Similarities Between Herbalife and Pyramid Scheme BurnLounge

In March, the Federal Trade Commission entered an order against multi-level marketing company BurnLounge, prohibiting the company and its founders from making certain misrepresentation and requiring them to disclose certain things in the future. Over the last few months, the heat has been on Herbalife, after short seller David Einhorn asked some important questions on a conference call. (Don’t let HLF tell you the questions were elementary or not important. They are very important.)

There is no doubt that Herbalife has had much financial success over the years. It is the largest publicly traded MLM, and its stock price has increased greatly since 2007. But are there things to be worried about? If you know something about multilevel marketing, the answer is YES.

Multi-level marketing is a type of business in which constant recruiting is required to replace distributors who quit, and the retention rates are dismal. If you look closely enough, you will see that on average, 99% of participants in MLMs lose money. Recruiting new representatives requires presenting an “income opportunity,” but if the potential recruits know they’re almost guaranteed to lose money, they are unlikely to sign up.

This is why multilevel marketers – – selling everything from makeup, to vitamins, to weight loss products – – depend on withholding information from recruits and focusing on misleading disclosures. Most of the time, MLMs get away with this. They have a very strong lobbying organization in the Direct Selling Association, which bills itself as a “trade association,” but really focuses its efforts on ensuring laws are not enforced or created against MLMs.

After years of fighting, the FTC finally settled a case it brought against MLM BurnLounge in 2007. Multi-level marketing companies like Herbalife, Mary Kay, Medifast, Pre-Paid Legal, and Usana work hard at distancing themselves from the phrase “pyramid schemes.”

But BurnLounge wasn’t so lucky. The regulators saw it for what it is and pursued it for nearly 5 years. And the case ended with BurnLounge being shut down by the FTC.

Could a company like Herbalife be in danger of being shut down by the FTC? I have no knowledge of whether or not the FTC is looking at Herbalife. But below, I am going to compare the problems at BurnLounge (as cited in the complaint in the FTC case) with what I know about Herbalife. You decide whether Herbalife could be in danger of action from the FTC or other regulators.

BurnLounge

Herbalife

BurnLounge recruited participants by selling them so-called “product packages,” ranging from $29.95 to $429.95 per year. As seen in this graphic, distributors can sign up for $57.75 or $95.55
More expensive packages purportedly provided participants with an increased ability to earn rewards through the BurnLounge compensation program. It is implied or stated by some recruiters that those who are more serious about Herbalife will buy the more expensive option.
The BurnLounge compensation program primarily provided payments to participants for recruiting of new participants, not on the retail sale of products or services, which the FTC alleges would result in a substantial percentage of participants losing money. Like other multi-level marketing companies, Herbalife contends that commissions are paid to distributors for product sales, not for recruiting. However, the commissions are paid to the upline when distributors order products from the company, regardless of whether those products are actually sold. A ruling against Herbalife in a Belgian court said endless recruiting is the name of the game.
Consistent with the incentives of the BurnLounge compensation plan which favor recruitment over music sales, the efforts of Defendants in promoting and training others to promote BurnLounge emphasizes recruitment over sales of digital music. From the Herbalife 10-K: “We are focused on building and maintaining our distributor network by offering financially rewarding and flexible career opportunities through sales of quality, innovative and efficacious products to health conscious consumers.” We see here that recruiting is the real business.
BurnLounge operated an illegal pyramid scheme, making deceptive earnings claims, and failing to disclose that most consumers who invest in pyramid schemes don’t receive substantial income, but lose money, instead. A Belgian court said earlier this year that Herbalife is a pyramid scheme. Most recruits lose money in Herbalife. And while a U.S. Court has not declared Herbalife to be an illegal pyramid scheme, the Belgian court’s decision seems to point to the truth about this opportunity.

There are many more comparisons that could be made between BurnLounge and Herbalife. If you examine the MLM industry in the United States, you see that these companies skate dangerously close to the line at which they can be called pyramid schemes. Certain lawyers cater to MLMs, advising them exactly how to set up their companies to comply with the letter of the law and fly below the radar so as not to be called pyramid schemes.

Sadly, the MLM industry is thriving, even in a struggling economy. But it is thriving by taking money away from eager recruits who are almost guaranteed to lose money. Money their families could use for important things like feeding their children and putting a roof over their heads.

