Anne Coughlan is Wrong on Herbalife

herbalifeAt yesterday’s big Herbalife investor day, the company paraded around Anne T. Coughlan, a marketing professor at Northwestern University, who proudly proclaimed that Herbalife is not a pyramid scheme. No, it is a legitimate multi-level marketing company.

In July, Coughlan published this paper on Herbalife, concluding that Herbalife is squeaky clean. Let’s be clear. Herbalife paid Coughlan to publish this paper. The paper notes:

This document was prepared with the financial and data support of Herbalife
Ltd.

I don’t want anyone to be fooled. This wasn’t a professor who just decided to write about Herbalife out of the goodness of her heart. She was paid to do so.

But lets talk about Coughlan’s conclusions. They’re wrong, and her paper is misleading, in my opinion. She did only a very limited analysis of Herbalife, one that was guaranteed to result in her concluding it was a legitimate MLM and not a pyramid scheme. Attorney Doug Brooks, one of the most knowledgeable people in the world on the topic of multi-level marketing, says that the analysis is superficial and full of misleading and inaccurate statements.

Let me be clear: Multi-level marketing companies have perfected the game of regulatory compliance. They know exactly what window dressing they need to appear to be legitimate. There are even attorneys (clowns?) who make their livings teaching MLMs how to make it appear that they are not violating laws prohibiting pyramid schemes.

Inevitably then, the “criteria” that Coughlan examined would all indicate that Herbalife is legitimate!

Ann T. Coughlan proves her theory with the following points in bold. My commentary follows:

Compensation is based on sales and not on mere recruitment – What Coughlan fails to realize is that compensation is not based on “sales” in any way shape or form. It is based on distributor orders of products from Herbalife. Commissions are paid when those products are ordered, and there is no correlation whatsoever to sales to consumers. Herbalife has no idea whether those products are sold or not.

And the word “mere” is something Coughlan threw in herself. She cited two important cases in her endnotes:

For example, The Webster v. Omnitrition case (Webster v. Omnitrition Intern., Inc. C.A.9 (Cal.), 1996) says that the “Sine qua non of [a] ‘pyramid’ scheme is [the] right to receive, in return for recruiting other participants into [the] product sales program, rewards unrelated to [the] sale of product to ultimate users.”

FTC v. BurnLounge (U.S. District Court, Central District of California, No. CV 07-3654-GW(FMOx), Statement of Decision, notes that “Inventory-loading pyramids are illegal not simply because there are wholesale purchasing requirements. They are illegal because the purchases are incentivized by commissions that result from recruiting others to join the scheme through similar purchases.”

But you see that neither of these decisions hinges on “mere” recruitment.  In the first, the problem is rewards unrelated to the sale of products to actual consumers. This is something many MLMs quietly run afoul of. Most MLMs pay commissions based on product orders by distributors, and the commissions have nothing to with any sale of products to ultimate consumers.

In the second, we hear about product purchases that are incentivized by commissions paid for recruiting others who make similar purchases. Most MLMs run afoul of this as well, again very quietly. Since MLMs are generally careful not to pay commissions directly tied to the act of recruiting, the recruits are persuaded to make product purchases to trigger the payment of commission. Again, it doesn’t matter if those products are sold, just that they are purchased by distributors.

And MLMs are even more clever when they require distributors to “qualify” to receive commissions. That is, the distributors can’t receive commission checks unless they have purchased a certain amount of product recently. MLMs are careful to say there is “no requirement” to purchase products, but the truth is that you don’t “qualify” to receive commissions unless you “choose” to purchase products.

Low enrollment fees – Most multi-level marketing companies have low enrollment fees. That is a carefully planned part of the operation.  A higher enrollment fee attracts attention from regulators. So they keep the fees low, and then offer separate “business builder” packages or product packages to extract more money out of distributors. A low enrollment fee proves nothing other than the MLM knows the types of things that can be red flags for regulators.

Scientific and product investment to create and manufacture sellable products – While Coughlan claims that Herbalife invests significantly in research and development (and now Herablife claims this too, as of yesterday’s investor party), Herblife’s own SEC filings show this is a lie:

The Company’s research and development is performed by in-house staff and outside consultants. For all periods presented, research and development costs were expensed as incurred and were not material.

Coughlan reports:

In 2011, Herbalife spent about $25 million combined on research and development, technical operations, scientific affairs, quality assurance and quality control, product safety, and compliance efforts. Beyond this, an additional $11 million was spent on nutrition affairs, product licensing, and strategic sourcing.

Herbalife’s investor day presentation gave similar information, reporting that $44 million was spent in 2012 on “R&D, quality assurance, products safety, and compliance, among others.”

You have to read these statements carefully. There is a whole lot of stuff thrown into this $36 million to $44 million. It  includes all sorts of costs related to manufacturing as well. What does that prove? That they’re not manufacturing products in dirty plants? So the company spends about 1% of revenue on all things R&D and manufacturing, and this is supposed to be a “significant” investment?

Bill Ackman’s point in his presentation was that Herbalife claims to be a products company, but they do relatively little research and development. That hasn’t been debunked in the least.

Coughlan goes on to say that the result of Herbalife’s research and investments is a sellable product! An illegal pyramid scheme wouldn’t care about having a product!

Again, this is one way that multi-level marketing companies give themselves an air of legitimacy. They provide a legitimate product that can theoretically be retailed. They can say “no, no… it’s not about recruiting, it’s about retailing.” But the truth is that the products are incidental to the scheme as a whole.

Willingness to take back unsold product when a distributor resigns – Yes, Herbalife is benevolent because it has a product buy-back policy, and since almost no one participates in that program, it must mean that the quitters are all happy. What Coughlan doesn’t mention is that several state laws require buyback policies, so MLMs have these  policies to ensure they can do business in all states.

Coughlan theorizes that an illegal pyramid scheme would have a bogus product and would experience high rates of return.  This whole line of thinking is wrong. In my years of researching MLM, I’ve found that most distributors don’t participate in the buyback program because of one or more of the following reasons:

  • they don’t want to lose what little downline and commission income they have (or think they may have in the future)
  • they are coerced by their upline to not return products
  • they are given misinformation by their about the return process, the rules, and the money they can expect to receive
  • they fear that the subtractions the company makes from their potential refund will make it “not worth it”
  • they don’t want to be prohibited from joining the company again in the future
  • they’re too embarrassed to admit failure and return their products

Discouraging distributors from inventory loading -  Coughlan claims that Herbalife discourages distributors from stocking large amounts of inventory (often called “inventory loading” or “frontloading” in the MLM world) that they cannot sell or consume in the near term. That sounds great, but is it true?

It depends on how you look at it. Again, we go back to the issue of “qualifying” for commissions. MLMs like Herbalife require distributors to purchase products at regular intervals, or they do not qualify for commission checks. They can plausibly deny any inventory loading by saying that distributors should only order what they can sell or consume.

But if you’ve studied multi-level marketing for any length of time, you have seen that these minimum purchases add up quickly. So even if a distributor doesn’t place a large initial order, making the required minimum purchases on a regular basis can easily cause the distributor to stock more inventory than he or she needs. The MLM will say distributors should be selling these products! But this ignores the fact that there is a teeny tiny market for MLM products outside of the distributors.

Consumption by non-distributor versus by distributor end-users is not a valid criterion – Coughlan claims that it doesn’t matter if anyone outside an MLM wants to buy the products. Sales are sales, and sales inside or outside the pyramid all count equally. Even though Herbalife doesn’t track actual retail sales (inside or outside the distributor network), surveys show there is retailing to third party customers!

First, it is important to understand that multi-level marketing companies do not track actual retail sales for a reason: The lack of retail sales outside the distributor network would go a long way toward supporting pyramid scheme allegations. These companies claim there is no way to track such sales, but that’s not true. They have a vested interest in not tracking retail sales, and so they do not track retail sales.

A problem with Coughlan’s claim that we should ignore retail sales to third parties is that it conflicts with the earlier claim that there are sellable products. Indeed, if the products were the focus, then sales would be occurring outside the distributor network. If the sales are only (or mostly) occurring within the distributor network, then I think you’ve got evidence of a recruiting scheme rather than a company focused on retailing.

