Business

Herbalife’s Misleading Lesson About The Collapse Of Qualification Buying

Editor’s note:  Herbalife has argued that the business model has changed over time, specifically that new distributors are not pressured to buy loads of product upfront to achieve sales leader status, a process known as qualification buying. They say more and more distributors buy smaller amounts of product over longer periods of time, proving that customers really are interested in buying the product for self-consumption. Richard’s own investigation into South American nutrition clubs shows how the scam has simply morphed. Distributors enter training programs and are required to space out purchases to maintain participation in the programs – thus creating an illusion that things have changed even though aspiring entrepreneurs are still required to make purchase after purchase to stay involved.

Christine Richard Herbalife’s Misleading Lesson About The Collapse Of Qualification Buying by Christine Richard

Christine Richard is the President of Orion Research LLC, which does investigative research for investors. She is a former reporter with Bloomberg News and Dow Jones and the author of Confidence Game: How Bill Ackman Called Wall Street’s Bluff (Wiley, 2010). Pershing Square Capital Management, which has a short position on Herbalife, is a client of Orion Research LLC.

Summary

Herbalife says fewer of its distributors are engaging in so-called “qualification buying”.

Instead, distributors make smaller, more frequent purchases, purportedly proof they’re buying from Herbalife to service retail customers.

That’s important because the judge in the FTC’s case against Vemma says evidence of qualification buying is “evidence of a pyramid scheme.”.

We follow a Colombian Herbalife distributor enrolled in a popular training program called “Escuela 500” to show how his smaller more frequent purchases have nothing to do with retailing and everything to do with qualification buying.

Percentage of Herbalife Supervisors Qualifying in Two Months or Less

Herbalife

Over the last several years, Herbalife Ltd. has been telling investors about a significant and positive change in its business: Fewer distributors are signing up and immediately purchasing the 4,000 volume points worth of products. Instead they become Supervisors more gradually, taking three to 12 months to purchase 4,000 volume points as they build a sustainable base of retail customers.

Nothing could be more important to the survival of Herbalife’s business than proof that so-called “qualification buying” is vanishing from the company’s business. The Federal Trade Commission is pursuing a case against competing multi-level marketing company Vemma and has criticized that company’s reliance on qualification buying. Vemma requires distributors to make an upfront purchase of $500-$600 worth of products and then to sign up for auto-shipments of $150 worth of products every month in order to earn commissions.

The judge in the Vemma case said:

“Evidence that distributors purchase and consume product for the purpose of qualifying for recruitment incentives is evidence of a pyramid scheme.” (Source)

Herbalife’s Qualification Issue

Herbalife’s marketing plan also encourages qualification buying. Herbalife requires distributors to buy 4,000 volume points to become Supervisors, a designation that allows them to receive commissions on purchases by those they recruit. Then they need to buy 2,500 volume points per month to maximize those commissions. One volume point costs roughly $1.

Instead of eliminating these controversial- and expensive- qualification requirements, Herbalife is attempting to convince investors, regulators and the public that distributors are not really influenced by them. Herbalife claims distributors are no longer talked into placing one or two large orders to immediately qualify as Supervisors. Instead they march to a different drummer when placing orders with Herbalife- demand from retail customers. This demand results in smaller and more frequent orders that allow a distributor to qualify over time- without ever engaging in disreputable qualification buying. (Herbalife says it has encouraged this transition by extending the time available to purchase the 4,000 volume points from one month to 12. It has also limited first-time orders to $1,000 or less.)

The argument seems convincing. Fortune Magazine’s Roger Parloff picked up on this in his recent article The Siege of Herbalife:

Throughout the Johnson era, the size of the average purchase has been getting smaller, while the number of orders has been increasing. Though the impetus for the changes was apparently not regulatory, its impact could be. While inventory loading seemed like a plausible charge when new recruits were being pressured to buy $3,000 worth of products in a month, it seems less so in a company that, since 2007, has actually been exhorting new recruits to slow down their purchasing.

