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Opinion

Smoke, Mirrors and the Herbalife Settlement

In 2013, the National Consumers League led the charge for a fair marketplace by becoming the first consumer organization to ask the Federal Trade Commission to investigate allegations of pyramid scheme fraud in the business practices of the nutrition company Herbalife. This summer, the FTC concluded their two-year investigation and reached a settlement that we think will change the playing field for how multi-level marketing companies should operate going forward.

The FTC’s settlement with Herbalife validated many of the concerns that NCL and others had expressed. The Commission found that the company drew people into its “income opportunity” with false claims about how much money they could make, when in fact the main income generator was the recruitment of other distributors, not legitimate retail sales. This is the classic definition of a pyramid scheme. As a result, the FTC’s settlement with Herbalife requires that the company completely restructure its business model.

We were surprised to read Herbalife’s public account of the settlement, however, which suggests it received nothing more than a slap on the wrist. In a press release, Herbalife’s CEO Michael Johnson trumpeted that the settlement represents “an acknowledgment that our business model is sound.” That’s not what the FTC said. “This settlement will require Herbalife to fundamentally restructure its business,” announced FTC Chairwoman Edith Ramirez. “Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make,” she said. Indeed, it sounded like Johnson and Ramirez were discussing two completely different settlements.

The FTC relies on precedent to guide future investigations. We therefore believe that the Herbalife settlement will serve a cautionary tale for all direct-selling companies, particularly those that rely on a multi-level compensation structure. First, the settlement requires Herbalife to completely overhaul its compensation program so that the company rewards actual, verifiable product sales to customers outside of the distribution network. While this seems like a common sense business practice, it represents a sea change in how modern direct-selling companies pay their distributors. Instead of being rewarded for enlisting recruits, who in turn hope to get still more recruits who buy inventory and in turn, do their own recruiting, Herbalife’s distributors will have to prove that there is a verifiable market for their weight-loss shakes and other offerings.

For Herbalife, this is a game changer. Half of the company’s distributors stop selling the products within a year and earn less than $5 per month in product sales revenue while incurring significant costs. Not much of a business opportunity! What the FTC has signaled is that if direct-selling companies like Herbalife want to stay on the right side of the law and maintain their distribution network, they will have to shift their focus from replacing an ever-churning base of recruits and ensure that their compensation plans provides enough income to allow distributors to cover their own costs.

Second, the Herbalife settlement calls for several important consumer protections. There is now a prohibition on making false claims that you can “quit your job” and become rich by selling their products. Likewise, the settlement requires that 80 percent of the company’s sales go to real buyers outside the company — that is, buyers who don’t have a business relationship with the company. This will prevent the current practice, where distributors buy inventory primarily to qualify for bonus rewards, rather than to sell product to end users.

We think the FTC’s requirements for this industry are powerful and important. Contrary to what Herbalife would like the public to believe, this settlement is not a “get out of jail free card” for them or, indeed, the direct selling industry. Instead, this settlement represents an unprecedented change that will fundamentally alter the way all direct selling companies — not just Herbalife — conduct business in the United States. The FTC took decisive action to protect consumers in this case. We hope the agency will prove as strong in enforcing the settlement as they have been in reaching a very important and tough outcome in the Herbalife investigation.

 

Sally Greenberg is the executive director of the National Consumers League. Founded in 1899, the nonprofit NCL is the nation’s pioneering consumer and worker advocacy organization.

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