Anne Caughlan’s presentation at Herbalife’s investor day added one amazingly foolish statement in addition to showing her “conclusions” from this article:

MLM can persist indefinitely and is not dependent on recruitment for survival.

That’s simply not true. If Coughlan had read Herbalife’s own comments in its last 10-K relative to this issue she would have been better informed.  The company says it has a high turnover rate amongst distributors.

What does that mean? In order for the company to survive, it needs new people to be recruited. Without new recruits, the organization would dwindle to nothing. All that would be left are higher level distributors, who get the bulk of their compensation from the purchases of the recruits below them. As those recruits dwindle, there will be no one and no compensation left.

One other point I found interesting from Herbalife’s presentation yesterday:  Herbalife cites “independent” research that shows 5% of U.S. households have purchased an Herbalife product within the last 3 months. How then, can it be, that during Bill Ackman’s presentation, only one audience member said they’ve ever purchased Herbalife products? Curious, isn’t it?

Notice also that Herblife provided no information relative to any of the questions I suggested they answer at the end of this article. How’s that for transparency and disclosure?

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Comments (26)

  • Ray

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    Nailed it! there is so much propagandizing by this company going on right now. I don’t buy it for a second. Why won’t they answer the real questions? SHUT THEM DOWN! and while you’re at it, take a hard look at the criminals in Xango, Monavie, and the rest of them

    Reply

  • Nishant

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    I was watching a Youtube video of Mark Hughes making a presentation to a crowd in Korea. I noticed something interesting that he emphasized during his presentation. He asked his distributors to never discount the products and always sell at Suggested Retail Price. He mentioned that by discounting the products, distributors will start competing with each other over price and margins will erode.
    Once margins erode, it is more attractive to recruit than sell products to retail customers.

    Please have a look at the video:

    https://www.youtube.com/watch?v=DiImdrf3G00

    Minutes 18:45 to 20:30

    My thesis is, maybe Herbalife was a legitimate MLM until distributors started discounting products and market competition for nutrition supplements increased. This competition made retail profit negligible and forced distributors to recruit more and sell less. This could have also led to the decrease of the so called “discount shoppers” as I can buy Herbalife products on EBay/Amazon for 30%-40% discount. Maybe this shift forced management to change their business model and become a pyramid .

    Also, selling nutrition supplements in 1980′s was a lot easier than it is today. Today, the nutrition market is flooded with new products which in turn has made it difficult for a Herbalife distributor to make retail sales.

    Reply

  • Adam Hawkins

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    Thank you for taking this stand! I know numerous people who have been hurt by this company and it has to end. They are strong, but we are stronger!

    Reply

  • Anton Miller

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    This article is irresponsible. Do you know the failure rate of a new small business in America? If not, do your research! Herbalife does NOT claim that each one of its distributors will surely become gazillionaires. No business can do that. At any company employees have to work hard and the most intelligent, resourceful and lucky ones make money. If Starbucks sells a commodity (coffee) for $4 a cup does that make it a fraud? If the vast majority of individual retail investors fail to make millions in the stock market does that make the entire stock market a pyramid scheme? Get real – please report responsibly rather than tacking onto a Hedge Fund’s fear mongering. Also, remember, Ackman has a lot of money to gain by this bear raid on the stock. Finally, it doesn’t take 330 slides to make a simple point – Ackman has no point that is why he needs a 3 hour presentation, 300+ slides and big fancy website to mislead investors!

    Reply

  • Tracy Coenen

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    I do know about failure rates for small businesses, and it is nowhere near as high as the failure rate in MLM. In fact, the MLM model GUARANTEES that 99% of people will fail.

    And you are wrong about employees at companies. You say the lucky ones make money. In truth, EVERY employee of a company makes money. It’s called a paycheck.