One reason Parloff is convinced is because the former director of the FTC’s Bureau of Economics, Dr. Joseph Farrell, is convinced.

Parloff quotes a 67-page report authored by Farrell in which the economist concludes that there is consumer demand for Herbalife’s products. Although the report has never been made public, according to Parloff, the economist concluded that “purchasing patterns were consistent with the purchasing you’d see when distributors were fulfilling consumer orders and not gunning for bonus qualifications.”

To summarize the argument: It’s not necessary for Herbalife to prove it has retail sales if the company can show that its distributors buy from the company in a way that “proves” they have retail customers.

But are these slow and steady 3- to 12-month qualifiers really distributors with retail customers? Let’s meet one.

Escuela 500 Tuition Payments

Last summer we highlighted the importance of training and certification programs to Herbalife’s business. We explained how these programs, including one of the most popular called Club 100, turn recruits and their family members and friends into conscripted consumers of the company’s products as the recruits attempt to qualify to open their own Nutrition Clubs. You can read more about Club 100 here.

A few months ago we decided to follow up on our Club 100 research by looking at another popular program called Escuela 500. The program appeared to incorporate aspects of Club 100- including the various shake and tea consuming activities required for certification and the requirement that distributors complete the training program before being allowed to open a Nutrition Club.

We asked a recent enrollee of the program in Bogota, Colombia to send us regular updates.

One of the first messages we got from our Escuela 500 student was an explanation for the name of the program. His message was headed: “Important.”

“To qualify to School 500, as part of the certification process, you must make one or more personal purchases of a minimum of 500 pts. So you have from the 1st to the 31st of each month to complete at least that amount for the next month so you can attend the training. So if you decide to make the purchase in October, you will be qualified for November.”

Product-based tuition payments!

Escuela 500, it seems, adds a twist to Club 100 by requiring that distributors not only consume products daily in Nutrition Clubs but also place substantial orders directly with the company in order to participate in this training charade.

Our Escuela 500 enrollee sent the following after his first day of classes:

“I arrived at 2.00 pm to the venue, a Christian church auditorium for more than 2000 people, located in the centre of Bogota, where a massive queue of persons were waiting to register to this event. The price for the event ticket was US$15 for distributors and US$35 for Supervisors. To attend this School 500, you had to prove you’d bought a minimum 500 volume points.”

The trainee explained that these tuition payments were carefully checked:

“In the registration area there were at least 10-15 persons receiving the crowd, and checking that everyone meets the 500 PV rule . . .”

How were the program’s operators able to check that 2,000 people had purchased 500 volume points of products from Herbalife during the previous month?

The trainee explained that distributors are required to show a print off of their Herbalife online account activity. This print off is necessary to get into every event.

Our student asked another student what she was doing with her purchases and she explained that she basically was living off the products. This was something she’d learned from her children who had signed up with the program earlier:

“Flor says she’s buying 500 VP per month by now. She explained: ‘My children had to work very tough for at least three years, seeding the garden, sometimes they had to eat exclusively Herbalife products to keep going with the business. Now they’ve reached a financial stability and are advancing in the ‘stairway the success, I hope to reach them soon.’”

This stairway to success is the marketing plan, which brings higher levels of commissions as distributors advance. But buying and consuming product in order to advance up the stairway sounds a lot like what the judge in Vemma warned against:

“Evidence that distributors purchase and consume product for the purpose of qualifying for recruitment incentives is evidence of a pyramid scheme.”

Events and More Events

Our trainee sent numerous dispatches from training events, of which there was a long list required for graduation:

  • 8 Training Sessions at Office System
  • 3 STSs (Success Training Seminars)
  • 3 Saturday Seminars
  • 3 500 Schools
  • 4 weeks visiting and training at recommended clubs

Events almost always began with distributors singing Tina Turner’s Simply the Best. Next came the string of trainee testimonials- stories of losing weight and gaining income. The sessions were capped off by a guest speaker talking about the products or the business opportunity and then invariably telling a rags-to-riches story before signing autographs.

