Archive for June, 2012

Myths from the Direct Selling Association (DSA)

Fresh on the heels of Pyramid Scheme Questions Causing Herbalife to Lose 3 Billion Dollars, the Direct Selling Association (DSA) issued an interesting view of legit businesses as opposed to pyramid schemes (PDF). This view was in stark contrast to the FTC's document about MLMs and pyramid schemes, which curiously didn't get a mention.

I should back up for a second. For those who are not familiar with the DSA, they are an association in which 95% of the members are MLM companies. It exists to serve the interests of those members. The DSA being almost all MLM companies is also one of the biggest reasons why most people in MLM confuse MLM, Network Marketing, and Direct Selling.

It is interesting to compare and contrast the two documents: the DSA version, biased due to its membership of MLM companies... and the unbiased one from the FTC who is simply trying to protect consumers. Let's look at some of the claims that the DSA one makes. We'll compare each one to the FTC document.

"Here's how to tell a legitimate business from a pyramid scheme:
Legitimate direct selling companies contribute to a vibrant marketplace by selling competitive, high-quality
products and services and providing a sustainable source of income for those who choose to sell those products."

There's nothing in the FTC document suggesting that legit MLMs contribute to a vibrant marketplace. This illustrates the DSA's need to sugarcoat their paper and exposes it for the marketing it is. As for the selling of competitive high-quality products and services, there's nothing in the FTC about quality of products at all. The FTC document does suggest that the consumer review the product's pricing, "Is the product priced competitively?"

We finally have a point that it seems the FTC and DSA agree on... competitive pricing. Unfortunately for the DSA, many MLM companies fail this test. Last year USA Today noted that even MLM advocates say the products aren't priced competitively:

"The problem so many have is their prices aren't competitive in the real world," says Lou Abbott, who works in multilevel marketing

It gets worse. USA Today noted, "A 31-day supply of Amway's Nutrilite Double X multivitamins is $75. Supplement retailer GNC's most comparable product, Ultra Mega Green multivitamins, cost $40 for a 60-day supply."

So a fair comparison is that about $20 of GNC's product (a 30-day supply) is more or less equal to $75 of Amway's product. This is not competitively priced and thus gives a sign that even the DSA thinks that even DSA member Amway is not a legit company and shares a trait with what they consider a pyramid scheme.

The last part of the DSA statement "providing a sustainable source of income for those who choose to sell those products", isn't addressed in the FTC document. This is more marketing because any business, even pyramid schemes can provide a sustainable source of income for those who choose to sell those products.

Let's look at the other bullet-points about legit companies from the DSA:

• Provide accurate information about the company, its products and what one can expect as a seller of the company’s
products and services.

A little research shows that MonaVie doesn't supply accurate information about the antioxidants in its juice. Additionally, LifeVantage and Dr. Joe McCord Lied about the Creation of Protandim and Joe McCord Illegally Says that Protandim is about Cancer Prevention.

MonaVie is a pending member of the DSA. LifeVantage is a member and of the DSA and has a "Code of Ethics 2012" badge.

• Charge a nominal fee for a starter kit – the median cost for the start-up kit is $99 and usually includes items
such as samples, catalogs, order forms and other tools that help the seller begin selling.

The FTC document doesn't mention anything about starter kits or pricing of them. In the past, this was a problem with MLM companies, but they've since moved to pricing the products more (see above) which costs consumers more than the expensive kits in the long run.

Nonetheless, this is the DSA promoting something that is unrelated to MLMs being pyramid schemes.

• Have a product or service that is competitive in the marketplace and is purchased by the ultimate user.

The competitive in the marketplace was covered above. The $40+ price for 25 ounces of MonaVie's 100% fruit juice blend is not competitive with V8 Fusion's 100% fruit juice blend which is around $3.50 for 46 ounces.

As for the product being purchased by the ultimate user, who else would purchase the product? The FTC document makes the point about "sales to people outside the plan who intend to use the products."

This is a stunning example of how the DSA continues to claim that selling products to other distributors who consume it themselves is legit while the FTC says otherwise. The FTC has been clear MLMs Must Focus on Sales to Outside Participants, which are very different than "ultimate users."