    Of course, the Herbalife fraud is not a “simple point.” It’s a complex fraud that has been covered up for 30 years. It takes time to get behind the numbers and find out the truth about the company

    Reply

  • Anton Miller

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    Trade, you are completely missing the point. MLMs are completely legal. Ever heard of Amway? The government already examined that business and deemed it 100% kosher. The issue here has nothing to do with MLMs. Sorry you are so confused! Just listen to yourself – “A complex fraud that has been covered up for 30 years.” You really think so? Well I have a bridge in Oregon I’d like to sell to you. Do you think the regulatory agencies are morons and haven’t been able to spot a fraud in 30 years?? What is a “complex fraud” anyway? If its so easy to tell its a fraud whats so complex? Unfortunately you and others like you are perpetuating the biggest fraud in American society — the ability of filthy rich hedge fund fear mongers like Ackman who can perpetuate a culture of fear to drive negative sentiment around a company. That is the real fraud here and there is nothing complex about it.

    Reply

  • Tracy Coenen

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    Anton – Have you ever heard of Bernie Madoff? You know, the massive Ponzi scheme that went on for 30 years despite regulators being tipped off multiple times. Yes, I do believe that regulators choose not enforce the laws against MLM. Yes, I do believe most are violating anti-pyramiding laws, but (thanks in part to expensive and consistent lobbying) our government chooses not to act.

    A complex fraud is one with many facets and layers. One that is calculated to evade detection. One that makes the activities look plausible.

    I suggest to you that the fraud is not by the hedge funds, but by company management and owners. They are selling investors a fairy tale, pumping the stock as long as they can and as long as they can say they’re legal with a straight face. You obviously have no problem with them hyping the company for the benefit of the longs. Why then, are you upset when the flip side happens – - exposing the negatives for the benefit of the shorts?

    Reply

  • watermelonpunch

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    Eeek, using Amway is legal, as a defense argument probably doesn’t do any service to either Amway or Herbalife. ha ha
    Over the years, I’ve never heard Amway referred to in a positive way. (Probably because I’ve never known any Amway distributors personally – ie: nobody I know has had a financial motive for speaking positively about them.)

    It reminds me of what I once read about how at one point in human civilization, it was generally accepted as okay for a married man to have sex with a woman, not his wife, who did not have the benefit of protection of a father or husband.

    But even if you use “it’s not currently illegal, strictly speaking” as an argument… I would say this blog post lays out the point about how MLMs make it their focus to find loopholes and means by which to appear legal by the letter of the law.
    And are laws in place for the purpose of their details? Or for the purpose of protecting citizens in a society?
    If a law’s purpose is protecting citizens, I hardly see arguing about legal loopholes around it as commendable.

    As for that independent research of 5% of US households having bought Herbalife… I hadn’t even heard of Herbalife until Ackman’s announcement.
    I’m sure a lot of Americans buy vitamin or herbal supplements at some point or another… But most are either on too tight a budget, or too financially savvy, to have sought out an Herbalife distributor.

    Reply

  • Anton Miller

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    Tracy your argument boils down to the assertion that its a fraud that no one in this country has been able to catch for 30 years. This is a ludicrous premise. Do you also think the moon landing was staged? Madoff was a completely different case. In consumer facing companies the likelihood of a company dealing with millions of people perpetuating a scheme that has miraculously slipped between the lines is absolutely nuts. Are you a compulsive conspiracy theorist? If you think that advocating an alternative point of view is “hyping the company” then you have major communication and comprehension issues. You can’t decide if its because the fraud is complex, if its “well managed”, etc etc. etc. Truth doesn’t require 20 hypotheses, lies do. The truth is that Ackman is screwing millions of Americans who owned shares in the company as part of their retirement portfolios. If you have bought a mutual fund from Vanguard, Fidelity, Janus, or any number of brokerage firms over the past 5 years, chances are you have exposure to Herbalife stock. The irony is that people like you are too naive to realize that you are actually losing money while helping Ackman make money based on fear mongering, lies and market manipulation.

    Reply

  • Anton Miller

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    I would add that the burden of proof is on those who are trying to prove that its a fraud. This country operates on a “innocent until proven guilty” system last time I checked. I would also like to point out that shorting a stock involve destroying tangible value from peoples’ investments, retirement portfolios and savings. When a stock goes higher people make money (except if you’re Ackman who embodies everything that is wrong with Wall Street and will squeeze Main Street for every penny).

