In light of the recent shutdown of multi-level marketing company Vemma (following allegations that it is a pyramid scheme),there has been much discussion of Herbalife. Is it a more legitimate MLM, or is it a pyramid scheme like Vemma and others that have been shut down before it (BurnLounge, Fortune Hi Tech Marketing, etc.)???

“Analyst” Tim Ramey, longtime Herbalife cheerleader, contends that Herbalife is not like Vemma:

Our opinion has always been that Vemma was likely an illegal structure – it has that endless chain feature where “Affiliates” are incentivized to buy a high-priced starter kit with minimal real value, only to turn around and very quickly find two, three or four others to do the same so that they can reap a quick profit and recoup their initial “investment,” said Ramey.

This is a familiar argument. MLMs left standing after one is shut down claim that THEIR company doesn’t pay for recruiting. And technically it appears that they don’t. Except they do. They may not have a “high priced starter kit” or may not pay a “commission” on the starter kit. Instead, they encourage distributors to buy a bunch of products up front and commission is paid on those. Since those products could theoretically be sold, I suppose that’s not paying for recruiting so much it is paying for getting the recruit to buy some overpriced, hard-to-sell products. MLM attorneys will tell you that you have to make it look like you’re not paying for recruiting or the kit.

Matt Stewart wrote an excellent article at Seeking Alpha about Herbalife, debunking many of the current claims that Herbalife is not like Vemma. Some of his better comments include:

To begin, I find the argument that Herbalife is not an endless recruiting chain absurd on its face. If Herbalife wasn’t an endless recruiting chain, how come its distributors are always recruiting? As far as I can tell, Herbalife is recruiting roughly 2 million new Members per annum at the moment. This quantity of people tethered to the bottom layer of the recruiting chain roughly equates to the run rate of people churning out of the salesforce at the same time.

How can it be argued that Herbalife’s marketing plan doesn’t deliberately encourage recruiting when the people who are Members are preoccupied with recruiting? Call me crazy but unless Mr. Ramey is the Mad Hatter himself, this sort of nonsense doesn’t exactly Pass Go!

Secondly, Mr. Ramey reveals yet again that he hasn’t read the Burnlounge case. Ramey points to the fact that Vemma affiliates pay a fee to acquire a starter kit. The fee is used to finance recruiting rewards. Affiliates are preoccupied with getting others in their downlines to pay the fee and subscribe to the auto-ship program. Presto, this is obviously a pyramid scheme.

Herbalife, we are told, charges no fee and is therefore out of the woods. This idea, again, is nonsense. Participants who purchase inventory to qualify for advancement in the marketing plan are inventory loading. This is a pay to play dynamic for certain.

Herbalife distributors are encouraged to get to Supervisor in order to qualify for discounts and recruiting rewards. Once there, distributors must requalify each and every year. Supervisor is “the gateway to the marketing plan” participants are told. All kinds of hard and soft incentives are given to new recruits to get them to buy their way up the plan’s ladder and to stay there. “In practice” ever since Pershing Square attacked Herbalife’s model, Herbalife has actually made it even easier to qualify for Supervisor. This gets more victims to chase this level of unicorn in the pay plan. Concurrently, nothing Herbalife has done has mitigated the failure rates of new participants who pursue the business opportunity.

[snip]

Herbalife’s strategy to counter Mr. Ackman all along has been to ask investors to get down in the weeds and to argue at a tactical level the merits and virtues of things like Gold Standard Guarantees or the bona fides of spokespeople. All the while, over 2 million people are churning out of the pyramid every single year since Pershing Square went public with its allegations. That’s close to 6 million total since Ira Sohn!Might this not be the trump card that drives a stake through the heart of Mr. Ramey’s arguments?

As always, time will tell.

[snip] Herbalife has had over 3 years to produce data for investors revealing:

• evidence of retail sales to non-Members
• evidence of healthy and material gross profit margins for salespeople
• evidence of successful franchisees earning positive returns on invested capital as retailers of Formula 1
• evidence of stability within the salesforce

Incredibly, none of this data has been forthcoming though as I understand it, Cristiano Ronaldo is one heckuva soccer player.

$500 million in FCF/ 2 million failing Members = $250 per failing Member. How’s that for an interesting stat?

Buyer beware!