• Require sellers to hold little or no inventory and has a buyback policy to protect against inventory loading.

Latest documents from the FTC like the one cited above don't mention the amount of inventory.

The FTC document does mention to look for the return policy saying, "policies vary on getting full refunds — and how long it could take..."

However, in the case of most MLMs, which involve overpriced, consumable products, the financial damage is done month after month and product that is consumed obviously can't be returned.

• Base compensation primarily on the sale of products and services to the ultimate user. Compensation can be
generated from either your own sales or the sales of others you have recruited.

This terminology makes it seem like it isn't a pyramid scheme if compensation is based entirely off of product bought those recruited. The FTC seems to have a very, very different view saying, "Not all multilevel marketing plans are legitimate. Some are pyramid schemes. It’s best not to get involved in plans where the money you make is based primarily on the number of distributors you recruit and your sales to them, rather than on your sales to people outside the plan who intend to use the products."

The FTC is clear that compensation should be primarily generated from your own sales to people outside the plan.

• Take time to describe the business and give potential sellers adequate time to make a decision – any opportunity
worth having will be there tomorrow."

The DSA and FTC agree on this, but this should be common sense and not a determining factor of whether a business is a pyramid scheme.

The DSA tries to be helpful in providing a few more tips where "pyramid schemes take advantage of and defraud people." Let's look at those as well:

• Promise large earnings with little effort.

Well the MLM One24, promises that one can retire in 24 months, simply by recruiting 24 people... just one a month. That's a lot of earnings from seemingly very little effort.

One of the biggest supporters of MLM recently spoke to a lot of people with the message MLM is not hard.

• Promise that one can earn a substantial income merely for recruiting people into the operation.

See the above about One24 and recruiting 24 people... just one a month.

• May or may not be a “product” to sell, but if there is it generally has little or no actual value.

The FTC document doesn't put the value of the product in their guidelines anywhere. In fact the FTC prosecuted JewelWay, which sold jewelry that had significant value.

This is an attempt by the DSA to try to make it seem like its members are legit companies because they sell products of value.

• Convince people to buy large amounts of inventory which they cannot easily sell to others and is not returnable
(this is called “inventory loading”).

The FTC document cited above does not address inventory loading. Again, this was a problem in the past, but modern pyramid schemes have abandoned the practice. It doesn't mean that they still aren't pyramid schemes.

• Charge large up-front fees to get involved, either as a direct payment or in the form of an obligatory payment for
“products”. Promoters of pyramid schemes will also try to pressure people to sign up immediately by suggesting
the same opportunity will not be available later.

Again the large up-front fees was a problem in the past, but modern pyramid schemes have avoided it by building the fees into the product pricing. However, in some cases the fees are still around. In order to be eligible in all the ways to make money with LifeVantage, one has to sign up for a package that gives a year supply of product at over $500, which constitutes both "inventory loading" and large up-front fees.

• Base compensation primarily on activity (these payments for recruitment are called “headhunting fees”).
Participants are convinced to pay to get involved with the promise of receiving “headhunting fees” when
they recruit others.

I've never heard of this. It doesn't seem to apply to any MLMs that I've come across. The participants do get compensated for the recruitment of others in the form of the product that they buy. It isn't much different than a headhunting fee. It's still a fee for recruiting since the recruited person typically has to buy product right away to be eligible for commissions.

In fact, a one-time headhunting fee is a logical way to compensate someone for a referral. Many companies have a one-time bonus to employees to recruit other employees to work for the company. This makes a lot more sense than giving compensation month after as a sales commission to a salesman who has quite possibly never met or interacted with the person making the sale as is often the case in MLM.

Bottom Line: The DSA suggests that the confusion about pyramid schemes is understandable due to their portrayal on television. The reality is that consumers don't get confused by jokes on television - they get confused by organizations like the DSA spreading misinformation like the very press release they sent out. When you read the official FTC literature on the subject, it becomes clear that the DSA is not interested in spreading the correct information about pyramid schemes, but instead creating misinformation in an attempt to make its members seem legitimate.

