While oceans of ink are now dedicated to the inner workings of Herbalife's (NYSE:HLF) "multi-level marketing" (MLM) model, Avon (NYSE:AVP), depicted in the MLM industry as the largest and oldest of all MLMs, receives only the typical tea leaf analyses of publicly disclosed financials. The Avon MLM box is not opened. The wrapping paper is not even removed.
The lack of inquiry into Avon, despite the Herbalife revelations and despite recent tipping point declines in Avon revenue and recruiting, a failed MLM acquisition by Avon and an Avon debacle in China, shows once again that Wall Street has not figured out what "multi-level marketing" is all about. The blind spot leaves investors operating not in darkness so much as delusion. The MLM landscape is plotted with dis-information. My own conversations with investment professionals and economists frequently begin with their question, "What is multi-level marketing?" Recent developments in Avon, especially in Avon's China experience, offer valuable insight into that company when viewed through the Herbalife lens. Applying an Herbalife-type analysis reveals that, when it comes to MLMs, the difference between protein powder drinks and lipstick is a distinction of little significance.
For more than a decade, Wall Street swallowed whole the MLM industry's diverting fairy tale of MLM revenue being driven by popular demand for its undifferentiated and sometimes silly products, including useless video phones, a panoply of snake oil remedies, miracle fruit juices, and "anti-aging" potions. This demand is so strong, Wall Street was told, the MLM companies need no advertising and millions of people sign long and foreboding sales contracts just to get access to small discounts. Wall Street believed the MLM story of armies of dedicated "direct sellers" canvassing the streets of America, though no one ever sees any of them actually knocking on doors, and it put unquestioned faith in MLM's pronouncements about the preciousness of "personal selling" even for commodity goods that are more conveniently available in stores in greater variety and at much lower prices.
It took Pershing Capital's fraud thesis to finally get Wall Street to consider that the Herbalife's version of this fairytale might not be true and that the company just might not be a "direct selling" enterprise at all, but rather a Ponzi purveyor of false income promises. As they say in MLM circles, "The pay plan is the product!"
Wall Street's lack of inquiry into Avon's MLM matrices - retail sales levels, income claims, pricing, saturation, recruitment incentives, top-loaded commission schedules, distributor churn, and geographic expansion - reflects investors' continued blind faith in the beguiling MLM tale. In this chapter of the tale, Avon is MLM's ancient and virtuous champion that really does exemplify all those traits that turned out to be missing at Herbalife. By association with Avon all "direct selling" companies lay claim to legitimacy. Anyone who has ever questioned any multi-level marketing company has had to answer the defiant challenge: "Are you saying Avon is also fraudulent?" Avon is, de facto, multi-level marketing's greatest ambassador.
Only in the MLM bizarro world could Avon be seen as the jewel in the MLM crown. In fact, Avon only adopted the MLM model in 2005, more than 100 years after the company's founding and 25 years after the famously ambiguous Amway/FTC court decision. Avon is, in reality, the latest, weakest and least representative of MLMs. More to the point, to the extent that Avon has employed the MLM system, it is contributing to its downfall.
The MLM system requires a rigorous purging of the traditional values and practices that Avon followed for those 100 years as a true "direct selling" business. But Avon did not purge itself of all the market-based values that shape direct selling, as the MLM model dictates. Instead, it has sought to maintain a focus on retail sales, competitive pricing and the "channel pull" of brand equity. Evidence indicates it has not sufficiently pursued the "beyond your wildest dreams" manipulation, which distinguishes MLM's "hyper-push" marketing. Also, contrary to the definitive MLM scheme, Avon maintained paid staff overseeing its MLM program, limited its recruiting channel to 3 levels for leaders, engaged in significant advertising support, extended short-term credit to distributors, offered competitive pricing and a higher gross profit margin on retail sales. Far from a stalwart MLM archetype, Avon is betwixt and between MLM and direct selling and to the degree it has relied upon MLM "leveraging" and recruiting incentives, it is so far proving to be an abysmal failure.
A grim lesson to be gained from this essay may be that in the direct selling area, sham is the only model that now works; fraud fares better than fairness, and mendacity wins over transparency. Avon, to the extent that it holds on to remnants of legitimate direct selling for commodity cosmetics - a model that is manifestly obsolete - will continue to decline. If Avon's China experience is an indicator, the decline could become a cascade.