    Reply

  • Tracy Coenen

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    Anton – You suggested that a fraud wouldn’t go on for 30 years without being discovered, so I provided you an example of a case in which that exact thing happened.

    I admit… Herbalife is different. It’s not that no one has seen the fraud. It is that our regulators choose to do nothing about it. The Direct Selling Association all but guarantees that anti-pyramiding laws will not be enforced against MLMs.

    I know that the fraud itself is not complex. It is a simple pyramid scheme. But the coverup of the fraud… … that is definitely complex.

    If there is no fraud, and it doesn’t take hours to prove it, why did Herbalife spend hours having a little investor day in which they proved nothing?

    Bottom line: Management hypes the company to try to make the stock go up. They cover up the negative, promote the positive, and hope the market responds. Short sellers highlight the negative, uncover stuff the company doesn’t want anyone to know about, and hopes the market responds. SHort sellers serve an important role in the market.

    Reply

  • Tracy Coenen

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    And the fraud has been proven. Burden met!

    How silly to say that it is the act of shorting that harms people. It is actually the acts of the company that cause the harm, if any. And don’t forget that if shorting can hurt investors, so can going long. Everyone makes money until they don’t, and then someone is left holding the bag.

    Reply

  • Anton Miller

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    Tracy,
    Anne Coughlan is a professor at the Kellogg school of management at Northwestern University, one of the very top and best business schools in the world according to such credible sources as US News and Wall Street Journal.

    Which esteemed business school faculty are you affiliated with?

    Its easy to take cheap shots at accomplished academics when you don’t exactly have a reputation to lose.

    The american public places much greater credibility in Anne Coughlan than a niche blogger, such as yourself, who seems to be a conspiracy theorist at heart and demonstrates questionable ability to think logically.

    Reply

  • Tracy Coenen

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    Herbalife got you, hook, line, and sinker. You fell for it. You assume that because Coughlan teaches at an excellent university, she must be right. Congratulations.

    The fact is that Coughlan did a superficial analysis. Actually, she did no analysis. She took Herbalife’s talking points and blessed them. She even ignored reality when she stated that sales to actual customers don’t matter, that MLM can persist indefinitely, and that Herbalife doesn’t depend on recruitment. These three statements are so silly, you should be embarrassed to hold her up as an authority on anything.

    Reply

  • Anton Miller

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    I think you should be ashamed to throw stones at an accomplished Academic at one of the nation’s top universities. A small-time blogger challenging someone of her stature- you have no credibility Tracy. Go work on your credentials before you try to take cheap shots at individuals far more accomplished than you will ever become. Ha.

    Reply

  • Tracy Coenen

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    I’m not throwing stones. I am simply pointing out how absurd some of Coughlan’s conclusions were. One of them – - the statement that Hebalife doesn’t need to recruit – - is proven wrong by Herbalife’s own disclosures in 10-Ks.

    I’m not sure what “credentials” Coughlan has besides being a professor, buy you might take a look around my site and see that my credentials are both deep and impeccable.

    Thanks for your interest in this topic!

    Reply

  • Tracy Coenen

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    I now understand Coughlan’s credentials: Marketing professor. Marketing research. End of story.

    Her background and education appear to have nothing to do with multi-level marketing. She doesn’t appear to have studied it in any depth, which is likely the cause of her erroneous conclusions.

    Reply

  • Anton Miller

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    Trace
    While I am loathe to spend any additional time saying the obvious, I feel compelled to address your point that, and I quote, “I now understand Coughlan’s credentials: Marketing professor. Marketing research. End of story.” This proves to me that not only are you irrational, illogical and emotional you also have a basic inability to do rudimentary research to substantiate your statements. You remind me of the people who persecuted Galileo when he claimed the Earth was no the center of the universe. Or the people who thought the earth was flat and sailors would ‘fall off the edge.’ Those misguided and misinformed individuals also fervently believed in their false statements, much like yourself.

    Now allow me to share with you Anne Coughlan’s credentials. These are very impressive and I doubt yours can compare.

