Examining Business Plans: Value Extraction Vs. Value Creation

by: Rogier van Vlissingen


The MLM model is based on extracting value: companies succeed by customers losing.

The TPO Rooftop solar model is based on extracting value, by selling the payments, not the investment.

The Pharma model likewise is based on extracting value.

The economics of sustainable business.

It has always amused me that Bill Ackman loved Valeant (NYSE:VRX) and hated Herbalife (NYSE:HLF) - because they clearly both operate on the same fundamental premise. How can we extract maximum value from society without contributing any?
Terrier Investing, "Sell Herbalife before it ends up like Valeant," on SA 3/20/16

Sustainable business has several major sets of stakeholders, shareholders, creditors, customers and employees, as well as the community at large. The only thing that makes a business sustainable is the fact that it creates value for all stakeholders. We are currently seeing what that means in the recent downgrade of Exxon Mobil (NYSE:XOM) with the exit of the Rockefeller fund: the divestiture of carbon-based energy became 'official' with the exit of the Rockefellers. The growth is now in renewable energy, even though too few have yet figured out how to do it profitably and sustainably.

The last few years, I have had a ball with writing about Herbalife (NYSE:HLF) and the MLM problem, even though I originally started writing on this site about renewable energy, but when Carl Icahn (NASDAQ:IEP) went long Herbalife, the temptation was too much not to dive into that issue. Why anyone would want to bet on a legal death trap like MLM remains absolutely unclear, even if it seemed like a safe bet that regulators and law enforcement would continue to do little or nothing. Icahn clearly did not grasp the issues, let alone do a rational risk assessment. So far, Icahn has seemed right, but history is not on his side.

The one theme that has stood out for me is the idea that business plans based on value extraction are unstable in nature. The philosophical counter point is that from a physics standpoint no business is sustainable, as indeed life is not, because of the second law of thermodynamics, a.k.a. entropy: nobody gets out of here alive and we live on borrowed time.

Arguably, certain processes might be more destructive than others, and for the moment, releasing more carbon in the atmosphere seems like a bad idea. Hence the shift to "renewable" energy sources. We better take it with a grain of salt, though, for everything has an environmental cost, including solar panels. For now, however, the pendulum is starting to swing the other way, and the externalities of carbon emissions are starting to impinge on the accounting of the energy industry. Extraction of value from the ground while putting the cost on society at large is now running into a wall.

In the context of the relationship with customers, it is important that any business understand that it serves several stakeholders: its customers, its investors and creditors, its employees and society at large. Sustainability implies good marks in all those categories, or else it is likely to catch up with you in the end. From time to time, the picture is further clouded by regulations and incentives, and politics in any number of forms, but that is just so many little boys and girls with their fingers in the dike. Eventually, the economic forces cannot be dammed up forever, as is now becoming evident in big oil. In the end then, it is always about the economics.

Third Party Owned Rooftop Solar PV

I have written, on this site and elsewhere, about every possible reason why TPO rooftop solar PV is over-rated and often a bad idea. It is a form of consumer finance that uses deceit ("Sell 'em on the payments!") to make something seem cheap, which may not be an economic value in many cases (very often it has a negative NPV for the property owners), because simply stretching the payments to make it appear cheap is not a way to create value for the customers. Hence, we are now starting to see newer entrants like Sunworks (NASDAQ:SUNW), as well as a long-term player like SunPower (NASDAQ:SPWR) focusing on making money on systems, and the value proposition for customers.

In short, the deceit of using finance to make something seem to be a value when it really is not, is used to extract value from customers, but eventually consumers will become educated, for other vendors will make them see the light, if nothing else will. Likewise, the deceit of customers implies misleading investors about the viability of owning the payments on those dubious consumer loans. Eventually, this issue plays into the shake out in the solar patch, starting with the Vivint Solar (NYSE:VSLR) and SunEdison (NYSE:SUNE) fiasco, but it impacts SolarCity (NASDAQ:SCTY), and Sunrun (NASDAQ:RUN) and others as well.

At the political level, it would eventually have to become evident that it made no sense to create incentives that resulted in massive numbers of bad deals for consumers, but that is a long process. Consumers are finding out the hard way when they sell a property with a solar lease or PPA installed, and have to get it assumed by the new buyers. Many end up losing all their supposed 'savings' at that moment, and sometimes more. The bottom line is, the PPA/lease companies were based on value extraction: selling 20 years (or even the promise of an illusory 30 years) of payments to investors, aided by tax breaks, and economically unsustainable net metering rules, which respectively extract money from tax payers, and from electrical rate payers. The scheme is running out of steam lately. The real customers are the investors in this debt, and the apparent customers are simply renting their rooftop for someone else to go green, since the Renewable Energy Credits, or RECs are sold off in these transactions.

The MLM/pyramid scheme value extraction model

Historically, it is now clear how law enforcement and regulation went into a skid with the FTC's Amway '79 decision, by allowing that something that was clearly seen as fraud before, now was deemed at least conditionally legitimate, and, conveniently, the conditions that were listed as potentially preventing an MLM from being a pyramid scheme were nearly impossible to enforce, and the industry promptly drove a truck through that weakness. Some brilliantly straightforward reflections on the absurd history of the case were provided in private correspondence by Bruce Craig, a veteran of pyramid scheme prosecutions as former AAG in Wisconsin (with minor edits):

My 2 cents' worth, by Bruce Craig, Esq.

When pyramids first hit the scene in a big way, around 1969, there was a general consensus that they were clearly illegal, along with Ponzi schemes, referral selling plans, and lotteries (before the states got into the business). Wisconsin had an early, 1907, case on the subject - see here.

The promoters such as Glenn Turner (Koscot) and William Penn Patrick (Holiday Magic) put on a public spectacle, enhanced with some dwarfs (Turner), F. Lee Bailey, and a lot of publicity and related mind-control offerings. They hoped to cash-in for the short term, before the law caught up.

In the enforcement community, there was the general consensus that we would have to assemble an enforcement response and that the FTC would lead the way in shutting down these scams. This is what happened, and by 1975 the FTC in Koscot and Holiday Magic cases, with unequivocal language, condemned these offerings. The states brought their own cases and it was just considered a matter of time. I drafted a rule in Wisconsin prohibiting pyramids and won 6 or 7 cases without having to go to full trial, basically lay-downs. I was fortunate in finding a UW Marketing professor, J. Howard Westing who, after two weeks of extensive discussions, understood the flaws in these offerings from a marketing standpoint. He was a key expert witness in my Holiday Magic case, and went on to be the key witness for the FTC in Koscot and Holiday Magic (you can see his name in the footnotes) - but not in the Amway case, for unknown reasons. There truly was no serious question about illegality until Amway.

The FTC Amway ruling was so flawed that it defies analysis, it was like saying that if you had clergy and counselors available outside an illegal casino that no public injury would occur. Our 1982 case against Amway, on income representations, was based on 1979 tax data that indicated a -$900 average annual net loss among Wisconsin's top 1% Amway Direct Distributors - proving, in my opinion, that Amway's testimony could not be reconciled with the tax return data, when it told the FTC that its 'rules' protected against loss. The tax data also indicated that these Amway distributors were claiming all product expenses as business losses - not 'personal' consumption.

I think we all know that the 'rules' which changed everything for "MLM" are never enforced nor are the distributor affidavits mandated by those rules examined by anyone to evaluate their existence, content or veracity. As far as the FTC is concerned, even if it wanted to, the magnitude of this task would be prohibitively massive and would produce data only after the fact. The press appears to have been intimidated by the Mother Jones incident. One area where some potential exists is in legal academics, where the fundamental flaws in Amway, and the case law that followed, could be analyzed - in my opinion a relatively basic task, perhaps by a law review author - somewhat insulated from industry intimidation. Other than Bill Keep, and of course Peter Vander Nat, and now Stacie Bosley I have seen virtually no high-end analysis from business academics (??Anne Coughlan) - not only from a current state of affairs approach, as Bill Keep has done, a practical response to the status quo - but from an historical standpoint which examines the basic structure of MLM in respect to non-adherence to basic marketing principles, e.g. recruiting others from your marketing area to compete with you for recruits, no territorial protections, no advertising or price competition etc. Use of the term 'direct selling' is in itself deceptive, as those who sold vacuum cleaners and Fuller Brush know.

Bill Keep has been on the front lines and has established a valid concern about what is going on. It might also be a good idea for some academic institutions, and law reviews, to make an historical broad based analysis, other than in Seeking Alpha, founded on the basic principles of their respective disciplines. The overall indifference to the structure of, and damage caused by, these institutions is a bit discouraging. A rear-view look at what happened may well be of no practical value.

Thus the ramblings of this old timer.

There's precious little to add to that. Law enforcement skidded off the road in 1979, as a reconstruction of the accident scene shows. Legal careers could have been based on examining the absurdity of that ruling. But the effect of the resulting stalemate has been that the clearly illegal fraudulent misrepresentation of MLM has now become normal and acceptable. For now, the FTC under Edith Ramirez has started to get the car back on the road with the recent Vemma case, but they have been inexplicably dawdling in the Herbalife case. The lessons of history are too easily forgotten... here are two articles on Glenn Turner and Koscot, with the Rice dwarves and F. Lee Bailey in tow: in the Orlando Sentinel, and New York Magazine.

At a recent event in Chicago, organized by the University of Illinois in collaboration with SEC, with participation by the FTC, FINRA, et al., some valuable information was presented on the societal cost and the damage caused by MLM/pyramid schemes. Still, Andrew Ceresney, as Director of Enforcement for the SEC, managed to offer a speech, which got only some of the concepts right, but skidded on the banana peel of product sales, the favorite fig leaf with which the MLM industry covers up pyramid schemes. The confusion that the product matters ignores the fact that pyramid schemes are financial crimes-with or without 'real' products - that have been missed by law enforcement on a massive scale thanks to the decoy of product sales.

That part of his speech sounded more like he was holding out a resume to the DSA, and the only saving grace lay in the disclaimer that this was just his opinion and he was not speaking for the agency. We could only hope so. The recent reports of the departure of FTC commissioner Julie Brill to a law firm that has the DSA for a client makes it clear that the issue of regulatory corruption is not moot.

MLM and 'momentum'

MLM survives by promoting a storybook version of how it works and why it is a 'business opportunity' in which all have the same chance. The reality of it is that MLMs get launched all the time by a small group of insiders who preposition themselves, and frequently with under the table deals, so these top dogs end up making all the money because program features such as roll-up, compression, and qualifications, along with compulsory consumption, ensure that the majority of commissions roll up to the small group at the top.

Generally, the industry considers that these programs enter "momentum," when they have at least 100,000 distributors, which is the point when mathematically the opportunity for the new person joining is effectively near zero. The majority of the income in MLM rolls up to the top 1% or even 0.1% in any given year, but the rate of churn in the other 99% is 50% or higher, so that the winners are mostly constant, but the large numbers of losers who try their hand in vain every year slide down the greasy pole, and lose pretty much everything they spend, including expenses and time, and the only 'benefit' of participation is the potential tax deduction for this 'business'.

To sum it up, MLM makes the bulk of its money on the hordes of people who fail to make it, and much like the carnival barkers promoting the greasy pole, or the shills of three-card Monte, the co-conspirators at the top of MLM make their money convincing the gullible (including regulators and law enforcement!) that the improbable is not only possible, but actually a desirable 'business opportunity'.

How regulatory capture works

Co-optation is undoubtedly the best form of regulatory capture, literally making the regulators a partner in crime, by having them buy in to some other benefit that could appear to partially or wholly supersede the harm, and have the effect of forestalling or even completely avoiding regulatory action. Just look at what is happening in food safety, to name one area. Favorites are always employment and other worthwhile benefits provided by the business. Herbalife has pitched that, and so has the rooftop solar industry. This is largely moot in many cases, since competent people can be redeployed, solar is not going away just because the rooftop variety is being over-hyped at the moment.

Outright bribery is more rare, but bribery disguised as consulting fees (Albright) and speaking fees (Clinton, Bush, Trump, Carson, Romney) is a prevalent practice in the industry, seemingly socially acceptable, and it has generally provided for a steady supply of get-out-of-jail-free cards. Juicy jobs in the industry are a close second, as has been very visible in the way Herbalife has been stocking up on former regulators. It seems they had to open a fresh can of former regulators a few times a year since the Ackman short.

For examples of regulatory capture, besides what is going on with MLM, it pays to look at what goes on with the nutritional advice (by the USDA serving the farmers, not HHS or FDA serving the public), as well as many of the examples below in the medical and nutritional areas. Also, the corruption of the "organic" label by USDA is a worthwhile story to understand.

The drug approval process of the FDA is another area of collusion, inadvertent or otherwise, as suggested below. In other words, the reality of government everywhere is that regulatory capture is the norm, not the exception, and the question always is: who polices the policemen, and how do you audit the system to prevent that stasis of regulatory capture, collusion and corruption. Failures of enforcement mean that criminal behavior is increasingly mistaken for 'normal'.

The MLM case makes it clear that Harry Markopolos' comment is as valid today as when he first made it in the Madoff case: the regulators are protecting the crooks from the consumers, not the consumers from the crooks, and the same goes in many areas besides the FTC and SEC.

The role of counter-productive tax breaks

In both of these cases, MLM and TPO rooftop SPV, tax breaks play a role, and they distort the picture tremendously.