This post involves:

Direct Selling Association, MLMs vs. Pyramid Schemes

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Understanding the Churn Rate in MLM

One of things that fascinates me about MLM is how they churn through people. The churn rate is a measure of how fast distributors leave the MLM. As Wikipedia suggests a high churn rate could be for a number of factors.

"It is a possible indicator of customer dissatisfaction, cheaper and/or better offers from the competition, more successful sales and/or marketing by the competition, or reasons having to do with the customer life cycle."

When we examine churn rate in distributors in MLM it seems most likely that it comes customer dissatisfaction. Since these are supposedly salesmen who deeply believe in the MLM product they are pitching we can discount the competition since MLM products are typically unique.

Looking at the churn rate in MLM

If the MLM business is working well, distributors at all levels are making money and happy with their MLM endeavor. Happy distributors, who are making money, have no reason to leave the business. So what kind of churn are we looking at in MLM? The answer is outrageously high numbers.

Let's look at some of the numbers put together by The Fraud Files on the MLM HerbaLife:

In the 2004 10-K, Herbalife disclosed: "For the latest twelve month re-qualification period ending January 2005, approximately 60 percent of our supervisors did not re-qualify and more than 90% of our distributors that are not supervisors turned over."

The disclosure on distributor turnover may well be the most important disclosure the company could make. While Herbalife touts that at the end of 2011 it had 2.7 million distributors, with 548,000 of them “sales leaders,” it doesn’t tell everyone that more than 90% of the 2.152 million must be replaced in 2012 (if turnover is in line with historical reports of such).

Non-disclosure of distributor failure rates is not a new problem in the MLM industry. Robert FitzPatrick notes from his research: "MLM companies seek to obscure their devastating failure rates by disclosing the number only of 'active' participants and limiting the income figures to a one-year or even shorter time frames, thus concealing the factor of the ongoing and mounting losses of new participants. If all the participants over a five-year period are included in the calculations, the failure rate rises even further. Less than one in one-thousand will be shown to have gained any profit at all. The so-called successes in MLM are in the same small group positioned, year after year, at the top of the recruitment organization."

HerbaLife stopped disclosing the turnover rate after 2005. After people like the above started to use that information to explore the massive failure of the business opportunity, HerbaLife would be silly to continuing publishing the data. After all, if it became common knowledge how bad these opportunities are, no one would get involved and the entire system would crumble.

Herbalife (Part 2)

From this Seeking Alpha article:

As we look at this quarter's results, some interesting data points pop out. First, the company started the year with 4.0 million Members. As of the end of Q3 the company has 4.0 million Members. According to the company's own regional key metrics disclosures, 1.6 million new Members joined Herbalife YTD. Solving for X, that means 1.6 million people churned out of the pyramid since December 31. That is certainly some impressive velocity. Annualized, over 2 million people will quit Herbalife in 2015 alone. I like to call that data point "Churn". I think the FTC also pays attention to this data point.

The website Pink Truth uncovered Mary Kay's turnover numbers from their own disclosure in 2005-2006. The conclusion was Mary Kay destroys a half million women a year:

"Depending upon how you look at it… 41% of the 1,180,000 involved during the year quit. Or of those 700,000 on the books at the end of the year, 69% of them will quit in the following year. 480,000 women churned and burned in 2006."

You've got the 60% of HerbaLife supervisors quit in a year and 90% of their distributors. You've got 69% of Mary Kay distributors will quit in a given year. If the business opportunity was so good, why are so many people pushing to get out of it.

The note by Robert Patrick above is particularly insightful. If we were to take a five year view of things, we'd see that the same people at the top of these MLMs making the money stay in year after year, while, logically, all the people at the bottom who aren't making money get churned through. In ten years, it's a 5 million women from Mary Kay and 20 million people from HerbaLife with more or less the same less than 1% collecting almost all the money.

Update: The New York Times chimes in:

"But like many multilevel marketing companies, Pre-Paid Legal suffers from high turnover. In 2005, the company replaced at least 50 percent of its active sales force, according to filings with the Securities and Exchange Commission. Industrywide, multilevel marketing companies typically replace almost all of their sales representatives every year."

This post involves:

MLM Business Opportunity

... and focuses on: