If you want to learn the truth about Herbalife, who better to talk to than a former distributor? This week, a successful former distributor reached out with a story to tell. More on that later.
Jeff Bezos is a genius. Mr. Bezos foresaw how the Internet would change the way people consume books and music, and disintermediated the traditional retail distribution model with a global website called Amazon.com.
Disintermediation is a threatening term for people who are part of a distribution chain or sales force. Effectively, what it means is simple. A budding entrepreneur will cut out the middleman to reduce costs in the supply chain. These cost reductions are then invested in lower prices. Lower prices help secure market share or gain broader reach. Legacy competitors with higher fixed and/or variable costs are left impotent to compete.
Most markets for product include a price-sensitive consumer segment. True, some customers will pay a premium for service or for convenience or for the unique attributes of a given product. Still, there are indeed rational purchasers who will seek out the lowest and best price, especially when a product is simple and easy to understand.
Today, I would like to tell you the story of a Herbalife (NYSE:HLF) distributor who was recently fired by the company. To protect his identity, we will just call him "Steve" and his wife "Susan." Steve reached out to me in an effort to share his story.
Steve and Susan joined Herbalife not that long ago. Steve's wife wanted to lose some weight, and so, joined a Herbalife Boot Camp. Before long, she had been indoctrinated into Herbalworld and was pursuing the business opportunity. Nutrition Clubs were all the rage in the local market. "You should open one here!" Susan's upline sponsor advised. Little did Susan know that the same advice was also being given to other would-be Nutrition Club owners.
Steve and Susan told me an honest tale about how potential entrepreneurs were toured around the local network of clubs to see how they operate "In Practice." Always, the club owner was telephoned ahead. Always, the members of the downline were quickly rushed to the otherwise empty club to give the veneer of legitimacy to the traffic flow within. Seemingly, many investors were fooled.
Steve opened an N.C., and surprise, surprise, it failed. Why? Too many N.C.s chasing not enough customers in the same zip code. Where have we heard that story before?
(Source: Pershing Square - The Big Lie)
Fortunately for Steve and Susan, they had a background in online marketing. So, Steve had a very simple idea. Why not sell Formula 1 directly to consumers over the Internet at heavily discounted prices? Surely there will be customers who will flock to the site and "Buy Direct." This idea is not unique to Steve and Susan. Many distributors sell online - just not as well as Steve.
Steve, as it turns out, is very good at what he does. He built a slick e-tailing website, and had it optimized for search engines. That way, any time somebody typed things like "Buy Herbalife" into Google, Steve's site would show up at the top of the list. Steve also purchased Google AdWords to drive traffic to his site. Pretty soon, Steve's site would routinely pop up at the top of the list of search results. Consumer traffic followed. Business flourished.
Steve and Susan were processing orders from places like Oklahoma and New Mexico and Puerto Rico and Miami. These communities are all known as Herbalife hotbeds (see saturation map above). Turns out, savvy consumers actually shop around.
Steve had a very simple supply model for his product. Product was discounted at prices 30% to 40% off Herbalife's Suggested Retail Price. This is not surprising. Most e-tail websites run by Herbalife distributors feature similar discounts. Some distributors "Stack" online and offer up to 50% off (More on "Stacking" tomorrow). When clients ordered from Steve, their orders were then drop-shipped directly from Herbalife's warehouses to the customer's address. This idea was brilliant. Steve's working capital cycle was incredible. He never had to take possession of inventory, finance inventory nor ship inventory. Herbalife did all the work for him. This efficient set-up allowed Steve to charge rock-bottom prices for Formula 1 and still generate profits.
After a while, Steve was pulling in $25k per month in compensation. The website was generating Volume Points in excess of 2 million per annum. Other distributors started to notice. How was it possible for anyone in Herbalife to generate such robust volume without a robust downline? What on earth was going on?
For starters, his upline noticed what was going on. "How come Steve's making all this money and not me?" Logical question. Yes, Steve's upline was getting Royalty overrides on Steve's volume, but the bulk of the spread on these volume points was being earned by Steve. Steve was also destined to qualify for a production bonus too, and pinch his sponsor's compensation. Passing your upline sponsor in Herbalworld causes tension. Yikes!
Second, other distributors in the Herbalife network began to cry foul. "No Fair," they said. "Steve's website is too successful. Steve is stealing my customers. We need you to shut it down."
Any guesses as to what happened next?
For starters, Herbalife told Steve he could no longer buy AdWords on Google. Then, he was told that he had to strip the meta data tags from his website that were causing search engines to list his e-tail store at the top of search results.
Finally, Steve's distributorship with Herbalife was terminated altogether when the company accused him of fulfilling orders for customers through a separate website, which he claims he was not.
Here's the thing. Steve was on the cusp of qualifying for President's Team within Herbalife - all within less than 2 years. That's how good he was at e-tailing. Unfortunately, before that could happen, Herbalife cut him loose unceremoniously. Seems that if you aren't "working downline" at Herbalife, you're branded a heretic.
Imagine that. Imagine a distributor with little to no downline, lots of "discount customers," actual retail sales from around the country and a successful business model getting axed just before being feted at an Annual Herbalife Extravaganza.
One would think that Steve would be the poster child for innovation and success. Instead, he was ostracized for being too successful. Of course, his upline sponsor now swallows up all of the volume points and cash that flowed to the website. Funny how Steve was pinched out of his sponsors downline, but not the Volume Points... hmmm?