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13 Comments

  • Dylan says:
    11 July 2012

    As an Herbalife Distributor I can honestly say that the majority of my income is derived from customer based product sales. Yes, I recruit and yes, many new distributors never earn a dime but that is because THEY NEVER EVEN DO THE TRAINING OR SEND IN THEIR APPLICATIONS! I call, I email, but I cannot do the work for them. Herbalife manufactures their products to the highest standards and the effectiveness of the products cannot be questioned. I’d love to see a financial disclosure from the author and this site’s management. Seems to me like a site like this has the ability to sell a stock short (or buy long put options or sell calls) then publish an article of this nature. Herbalife is very up front about the fact that many of its distributors are really just customers taking advantage of the distributor discount (similar to a Sam’s Club member)

  • Tracy Coenen says:
    11 July 2012

    Dylan – You set forth a common argument used by MLM supporters – the majority fail because they don’t do the work. That’s not true. The truth is that the majority fail because MLM is a broken system in which 99% will fail BY DESIGN.

    What would you like me to disclose? Whether I’m short Herbalife stock? I’m not. And I don’t do options or calls.

    This article is simply about the truth. I don’t care one bit about the price of Herbalife stock.

  • Glenn Hudson says:
    11 July 2012

    If not succeeding in a business is how we judge things,we need to indicte our entire our entire capitalistic system. Over 80% of businesses including a lot with major dollars invested go out of business in their first two years. With all MLM’s there are a lot of people who don’t put much effort forward and lose a small amount of change. Even in most sales organizations it’s commonly known that 20% of the sales people make 80% of the sales.

    I happen to be an inventor. I have invented and patented 2 products. The first product I invented I signed a royalty agreement with a company called Sportime out of Atlanta Georgia. They were really high on my product but to make a long story short they ran into production difficulties overseas and didn’t bring the product to market. I lost a nice chunk of change of that attempt(dramatically more than the cost of any MLM).

    My second invention has cost me a lot of money to patent, try to launch myself and have signed a royalty agreement where money is coming in monthly (I spent over $100,000 so far on launching this product). Now it’s in sold throughout the USA as well as internationally. It’s even sold in some Dicks Sporting Goods, Sports Authority, at Walmart.com as well as in many other locations. One day hopefully I will recoup my investment and be cash flow positive.

    My point- I have been asked to give talks about my invention and here’s what I found out-

    “99.8% fail. Only 3,000 patents out of 1.5 million patents are commercially viable”

    “97% to 98% fail – “[O]nly 2 to 3 percent of registered patents ever make it to the market.””

    “99.9% fail. Only 2 products are launched out of every 3,000 ideas. “Out of 3,000 ideas, for instance, only about two products are ever actually launched — and only one of those succeeds, says Greg Stevens ”

    Here is a link where you can verify those statistics-
    http://www.inventionstatistics.com/Innovation_Risk_Taking_Inventors.html

    How about trashing the opportunity for people to start any business which is one of the basic elements for the success of our country?-

    “Holland (1998) quotes a Dun & Bradstreet report which estimate,“businesses with fewer than 20 employees have only a 37% chance of surviving four years (in business) and only a 9% chance of surviving 10 years.” Restaurants have the highest failure rate, with only a 20% chance of surviving two years. No one starts a business with the intention of failing. Many, however, start a business with the odds greatly stacked against their success. ” Here is a link-

    http://sbaer.uca.edu/research/asbe/2004/PDFS/23.pdf

    My point is that even though most people don’t succeed at something, do we want to take away the opportunity for those people who are willing to put in the effort to succeed from being able to do it. I was able to beat the odds by inventing a product that I believe one day will be tremendously successful and a money maker- so do you want to eliminate all the people from being able to patent products??

    For the record, when I was younger I tried an AMWAY business and didn’t make money but for the amount of money invested, I learned a lot and it has more than paid me back by things I have used in opening other businesses.

    As far as I can tell Herbalife is a well managed business and their opportunity is as good or better than other MLM businesses. It doesn’t cost a lot to start up, their product is helping people become healthier, and they will buy back product if you choose to get out. I don’t see anyone trying to pay me back for the money I lost which was considerable on my first invention!!

    It will be interesting to see if you post this or if you are to biased to understand my points.

  • Tracy Coenen says:
    11 July 2012

    Glenn – MLM is not a business. It is a legalized pyramid scheme in which 99% are guaranteed to lose money.

    In a real business, your level of success is highly correlated to your effort. In MLM, it is not. A high level of effort does not correlate to success.

    Of the 1% that turn a profit, the vast majority are making minimum-wage level earnings. For the 99% who lose money, MLM is not a business but is simply a scam in which they participate.

    How do they get sucked in? With false hope. They are given misinformation about the success of distributors. They aren’t told that they’re almost guaranteed to lose money. They don’t realize they are going to be paying money into the scheme and are almost guaranteed to never get that money back.

    The only people for which MLM is a business is the owners of the MLM companies. They get filthy rich off the backs of the distributors… distributors who lose money buying into the dream, and who often can’t afford to lose the money.

    I am not “too biased” to understand your points. Your points about MLM are just largely wrong. And as for the patent business, I wouldn’t recommend anyone get into that either, but for different reasons. Comparing MLMs to the patent business is not valid.

  • Tracy Coenen says:
    11 July 2012

    P.S. If knowing the truth about MLMs and daring to tell the world that truth makes you label me as “biased,” then I will gladly wear that title.

  • Dylan says:
    11 July 2012

    Tracy, I like how you hedge your comparison with the words “with what I know about Herbalife”. Where did you garner this knowledge? Did you join as a distributor to gain REAL insight into the process or did you merely read what others have written? Over the past 6 months I have signed up 36 distributors. Of those only 16 have even signed in to begin their training. Of those 16, only 10 have completed their training. How can you ever hope to even try to make money if you don’t ever learn how to market, price and drop ship the product? I follow up with all my distributors to ensure they are getting the support they need or in the case of those who have not completed or started training, I try to provide encouragement. Each distributor’s success depends on their talent and effort. No effort will result in no sales, just as in ANY business. What sets Herbalife apart is that you don’t have to recruit to make money. Of those who completed their training, all have made back their initial investment in profits generated from sales. Do not group Herbalife (a company with REAL products) into the same MLM pile as most of the miracle juice/get paid to blog/get paid per click/create your own website to drop ship products types of MLMs. Seems like you’re picking on Herbalife cause they are biggest target.

  • Glenn Hudson says:
    11 July 2012

    So what is your thoughts about 80% of businesses failing in their first 2 years? I have started up multiple businesses investing a large sum of money without any guarantees. I am sure out of those 80% of failures, a large # of people have lost huge amounts of money some that have lost all of their money.

    I know MLM’s because I have been a distributor for AMWAY, I am a CPA and have been an entrepreneur in multiple businesses over several years as well as being familiar with several MLM companies.

    What I know is that most take a minimal investment money wise to get into, MOST of the people that get into them put relatively little effort and give up(more than the 80% since it doesn’t take that much to get in to one = EASY IN=EASY OUT)

    NO DOUBT it’s a tough business to succeed but anyone that really understands the concept of WORKING UNBELIEVABLY HARD and sticking with something that requires a lot of rejection and dealing with a lot of negativity CAN BUILD AN ORGANIZATION AND CAN SUCCEED. YES it’s not a large percentage but it can be done by someone really willing to work at it. It is especially a reasonable opportunity for someone REALLY WILLING TO WORK AT IT if they don’t have the money to start up a business that costs a lot of money!

    On the other hand, there are a lot of other reasons other than profits that a lot of people like to be part of a MLM.

    1) Being part of an organization of positive people and learning new skills
    2) Meetings & travel that can be deducted for business purposes
    3) Some people like the products and are able to get their own products at a discount as well as to sell some to a few of their personal contacts.
    4) It’s a small investment and they can make the business be whatever they want it to be

    Part of the reason a lot of people don’t succeed at MLM’s is as you even try to say- they don’t treat them as a business SO THEY GIVE UP. Even though I know I could succeed at growing a profitable MLM business. I admit I don’t want to work that hard and there are other ways that I can (since I have the money to invest) succeed.

    As far as you not recommending people to invest in an invention and patent, you obviously are not a risk taker but I am living the American dream of going for it even when the odds are against it. Don’t take away another dream that I know a lot of people have, inventing a product and making it big which I plan on doing.

    Also just because you don’t want to be part of a MLM or see it as a business opportunity- obviously millions of other people do so I recommend that you don’t become part of a MLM but don’t put your limitations on other people who may find it as their best opportunity to make something of themselves. Losers->lose and quiters->quit-> that’s what they do.

    Maybe if you feel so strongly about not being part of MLM’s why don’t you start a business loaning the large sums of money it takes to start up other types of businesses. I know thats not going to happen because you aren’t a risk taker.

    Other interesting facts- more money was made by those selling the mining equipment to miners than the profits made from mining gold during the California gold rush (SOME SUCCEEDED REALY SUCCEEDED BIG)

    More money has been made from selling the tools to start a business on the Internet than the profits from those businesses (BUT SOME SUCCEEDED REALY BIG)

  • Tracy Coenen says:
    11 July 2012

    Dylan – I have been researching MLMs for years, and I know plenty about Herbalife. I don’t actually have to give HLF any money to know exactly how it works.

    I am happy to hear that most of the distributors who signed up with you wised up quickly before wasting more of their time and money on Herbalife.

    You seem to be putting for the theory that most people fail in MLM because they don’t try. My research shows otherwise. It shows that even when they do try, the vast majority fail, and the results are not highly correlated to the amount of effort put forth.

    Herbalife is like any other product-based MLM. They sell an overpriced, over-hyped product, using the product as a front for their scheme. This way they can say “we have a real product!” The truth is that actual retailing to 3rd party customers is dismal, because the business is not about products, it is about endless chain recruiting.

    I am not picking on Herbalife. I am writing the truth about Herbalife and every MLM that I’ve examined: It’s not a real business opportunity, just a money transfer perpetuated by continual recruiting and the use of a product to make it look legitimate.

  • Tracy Coenen says:
    11 July 2012

    Glenn – I would never compare real businesses to MLM, so my thoughts on the failure of real businesses are not important here.

    Unfortunately, you use the MLM scripts well. Yes, it’s a small investment, and 99% will never recoup their investment. MLM is simply silly for anyone serious about making a living. People fail in MLMs because the system is designed for them to fail. Success in MLM is not correlated to effort.

    I have owned my business for more than 12 years, and have been quite successful. I think that qualifies me as a risk-taker. I just suggest that people take risks with real business opportunities, not the pretend opportunities offered by MLMs.

  • Glenn Hudson says:
    11 July 2012

    These are 2 of the dumbest comments I have ever heard someone say about MLM’s which allow me to understand that you really don’t understand MLM’s-

    “People fail in MLMs because the system is designed for them to fail. Success in MLM is not correlated to effort.’

    First of all, whether people make money or not MLM’s need people to succeed or they won’t be an MLM for long. Can you name me one MLM which has been around for over 10 years where there aren’t people making some serious profits? I didn’t think so. For an MLM to grow they need to provide a plan that rewards people for growing their businesses and even though most of the people aren’t making money(no doubt)trust me there are people making money or everyone would quit. If a MLM was able to design a program where everyone made money, they would grow like crazy- make sense!!

    Secondly- For those who choose to build organizations – if you think you can build a MLM organization without A LOT OF EFFORT you obviously have never tried to build one like I did. Building an organization is incredibly difficult especially since we live in a world where most people aren’t willing to work hard to accomplish anything of significance.

    Actually the reason the MLM opportunity is still available to this day is that if it was easy- everyone would have gotten in and stuck with it. This great difficulty enables someone who has the desire and commitment to build an organization from nothing even after some MLM’s have been around for over 30 years, a person can still succeed if they work hard enough.

    Congrats on 12 years doing whatever you’re doing but if you’re are following the footsteps of Herb Greenberg and some of his cronies, they tried the same thing or worse with Prepaid Legal Services over a 10+ year period and that MLM got sold to a private investment group just last year for almost 2 1/2 times what their share price was when all those attacks began.

  • Tracy Coenen says:
    11 July 2012

    Glenn – The reason MLMs are around today is twofold:

    1. The lobbying organization The DSA ensures that laws will not be enforced against MLMs.
    2. MLMs lie to potential distributors to get them to sign up.

    There are some people who have made money in MLM, but it is only because people below them lost money. It works like this: Woman joins Mary Kay and buys inventory. Upline gets a commission. Most of the inventory never gets sold because it is overpriced, of mediocre quality, and the market is saturated. The non-sale doesn’t matter because the upline already make their cut.

    The percentage of people in MLM making a respectable amount of money is miniscule. Such that no real business would ever stay afloat with such abysmal results. But MLM keeps going because they sell a dream.

    As I mentioned above, MLM companies are very good deals for the owners of the companies, and very bad deals for the distributors. So when you look at the owners of HLF or PPD or any other MLM, understand that they are making money hand over fist. That is why stock like HLF remains popular.

  • Scott B says:
    12 July 2012

    Burnlounge, Herbalife and the exposure from a hedge fund guru/CEO shows a pretty clear picture to anyone with any ethical honest business sense— NO END CONSUMER.

    They look and perform just like a true pyramid scheme. Products are just a cover!

    Again anyone with any business sense looking at a companies income disclosure statement could see MLM is a bad investment for 99.9%. No one is making money except those at the very top and that is a too small of a number to consider investment. Anyone joining MLM is not a business owner, they are only a sales representative, selling the dream of making $$$, not the value of a product to real consumers.

  • UTAH says:
    8 December 2012

    Tracy, you made my day!

    Although MLM originates from the USA it was scattered and infected through the many countries, here, in the ex-USSR, one simple question makes ANY ‘successful’ MLM-pusher shy away:

    Could you, please, show me you income statement?

    And the second ‘ugly’ question to finish off the wounded animal:

    How much did you ‘invest’ in the biz? (What is the net profit?)

    If one needs about a hundred of participants in his downline to be ‘happy’ then the ratio is fixed and nothing can change it — 1:100. But if a clever man thinks, then he will surely realize, that MLM falsely uses the term ‘infinity’ whereas all upon this Earth is very-very limited. MLM is but a fake nonsense–whatever its name and plan might be.

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