Herbalife: Has The DSA And Multilevel Marketing Given Up On Retailing? by William Keep, Seeking Alpha

Summary

  • DSA 2013 reports the number of “Direct Sales Representatives”; DSA 2014 reports the number of “People Involved in Direct Selling.” Involved doing what?
  • DSA says whether the customer is a distributor is “immaterial”; Vemma and BurnLounge courts say otherwise (DSA also claimed to “perfect” the definition of pyramid scheme).
  • Vemma and BurnLounge notice to Herbalife and others: effective anti-pyramid scheme safeguards (e.g., Amway ’79) still relevant.

Investors know well the risks of “retailing”.

You have seen the numbers. Upwards of eighteen million adults — more than 8% of adult Americans — participate in direct selling (overwhelmingly MLM), presumably to earn part- or full-time income. Despite accounting for less than 1% of total US retail sales, it is not hard to find extreme claims about the importance of the industry (move over 1%ers!). Available public data, however, indicate that most participants are “inactive” and therefore ineligible for company earnings. That is just part of the picture. MLM companies often promote a second income opportunity as independent business owners participants can obtain profits from selling products to non-distributor customers.

Analogous to being a retailer, MLM-style direct selling (as opposed to traditional direct selling) can be similar to owning a store but without the overhead costs. Whether products are delivered by the distributor or direct shipped via the parent company, the distributor establishes the price and accepts the risks of a retailer. Providing information and ensuring a positive buying experience increases customer satisfaction and repeat purchases and limits product returns. In this way, so the story goes, income can be earned based on purchases by distributors in one’s downline, and from the margin on sales to non-distributors.

If the latter income source was ever significant, it appears that things have now changed. Over the past year and a half the DSA has promoted the view that sales to non-distributors are not critical to the opportunity and likely not even relevant. Inaccurately paraphrasing the BurnLounge decision, in 2014 DSA president Mariano claimed: “the Court affirmed that compensation in a multilevel marketing business must be primarily based on the sale of products and services to the ultimate consumer, whether or not that consumer is also a seller of the products.” More recently he was quoted: “‘The legal analysis should be: is the product being used by real customers?’ Whether the consumer is a distributor is immaterial” (emphasis added). As explained here, this public position by a national trade association contradicts decades of pyramid scheme case law. The DSA sought to bolster its view with a pitiful analysis conducted by a consulting firm that may now well wish it had taken money from someone else (see: the report and the many ways the authors misunderstood and misrepresented the industry).

This DSA website reads: “The direct selling channel differs from broader retail in an important way. It isn’t only about getting great products and services into consumers’ hands. It’s also an avenue where entrepreneurial-minded Americans can work independently to build a business with low start-up and overhead costs…”

The DSA continues that, “Direct selling consultants work on their own…retaining the freedom to run a business on their own terms.” But if, as highlighted above, non-distributor customers are no longer part of the equation (or are, in any event, people whom the distributors may safely ignore), then the DSA-promoted model appears to simply pay distributors to enlist new distributors, who purchase products at the same “discount” price, making the term “distributor” a misnomer and one more aptly replaced by “referral agent.” Under this approach, agents do not: establish the selling price; collect sales tax; take possession of, inventory, finance, or insure product; deliver, or take any risks typically associated with retailing. The MLM parent company, in addition to manufacturing the product or outsourcing production, is the sole retailer. As there is no additional retail channel and the absence of a retail markup obviates any entrepreneurial incentive for retail selling, why then does the DSA continue to describe the MLM industry as a “Direct Selling Retail Channel”? Perhaps the next DSA report should be on the difference between risk incurred by “retailers” and risk incurred by their MLM “distributors.”

The DSA correctly points to the Amway ’79 decision as the watershed decision that recognized Amway’s MLM model to be a legal form of business. Curiously, it then ignores the anti-pyramid scheme safeguards ensuring retail selling and presenting distributors as both direct and indirect retailers, terms critical to Amway’s defense. The successful Amway ’79 defense might be considered by some to be passé, old news to 21st century “direct sellers.” However, the BurnLounge and Vemma courts indicate that is not the case, just as they also reaffirm the relevance of Koscot and Omnitrition.

Until we get public clarification, it seems that in the new DSA its member companies sell “to” (not “through”) a downline of agent/customers — all at the same price, while they pursue company-granted rewards by recruiting the next agent/customer who in turn… well, you get the picture. For example, the DSA award-winning Jeunesse: “If you are a Distributor, sign up your first two Preferred Customers (PCs) with product purchase (one will automatically be placed on your left and the second on your right) and you: ‘Get $50 USD’).” With downline positions are PC’s now ready to earn compensation? Note, “The Preferred Customer has three products to choose from at a reduced rate from the retail price. Once they choose their product, they get a website.” One can understand why continuing customers have special access to a retailer’s website, but why give a “customer” a downline position and website of their own if it were not for them representing an agent in-the-making?

Earnings statements by Jeunesse and companies such as Herbalife show the vast majority of participants eligible for company earnings earn between $0 and $1000 per year. But that’s OK, because Herbalife CEO Johnson, says $1,000 “That’s a lot of money” (minute 2:38). After required purchases to maintain eligibility, selling expenses (e.g., free product samples, gas for the car, etc.) and the time involved, how much per hour did the representative effectively earn? With the DSA recommending sales to non-distributors be immaterial to defining a legal MLM model (i.e., “The legal analysis should be..,”) can the industry actually support the portrayal of millions of Americans earning part or full-time income? I maintain the evidence indicates otherwise.

Additional disclosure: I have not received compensation from any parties associated with the Herbalife controversy and have no known financial position with any firm mentioned.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Herbalife Ltd. HLF