    Source: http://www.kellogg.northwestern.edu/Faculty/Directory/Coughlan_Anne.aspx#vita
    Anne Coughlans Credentials:

    Education
    PhD, 1982, Economics, Stanford University
    BA, 1977, Economics, Stanford University, Honors and Distinction, Phi Beta Kappa

    Academic Positions
    John L. & Helen Kellogg Professor of Marketing, Kellogg School of Management, Northwestern University, 2009-present
    Professor, Kellogg School of Management, Northwestern University, 2007-2009
    Associate Professor, Kellogg School of Management, Northwestern University, 1988-2007
    Visiting Professor, INSEAD, 1997-1998
    Assistant Professor, Kellogg School of Management, Northwestern University, 1985-1988
    Assistant Professor, Graduate School of Management, University of Rochester, 1981-1985

    Grants and Awards
    Selling and Sales Management Special Interest Group’s Excellence in Research Award, AMA, 2010
    Academic Member, Incentive Compensation Advisory Board, Sales Management Association, 2010

    Reply

  • Tracy Coenen

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    Yes, exactly as I said: Marketing professor, marketing research. Unfortunately, neither of these has allowed Coughlan to make a thorough or accurate analysis of Herbalife. Thanks again for your interest!

    Reply

  • Anton Miller

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    Tracy, like I said, your credentials don’t exactly hold a candle to Professor Anne Coughlan’s. Most people would be more inclined to trust a peer-reviewed published academic who has had a long accomplished career with tenure at a top university than a publicity-hungry small time blogger such as yourself who is trying to milk a controversy to drum up business. You also sound like a conspiracy theorist to be honest.

    By the way, and I hope you won’t take this the wrong way, have you tried any Herbalife products yourself? I say this respectfully, but you yourself may have some nutritional and weight management benefits from these products that seem to be best-in-class in the nutritionals category. Give it a try! And discover a slimmer, healthier you!

    Reply

  • Mike

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    Hey Anton that shut the blooger up LOL

    Reply

  • Tracy Coenen

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    Anton/Mike – It’s a shame that Coughlan’s Herbalife work wasn’t peer reviewed. It might have saved her the embarrassment of writing an opinion that was directly opposed to Herbalife’s own filings (that it doesn’t need to recruit).

    You may not have noticed, but my job isn’t blogging. I blog for fun, and I have researched MLM for years as a hobby of sorts. I work as a fraud investigator, and yes, my credentials are impeccable and my reputation in the field is excellent. I make no money blogging about Herbalife or any other MLM. I do it simply because I’m interested in it and I want to educate consumers about it.

    Your time is up here. Your personal insults have gotten old, and we don’t allow sock puppeting here. Good luck with your Herbalife “business.”

    Reply

  • Anton is an idiot

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    Anton,

    You’re an idiot. There are pleanty of people with credentials who can’t thi for themsekves when money is presented to them. Money corrupts people which is why herbalife is so pleasing to the newer customers who hope to recruit others and make money off of them. Ann’s just another people with ‘power’ because of some stupid credentials who was taken advantage of by big business because they offered her money and so like their bitch, she’ll write whatever she wants.

    Bargaining and temptations are everywhere in the industry. Sorry you’re too blind to see that. Go read a book and get some god damn ‘credentials’ and get off the Internet you annoying ass blogger.

    Reply

  • Anton the Herbalife Shill

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    Anton reminds me of my annoying 11 year old next-door neighbor

    Reply

  • Don

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    Wow, is Anton off the charts in the zealous fanaticism department. I also believe he is a SHILL. This shows you what lengths pyramid operators will go to in order to keep people blind to the truth!

    Anton: the government did NOT investigate Amway and deem it 100% legit. The government does not endorse commercial enterprises!

    What an incredibly DECEPTIVE statement you made there. It is NOT TRUE! And you know it!

    And yet, scores of pyramid hawkers like yourself use that same verbal trickery day in and day out to deceive others into wiping out their savings for snake oil.

    If the FTC fails to act on Herbalife, then our system has failed.

    Other agencies need to come on board – this should be treated as a non-civil matter.

    Reply

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