Center for Ethical Organizational Cultures Auburn University

http://harbert.auburn.edu

ThiscasewaspreparedbyMichelleUrban,KatyMelloy,CarinMalm,andEmilyMcGowanforandunderthedirectionofO.C.FerrellandLindaFerrell.Itwaspreparedforclassroomdiscussionratherthantoillustrateeithereffectiveorineffectivehandlingofanadministrative,ethical,orlegaldecisionbymanagement.Allsourcesusedforthiscasewereobtainedthroughpubliclyavailablematerial.©2013

MultilevelMarketingUnderFire:

HerbalifeDefendsItsBusinessModelINTRODUCTION

HerbalifeInternationalisthethirdlargestdirect-selling,multi-levelmarketingcompanyintheworld.Itsproductlineconsistsofweight-managementandnutritionproducts.Theseproductsarenotsoldinretailstores;rather,consumersinteractwithindependentcontractorstoordertheproducts.Herbalife’sheadquartersarelocatedinLosAngeles,California,andtheyoperateinseveralcountriesthroughouttheworld.Herbalifeisapubliclytradedcompanythatisbothlovedandhatedbyinvestorsandconsumers.

Thiscasefirstdiscussesthehistoryofthecompanyfromitsfoundingtoitspresentstatus,followedbyadescriptionofthetypesofproductsHerbalifeoffers.Thenwewillgetintoadiscussionofmultilevelmarketingandtheroleofindependentcontractorsinthedirect-sellingmodel.Nextwillbeadiscussionofpyramidschemesandwhytheyareoftenconfusedwiththemultilevelmarketingmodel.WethenexamineHerbalifetodeterminewhetheritisapyramidscheme.

WewillilluminatetheroleofhedgefundinvestorWilliamAckmanbehindthebackdropofHerbalife’sbusinessmodelandshowhiscontentionswiththecompanyandsomeofthecriticismsagainsthim.ThecaseshowsthatwhileAckman’saccusationsmaybethemostwidelyknown,thereareotheraccusations(mostlyreferringtopyramidschemes)thatHerbalifehashadtofaceoverthecourseofitsexistence.ThecaseendswithabriefoverviewofHerbalife’ssocialresponsibilityprogramandconclusions.

HISTORY

Herbalifeisacompanythatfocusesonnutrition,weight-management,andpersonalcareproductswithindependentcontractorsinmorethan90countries.MarkHughesfoundedthecompanyin1980outofadesiretocreateasafealternativetootherweightlossproducts.Herbalife’sfirstsalesweremadefromoutofthetrunkofHughes’carinLosAngeles,California,andtwoyearslaterthecompanyreached$2millioninsales.Herbalifewastakenpublicin1986ontheNASDAQstockexchange.Sincethen,Herbalifehasbecomeamulti-billiondollarglobalcompany

In1999Hughesplannedtotakethecompanybacktotheprivatesectorbypurchasingallofitsremainingshares,butthisattemptwasstoppedasinvestorssoughtlegalaction.Thenextyear,MarkHughesdiedunexpectedlyattheageof44.ChristopherPair,whowasHerbalife’sformerChiefOperatingOfficer(COO),thenbecamePresidentandChiefExecutiveOfficer(CEO)ofthecompany.HisreignatHerbalifewascutshortashesteppeddownoneyearlater.AnInternetretailer,Rbid.com,madeabidof$173milliontoacquireHerbalife,buttheMarkHughesFamily

http://harbert.auburn.eduhttp://Rbid.com

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Trustrejectedtheoffer.In2002,theinvestmentfirmJ.H.Whitney&Co.purchasedthecompanyalongwithanotherinvestorandtookitbacktotheprivatesector.However,in2004,HerbalifewentpubliconceagainandwastradedontheNewYorkstockexchange.MichaelO.JohnsonhasbeenHerbalife’sCEOsince2003.Thecompanycurrentlyemploys6,200peopleandhasalmostthreemillionindependentcontractorsthroughouttheworld.

PRODUCTS

Herbalifesellsweight-management,targetednutrition,energyandfitness,andpersonalcareproducts,allintendedtosupportahealthylifestyle.Additionally,thefirmoffersasetofcoreproducts:Formula1NutritionalShakeMixisaproteinandfibershakewithseveralminerals,vitamins,andnutrientsofferedinsevenflavors;Formula2MultivitaminComplexisamultivitaminthatcontainsover20vitamins,minerals,andherbsessentialtohealthyliving;andFormula3CellActivatorpromotesabsorptionofmineralsandvitaminswhileimprovingenergylevels.ThesethreecoreproductsareattheheartoftheHerbalifeproductlineandserveasthebaselinefornutritionandweightmanagementgoals.

Theweight-managementlineconsistsofavarietyofFormula1proteinshakes,supplements,weight-lossenhancers,proteinbars,andsnacks,allservingthepurposeofhelpingcustomersattaintheirweightgoals.Therearethreeweight-managementprogramsets,eachwithacombinationofshakes,supplements,andenhancersdesignedfordifferenttypesofweightmanagementneeds.Eachcomponentofthislinecanalsobepurchasedseparately.ThePersonalizedProteinPowderandtheProteinDrinkMixofferanalternativetotraditionalmealswhileprovidingenergyandcurbinghungercravings,whetherconsumersjustwanttoloseormaintaintheirweightorbuildmusclemass.Theenhancersandsupplementsofferamixofvitamins,minerals,herbs,andnutrients.Forexample,ProlessaDuoandSnackDefenseworktostaveoffhungerinordertocontrolweightgainandhelpthebodyprocesssugarsmoreefficiently.Otherenhancers,suchasTotalControl,boostmetabolism,energy,andalertness,whileThermo-Bondhelpsthedigestivesystem.Cell-U-Losshelpsthebodyeliminateunnecessarywaterandrejuvenateskinwithitscombinationofherbalextracts.Anassortmentofhealthysnacksandbeveragesarealsoofferedinthisline,suchasproteinbars,soups,teas,andsoynuts.

Targetednutritionproductsincludedietaryandnutritionalsupplementsthatcontainherbs,vitamins,minerals,andothernaturalingredientstostrengthenspecificareasofthebodythattendtobeproblematicformostpeople.Forexample,Tri-Shieldhelpstheheartstayhealthybymaintaininggoodcholesterollevelsandprovidingantioxidants;OcularDefenseFormulaandJointDefenseAdvancedoffersupporttotheeyesandjointsofagingadults;ActiveFiberComplexandAloeVeraPowderhelpsthosewithdigestiveissues;RoseGuardandSchizandraPlusstrengthentheliver,immunesystem,andcells;andRelaxNowandSleepNow,whicharepartofthestressmanagementline,servetopromoteeaseandrest.Herbalifealsooffersnutritionproductsspecificallyforwomen,men,andchildren.

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Herbalifealsoprovidesenergyandhydrationdrinksforthoseengagedinsportsandfitnessactivities.CustomerscanchoosefromanassortmentofbeveragessuchasLiftoff,afizzydrinkmixthatenhancesclarityandrehydratesthebody,ortheycanchoosesupplementssuchasN-R-GNature’sRawGuaranaTablets,whichalsopromotementalclarity.Herbalife24isthesportsdrinklinethatincludesformulasforhydration,prolongedendurance,restorationofstrength,andrecovery.

Personalcareproductsincludeskincleansers,moisturizers,lotions,shampoos,andconditionersfromavarietyofdifferentlines.HerbalAloeStrengtheningShampooandConditioner,handandbodywash,cream,soothinggel,andbathandbodybarisclaimedtoimprovethelookandfeelofhairandskin.TheMultivitaminlineissimilartotakingamultivitamineverydayandincludesacleanser,toner,moisturizer,sunscreen,eyegel,andcreaminfusedwithvitaminsforskin.RadiantCscrubcleanser,skinbooster,andbodylotionclaimtorenewandrehydratetheskinwithaconcentrationofvitaminC.Otheritemsincludeanti-agingproductsandfragrancesformenandwomen.

MULTILEVEL MARKETING

Directsellingisthemarketingofproductstoultimateconsumersthroughperson-to-personsalespresentationsathomeoronline.Peopleareattractedtodirectsellingformanyreasons.Somearepassionateabouttheproductandwanttopromotethecompany.Otherswanttoreceiveadiscountontheirpersonalorders.Manyfindworkingasadirectsellertobeaflexible,part-timeopportunityforextraincome.Additionally,someindependentcontractorssimplyenjoythesocialaspectofdirectselling.Withinthedirectsellingmodelaretwocompensationmodels:single-levelmarketingandmultilevelmarketing.Single-levelmarketingiswhenacontractormakesacommissionforarrangingasaleorearnsamarginasareseller.Multilevelmarketing,sometimescallednetworkmarketing,isacompensationwhereincontractorsearnincomefromtheirownsalesofproductsaswellascommissionsfromsalesmadebythosetheyhaverecruited.Salesareneverforced,asalegitimatecompanydoesnotforcedownlinesales.

However,itisnotnecessaryforcontractorstorecruitotherindividualsinordertoearnmoney.Itisachoicemadebythecontractoriftheywanttoincreasetheirearningsbymakingacommissionfromthesalesoftheirrecruits.Approximately71to72percentofHerbalifemembersaresingleleveldistributors,meaningtheydonotsponsorotherHerbalifedistributors.ThismeansthattheseHerbalifemembersbuyproductsfromthecompanyatadiscountandhavethecompletefreedomtodeterminepricingaswellasinalldecisionsinvolvingtheirfinalcustomers.Sincemanyofthesememberssimplywantadiscountontheseproducts,theymaynotbeasinterestedinmakingprofitsbutsimplyenjoytheopportunitytoreceivethesediscounts.Furthermore,rewardsarenotgivensimplyforrecruitinganothercontractor.SeeTable1forthetoptendirectsellingcompanies.

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CompanyNameandProductLine 2013Revenue(USDBillions)

1 Alticore(Amway)

Nutrition,Beauty,

Jewelry,Foodand

BathandBody,Home,

Beverage,Fragrances

$11.8

2 Avon

Cosmetics,SkinCare,Fragrance,

HairCare,Jewelry,Gifts

PersonalCare,

$9.95

3 Herbalife

Nutrition,

Care

WeightLossManagement,Personal

$4.80

4 Vorwerk

HouseholdAppliancesandCosmetics

$3.70

5 MaryKay

Cosmetics,SkinCare,Body

Product’s,FragranceGifts

andSun,Men’s

$3.60

6 Natura

Cosmetics

$3.20

Table1:Top10DirectSellingCompanies

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7 NuSkin

SkinCare

$3.18

8 Tupperware

FoodStorageandPreparation,Cookware,

ServingItems,Cosmetics,BeautyProducts

$2.67

9 Belcorp

BeautyProducts

$1.96

10 Oriflame

Cosmetics

$1.95

Sources:DirectSellingNews,“2014DSNGlobal100List,”DirectSellingNews,2014,http://directsellingnews.com/index.php/view/2014_dsn_global_100_list(accessedMay22,2014).

Anotheraspectofmultilevelmarketinginvolvesinternalconsumption,whichisthepurchasingofproductsatadiscountfromthefirmforthecontractor’sownuse.Mostretailersprovideinternalconsumptionincentivesbyofferingdiscountstoemployeeswhopurchaseproducts.Departmentstores,automobilemanufacturers,andairlinecompaniesprovideincentivessuchasdiscountsthatencourageinternalconsumption.Manypeoplebecomeresellerstogetdiscountsonproductsfortheirownuse.Therefore,theclaimthatinternalconsumptionisunacceptableisrefutableonthebasisthatthevastmajorityofcompaniessellingconsumerproductsencouragetheiremployeesorindependentcontractorstopurchasetheirproducts.Manyindividualscommittedtotheseproductsbelieveinthebrandsfortheirownpersonaluseandwantto‘spreadtheword’bycreatingabroadersalesandcommunicationnetwork.Somedonotevennecessarilycareaboutmakingaprofitfromthebusiness.Thisisacommonandlegalapproachfordirectsellingproductsaroundtheworld.Infact,mostdirectsellingcompaniesusemultilevelmarketing.AtHerbalife,thereisnolimittothenumberoflevelsofrecruits.

http://directsellingnews.com/index.php/view/2014_dsn_global_100_list

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Despitethelegitimacyofmultilevelmarketing,Chinahasrestricteddirectsellingtosingle-levelmarketingonly.Thesecountriesbelievemultilevelmarketingislinkedtofraudulentactivitiessuchaspyramidschemesbecauseoftheassumptionthatdiscountsareusedtoforceinternalconsumption.China,forexample,allowsdirectsellingcompaniestodobusinesswithintheirbordersiftheysignacontractsayingtheywillnotemploythemultilevelmarketingaspectofdirectselling.Insteadofhavingindependentcontractorsrecruitothers,theyselltheirproductsfromretailstores.

INDEPENDENTCONTRACTORS

Therearenearly3millionindependentcontractorsofHerbalifeproducts,andallofthempersonallyusetheseproducts.ManyareattractedtothelowstartupcostofsellingHerbalife.Thestartupcostforapart-timecontractoris$57.75forakit.Forthisprice,theywillreceivethemini-InternationalBusinessPack,whichincludesforms,applications,atotebag,andsamplesofvariousHerbalifeproducts.Informationalandtrainingmaterialseducatethecontractoronusingandretailingtheproducts,businessbasics,andhowtobuildasalesandmarketingplan.Alternately,ifacontractorwantstoworkfull-time,theycanpurchasethefullInternationalBusinessPackfor$89.55.Thispackcomeswithallofthematerialsthatthemini-packoffers,butwithmoreproductsamplesandinformationonhowtorunyourbusiness.Thereisnofeetojoin,andtheonlymoneyspentisforthevalueofthekit.

Contractorsenjoydiscountsoffproducts,rangingfrom25to50percentdependingonthelevelofcontractorship.Herbaliferesellersoftenpurchasetheproductsthemselvesandthenresellthemdirectlytobuyers;however,itispossiblefortheresellertomakethesaleandgettheproductdirectlyfromHerbalife.Resellerscanreselltheproductsatanypricetheywant.EachHerbalifeproducthasacertainnumberofValuePoints,andthenumberofValuePointsacontractoraccumulatesdetermineswhatlevelofcontractorshipheorshehas.PersonallypurchasedValuePointsareawardedbasedonthevolumethatacontractorpurchasesfromHerbalifeusinghisorherHerbalifeidentificationnumber.RoyaltyOverridePointsareaccumulatedbasedontheTotalVolumeofproductssoldbypersonally-sponsoredsupervisorsthattheresellerhasrecruited.

TogofrombasicdistributortotheSeniorConsultantlevel,aHerbalifemembermusthaveaccumulatedaminimumof500VolumePointsinonemonth.TobepromotedfromSeniorConsultanttoSeniorContractor,acontractormustaccumulateatleast1,000personallypurchasedValuePointsinoneorder.LevelsafterthatincludeQualifiedProducer(2,500VolumePointsaccumulatedin1to3months),Supervisor(4,000ValuePointsinonemonth,2,500ValuePointsineachoftwoconsecutivemonths,or5,000personallypurchasedValuePointswithin12months),andWorldTeam(2,500ValuePointsineachof4consecutivemonths,10,000VolumePointsat50percentinonemonth,or500RoyaltyOverridePointsin1month).OnceacontractorreachestheSupervisorlevel,theproductdiscountisincreasedfrom25percentto50percentandaprofitcanbemadeonsalestoothercontractors,whichcanreachuptofivepercent.

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IntheeventthatacontractornolongerwantstosellHerbalifeproducts,thecompanywillbuybacktheremaininginventorythecontractorhasonhand.HerbalifegoesbeyondtheDirectSellingAssociation’sethicalguidelinesforbuyingbackproductsbyreimbursingthedistributorforeverythingthatheorshepaidforinitially(100percentbuybackpolicy).Thecompanyalsodiscouragescontractorsfrominventoryloading,whichtheFederalTradeCommission(FTC)hasdefinedasapracticerequiringacontractortomakealargepurchaseofalargeamountofnonreturnableinventory.Torenewtheirmembership,contractorspaya$10annualmembershipfeetoHerbalife.

TheHerbalifebusinessmodelhassucceededduetotheirexcellentproductsandcustomersupport.Mostindependentcontractorsdonothaveaphysicalstorelocationbutpracticedirectsellingfromhome.Theyarenotemployees,butbusinesspeoplewhochoosehowtheywanttooperate.Therearestrictcompanypoliciesandlegalrequirementsthatcontractorsmustabidebythatregulateproductinformation,salestechniques,advertising,leadgeneration,socialmedia,andrelatedissues.Forinstance,memberscansellonline,butthereareadvertisingrestrictionsforonlinesales.Theproductscannotbesearchableonlinebytheirprice,andtheonlywayapotentialbuyercangetmoreinformationisbygettingapasswordfromthereseller.Thisfacilitatesaconversationbetweenthebuyerandreseller,allowingarelationshiptodevelopeventhroughonlinetransactions.Contractorsarenotabletoresellproductsonauctionsitesorinretailstores(excludingChina).

Herbalife’ssellingpoliciesareguidedbytheprinciplesoftheWorldFederationofDirectSellingAssociation(WFDSA)andtheDirectSellingAssociation(DSA)intheUnitedStates.TheWFDSApromotesethicalpracticesindirectsellinggloballythroughadvocacyandstrongrelationshipswithgovernment,consumers,andacademia.TheDSAalsoemphasizesethicsandrequiresthatmembersadheretotheircodeofethics(SeeTable2).HerbalifeisamemberoftheDSAandabidesbytheircodeofethics.Thiscodeofethicsrecognizestheimportanceofafairandethicalapproachtodirectselling,sincedirectsellingrequiressensitiveandpersonalone-on-oneinteractionthatcanleadtounduepressuresplaceduponconsumers.Thecodehasnotolerancefordeceptiveorunlawfulpracticesregardingrecruitsandcustomers;requiresthatsalespeopleprovideaccurateandtruthfulinformationabouttheprice,quality,promotion,etc.oftheproducts;illuminatesandenforcestheneedforaclearrecordofthesalesmadebycontractors;necessitatesthatwarrantiesandguaranteesbefullyacknowledged;requiressalespeopletoclearlyidentifythemselvestocustomersandmaintaintheconfidentialinformationoftheircustomers;hasnotoleranceforpyramidschemes;andprovidesguidelinesoninventorypurchases,earningsreporting,inventoryloading,payingfees,andtraining.

Table2:DirectSellingAssociationCodeofEthics

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Asaconsumeryoushouldexpectsalespeopleto:

• Tellyouwhotheyare,whythey’reapproachingyouandwhatproductstheyareselling.

• Promptlyendademonstrationsorpresentationatyourrequest.

• Provideareceiptwithaclearlystatedcoolingoffperiodpermittingtheconsumerto

withdrawfromapurchaseorderwithinaminimumofthreedaysfromthedateofthe

purchasetransactionandreceiveafullrefundofthepurchaseprice.

• Explainhowtoreturnaproductorcancelanorder.

• Provideyouwithpromotionalmaterialsthatcontaintheaddressandtelephonenumberof

thedirectsellingcompany.

• Provideawrittenreceiptthatidentifiesthecompanyandsalesperson,includingcontact

informationforeither.

• Respectyourprivacybycallingatatimethatisconvenientforyou.

• Safeguardyourprivateinformation.

• Provideaccurateandtruthfulinformationregardingtheprice,quality,quantity,

performance,andavailabilityoftheirproductorservice.

• Offerawrittenreceiptinlanguageyoucanunderstand.

• Offeracompletedescriptionofanywarrantyorguarantee.

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Asasalesperson,youshouldexpectaDSAmembercompanyto:

• Provideyouwithaccurateinformationaboutthecompany’scompensationplan,products,

andsalesmethods.