Conversely, to the degree that Avon should master the levers of MLM, magically converting salespeople into end-users, banishing the specter of saturation, and promising "unlimited opportunity" to all applicants forever and ever, it might survive for a time, but at the dire expense of those who fall for the pitch. Whether Avon becomes an MLM Master Manipulator or not, the MLM model cannot rescue its enterprises from the inexorable limits of saturation and it can never correct the extraordinary distributor loss rates it must inflict. Nor can it ever allow full disclosure.
For those speculators or long-term investors who do not examine Avon through an Herbalife/MLM prism, they are indeed seeing only a shadow. It is time for the investor community to take as close a look at Avon's business model and practices, vis á vis MLM, as it is doing with Herbalife. The writing is on the wall.
Avon's MLM Program Is Faltering in the USA
Following its 2005 move to MLM, Avon ramped up recruiting, treating capital investments of new salespeople as new sales revenue. The strategy reached its apex in 2009 with the largest advertisement in Avon's history, a 2009 Super Bowl television commercial featuring Avon's "income opportunity," not its cosmetics. In the depths of the Great Recession, as Avon's own revenue dipped, Avon used the Super Bowl to claim it could offer American consumers a solution to their income problems. That year, the Avon USA sales force reached a reported peak of 471,000, about one sales representative for every 200 households in the country.
In a 2009 article in USA Today, Avon confirmed the strategy of adding new salespeople to offset shrinking revenue. "Right now, our direct-selling opportunity is really the No. 1 product that we have to sell," says Geralyn Breig, president of Avon North America. With that in mind, Avon this year launched its most ambitious recruitment campaign…
The strategy worked, only for a short time. By 2010, the growth trend reversed. Today, Avon, a 100+ year old American company with one of America's greatest brand names, is in indisputable decline in its home country. Avon's USA revenue is 24% less today than it was in 2005 when Avon adopted MLM.
Meanwhile, a host of comical MLM upstarts with names like Visalus and Vemma, Xocai and Xango are going gangbusters, selling energy drinks, "healthy" chocolate and coffee and snake oil remedies at absurdly high prices. These audacious schemers, lacking any brand equity at all, alongside the wily older MLMs like Herbalife and Nu Skin (NYSE:NUS), are savaging Avon in the MLM vital spot - recruiting distributors. In 2012 Avon's USA sales force was 16% smaller than it was after the Super Bowl of 2009.
Avon Revealed Ineptitude in Growing its MLM Business by Acquisition
While the MLM strategy of growth through recruiting incentives for salespeople flagged, Avon's 2010 10K informed investors that "In July 2010, we purchased substantially all the assets and liabilities of Silpada Designs, Inc., a direct seller of jewelry products, primarily in North America." Silpada was a MLM company with about 35,000 distributors. Purchase price: $650 million. Almost immediately under Avon management, Silpada sales slipped and, more importantly, Silpada recruiting slowed. On June 30, 2013, Avon entered into an agreement to sell its Silpada jewelry business. Selling price: $85 million.
Avon's Stock has Plummeted since it "Went MLM"
Perhaps the most simplistic indicator that Avon's MLM venture is failing by MLM industry standards is to note that since 2005, the year Avon half-way adopted the MLM model, Avon's stock has dropped 57% while other large MLM companies' stock values exploded, e.g., Herbalife (+789%), Nu Skin (+380%) and Usana (NYSE:USNA) (+111%) in the same time frame.
Avon's Global Growth Is Stunted or in Early Signs of Significant Decline
Though the general economy is improving and the largest MLMs are spreading, Avon's global revenue, under its new MLM model, dropped 5% in 2012, but even more ominous is that Avon's reported global sales force shrunk 8% between 2010 and 2012. Avon's drop in revenue can be meaningfully scrutinized only if the MLM aspect of the business is examined. In the MLM model, the concept of sales force "production" is fundamentally changed. The salesperson's role as end-user surpasses distributor and the mission of recruiting overtakes sales. A net decline in salespeople, therefore, not only stunts revenue but is also a reliable predictor of stunted future expansion.
Avon is Falling Apart in China
Nothing is more significant about the underlying importance of Avon's employment of the MLM model than the state of affairs in China. Yet, as part of the Wall Street's imaginary analysis of Avon, in which the company is measured only in traditional terms of product sectors and financial formulas, this enormous operational factor is largely ignored in the China picture. Avon's execution of the MLM model is the key to its performance in China, and China is key to the entire MLM industry.
Avon's disastrous fate in China is a tale yet to be fully told, but the hard facts are that Avon took 31% less revenue out of China in 2012 than it did in 2005 when it "went MLM" globally. The decline is accelerating. Revenue dropped 20% in 2011 over 2010 and another 22% in 2012 over 2011.