The checking and dispensing of qualification volume was a big part of every training event as well. Attendees queued up to show their Herbalife receipts and prove they’d purchased their qualification volume. Later, they queued up again so that the group could disperse the qualification volume of higher level distributors into cups, and serve it to the trainees.

Here’s a photo of product being doled out to trainees:

Herbalife's Misleading Lesson About The Collapse Of Qualification Buying

And a typical entry for an event:

“[The Millionaire Team member] is received by a crowd of people looking for an autograph. At that moment, the doors of the room open to allow people outside to see the conference. A couple of people begin to hand out complementary NRG [an Herbalife tea] to about 200-plus people.”

During one of the larger events in Bogota, our trainee sent this photo of a cup of frozen Formula One titled: “Ice Cream Break.”

Organizers provided this treat to 2,000 attendees.

Trainees also consume as part of their internship: “Today, as every intern student, I had to pay for the Basic membership ($3.5), “ our trainee wrote.

The distributor training him consumed even more:

“(The club operator) took a full Herbalife nutrition meal (Aloe + Tea +F1+Protein = $5), plus 3 extra Proteins ($3), another scoop of Formula 1 ($1), 2 NRG teas ($1.5) and a Fiber ($1.5) for a total of ($12).”

At one point, we asked our Escuela 500 student to ask his upline about the history of the Escuela 500 training program. Here’s the response we got back from him:

“Escuela 500 was created by the leadership [the highest ranking distributors] of Colombia to make it possible for associates without a large amount of money to invest and start winning money gradually through Herbalife, by purchasing 500 VP (US$600), which is basically enough product for you to try with your family at home, to recommend and to sell. This tool is being used across Latin America but is not as popular in America as the income over there allows the use of other tools.”

In other words, this is a way to enforce qualification requirements on people with less money or access to credit than people in the United States.

Lessons Learned

After three months, our trainee graduated. In a green and white sash, he stood with other graduates and smiled for photos.

So what did our Escuela 500 student accomplish?

  • He purchased 500 volume points of Herbalife products every month to make tuition payments, spending about $1,800 in three months.
  • He spent hundreds of dollars more on door charges to gain admittance to training events where he effectively purchased the qualification volume of higher-level distributors via the consumption of endless “complimentary” teas and shakes.
  • He provided testimonials to help recruit more trainees into the scheme.
  • He learned that a person could live off Herbalife products, if necessary.
  • Finally, he made Herbalife look like less of a pyramid scheme because he bought just 500 volume points a month, putting him on track to become one of Herbalife’s highly touted 3- to 12-month qualifiers. Had he continued in the program, he would have qualified as a Supervisor after eight months.

Looking at our Escuela 500 student’s buying patterns, one might conclude he had regular customers, but he had no retail customers, at all.

Herbalife has failed to disclose to its investors and to the public how training programs such as Club 100 and Escuela 500 are vital to its business, driving sales and recruiting efforts. These training programs create their own qualification requirements, which are tailor-made to victimize those who can’t afford to pay several thousand dollars upfront. Qualification buying hasn’t ended; it’s just changed its shape.

In summary, Herbalife has used the growth of smaller, more frequent orders to teach a faulty, self-serving lesson:

500 vps + 500 vps + 500 vps = Retail Sales = Herbalife Isn’t a Pyramid Scheme

Knowing what we know about Escuela 500, let’s rethink that equation:

500 vps + 500 vps + 500 vps = Escuela 500 Tuition = Qualification Buying = Herbalife is ___________________________________.

(Fill in the blank)

Additional disclosure: The author does not take positions in companies she researches. Pershing Square Capital Management, which has a short position on Herbalife, is a client of Orion Research LLC.