• Describetherelationshipbetweenyouandthecompanyinwriting.

• Beaccurateinanycomparisonsaboutproducts,servicesoropportunities.

• Refrainfromanyunlawfulorunethicalrecruitingpracticeandexorbitantentranceor

trainingfees.

• Ensurethatyouarenotjustbuyingproductssolelytoqualifyfordownlinecommissions.

• Ensurethatanymaterialsmarketedtoyoubyothersinthesalesforceareconsistentwith

thecompany’spolicies,arereasonablypricesandhavethesamereturnpolicyasthe

company’s.

• RequireyoutoabidebytherequirementsoftheCodeofEthics.

• Safeguardyourprivateinformation.

• Provideadequatetrainingtohelpyouoperateethically.

• Baseallactualandpotentialsalesandearningclaimsondocumentedfacts.

• Encourageyoutopurchaseonlytheinventoryyoucansellinareasonableamountoftime.

• Repurchasemarketableinventoryandsalesaidsyouhavepurchasedwithinthepast12

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monthsat90percentormoreofyouroriginalcostifyoudecidetoleavethebusiness.

• Explaintherepurchaseoptioninwriting.

• Havereasonablestart-upfeesandcosts.

Source:DirectSellingAssociation,“SummaryVersionoftheDSACodeofEthics,”DirectSellingAssociationhttp://www.dsa.org/ethics/shortcode/(accessedJuly9,2013).

A2013surveyconductedbyNielsen,areputableglobalinformationmeasuringcompany,showed(withoutinterferencefromHerbalife)thenumberofend-consumersHerbalifeserves.Thestudy,whichtookplaceonlineoverthecourseoftwomonths,sampled10,525consumersandwasbalancedintermsofdemographics,income,andgeographicplacement.Theresultsindicatedthat3.3percentofthegeneralpopulationmadeaHerbalifepurchasesometimeoverthelastthreemonths.Thispercentageofthepopulationtranslatesinto7.9millioncustomers,whichdoesincludeHerbalife’scontractors.Accordingtothedata,however,thenumberofcontractorsisapproximately550,000,indicatingthatthenumberofendusersishigherthanthenumberofindependentcontractors.Additionally,thestudyshowedthatthosewhomadeapurchaseinthelastthreemonthstendtomakeHerbalifepurchasesconsistently(approximatelyeverytwomonths),andthatthemostpopularproductsarethosehavingtodealwithweightmanagement(95percentofthosewhomadeapurchaseinthelastthreemonths).

OneofthebiggestargumentsagainstHerbalifeisitslinecommissions.Currently,Herbalifecontractorscanearncommissionsonwhateveryrecruitbelowthembuysorsells.Therearenorestrictionsonthenumberoflevelsofrecruitsthatcontractorscanearnacommissionon,unlikesomeothermultilevelmarketingcompanies.

PYRAMID

SCHEME

Therearefourdefiningcharacteristicsofapyramidscheme.Thefirst,whichisdictatedbytheFederalTradeCommission(FTC),isthatconsumersorinvestorsarepromisedlargeprofitsbasedprimarilyonrecruitingotherstojointheirprogram.Thepromiseisnotbasedonprofitsfromanyrealinvestmentorrealsaleofgoods.Second,accordingtotheSecuritiesandExchangeCommission(SEC),thepromiseofhighprofitsrestsonnothingmorethanaconsumerorinvestorhandingovertheirmoneyandconvincingotherstodothesame.Third,theFederalBureauofInvestigation(FBI)warnsthatpyramidschemescanbeintheformofmarketingandinvestmentfraudswhenanindividualisofferedacontractorshiporfranchisetomarketaparticularproduct.Therealprofitisearned,notbythesaleoftheproduct,butbythesaleofnewcontractorships.Lastly,theCaliforniaDepartmentofJusticeidentifiesthedifferencebetweenapyramidschemeandalegitimate

http://www.dsa.org/ethics/shortcode/

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multilevelmarketingplan.Inamultilevelmarketingmodel,moneyisonlymadethroughtheeventualretailsaleoftheproducttoanenduser.Inanillegalpyramidscheme,theparticipantsatthetopofthepyramidearnmoneywhennewmembersarerecruited.Eachnewmemberisthenrequiredtorecruitnewparticipants.Asthisprocessgoeson,thepossiblepoolofparticipantsshrinks,makingithardforthoseatthebottomtogainareturnontheirinvestment.Apyramidschemewillultimatelycollapseduetoalackofnewrecruitsandisthereforeunsustainable.Anotherimportantpointisthatapyramidschemethatseemstoofferaproductwillhavelittletonomarketvalue.Therecruitsarebeingsoldonanideaoramodel.

Pyramidschemescanbehardtoidentifyclearly,buttheFTChaswarnedconsumersabouttworedflags.Thefirstisinventoryloading,whichlookssimilartointernalconsumptionbecauseitencourageslarge-scalepurchasesofnonrefundableproductsbyadistributor.Notonlyisinventoryloadingaredflag,butitisalsoillegal.Thesecondisalackofretailsales.Ifasupposedbusinesshasbothofthesecharacteristics,itispossiblethatitisapyramidschemeandnotabusinessatall.Anotherwayofdetectingapyramidschemeisbyexaminingtheintentionofthebuyer.Ifthebuyerpurchasedaproductheorshereallydidnotwantjusttoparticipate,itisanindicationthatitcouldbeapyramidscheme.Itisforthesereasonsthatsomedirectsellingbusinessesusingthemultilevelmarketingcompensationmethodcanappeartobepyramidschemes.BecauseHerbalifesellsnotonlytheirnutritionproductsbutalsoabusinessopportunity,thefirmhasbeenaccusedofrunningapyramidscheme.

ISHERBALIFEAPYRAMIDSCHEME?

In2012HerbalifewasaccusedofbeinganelaboratepyramidschemebyhedgefundmanagerWilliamAckman.Ackmanhadbet$1billioninashortsaleoffHerbalife’sstock.Shortsellingoccurswhenaninvestorsellssharesborrowedfromalender(e.g.abroker)inthebeliefthatthestockwilldecrease.Theinvestortakesthemoneyforthestocksale,buteventuallymustre-purchasethestockandreturnthemtothelender.Ifthestockhasgonedown,theinvestormakesaprofit.However,ifithasgoneup,theinvestorlosesmoneybecauseheorsheisbuyingbackthesharesatahigherratethanthepriceatwhichtheyoriginallysoldthem.

