but its policies do not technically require distributors to sell to customers outside the network and so do not necessarily push product outside to end customers outside Herbalife’s distribution network. Here are Herbalife’s versions of the 10 customer, 70% rules, according to the Bostick case (and these same descriptions can be found in past letters Herbalife wrote to the SEC to address questions posed by the agency, like this one here):
The 10 Retail Customers Rule: A Distributor must personally make sales to at least ten (10) separate retail customers in a given Volume Month to qualify for and receive Royalty Overrides, Production Bonuses, and other bonuses paid by Herbalife. For the purpose of fulfilling the certification requirements of this Rule, a Distributor may count any or all of the following each Volume Month.
A sale to a retail customer
A sale to a first line Distributor with up to 200 personally purchased Volume Points (and no downline Distributors) which may be counted as a sale to one (1) retail customer; and
A Nutrition Club member who consumed products during ten (10) visits to a Nutrition Club within one Volume month, which may be counted by the Nutrition Club operator as a sale to (1) retail customer.
Dr. Keep pointed out to ValueWalk some problems with this interpretation of the 10 customer rule:
“Clearly selling to another distributor simply moves product within the distribution network with no guarantee of sales to customers outside the distribution network. Also notice that it says products ‘consumed’ at a Nutrition Club and not products ‘sold’ to a customer at a Nutrition Club. That way a distributor can be encouraged to buy products and offer them as a ‘trial’ to customers and never secure a sale. Why would they do that? They would do it maintain their eligibility for ‘rewards’ while at the same time getting rid of excess product.”
And here’s what Herbalife says about the 70% Rule:
In order to qualify for and receive Royalty Overrides, Production Bonuses, and other bonuses paid by Herbalife, at least 70% of the total value of Herbalife products a Distributor purchases each Volume Month must be sold or consumed that month. For the purpose of fulfilling the certification requirements of this Rule, a Distributor may count any or all of the following:
Sales to retail customers;
Sales at wholesale to downline Distributors;
Product consumed at Nutrition Clubs
Product used for personal or family consumption (This one is not explicitly listed in Herbalife’s letter to the SEC, although it appears to be included in this statement following that list: “If the Distributor fails to timely certify to Herbalife that they have sold or consumed 70% of the product purchases made that Volume Month, Royalty Overrides, Production Bonuses, and other bonuses will not be paid to the Distributor.”)
“Again we see the explicit recognition that a ‘retail customer’ is different from selling to another Distributor but there is nothing here to ensure such a sale,” Dr. Keep told ValueWalk. “In addition to my comments above regarding sales to Distributors and products consumed in Nutrition Clubs, this Rule can be satisfied simply by claiming self-consumption (i.e., ‘must be sold or consumed that month’ and ‘used for personal or family consumption’).
We contacted Herbalife for further clarification on their interpretations of the 10 customer, 70% rules, but a spokesperson declined to comment. Dr. Keep says the company never previously addressed his concerns about these interpretations either.
It should be noted that Vemma did not attempt to address these rules in any way, however, so Herbalife is ahead of the company in this area, even though the rules seem to leave some loopholes in terms of trying to get sales outside of its distributor network.
Is Herbalife still vulnerable?
So in light of what appear to be loopholes in terms of getting products outside its distribution network, does Herbalife have anything to worry about in regards to the Vemma case? Dr. Keep thinks so, although Herbalife management says there is no danger.
Aside from the 10 customer, 70% guidelines, another issue named in the FTC’s case against Vemma is false or misleading statements allegedly made by the company’s distributors. This is a problem Herbalife has battled and tried to fix, to its credit, to try to enforce compliance among its distributors regarding what they can and can’t say about the company’s products.
Dr. Keep highlighted some comments made by Herbalife Treasurer John DeSimone a year ago in terms of how the company distances itself from its distributors, adding that Herbalife is “quick to disavow virtually any accountability” for what its distributors say. In this interview, he noted the following comments made by DeSimone.
“Actually I think we do a great job controlling the distributors. It’s a four-pronged approach,” DeSimone said in the interview. Later he was asked, “So you do control Club 100 though?”
He answered: “We don’t – Club 100 was not an Herbalife-identified strategy. Our members are independent.”
“This continues to be a fundamental problem,” Dr. Keep told ValueWalk in an email. “Herbalife distributors are independent agents essential to generating company revenues. “In the DeSimone quotes (and I can find others from Herbalife representatives) we see statements that convey a form of risk management (which, I am sure pleases investors) by benefiting from distributor actions (even sales based on illegal misrepresentations) co-mingled with statements that distance the company from its distributors.”