As in all MLM analyses, the Avon story in China cannot be told in the classic market terms of brand equity, supply and demand, competitive pricing, product quality, distribution efficiency, etc., that normally apply to all other types of enterprises. Instead, non-market factors, endemic only to MLM's pyramid recruiting model, are involved, including skill and cunning in recruiting, the effective use of false income promises to lure and gain control over the minds of recruits, and political influence-buying to forestall law enforcement. The sheer ferociousness of an MLM recruiting campaign and the leaders' prowess in captivating the minds of followers with utopian dreams of wealth and happiness - gained exclusively, they are told, in the MLM program and under strict direction of the leaders - are tools of the trade in MLM. Such tools are almost never referenced in investor reports. In the use of these dark tools, Avon is a childish amateur.
MLM Recruiting Train Ends in China
China is the world's newest, and potentially largest and most lucrative market for multi-level marketing. For the largest MLMs it is their last stop on a worldwide rampage. No other significant territory is left after China. MLMs do not maintain sustainable sales forces or customer bases. Indeed, as inquiries into Herbalife have shown, they don't have verifiable retail customer bases at all. The function of purchasing goods at the end of the supply chain is fulfilled by the "distributors" themselves, the proverbial "last ones in." Buying product is an integral element in pursuing the pay plan. Demand for income, not product, drives MLM "sales."
Since a leveraged multi-level structure permanently places the vast majority of participants in the lower ranks where profit is not feasible, the MLM's number one challenge is relentlessly replacing "losers" who fall out at 50-80% rates per year, never to return. This quest for more bodies, by the millions, has taken the MLM business to China's 1.34 billion citizens who, as might have been predicted, are eager to embrace MLM's seductive promises of a capitalistic utopia, exclusively reserved to those who "believe." Amway has now become America's number one ambassador in China for teaching American business principles. Does this make you proud?
How Avon Was Defeated by Amway, Harvard and China Politics
In 1998, after massive outbreaks of "direct selling" pyramid schemes that gained cult-like power over huge numbers of Chinese, China banned all direct selling. The government allowed some large sales companies such as Avon and Amway to continue but only on a strictly retail basis, without "non-employee" sales. After a six-year period of deliberation, in 2005 China passed a strict new law, the first such law in the world, that specifically bans the Amway-type pay plan, the hallmark of all MLM companies. Direct selling was legalized. MLM was outlawed. In 2005, Chinese officials were quoted in the US press predicting the decline of revenue in China for all MLM companies. Indeed, Avon's 2005 10K reported a 7% decline in China.
The new law could not have been clearer that the MLM pay plan and its leveraged, multi-tiered recruiting structure could not be used to induce distributor purchases or used as a system for allocating rewards. Spelling out what is included under its prohibition against "pyramid selling," the law states:
An organizer or operator seeks for unlawful interests by recruiting persons to participate in pyramid selling and asking the recruiters to pay fees explicitly or in any disguised form like purchasing commodities for obtaining the qualification for participating in pyramid selling or recruiting others to participate in pyramid selling; and an organizer or operator seeks for unlawful interests by recruiting persons to participate in pyramid selling, asking the recruiters to persuade others to participate in pyramid selling so as to form a multi-level relationship, and calculating and paying the remuneration to an upper-level promoter on the basis of the sales performance of the promoters below.
Avon had 100 years experience with training individuals in true direct selling. Amway, on the other hand, was all-MLM from its inception. Same for Nu Skin and Herbalife. The new anti-MLM statute, passed the same year that Avon adopted MLM incentives, would seemingly have favored Avon whose historical business was based on training salespeople in retail selling of branded products. Amway, it should be noted, just shelled out tens of millions to settle a distributor class action lawsuit in America that charged it was operating a pyramid scheme. In 2008, the UK government also sought to "wind down" (shut down) Amway UK due to revelations that over a 30-year period, 99% of all Amway UK distributors had failed to make a profit. Nu Skin and Herbalife have similarly faced pyramid lawsuits and prosecutions for false income or product claims related to their MLM operations.
In China in 2005, Avon had $206 million in revenue with a reported 30% per year growth, but Amway was already far larger, according to China Daily, which reported Amway's claim to $1.2 billion in China revenue at that time.