Ackman’saccusationsagainstHerbalifeincludedthefollowing:1)themajorityofcontractorsforHerbalifelosemoney,2)Herbalifepaysmoreforrecruitingnewcontractorsthansellingactualproducts,and3)onlythetop1percentofcontractorsearnmostofthemoney.Theaccusationisaresultoftheconfusionthatcomesfromthewaytheirearningstructureoperates.AckmanarguedthatHerbaliferecruitscontractorsunderfalsebeliefsthattheycanearntheincomeofthoseatthetopbysellingtheproduct,andthattherealmoneycomesnotfromsellingproductsbutfromrecruitingothercontractors.Hisreasoningisthatcontractorsearnrewardsforeverymembertheyrecruit,andeverymembertherecruitsrecruit.Howevertheterm“rewards”ismisleading.Inamultilevelmarketingcompensationmethod,contractorsearnacommissiononthesalesoftheirrecruits.

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Theterm“rewards”impliesthatthereissomeamountofmoneygivenforsimplyrecruiting.However,thisisnothowHerbalifepaysitscontractors.Herbalifeoperatesalittledifferentlythanothermultilevelmarketersinthatmosthaveacut-offonwhatlevelofrecruitsacontractorcanearncompensationfrom.Herbalifedoesnothaveacut-off(althoughtheaverageisapproximatelysixlevelsdownline).Whilethischaracteristicdiffersfromothermultilevelmarketingcompanies,itisnotenoughtoclassifyHerbalifeasapyramidscheme.

AnothercontentionofAckman’sisthatwhenanindividualgoestopurchaseHerbalifeproducts,distributorstrytoconvincehimorhertobecomearecruitratherthanremainacustomer.Hearguesthattheonlythingkeepingthecompanyrunningisnewrecruits,anditwillsoonrunoutofavailablepeopletorecruitintothebusiness.AckmanallegesthatHerbalifeentersnewcountriesafterthecurrentpoolofrecruitsinaparticularcountryisexhausted.

Ontheotherhand,manyconsumersandorganizationsbuyanduseHerbalifeproductsandseethemashigh-qualityandcredible.Forexample,LosAngelesfireandpolicedepartmentofficersuseHerbalifeproductsintheirfitnesscenters.HerbalifeproductshaveevenbeenadoptedbysomeChineseOlympicteams.Additionally,becausethenumberofendusersislargerthanthenumberofindependentcontractors,supportersofHerbalifeclaimitcannotpossiblybeoperatingapyramidscheme.ThissupportsthefactthatHerbalifeusesavalidandsuccessfulbusinessmodel,whichisproducingprofitsdirectlyrelatedtoproductsalesandallowingthemtoexpandglobally.

Ackman,however,hasmadeclaimstoinvalidatethesenumbers.Heclaimsthatthesurveymeasuringthenumberofcontractorsversusendconsumerscontradictstwoothersthatwerereleasedbythecompany.HealsostatesthatHerbaliferefusestomakethedetailsofitsrecruitingprocesspublicknowledgesoitcanbescrutinized.Ackman’scompanyhasaccusedthesurveysampleofbeingtoosmall,makingtheresultsoverlyoptimistic.Hetakesissuewiththefactthattherearenotenoughspecificsinthesurvey(pricesconsumerspaidandanitemizedbreakdownoftheproductspurchased).

Herbalifehasalsobeenaccusedofissuingfalseaccountingstatements.Therehasneverbeenanylegalaccusationabouttherecordingofsales.Accordingtoallegations,productsaresoldtocontractorsandareshownasretailsalesonthecompany’srevenue.Thecompanydoesnotalwaystracewhethertheproductwasconsumedbythecontractor(i.e.,internalconsumption)ortowhomthecontractorsoldtheproduct.Thecriticismisthatthecompanyshouldnotbemakingmoneyoffthecontractorsbutshouldonlyrecordrevenuesmadefromendusers.Thosewhocriticizeinternalconsumptionbycontractorsoremployeeswithinacompanyfailtorecognizethatthisisanacceptablepractice.Coca-Colahas100percentinternalconsumptionbecauseallofitsproductsaresoldtoresellers.Costcoalsohas100percentinternalconsumptionbecauseallofitsproductsaresoldtoCostcomembers.Thisshowsthatthepercentageofinternalconsumptionisnotbyitselfenoughtoindicateapyramidscheme.Therehasneverbeenmajorcriticismsofcompanies

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encouraginginternalconsumptionexceptwiththedirectselling,multilevelmarketingcompensationmodel.

Second,sometimeswhennewcontractorsarerecruited,theyneedtobuyproductsthattheycanconsumethemselvesorselltoothers.ThesepracticeshavecausedsuspicionamongHerbalife’scritics.Ontheotherhand,acontractorisonlyrequiredtobuymoreproductsaftertheinitialpurchaseiftheywantorneeditforpersonalorbusinesspurposes.Onceindividualssignuptobecontractors,theyindicateiftheywanttheproductsforpersonaluseortomakeavailableforsale.Ifthecontractorhasrecruitsunderthem,theyhavetheopportunitytoearncommissionsbasedonthesalesofthoserecruits.Ontheotherhand,ifthecontractordoesnotcareaboutthecommission,theydonothavetopurchaseanythingmore.InthecaseofHerbalife,theamountofproductscontractorsarerequiredtopurchaseislowerthanmanyothermultilevelmarketingbusinesses.

Thereisalsoacriticismthatalargenumberofcontractorsarenotsuccessfulinsellingtheirproducts.Theeaseofentryandextremelylowcostofbecomingacontractormakesitpossibleforthosewithlittleexperiencetoenterthebusiness.Eveniftheyarenotsuccessfulatdirectselling,thecostofentryislessthan$100andtheystillhaveproductsthattheycanconsume.Herbalife’srecordsshowthatonly1percentofitsregisteredcontractorswillmake$100,000fromthebusinessintheirlifetime.AckmanhasarguedthatthenumbersHerbalifereportsarefalse.Heestimatestheirretailsalestobeonly3percentoftheirrevenue,whiletherestismadebyrecruitingpractices.AckmanalsoimpliedthatHerbalifesaturatesmarkets,requiringittogetmostofitssalesformnewundevelopedmarkets.

Thesediscrepanciescanbeexplainedwhenthetypesofcontractorsareanalyzed.Therearethosethatsignuponlytogetthecontractor’sdiscountontheproductbecausetheywanttheproductforpersonaluse;thosewhoonlywanttoselltheproductsasasourceofadditionalincome;andthosethatwanttosellasafull-timebusinessopportunity.Furthermore,everykindofdirectsellingbusinessrequiresalargeamountofefforttomakeagoodprofit.EvenwithbusinesseslikeHerbalife,ifacontractorwantstomakealivingfromdistributing,relationshipswithcustomersmustbemaintained,andrelationshipswithrecruitsmustbemaintainedtoencouragethemtomakeasmanysalesandnewrecruitsaspossible.Manywhobegininanydirectsellingbusinessareeithernotwilling,orlackthebusinessknowledge,toputinthatmucheffort.Thosewhosignupforthisopportunityasasidejobonlyworkpart-timeorless,dependingonhowmuchextramoneytheywanttomake.Intermsofmarketsaturation,itwouldappearthatAckmanisincorrect.Herbalifereceivesapproximately90percentofitssalesfrommarketsinwhichithasdonebusinessforatleasttenyears,andgrowthinmaturemarketsaregrowingbydoubledigits.

Herbalifehasdefendeditselfagainstallegationsofbeingapyramidscheme.ItrespondedtoAckman’schargesinJanuary2013.However,thecompany’sstockfell43percentfourdaysafterAckman’saccusationsto$24.24,whichwasthelargestdropthecompanyhadseeninseveral

14

months.InresponsetoAckman’slobbyingefforts,HerbalifehiredalobbyteamconsistingofGloverParkGroupandthePodestaGroup.

CRITICISM

AGAINST

WILLIAM

ACKMAN

Asmentionedearlier,inaccusingHerbalifeofoperatingapyramidscheme,WilliamAckmanbetagainsttheirstocktotheamountof$1billion.Initially,theaccusationscausedHerbalife’sstocktodrop,benefitingAckman’scompanybecauseofhisshortsale.Ackmanhadpledgedtogiveanyprofitsfromtheshortsaletocharity,buttomanypeopletheshortsaleandsubsequentaccusationsappearedtobeaseriousconflictofinterest.

AnotherissueinvolvedlettersfromsupposedvictimsofHerbalife’sdeceptivepractices.BecauseoneofAckman’scontentionsisthatHerbalifetargetsminorities,Ackman’scompanyhaspaidcivilrightsorganizations$130,000tocollectnamesofpeoplewhowerevictimsofHerbalife.However,theNevadaAttorneyGeneralfoundissueswithsomeoftheseletters.ThreeofthelettersfromnonprofitgroupssignedbyHispaniccommunityleaderswereidentical,andnoneoftheleaderscouldidentifyanyHerbalifevictimsbyname.Otherattorneysgeneralhavehadsimilarexperiences.Someoftheleaderswhohadallegedlywrittentheletterslaterdeniedtheyhadwrittenthem.Thiscouldrepresentquestionableconducttoencourageregulatorstoact.

ShortlyafterAckman’saccusations,anotherinvestor,CarlIcahn,cametothedefenseofHerbalifeandbecameamajorityshareholderandboardmember.ThishelpedboostinvestorconfidenceinHerbalife,andtheirstockbegantoincrease.ThiswasbadnewsforAckmanwhenhewasforcedtocoverhisshortsell.Hetookalosson8millionsharesofstock.However,thestateofHerbalifewasstilluncertainamidaccusations,investoruncertainty,andHerbalife’sstrongstancethatitwasnotoperatingapyramidscheme.Pyramidschemestakesometimetorevealthemselves,soitwasjustamatterofwaitinguntilHerbalifeeithercrumbledorsucceededbeforeanyonecouldbecertainaboutthefutureofthecompany.

AnarticleintheMarch15,2014issueoftheEconomistaswellasTheNewYorkTimesprovidedacriticalassessmentofAckman’sattemptstousestate-of-the-artlobbyinginWashingtontosupporthis$1billionshortbetagainstHerbalife.Ackmanhasbeenattheheartofwell-executedlobbying,althoughheclaimstohavespentonly$264,000onhislobbyingcampaign.Ontheotherhand,Ackman’scompany’slobbyingbudgetwasseventimesthatmuch.AccordingtotheEconomist,AckmanseeshimselfasamoralcrusaderagainstHerbalife,buthiscriticsseehimassimplya“greedybillionairewhoisnowexploitingAmerica’snewlylaissez-faireattitudetopoliticalspendinginpursuitofabigfinancialpayday.”AckmanhasgainedsupportfromoneU.S.senatorandaU.S.CongresspersonwhohaveaskedfortheFTCtoinvestigateHerbalife.TheFTCdidbeginaninvestigation,andHerbalifeclaimsthattheywelcometheopportunitytovettheirbusinessmodelandputtheseattacksbehindthem.

15

THE

CONTROVERSY

CONTINUES

Despitethecompany’srecentsuccess,theallegationscontinue.SpecialinterestgroupssuchastheHispanicFederationandtheNationalConsumersLeaguearetakingissuewiththecompanyandurgingtheFTCtoinvestigateHerbalife’soperations.NotonlyaretheycontinuingtheclaimthatHerbalifeisoperatingamassivepyramidscheme,buttheyarefurtheringtheargumenttosaythatthecompanyistargetingvulnerablegroupsincludinglow-incomeHispanicimmigrantsandlow-incomeAfricanAmericans.TheallegationsagainstHerbalifeincludeaggressiverecruitingtechniques,promisesofgettingrichwithminimalwork,andtakingadvantageofpeoplewithlittleornobusinessexperience.

TheclaimsarosefromtheproliferationofnutritionclubsthathavebeenestablishedinLatino/HispaniccommunitiesinSouthernCalifornia.NutritionclubsinvolvecommunitymemberswhopayamembershipfeetodiscusshealthissuesandconsumeHerbalifeproductsinasocialsetting.ThepopularityofthesenutritionclubsoriginatedinMexico,whichiswheremostoftheimmigrantsinSouthernCaliforniaimmigratedfrom.HerbalifeclaimsthatthenutritionclubsstartedarisingintheseareasbecauseHispanicssawhowsuccessfultheywereinMexicoandwantedtoimporttheideatotheUnitedStates.Othersclaimthattheseclubsareharmingthecommunitybecausetheyturnouttobetoocostlyforthosewhorunthem,andtheyenduplosingmorethantheybargainedfor.CongresswomanLindaSanchez,whorepresentsSouthernCalifornia,haswrittenalettertotheFTCaskingtheagencytoinvestigateHerbalife.ShecitedtheintensemediacoverageandoutreachfromspecialinterestgroupsandconstituentsasreasonsfortheFTCtoinvestigatethecompany.SimilarclaimsalsoaboundinNewYork.NewYorkCityCouncilwomanJulissaFerrerashasalsowrittentotheFTCadvocatingforaninvestigation.