In TPO rooftop solar PV, it is the bad design of both the tax incentives, and the feed-in tariffs which has distorted the market and enabled the raw deal for consumers, in which not the value added to the property, but the deceptive and deliberately falsified analysis of 'savings', simply tricks consumers into signing for 20-year PPAs and leases, even if it does not make financial sense. (Note: rather than argue there should be no incentives, I would propose they should be geared to results, not spending.)

In MLM, companies are trying to promote what amounts to no more than an illegal lottery in which the house always wins, by promoting it deceptively as a 'business opportunity', even though the chances of success are effectively zero, as Robert L. FitzPatrick recently highlighted in this article, prompted by the release of the movie "Betting on Zero." The bottom line is that the industry data tend to misrepresent the actual 'opportunity', even if it is taken into account that less than 1% make any money, and 99% lose money in any given year, because the 1% are relatively constant, and the majority of the 99% fresh victims every year. The result is the new recruit effectively has a zero chance of ever making reasonable money, let alone approaching what the guys and girls at the top make.

In short, it is not just that FTC, SEC, and DOJ are enabling the continuation of the MLM/pyramid scheme business, but the IRS plays a supporting role as well. The role of the IRS as an unintentional endorser of this form of fraud lies in accepting these tax deductions. As Bruce Craig noted (above), the cost of personal consumption is often deducted by many as well, because the real business is the pyramid scheme, not the distribution of product... product is also often given away as free samples. Instead, if MLMs were treated like a form of illegal gambling, expenses should not be deductible unless someone clearly made their living at it, and MLMs would be committing tax fraud if they promoted the tax-deductibility of expenses.

In short, the organizers of an upcoming forum on tax justice might do well to include these issues:

  • For MLM, not only does tax-deductibility enable the scam, but it means that the losses of the 99% are being socialized at the expense of other tax payers, with continuous encouragement of the companies in this 'industry'.
  • For rooftop solar, there is a fair case to be made that the overwhelming majority of people will never enjoy the benefits of overpriced rooftop solar systems, perhaps at the rate of 95% versus 5%, when utility scale projects, and large commercial solar arrays are much more economically viable and would benefit all utility rate payers. Fortunately, the ITC also does apply to those. On the whole, if solar is a desirable social benefit, it makes more sense to subsidize $1 (or less) per installed watt utility scale solar that benefits all consumers than $3 a watt rooftop solar that benefits only one home owner at a time. The utility subsidies via net metering make the distortion only more extreme, once they exceed the level of net benefit to the overall operating cost for a utility.
  • It is especially heinous if even NREL, a government agency, finds that solar PPA and leases are by and large a raw deal for consumers, and these are enabled by the ITC, when it could be structured much more effectively by tying subsidies to results, not on spending.

The medical industrial complex

At this point, Martin Shkreli and Michael Pearson (Valeant) are merely poster boys for the greater issue of the total dysfunctionality of the unsustainable big pharma model of medicine, in which disease management is profitable and healthcare is not. Value extraction is the name of the game, from the consumers directly and indirectly (via medical insurance), and also via taxes. I will cite some observations in bullet form:

  • This marvelous article in US News and World report on the plant-based diet, by Susan Levin, the director of nutrition education at the Physicians Committee for Responsible Medicine, sums up why the Standard American Diet (SAD) is the single biggest healthcare cost we have, and it can be eliminated at will. Adopting a plant-based diet could eliminate trillions of healthcare spending.
  • The national conspiracy that keeps the bad habits of SAD going on have become more exposed in the last 20 years, starting with "mad cowboy" Howard Lyman on the Oprah Winfrey show, and recently reinvigorated by the Renee King-Sonnen, and her Rowdy Girl Sanctuary. Meanwhile the list of famous vegans is growing, based on the work of Dr. Caldwell Esselstyn, and his son Rip, through Forks over Knives. Former President Bill Clinton but also Jennifer Lopez, and the Williams sisters are on that growing list.
  • Along with the personal health and well-being that goes hand in hand with the vegan diet is a growing list of people who have thrown out their medications, sometimes after years. I personally did that once in ca 1991, when I told a doctor not even to bother with a prescription for Claritin, and I solved my allergy problem myself with some hydrogen-rich water, and some simple supplements to raise my glutathione level. Again, after a recent physical, I "officially" was taken off three medications that I had been told I would have to take for the rest of my life, and apparently I improved sufficiently due to my switch to vegan living in May of 2015, along with becoming a bit more disciplined about my exercise routine. My cholesterol was 171, and my weight was 190 lbs at a physical on 12/5/14, and by 3/11/15 they were 151 and 165 respectively, I was off of blood pressure medication, and I am eating better than I ever have in my life before...
  • Independent from the vegan lifestyle, which is growing by leaps and bounds, there is a growing number of people who prefer quality of life and dignity of dying to the over-zealous medical profession. I've seen examples of this on numerous occasions, among others with a distant uncle who was diagnosed with an aggressive cancer with cloudy prospects at age 63. Clearly, medical cost was no issue, as he was a billionaire, but he chose to forego treatment and simply said his goodbyes and prepared for dying with dignity. The most famous case, if often overlooked, was the Jesuit philosopher Ivan Illich in the seminal book on the topic, Limits to Medicine and the Expropriation of Health.
  • Another famous case is of course the superfluousness of essentially all ant-acids, as pointed out in the famous book by Dr. Batmanghelidj: Your body's many cries for water. The point is: drink more water and throw out the ant-acids. By obfuscating the problem instead of addressing it, ant-acids make things worse, not better.
  • The most recent cause célèbre is the hausse in ED treatments, which according to Rip Esselstyn, is mostly the canary in the coalmine if you understand that a lot if not most of ED is simply a precursor to Cardio Vascular Disease (CVD). A simple change of diet might do the trick.
  • Besides my own personal experiences, I know a diabetic who has reduced her need for insulin by 2/3rds by going vegan, and while I live in the poorest district in the Bronx, I meet younger people who simply say they don't want another fast food restaurant in the district, they want to give their children better nutrition, and I attended a dinner recently where I was sitting next to a former gang member, turned community activist against gun violence, who proudly told me he had not eaten meat in twenty years, and his seven-year-old son never asked for a hamburger. Symbolically, the McDonald's (NYSE:MCD) on the main drag nearby has gone out of business, and the butcher at the end of my street is giving it up after 50 years, and his daughter is a vegan. And this is in the district Jennifer Lopez hails from, one of the famous vegans of the moment.
  • With the recent appearance of Cowspiracy, the compelling environmental/economical case that animal husbandry and the carnivore diet are not sustainable is now entering main stream conversation. Simply put, a diet based on animal products even a vegetarian one is not sustainable, and shifting to veganism would radically advance the greening of the planet. The new documentary What the Health, from the same team should do equally well.
  • Interestingly, as pertains to Herbalife, and the whole diet industry, they can all be made superfluous overnight if people switched to all-you-can-eat veganism, which tends to regulate bodyweight completely without effort. The recent documentaries Fat, Sick, and Nearly Dead tell the tale of people succeeding with weight loss, and getting off of handfuls of medications all at once.
  • Overall, iatrogenic disease, alongside bad dietary habits, including the tacit assumption that behavior modification, including diet are not achievable, are the biggest medical deathtraps we are facing in all of healthcare, and they can't be solved with more of the same... but they can be solved.
  • One of the funniest episodes may be the current 'crisis' of 78 heroin overdoses per day, fed in part by the (very profitable) over-prescription of opioid pain medications, while 1675 CVD deaths per day (according to CDC data on Cardio Vascular Disease) is apparently "business as usual," for the sake of protecting McDonald's from public outrage.
  • Structurally, the very regime of the FDA is flawed in its focus on the assessment of the effectiveness of drugs. The question that should be asked is are they necessary? That is at least as important as if they deliver what they promise. Even acne can be solved with dietary change in most cases. The above list contains numerous reasons why many drugs are not necessary the majority of the time, because they merely suppress the effect, and do not treat the cause, making the problem worse, not better.

In short, much of the medical industrial complex extracts value based on fear, but de-facto enables the perpetuation of the SAD diet and the resulting health problems. In this case, there may not be deliberate deception, but cultural blindness - the paradigm is wrong. Recently, major funding was announced because we have a 'crisis' with heroin overdoses at 78 per day, but somehow 1675 CVD deaths per day, as per the CDC data, are just business as usual, and we continue to publish a food pyramid that protects the dairy industry, and not the consumers. Still, it is fairly clear to growing numbers of people that milk is food for baby cows, and not people.


Value extraction and treating customers as victims to be plundered does not make for a stable business, whereas providing value does tend to create repeat business. In MLM and TPO rooftop solar, the consumer deception is very overt, though the MLM variety is more clearly illegal if it is understood as a pyramid scheme hidden behind the apparent product sale. In rooftop solar, it is more like the used-car sales pitch of selling people on the payments, so they don't focus on the price of the car. In the medical, for-profit-disease-management scenario, irrational fear is exploited to extricate exorbitant amounts of money from consumers, and frequently by ignoring or obfuscating the obvious solutions.

All of these are paradigms that are very fragile, because once understood, the customer can simply decide against them.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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