Isn't it funny how the upline always wins at Herbalife?
What's the point of relating this story?
For starters, if you ever wondered whether or not Herbalife inventory is sold at heavily discounted prices in volume, you needn't wonder any more. Enterprising supervisors routinely discount product to acquire market share and price junior distributors out of the retail marketplace entirely. Steve's wife told me verbatim "Nobody charges Retail Price for the product. The distributor down the street will just cut you on price." Turns out, the forces of competition actually work.
This is the risk that the FTC's anti-trust counts levied in both the Koscot case and the Holiday Magic case identify. Price discrimination creates a monopolistic advantage for certain classes of distributors. Steve took advantage of this cost advantage, as well as his love and knowledge of the Internet to steal market share away from other Herbalife distributors. Smart guy!
Second, this story is symptomatic of the absurd endless chain nature of Herbalife's sales force. When you grant distributorships to people without limitation, territorial rights, nor other jurisdictional protections, it is inevitable that salespeople will fight to the death for market share between and among one another. The results of this internal competition are both foreseeable and predictable. Prices are heavily discounted, margins are compressed, average sales volume is compressed and profits are elusive. Too many mice chasing not enough cheese means that many mice will starve. This, of course, is what happens at Herbalife. This is what we can easily refer to as SATURATION. This is the risk envisioned in Koscot, associated with an ENDLESS CHAIN of recruitment. This is the mathematical fallacy "in practice."
Historically, Herbalife has been a person-to-person marketer. Increasingly, innovative Herbalife distributors are turning to the web to peddle their wares. Facebook, Instagram, Twitter, Independent e-tail sites, etc. all broaden the reach of salespeople beyond their native geography. Of course, the collision course with other salespeople should be apparent to anyone with a scintilla of common sense. Meanwhile, Michael Johnson sits back and laughs as these salespeople literally fight tooth and nail for finite market share. No retail profits? Not to worry - Mr. Johnson always makes money. That's how pyramid schemes work "In Practice."
Third, Herbalife's representations to potential recruits about their earnings potential are fraudulent. As I pointed out in an article yesterday, Suggested Retail Price is a fiction. Distributor Allowances are also a total and complete and utter fiction. Unless you are a Supervisor in the Herbalife pay plan, you have absolutely no chance whatsoever to succeed as a retailer, because the retail market is already flooded with inventory at prices 25% off SRP or more. When Herbalife tells new recruits they can earn up to 50% profit, this representation is obviously the exception to the rule, and therefore, deceptive. What does that leave? If you said "RECRUITING," you are starting to understand the business.
Fourth, consumers are intelligent. Formula 1 is a simple product to understand. Putting two scoops of powder into a blender is even easier to understand. The legitimate DIY shopper wants a great price, and will search to find it. This makes it difficult for Herbalife salespeople to add value and to make money over time. Would it surprise anyone if a customer went to a Fit Camp, visited a Nutrition Club and then shopped online themselves as a rational consumer life cycle? Of course not.
Channel conflict is a complicated issue to manage for many companies. Disintermediation is a powerful force. Here's the big strategic question. Do I disintermediate myself, or do I allow someone else to do it and cede market share to a competitor?
Herbalife has all kinds of issues with distributor conflict. This is an inevitable outcome of a company that commits franchise fraud and sponsors a pyramid scheme. Endless chains unleash hyper-competition. Consumers may love it. They get product at rock-bottom prices because salespeople are killing one another for diminishing chunks of market share. Meanwhile, the entrepreneur who seeks out the business opportunity is betrayed daily by The Marketing Plan, which constantly seeks to push out the supply of salespeople to the point of maximum pain. After all, that's how pyramid schemes work with their geometric expansion.
John Hempton sees consumption. To this I ask, "Where are the profitable salespeople John? Where is the business opportunity? Why so much churn?"
In the end, "Steve" and "Susan" were killed off by Herbalife for being too successful, too innovative and too rational. They figured out a way to disintermediate the person-to-person business model with great success. Put another way, they threatened the Golden Goose known as "working downline." Herbalife's hidden message? It's fine if you want to sell online - just don't sell too much, okay?
How's that for forward-looking thinking?
Herbalife commits business opportunity fraud each and every day.
- Exaggerated Income Claims
- Proliferation of a Pyramid Scheme
- Unprofitable salespeople
Most who sign up to pursue the business today fail. Is it any wonder why?
What else did Steve and Susan tell me?
- Bill Ackman is bang on the money as to how Herbalife works "In Practice."
- The entire business model emphasizes Recruiting.
- Club 100 is pervasive in Spanish Nutrition Clubs.
- Training Sessions and Extravaganzas and Supervisor School are all revenue streams for upline sponsors.
- Its home market is totally saturated with distributors, Nutrition Clubs and competition to the point where in-fighting is habitual and local resentment for the brand is growing.
- Incumbent salespeople don't like new competitors.
Steve's story is but one of many I am sure out there in Herbalworld. If you have a story you would like to tell and your name is not "Powershake," why not write it in the Comments stream or drop me a message through Seeking Alpha? Maybe it's about time we shine some additional light on this confidence game from within?
In the interim, the sooner regulators euthanize this franchise fraud, the better.
Steve and Susan plan to take legal action against Herbalife soon, I am told - it won't be the first time, and most likely won't be the last. So much for non-recurring legal expenses.
Full Disclosure: This article articulates their version of events. Herbalife was not contacted for a response.
Disclosure: The author is short HLF.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.