MLM Beats Direct Selling
Fast forward to today and it is clear that Amway and its MLM counterparts triumphed in China while Avon, the historically retail-based company, is in full retreat. Amway recently told Bloomberg News that it now has over $4 billion in revenue in China (as a private company, the figure is not verifiable). Avon is down to $143 million. In 2005, when MLM was banned, Amway claimed to have 6 times the revenue as Avon did in China. Eight years later, under that legal ban of MLM, Amway the champion of MLM, has twenty-eight times the revenue of Avon, the champion of direct selling. And Herbalife, which did not even enter the China market until 2001, reported almost twice the China revenue as Avon's in 2012, a 51% increase over 2010 for Herbalife, while Avon experienced a 38% drop in that time. How did this happen?
In just a few years time, the largest pure-bred MLM companies found ways around the anti-pyramid law. Reports have been publicized in the USA that multi-level pay plans are rampant in China as well as "purchasing commodities for obtaining the qualification." Some Chinese are using fake Taiwan addresses to join MLMs.
In a recent feature on Amway in China, Bloomberg investigators talked with Amway recruits who explained their reward plan, as it was taught to them and as they were pursuing it:
The salespeople said they would also earn a bonus on the sales of each person they brought into the organization. If the salesperson made 8,000 yuan in net sales and enlisted four people, who each also made 8,000 yuan in sales, he would get a 3,360 yuan bonus (18 percent of the total 40,000 yuan in revenue minus the 12 percent, or 960 yuan, that would go to each of his four recruits).
Harvard Puts Lipstick on a Pyramid Scheme?
One-third of Amway's China revenue comes from a global cosmetic line similar to Avon's but which dwarfs Avon's China sales. Amway's cosmetic brand is called "Artistry." Ever heard of it?
How could it be that the hardly known "Artistry" cosmetic brand could swamp America's best known brand marketed by one of the most trusted and best known companies? Not only is "Artistry" far lesser known, it is much higher priced. Artistry lipstick, for example is 45% higher than Avon's comparable product. And how did MLM companies whose histories are replete with accusations of running pyramid schemes overrun the direct-selling expert, Avon, in a country whose law explicitly outlaws the MLM "multi-tiered" pay plan in favor of direct selling?
The Bloomberg News story on Amway in China reported an unlikely player that its investigative writers placed in the leading role as Amway's secret weapon for evading prosecution and perhaps for defeating Avon too: Harvard University.
Quoting the Bloomberg investigation,
In a program bankrolled by Amway at a cost of about $1 million a year, Harvard's John F. Kennedy School of Government has been training Communist apparatchiks known as Amway Fellows. Since it started in 2002, the program has brought more than 500 Chinese officials to Cambridge, Massachusetts, to study public management for a few weeks. Every group also visits Amway's headquarters in Ada, Michigan, near Grand Rapids.
Some of these officials are equivalent to US state governors or even higher in rank.
It is difficult to imagine top government officials prosecuting anything Amway's distributors might do in their provinces after being personally trained in a prestigious Amway-funded program run by Harvard University and being taken on a personal tour of Harvard and Amway "campuses." How could the Chinese government accuse Amway of running a MLM pyramid pay plan, when Amway is officially linked to - and implicitly endorsed by - America's most respected educational institution?
Ironically, for years on MLM's Mean Streets, the false rumor was circulated and aggressively cited by Amway distributors that "MLM is taught at Harvard." Today, the actual truth for Amway is even better than that planted rumor. Harvard is effectively endorsing the Amway enterprise for a measly million bucks. Who needs professors, when the University's brand name can be obtained?
In America, Amway and the Direct Selling Association have incomprehensibly argued that the sales of products by MLM companies automatically remove them from any definition of a pyramid fraud. Somehow, according to this thesis, the filtering of money through product purchases exempts the "endless chain" income promise from the laws of exponential math, the realities of market saturation, and the geometry of pyramid expansion. It somehow makes the promise of "unlimited" income" truthful, no longer "inherently deceptive."
Armed with its standard "It can't be a pyramid if products are sold!" story in China, according to Bloomberg, Amway has taken the claim of pyramid exemption to new levels. The report describes how Amway pays for programs to expose and shut down "pyramid schemes." Not only is Amway not being investigated by the government for running MLM pay plans; it is taking on a public role of enforcer against other pyramid schemes! George Orwell would surely appreciate this.
Meanwhile, as Amway basks in Harvard's pure light of enlightenment and glows with the aura of legitimacy by association with that august body, poor Avon has haplessly found itself the target of an investigation for bribery in China, accused of improperly influencing government officials. The bribery is said to be connected to licensing in China in relation to China's strict anti-pyramid law.
Disclosure: I 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.