Questions posed to Herbalife earlier this year by David Einhorn sent the stock price down quickly. Einhorn simply wanted to know about customers… actual consumers of the Herbalife products.

One has to assume Einhorn has done lots of research on multi-level marketing. And he knows the real deal. Herbalife’s customers are the distributors. Corporate doesn’t care much if the products get to a real customer after that. They’ve already made their sale and collected their money.

Multi-level marketing has very little to do with selling the product, and relies almost exclusively on continual recruitment of new distributors. But the product is important to make the MLMs not look like pure pyramid schemes.

Herbalife downplayed Einhorn’s questions in general, and  in an SEC filing, Herbalife says the amount of product sold to third party consumers is not important:

Question #1 from David Einhorn: “First, how much of the sales that you’d make in terms of final sales are sold outside the network and how much are consumed within the distributor base?”

Answer: We don’t track this number and do not believe it is relevant to the business or investors.

Herbalife believes the majority of its distributors are discount buyers, who become distributors in order to purchase their favorite Herbalife products at a minimum discount of 25 percent (either directly from the company or from their upline distributor/supervisor). In addition, some of these distributors will also share with, or retail the products to other friends, family, and customers.

The percentage of product of any multi-level marketing company consumed by its distributors is substantial. This is not surprising since consumers who are enthusiastic about the products become distributors in order to purchase at a discount and possibly to share and sell the products to others. In addition, in order to minimize the risk of product being accumulated by distributors, the company has policies in place such as the 70% Rule, the Ten Customer Rule and the Buy Back policy.

Yet during this week’s conference call, Herbalife made it clear that the figure is important:

Today, for example, we know that 20% of our U.S. volume is shipped directly from Herbalife to the end consumer who is not a distributor. And 30% to 35% of our volume in the U.S. is sold directly to consumers through nutrition clubs, so over half of our U.S. volume is going to the end consumer through these two business methods. And this doesn’t include volume from our traditional person-to-person selling method.

We recently engaged Lieberman Worldwide Research, one of the top market research companies in the world, to conduct a survey to help develop a better understanding of Herbalife consumers in the U.S. This survey reported that there are approximately 5.6 million U.S. households that bought Herbalife products in the last 90 days. Of this number, less than 10% of the households said they were an Herbalife distributor. This further validates the degree to which daily consumption business methods have expanded the consumption of Herbalife products among a broader segment of the U.S. population. We have contracted with Lieberman to repeat this survey on a quarterly basis and look forward to having more information to share with you in subsequent quarters.

Now the issue is so important that Herblife has retained a company to help it figure out how many consumers of the product exist?

So is the volume of product purchased by actual consumers important or not important? I guess it depends on which day Herbalife is answering that question.

The truth is that the question is important, and Herbalife and Einhorn both knew that all along. Multi-level marketing companies are deliberately oblivious to the sales of products to third party customers, largely because they know that distributors stockpile the products. Why? MLMs require minimum purchases by distributors in order to qualify for commissions. This means that distributors must purchase products regularly or lose their commissions. MLM products are difficult to retail for a number of reasons, so distributors end up purchasing the products themselves, and then aren’t able to resell them to willing customers, resulting in the stockpile.

This lack of actual retailing of porducts is one of the dirty little secrets of multi-level marketing. See how Mary Kay Cosmetics lies its way around this issue in an article at Pink Truth.

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