DesmondWalsh,PresidentofHerbalife,maintainsthatthecompanydoesnottargetspecificdemographicsandthattheriseofnutritionclubsinLatino/HispaniccommunitiesisaresultofimmigrantsseeingthebusinessopportunityandimportingtheclubsfromMexico.Anotherissuewiththeseclubsisthatownersareoperatingthemoutoftheirhomesandmakingandsellingshakes.TheLosAngelesDepartmentofHealthhasclosedsomeoftheseclubsasitisillegaltomakeandsellfooditemsoutofone’shome.Theseclubshavetofollowthesameregulationsasrestaurants,requiringpermitsandothersortsoftime-consumingandexpensivegovernmentalredtape.CriticsclaimthatHerbalifedoesnotadequatelytraintheircontractorsinareassuchasbusinessandlaws,sotheyaredestinedtofail.Herbalife,ontheotherhand,refutesthoseclaimsandstatesthattheyencouragetheircontractorstoabidebytheirlocallaws.

InFebruary2013,itwasreportedthatHispanicsmakeup60percentofHerbalife’scustomerbase.Onereasonmaybebecausetheyaregoodatdirectsellingduetotheirlargenetworkbaseandrelationshipbuildingtendencies.TheSecuritiesandExchangeCommission(SEC)iscurrentlyconductinganinvestigationintoHerbalife’sbusinessoperations.

16

OneoftheirownformercontractorsfiledaClassActionComplaintagainstHerbalifeclaiming,amongotherseriousallegations,thatthecompanyisoperatingasapyramidscheme.Someofthekeyallegationsprovidedinthisparticularcaseincludeundisclosedfacts,suchasalargemajorityofallcontractors(approximately71percent)makefew,ifany,retailsalesandareforcedtoself-consumetheHerbalifeproducts.Herbalifewilllikelycontinuefacingsimilaraccusationsinthefutureandmustremainproactiveinaddressingthem.

In2014AckmanprofiledHerbalife’stopdistributorsandcontinuedhislobbyinginWashingtontohaveHerbalifeinvestigatedbytheFTC.TheFTCannouncedthatitwasinitiatingaprobeintoHerbalife’sbusinesspractices.Herbalifehasrespondedbylaunchinganewwebsite,iamherbalife.com,thatfeaturesdozensofpositivetestimonialsfromusersofitsproducts.OneofAckman’saccusationsisthatthecompanysellsaquestionableproducttogullibleimmigrants.ResearchshowsthatHerbalifesalescontinuetoincreaseandthatithasmillionsofcustomerswhoarenotindependentcontractorsordistributorsusingitsproducts.WhilemultilevelmarketingcompensationsystemshavebeenexaminedbytheFTCinthepast,thelawsassociatedwithpyramidschemesareconsideredambiguousbysomestakeholders.Oneofthekeyfactorsinapyramidschemeisthatthereisnoproductsell-through,andinthecaseofHerbalife,theyhavedefinitivelydemonstratedthatthesalesaredrivenprimarilybysellingproductstoconsumers.

However,theconceptofinternalconsumption—althoughlegitimate—continuestobequestionedbyregulators.Thebeliefprevailsthatalargeamountofinternalconsumptionindirectsellingcompaniesindicatesapyramidscheme.In2012aU.S.judgeorderedanorganizationcalledBurnLoungetodisbandandreimbursecustomers$17millionaftertheFTCdeducedthatthecompanywasoperatingapyramidscheme.BurnLoungemarketeditselfasawayforentrepreneurstoselldigitalmusicandearnlargeincomes.Participantspaidtoenterthescheme.Verylittlesaleswererecorded,and90percentofparticipantsdidnotactasindependentdistributorssellingaproduct.

BurnLoungeappealed.TheystatedthattheFTCdidnothaveenoughevidence.Theappealin2014washeldbytheNinthCircuitCourtofAppeals.Theimplicationsofthiscaseforthemultilevelmarketingdirectsellingindustryweresignificant.IntheinitialjudgmentagainstBurnLounge,itwasruledthatsalesofproductstoultimateusersdonotincludesalestoparticipants.Itwasfearedthatalegaldecisioncouldrulethatthemajorityofproductsmustbesoldtopeopleoutsidethecompany’snetwork.Inotherwords,amajorityofsaleswouldhavetobemadetoendconsumers,withsalestodistributorsnotcounted.Thispossibilitycouldhaveputlimitationsoninternalconsumption.

ThefederalappealscourtupheldtheFTC’sdecisionthatBurnLoungewasoperatinganillegalpyramidscheme.However,therulingwasviewedfavorablybythedirectsellingindustryoverallbecauseBurnLoungewasdeterminedtobeapyramidschemeduetothefactthatparticipantshadtopaytojointheschemeandweremainlymotivatedbyrecruitingothersintothescheme(versus

http://iamherbalife.com

17

sellinganactualproduct).ThebiggestrelieffororganizationslikeHerbalifeisthatthecourtdidnotrulethatcommissionsgeneratedfromgoodssoldtoindependentcontractorswasillegal.Likeanyotherreseller,theyhavetheoptionofconsumingtheproductandsellingittoothers.Itwouldbeimpossibletoknowtheexactpercentageoftheproductbeingconsumedbytheindependentcontractorversussalestoconsumers.

Ratherthanfocusingupontheamountofconsumption,thedecisionseemedtofocusmoreuponwhethertheemphasisofthebusinessinvolvessalesofproductsorrecruitment.Otherareasofemphasisinvolvehowtheseorganizationscalculatecommissionsandtheimportanceofsellingtheproductforthesuccessfuloperationofthebusiness.Theintentforpurchaseisalsoacrucialcomponent.Ifthepurchasesaredrivenbytheproduct’svalue,insteadofbymoney-makingventures,thenitismostlikelyalegitimateoperation.

Additionally,theBurnLoungedecisiondescribedsometeststhatcouldindicateapyramidscheme.Specifically,redflagsincludefocusingmoreuponrecruitmentthanmerchandise,payingbonusesprimarilyonrecruitmentactivity,promotingtheprograminsteadofsellingtheproduct,havingparticipantspurchasetherighttoearnprofitsthroughtherecruitmentofotherindividuals,developingstrongincentivesforrecruitment,motivatingpackagepurchasesbytheopportunitytoearnmoney,andmakingitunlikelythatmeaningfulretailsaleswilloccur.Althoughsomeofthesebythemselvesarenotnecessarilyredflags,severalofthemtakentogethercouldindicateapyramidscheme.BecauseHerbalifecontractorssellproductsofvalue,participantsdonothavetopaysimplytoparticipate,andretailsalesdooccur,thislegaldecisionlendsmorecredencetoHerbalifeasalegitimatebusinessmodel.

HERBALIFE’S

SOCIAL

RESPONSIBILITY

HerbalifeisproudofitsCorporateSocialResponsibilityprogramandbelievesitbestsumsupthecompany’stopvalueofdoingtheright,honest,andethicalthing.Thesemethodsandpoliciesrelatetothedirectingandadministeringofshortandlong-termgoals.TheyareputinplacetoensureaccountabilityandeconomicefficiencyforHerbalife’sstakeholders.HerbalifeisproudthatbecauseofthesepoliciestheymetindependencecriteriaalmostayearearlyandmeetallNYSE-listedpubliccompanyrequirementsfortransparency.

Herbalife’sbusinessethicsallowsittoupholdthehighestethicalstandardsintheoperationofthecompany.CEOMichaelJohnsonhassaidthatitsreputationisitsgreatestasset,anditsCorporateCodeofBusinessConductandEthicsreflectsthis.Herbalifeencouragesfairinteractionsandgoodjudgmentbetweenanypersonsassociatedwiththecompanyandcustomers.ThereareguidelinessetinplaceastohowcontractorsandemployeesofHerbalifeshouldinteractwithsuppliers,competitors,businesspartners,andthegovernment.Herbalifeencouragesobediencetolawsandsetsboundariesongiftsandentertainment,describingthedifferencebetweensmallgiftsforhospitalityandbribes.Thecompanydiscouragesconflictofinterestsituationsaswellasinsider

18

tradingandofferthreemethodsofreportingunethicalbehaviorthroughthecompanyhotline,website,orbycontactingtheGeneralCounsel.Individualswhodonotcomplyaredisciplined,suspended,orterminated.Herbalifealsorequiresannualethicstrainingforallemployeesworldwide.

AnotheraspectofitsSocialResponsibilityprogramincludesitsphilanthropicefforts.TheHerbalifeFamilyFoundation(HFF)andtheCasaHerbalifeprogram,foundedin1994byMarkHughes,providefundingandvolunteerismtocharitableorganizationstakingcareofchildren-at-riskaroundtheworld.HFFworkstoimprovenutritionandhelpwithdisasterreliefefforts.HerbalifehasalsopartneredwiththeGlobalAllianceforImprovedNutrition(GAIN)andDSMNutritionalProducts,aproducerofvitaminsandnutritioningredients,tohelpdelivernutrientstowomenandchildrenaroundtheworld.ThispartnershipisundertheumbrellaofGAIN’sFutureFortifiedcampaign.

Lastly,asapartofHerbalife’sCorporateSocialResponsibilityprogram,itengagesinEmployeeWellnessandLiveGreenenvironmentally-consciousinitiatives.Thecompanyencouragesandincentivizesemployeestobecomeandstayhealthyandparticipateinfitnessactivities.Suchincentivesincludecomplimentaryproductsandlowerindividualhealthinsurancecosts.ThecompanyhasevenbeenrecognizedbyMen’sFitnessmagazineas“Oneofthe15FittestCompaniesinAmerica.”Throughenvironmentally-consciousinitiatives,LiveGreenandthe3Rs–reduce,reuseandrecycle–Herbalifemakesitseffectontheenvironmentapriority.

CONCLUSION

Herbalifehasfacedseveralallegationsovertheyearsbutcontinuestobesuccessful.Asof2013thecompanyreachedworldwidenetsalesof$4.8billion,upsignificantlyfrom2012inspiteofAckman’saccusationsandlobbyingcampaignagainstthecompany.Herbalife’sstockpriceclimbedtoover$80asharein2013duringthetimethatcriticismswerebeingleviedagainstthecompany.Ontheotherhand,Herbalife’sstockdroppedafterChinainitiatedaninvestigationintothemarketingpracticesofNuSkinEnterprisesandtheannouncementoftheFTC’sinvestigation.Thestockissellingforover$50ashare,whichisstillsignificantlyhigherthanitsearly2013value.

Itsproductsareexclusivelysoldbynearly2.3millionindependentcontractorsin90differentcountries.Herbalifesponsorsseveralprofessionalathletes,teams,andsportingevents.Additionally,thecompanyisproudofitsCorporateSocialResponsibilityinitiatives.Herbalifeisasuccessfulcompany,butethicalissueswillcontinuetoensue.Trustinbusinessisatalowpointinoursociety.Marketingisoftenseenasapartofbusinessthatissuspect.Adirectsellingfirmreceivesadditionalscrutinyasitisfocusedonpersonalsellingtodistributeallofitsproducts.

Herbalifecontractorsdonothavetheoverheadexpensesthataretailstorewithabuilding,fixtures,utilities,andotherexpensesrequires.Therefore,themarkuponproductssuchascosmetics,nutritionalsupplements,jewelry,andclothingmaybesimilarinboththeretailstoreandindirectselling.Adirectsellingcompanyisaflatorganizationwithlowoverheadandcompensationsystems

19

forthenetworkofsalescontractorsthatmaketheproductavailabletofinalconsumers.Theconceptofinternalconsumption,whichexistsinnearlyallbusinesses,isconsideredquestionablebysomecriticswhofailtounderstandthatthereisnothingillegalorunethicalaboutinternalconsumption.

Ontheotherhand,somedirectsellingcompanieshavebeenassociatedwithinventoryloading,sometimescalledgaragestuffing,whensalescontractorsareencouragedtobuymoreproductsthantheycanconsumeorsell.Thisethicalbreachhasnothingtodowithacompanybeingapyramidschemejustbecauseitusesamultilevelcompensationmethod.Allbusinesseshavecompensationmethodsthatrewardsalesmanagersandhigher-levelmanagers,includingtheCEO,forperformance.Everybusinesshastoproducerevenue,andthemarketingfunctionisexclusivelyinchargeofdevelopingsales.

However,companiescanfightagainstcriticismoftheiroperationsbymaintainingtotaltransparencyconcerninghowtheirsalesincentivemodelswork,andthereshouldbeduediligencetoensurethatsalescontractorsarenotexploitedinanyway.Herbalifecontinuestohavemanyloyalcontractorsthroughoutouttheworld,showingthatthefirmhasmanysupporterswhobelievethecompanyisalegitimateandsuccessfulbusinessoperation.

QUESTIONS

1. WhyhasHerbalife’smultilevelcompensationmodelbeenconfusedwithapyramidscheme?2. Describethedifferencesbetweenalegitimatebusinessmodelandapyramidscheme.3. HowhasHerbalifedemonstratedsocialresponsibility?

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MultilevelMarketingUnderFire:HerbalifeDefendsItsBusinessModelINTRODUCTIONHISTORYPRODUCTSMULTILEVELMARKETINGINDEPENDENTCONTRACTORSTable2:DirectSellingAssociationCodeofEthicsAsasalesperson,youshouldexpectaDSAmembercompanyto:

PYRAMID SCHEMEISHERBALIFEAPYRAMIDSCHEME?CRITICISM AGAINST WILLIAM ACKMANTHE CONTROVERSY CONTINUESHERBALIFE’S SOCIAL RESPONSIBILITYCONCLUSIONQUESTIONSSources