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Summary

  • Federal Appeals Court Confirms Burnlounge is a Pyramid Scheme.
  • Federal Appeals Court confirms Dr. Vander Nat's Status as an Expert Witness.
  • Herbalife claims Victory further insulting the FTC.

Yesterday the FTC won an important victory in Federal Appeals Court when the court confirmed that Burnlounge operated an illegal pyramid scheme. The ruling can be found here.

Certainly, it seems like the FTC knows what it is doing when it prosecutes companies that run recruiting scams.

Still, Herbalife (NYSE:HLF) seems to continue to think that the FTC may be dumber than a bag of hammers.

In spite of the fact that:

  • Herbalife recruited over 2 million new people last year.
  • Well over 2/3 of these people will resign as distributors in less than a year.
  • Very few distributors make any money.
  • "Rags to Riches" stories are told to recruits as a matter of routine.

Herbalife corporate issued the following Press Release last night celebrating the absurd idea that the 9th district's ruling cements their position as a legitimate MLM.

Q. Is the FTC dumber than a bag of hammers?

Let's review:

Herbalife and its recruiters sell a business opportunity to people looking to make a living or part-time income. The business opportunity is to make money earning retail profits (are there any?) as a reseller of Nutritional Supplements or to make commissions from the retail sales of people who you recruit into your downline. These are the only two legitimate ways to make money as a Herbalife distributor. Recruiting rewards are a "No-No".

Overhwhelmingly, participants fail.

Why?

Because Herbalife's pay plan is a rigged game.

Q. To what extent do participants in the Herbalife pay plan emphasize recruiting over retailing?

The answer seems to lie in the specific mechanics of the MLM in question. Herbalife's mechanics work as follows.

Herbalifers certainly pay a fee to Herbalife to gain the right to sell a product.

Q. Can they also be remunerated simply for recruiting somebody else into the scheme? Put another way, is it possible for a recruiter to make money selling the Herbalife dream without promoting actual retail sales at all?

The answer is an obvious "Yes".

More specifically, the pay plan encourages just this kind of outcome.

If I am a Supervisor in the Herbalife pay plan and I recruit you I qualify to earn a commission and a royalty override on any inventory you purchase. If I can convince you to invest in a Supervisor order up front when you start your business, I get paid. I get paid before you find a retail customer. I get paid whether or not you ever find a retail customer.

If I can then convince you to focus on recruiting too v. retailing, I also get paid not only on the inventory you buy but also on the inventory anyone you recruit tries to buy.

In the Herbalife world, the road to riches is paved when downline participants perpetuate the recruitment of an endless chain of business opportunity seekers who are willing to risk their capital and energy pursuing a false promise - namely that there is lots of money to be made.

Herbalife tries to spin for your consumption the nonsensical argument that everyone is buying shake mix for the value of the product itself.

Q. What kinds of things would be true if that were the case?

#1 - The Product would have long-term value. That is to say, people would use it for more than a year. Instead, we see huge failure and churn rates in the distributor network.

#2 - Consumers would, rationally, seek out the lowest price for the product and/or any competitive substitutes. Why don't consumers opt for GNC or buy product directly online at 35% off SRP v. paying an up-front fee to get a smaller discount? The answer is because most product purchases are tethered to the pursuit of the income opportunity.

#3 - Distributors would make money. If there was a healthy and robust pool of repeat retail customers, turnover rates in the salesforce would be low because distributors would be able to earn an income. Instead, most fail and quit in less than a year.

#4 - Distributors would not emphasize recruiting v. retailing. If you had a license to sell a unique product to real retail customers, it strikes me as highly unlikely that you would want to share that license ad nauseam with an endless chain of distributors. Rather, common sense advances the idea that you would want territorial exclusivity so all retail profits would belong to you.

#5 - Competitors would copy the model.

So, the question remains. Does Herbalife sell more shake mix to distributors or through distributors?

To date, Herbalife has offered scant evidence at all that product is sold through distributors. There is no retail sales data, no empirical support that the 70% rule has teeth and no hard data confirming that product is sold at anything close to SRP. We also have no data on retail margins earned by distributors or whether or not distributorships are profitable. In fact, we have no evidence from the company at all that it is even possible for a business opportunity seeker to make money as a retailer.

Q. What is the company line?

By now, the answer is obvious. Absent evidence of sales through the distributor network the company has taken the position that sales to the distributor network are evidence of legitimate retail sales to ultimate users. Ergo - "See, we're not a scam."

Trouble is, this argument seems like an uphill battle with the FTC - here's why. It's nonsense.

First - the recent ruling from the 9th district affirms the notion that within an MLM network there may be different segments of distributors. For simplicity's sake, let's classify these people into 2 buckets.

Bucket A - personal consumers

Bucket B - business opportunity seekers

The court has been very clear, the existence of some retail customers is not enough to escape a charge that the company is a pyramid scheme. Herbalife wants the world to pay attention to the segment of its salesforce it likes to call personal consumers.

The FTC is likely to be more interested in how the company's pay plan treats the segment of its salesforce that pursues the business opportunity. Obviously, these are the people who are being defrauded.

A deconstruction of the economic activity in the Herbalife micro-economy is likely to reveal the following outcomes.

  • Most product is sold to downline participants in the network not outside the network
  • Most participants pursue recruiting activity over retail activity as a pathway to success
  • Most give up and quit within a year or two when they discover their downlines remain empty
  • Legitimate retail profit margins are elusive and so there is no money to be made
  • Participants are defrauded by the sale of a business opportunity that is a mathematical fallacy

To conclude, the simple way to think about Herbalife is as follows.

Is most product purchased by participants trying to get skinny or trying to get to Supervisor?

The FTC can easily drive a stake through this argument with a simple regulatory action. If Herbalife is not allowed to price discriminate against its own distributors then the Inventory loading incentive tied to the Supervisor status goes away. Ergo, the demand for inventory would have no other rationale other than to sell it through to a legitimate retail customer.

Q. Would many people still buy-in? Doubtful.

The life-cycle right now for a Herbalife newbie likely looks as follows:

  • Inventory Load as a Supervisor/Buy Your Discount
  • Hunt for Downline Recruits, Retail Customers, etc.
  • Consume a little, sell a little, write-off a little, sample a little product.
  • Churn Out of the business when you discover no money can be made due to saturation.

Meanwhile, the upline recruit skates away gleefully with his commission plus any additional revenues earned from off-book business development tools selling the scam.

If the FTC takes away the company's ability to tier its wholesale pricing based upon a volume rebate - Presto! Participants no longer have any perverse incentive to inventory load.

More importantly, recruiters no longer have a recruiting reward/cash incentive to tie their "Rags to Riches" nonsense to.

In the end, isn't this just common sense?

If you were silly enough to start a Herbalife distributorship tomorrow, how much inventory would you buy up front to finance your working capital?

Wouldn't the answer be as little as possible?

And yet Herbalife's pay plan makes it virtually impossible for anyone to succeed as a retailer unless they place a Supervisor order.

Herein lies the clever trick in the Herbalife pay plan which the FTC will spot like a streaker at a Rugby game. A Supervisor order is the sinister chemical that gives the incentive to participants to emphasize recruiting over retailing.

Damn - if I can just recruit 10 Supervisors I can make a fine pay day.

Isn't it obvious by now that this is exactly what Herbalifers do? How else have they recruited so many people the past 5 years?

All of their sales presentations emphasize the good life, striving to get to President's team, that Supervisor is the gateway to the marketing plan, that duplication and recruiting is the pathway to success, that if you just try a little bit harder or buy just one more lead then you are sure to crack the code.

What a bunch of malarkey.

Of course, all of this nonsense is symptomatic of a highly sophisticated and well-oiled and globally prohibited marketing scheme aka a Pyramid Scheme.

Q. Is the FTC dumber than a bag of hammers?

If you remain long, don't bank on it.

By the time the FTC has completed its investigation, it strikes me as obvious that regulators will thread the needle through Herbalife's network of nonsense and get right to the heart of the matter.

Herbalife is an endless chain recruiting scam that victimizes millions upon millions of people with a false promise and a rigged carnival game. Saturation bids away all retail margins. Distributors fail in droves.

The trail of destruction the company leaves in its wake is as obvious as the mountain of earnings Michael Johnson makes annually.

Formula-1's value is tethered to the pursuit of the business opportunity aka recruiting rewards.

Evidence of profitable retail sales is scant.

Still not convinced?

Ask yourself this simple questions. If Formula-1 is such a great product that produces lots of retail sales, how come nobody sticks around for long to sell it?

What would happen to the company if it stopped recruiting tomorrow?

Disclosure: I am short HLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Does Herbalife Think The FTC Is Dumber Than A Bag Of Hammers?