The FTC, Fortune Hi-Tech Marketing and Herbalife
Whilst much of the news coverage surrounding Bill Ackman’s claims that Herbalife is a pyramid scheme has focused on stock market shenadigans, here at BehindMLM we’ve largely been focused on the issue of whether or not distributors can be classified as retail customers.
In one corner you have Herbalife and its supporters claiming you can, primarily on the premise that distributors purchase products for consumption in the exact same manner that retail customers do.
In the other corner are people like myself who believe that if you’re a distributor and participating in an MLM business opportunity, you’re obviously not a retail customer.
At least that’s the simplified core of the discussion that has ensued since I wrote my Herbalife review a few weeks ago.
Another tangent to the discussion is the familiar “well the regulators (FTC) haven’t done anything so obviously they don’t have a problem with Herbalife” argument. Here at BehindMLM we see this argument a lot, primarily used as an unofficial endorsement by the authorities of an MLM company’s business model I might find issues with.
Needless to say it’s a shallow argument that doesn’t carry any water. Moreso when you consider that the public aren’t privy to investigations carried out unless court action results (or the company in question voluntarily reveals they are being investigated, which for obvious reasons never happens).
On this particular topic of regulatory inaction, today news comes down the grapevine that the FTC have shutdown the MLM company Fortune Hi-Tech Marketing for operating what Kentucky Attorney General Jack Conway described as being ‘one of the most prolific pyramid schemes operating in North America‘.
Unfortunately I never got around to reviewing Fortune Hi-Tech Marketing (FHTM) so my knowledge of the company is limited. Fortunately for the purpose of this analysis however, FHTM itself is largely relevant.
Putting aside the stock market and Herbalife share prices for the moment (which incidentally slumped 11% upon news of the FTC taking down FHTM), I thought today we’d take a look at specifically what the FTC took issue with in the FHTM case and see if any of it applies to Herbalife from a purely MLM perspective.
Taken straight from the FTC’s complaint against FHTM,
Since approximately 2001, FHTM has purported to operate a multilevel marketing company, selling various products and services using a network of “Independent Representatives” (“Reps”).
In order to become a Rep, consumers must pay FHTM an initial fee, previously as high as $299, but now $250. In return, FHTM claims to pay its Reps lucrative bonuses and commissions once they satisfy certain sales and recruiting requirements.
As noted in my Herbalife review, the company does not openly disclose the distributorship costs of joining on their website. Only able to thus rely on Herbalife distributor information, the various sites I visited pegged Herbalife distributor ship at anywhere between $60 to $200.
In return for paying this fee, Herbalife pays distributors bonuses and commissions for selling Herbalife’s products to retail customers and recruited distributors (non-retail).
In reality, since at least 2001, FHTM has been operating an illegal pyramid scheme.
FHTM’s complicated and convoluted compensation plan ensures that the vast majority of FHTM’s Reps make little or no money.
To the extent that Reps can make any income,this income results primarily from recruiting new consumers to become FHTM Reps and not from the sale of products or services.
Whether intentional or not (the FTC and vagueness seem to go hand in hand when it comes to MLM), the FTC have simply focused on recruitment (selling of memberships) and the “sale of products or services”.
Although I haven’t analysed the FHTM compensation plan, one can assume that affiliates were paid commissions upon the payment of membership fees made by new recruits.
Here FHTM technically differ, even though the premise is mechanically the same.
Whereas in FHTM you recruit a new member and earn a commission purely on payment of their membership fees, Herbalife differ in that distributors earn on their purchasing of the product (which also qualifies the distributor buying the product for commissions).
The problem here of course being that these new distributors then go out and recruit new distributors and earn on their purchases, who in turn must do the same if they wish to earn anything that resembles an income.
As noted by a Commercial Court in Belgium who found Herbalife guilty of being a pyramid scheme in 2011,
it is a lot more profitable for a (Herbalife) supervisor to sell to a distributor, rather than selling directly to a consumer.
Ackman even went so far as to peg the amount made via the recruitment of new Herbalife distributors and getting them to buy products at “10 times as much” as can be made selling Herbalife’s products to retail customers.
As such, despite not earning commissions via membership fees, both FHTM and Herbalife share the common denominator of required recruitment when it comes to success in the company.
FHTM is a literal requirement, whereas Herbalife is an effective one given that selling to actual retail customers largely appears to be virtually non-existent within the company.
There are several levels ofFHTM Reps. New entrants now pay $250 to join as Managers, and must pay $250 annually to remain with FHTM.
Previously; the initial fee was as high as $299. Unlike a legitimate multi-level marketing business, FHTM’s business model emphasizes recruiting new Reps over the sale of products and services.
Herbalife distributors have the potential to earn “10 times as much” getting recruited distributors to purchase products as opposed to selling the same products to genuine retail customers.
Need I say more?
Managers are strongly encouraged to immediately purchase either “starter packs” or “bundles,” which contain various FHTM health and beauty products, as well as other products and services offered by FHTM.
Herbalife don’t disclose specifics on their website but they too offer new recruits a a series of “starter packs” upon joining the company as a distributor (this I believe is why my research into how much it costs to join Herbalife revealed the $60-$200 range rather than a specific dollar amount).
FHTM assigns a “point” value to most of the products and services it offers.
In most cases, FHTM Reps must buy or sell products and services comprising a minimum required number of points to be eligible to obtain commissions and bonuses.
Depending on the Reps’ level in the pyramid and the type of commission or bonus, a Rep must earn five, ten, or fifteen points to be eligible for most commissions or bonuses.
Herbalife assign “volume points” to all their products. Under the “Senior Consultant Sliding Scale” (see BehindMLM’s Herbalife review), distributors can qualify themselves for higher commissions on the purchases made by their recruited downline by purchasing more product themselves.
The required point value can be a single order worth 400 points or multiple orders totalling 800 volume points or more.
Going by the FTC’s complaint, much of the FHTM compensation plan revolved around the recruitment of a specific number of new affiliates and the maintaining of a minimum monthly order to qualify for regular commissions.
Herbalife don’t set any specific recruitment amounts, instead tying their distributor promotion to volume points. Dubiously however Herbalife count distributor purchases and actual retail purchases the same when it comes to the generation of said points.
With the bulk of Herbalife’s revenue coming in from its distributors, once again we have an effective recruitment requirement if a Herbalife distributor wishes to make any significant money.
FHTM induces new recruits to join FHTM by representing that such recruits will be able to resell FHTM products and services to people not affiliated with FHTM for a profit and simultaneously earn large commissions.
FHTM claims that its representatives will be able to easily sell its products and services to consumers not affiliated with FHTM.
In fact, few of FHTM’s products and services are ever sold to anyone other than the Reps themselves.
Furthermore, Reps receive minimal financial rewards from FHTM for selling the products and services to outside consumers.
Although not explicitly clarified as a percentage, here we have what is undoubtedly a retail requirement.
The FTC believe that not enough FHTM products are sold to retail customers (“non-reps”).
In the case of Herbalife this would be the sale of Herbalife products to non-distributors (true retail).
In addressing Ackman’s claims against the company, Herbalife revealed that just 31% of the products sold by the company (through its distributors) are shipped to retail customers.
That means that 69% of the product sales in Herbalife are “sold to the reps (distributors) themselves”.
As for ‘minimal financial rewards for selling the products and services to outside consumers‘ again, the Herbalife compensation plan is clearly titled incentive wise towards the sale of products to recruited distributors as opposed to retail customers (as further evidenced by the quoted sales figured above).
FHTM’s recruitment bonus rewards a Rep for his or her recruitment efforts, as well as the recruitment efforts of his or her downline recruits.
FHTM provides much larger rewards for recruiting new Reps than for sales of products or services, thereby. encouraging Reps to recruit new members rather than to sell of products or services to ultimate users.
As we’ve previously covered Herbalife don’t directly compensate distributors on the recruitment of new distributors, however if you look at the compensation plan, there’s clearly an incentive to sell to recruited distributors as opposed to retail customers.
Accepting this fact, then so too Herbalife “provide much larger rewards for recruiting then to sell products or services to ultimate users”.
“Ultimate users” is a bit vague (Herbalife will claim distributors are ultimate users), however given the points above referring to the sale of products to “non-reps”, one can assume these are the “users” the FTC are talking about.
More than 85% of the compensation paid to FHTM Reps is tied directly to recruiting new members.
This is a bit of an interesting one. If we take that 31% of the products sold in Herbalife are shipped to retail customers, that means that 69% of the revenue made via the sale of products (by the company) is from distributor purchases.
Given that Herbalife distributors earn commissions on these distributor purchases, 69% of the product sale compensation within Herbalife is then also tied to recruitment (the distributors purchasing product month after month are recruited).
69% isn’t quite 85% but it’s still well short of the common sense 51% of more majority figure I use as a general rule of thumb in evaluating MLM business opportunities (51% of your revenue must be from retail customers).
FHTM pays many types of recruitment bonuses. These bonuses are earned from enlisting new recruits.
Again, if we take the revenue makeup of Herbalife and accept that the vast majority of revenue is coming from distributors, then so too are Herbalife effectively paying recruitment bonuses to its distributors.
Not in the literal sense but in the sense that, without recruitment these bonuses would be significantly lower.
In contrast to the claims of profitability, the compensation plan used by FRIM is designed so that, at any particular time, the majority of Reps will spend more money to participate in FRIM than they earn through their involvement with the company, and the majority of Reps will not make the substantial incomes represented.
Herbalife acknowledge that most distributors fail to turn a profit, however the company claims that these are infact retail customers who signed up as distributors for a wholesale discount, as opposed to failed distributors.
Once again I remind readers that if you’re a distributor with access to a compensation plan, you simply aren’t a retail customer.
The MLM industry’s solution to this was the creation of the “preferred customer”. Preferred customers cannot earn commissions, however by placing a regular order (which Herbalife’s distributors do), they qualify for a wholesale discount.
Herbalife have been around for 33 years and for whatever reason, despite claiming that the majority of their distributors are just in it for discounted products, have never bothered to set up a preferred customer class within their compensation plan.
You can claim this is just a co-incidence but in all the time I’ve spent covering the MLM industry one thing I quickly learnt is that there are no co-incidences.
At worst Herbalife are deliberately choosing to operate in a grey area by claiming their failed distributors (who spend more than they make) are infact retail customers.
They know that should they dare to introduce a preferred customer class that they can no longer misleadingly make the claim that their distributors are retail customers. Of course they’ll also no longer be able to simply write off concern about the percentage of “income negative” distributors in the company as simply product loving customers either.
At best after thirty three years of business and a series of very public lawsuits against MLM companies by the authorities specifically targeted a lack of retail (“non-rep”) sales, Herbalife have been completely negligent and ultimately failed their distributor base by not implementing a preferred customer class at some point.
The rest of the FTC complaint then goes into claims about “income misrepresentations” made by FHTM affiliates, which isn’t really what I wish to discuss here (I’m not saying Herbalife distributors are or aren’t doing this, just that it’s not really conductive to analysis of the Herbalife business model).
At the end of the day as you can see much of the FTC’s complaint against FHTM can be applied to Herbalife’s business model and compensation plan. It’s not quite an exact fit but given the distributor heavy makeup of Herbalife, only requires slight rewording to do so.
Following my analysis of Herbalife’s business model and compensation plan and the FTC’s complaint against FHTM, I still maintain that the easiest way to solve the question of whether or not Herbalife is a pyramid scheme would be the introduction of a preferred customer class.
There’s simply too many points in the FTC’s complaint against FHTM that can be easily applied to Herbalife to ignore and not only that, the creation of a preferred customer class would ultimately settle the required differentiation of distributor revenue vs. retail revenue.
Either Herbalife and its distributors are making more money from the recruitment of new distributors than they are from product sales to genuine retail customers, or they aren’t.
The ball is in your court Herbalife, why not act now before it’s too late?
Footnote: You can read the entire FTC complaint against FHTM here.