If Herbalife is a Pyramid Scheme, then…

… thats trouble. Big Trouble.

That’s trouble in a number of ways, but immediately I think about similar network marketing (or multi-level marketing) programmes, which are BIG here in Jamaica – Organo Gold, GNLD, and Visalus are just a few. Trouble not because they could befall the same fate (yes they could), but because of perception. People have a way of aligning something with what they see, hear, think and feel; and if Herbalife suffers, then who knows…

But if it’s a real company, then… that’s good.

Herbalife Has Had To Defend Itself
Today the company went public defending itself as a real company. It went into extensive detail about a number of things including their US$44 million per year spend on Research & Development, its payments to ‘distributors’ (its network of sales people), its retail prices (which are said to be too high), its brand, and its approach to selling (the multi-level marketing technique).

Is Herbalife a Pyramid Scheme

Under Attack
The Company has been under attack since late 2012, when a high publicity investor decided to short sell the stock (bet that the price of the stock would fall) and went to great lengths and detail to convince the public that Herbalife was operating a pyramid scheme. In fact the investor gave a 3 hour, 343 slide presentation which as Dealbook reports, has been downloaded over 2.8 million times already.

Now he hopes that the price of the stock will fall to $0, and that the regulators will step in and declare Herbalife a pyramid scheme. Why? Well he’s an investor and there’s money to be made, that’s one reason. (Even though he has pledged to give all his profit to charity.)

Why is this important
It’s amazing how things can change overnight. One day, we are investing in a company with a solid business model, and another day, someone questions it, and our whole future is in doubt.

Dealbook writes that this is important, as the answers to a few questions will determine the the future of Herbalife. Like this question for example.

Is Herbalife selling its product to people outside its network or to its own distributors? And are those distributors making more money by pushing product than actual sales?

The reason is based on a decision from the 1970s by the F.T.C. that rejected claims that Amway was a pyramid scheme. Multilevel marketing models like Herbalife and Amway sell their goods through distributor networks. People make money not only from sales, but by recruiting people to make sales and recruit further salespeople. The recruiters earn a commission on any sales made by people they recruit or people who their recruits recruit, and so on. The problem is that when the money made is all on commissions and not on sales to outsiders, the model becomes a pyramid scheme that will eventually collapse when new people stop entering at a sufficient rate and sales are only made to people buying the goods to earn commissions.

Read the underlined section again. And take this other question.

So is Herbalife a legitimate sales operation selling to outsiders? Or are all of its sales to distributors who purchase the product to make commissions from themselves and sales people beneath them in the marketing scheme?
For Herbalife, providing an answer is harder than you might think. While Herbalife has rules to bring it in compliance with the F.T.C. guidelines, including the 70 percent and 10 customer rule (a rule that distributors had to sell to 10 customers a month and also sell 70 percent of their product each month to others), it does not directly track sales to distributors outside its network and has not disclosed this information in the past.

These are some interesting questions. We will keep you up to date on this.