This Is Not a Pyramid Scheme!

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pay for this job, you ask? Okay, I realize paying for a job might seem unusual. But, you see, this opportunity is unique. By paying your $399 you gain not only the right to sell our products to the general public but also the right to recruit other salespeople to sell for the company. When you sign up new salespeople and they buy some of our products, you’ll get a commission on all their purchases, month in, month out. It’s like becoming CEO of your own sales company.

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The Case of Herbalife's Missing Customers

A court in Belgium recently ruled that the US-based multi-level marketing company, Herbalife International, is an illegal pyramid scheme. Herbalife is one of the largest and oldest of all multi-level marketing companies and operates in 74 countries. It is an American icon and a world-class representative of the entire multi-level marketing industry. Yet, the court in Belgium says Herbalife is a fraud.
The Belgian court’s conclusion, arrived at after 7 years of litigation and the result of a lawsuit brought by a Belgium consumer-protection organization, is not the first time Herbalife has been called a fraudulent pyramid scheme. A
class action lawsuit in the USA made exactly this same claim, and resulted in Herbalife’s paying millions to settle, while admitting no guilt. Other lawsuits and fraud investigators have similarly charged Herbalife with pyramid fraud, calling it an “endless chain,” closed market, and a financial trap.

Global Predator?
Before examining this charge, it is important to note how significant this claim of Herbalife fraud is to millions of people. Herbalife reports that it had 1.2 million distributors in over 70 countries in 2010. About one-quarter million of them are in the USA, that’s about one out of every 400 households in America with an Herbalife distributor in it. So if Herbalife is a fraud, it is one of enormous proportions, touching millions of people each year. It would be costing consumers in 70 countries billions of dollars, wasting untold amounts of people’s time and effort and falsely raising millions of people’s hopes.
In 2005, Herbalife disclosed in its annual 10K report to the SEC that the dropout rate of its distributors was 90% for the “non-leaders” and 60% for the leaders. It reported that about 25% of all salespeople were “leaders.” So, overall, approximately 80% of Herbalife’s distributors quit the scheme every year. Translation: Herbalife signs up hundreds of thousands of
new people every year! The Belgian court says all recruited people will be deceived and virtually all will lose money. If that is the case, Herbalife would be a global predator.

Can’t Find the Customers
What’s the basis for this extraordinary and far reaching charge? The Belgian court centered its conclusion on the very same factor that the US lawsuits cited: missing customers. Where are Herbalife's customers? Said another way, “Where does Herbalife’s money come from? Out of the wallets of a churning base of failed salespeople/investors or from sales to their retail customers?
This question goes to the heart of whether Herbalife is a fraud or not. If most of the money comes directly and ultimately from the recruits (salespeople), and most of the rewards that are paid to the recruiters comes from the recruits – not their retail customers – then, Herbalife is a devastating pyramid scheme. Early recruits get paid to sign up new recruits. The
recruits are the source of Herbalife’s money. This would not be a sales business, but an “endless chain” recruitment scheme. When recruits sign up others and get rewards for doing so, those recruits will have to do the same in order to recoup their investments and gain their rewards – get money from the pockets of those they recruit. Ad infinitum!

Near Total Losses Inflicted
If Herbalife gets most of its money — ultimately — from the recruits (not retail customers)
PyamidScheme
and uses the recruits’ investment money to pay the recruiters, how many recruits will lose? Answer: virtually all of the newest recruits will always lose. This is because virtually all the recruits are always in the bottom ranks. (see graphic) Those at the bottom could not have large enough (or none at all) “downlines” to recoup their costs. (because they are at the bottom!) So, as the Belgian court sees it, year after year, Herbalife enrolls hundreds of thousands of consumers who lose their money, quit within a year, and are replaced by new hopefuls who will similarly lose. That is precisely how a pyramid scheme works. It operates only so long as it can gain new recruits and it financially ruins those it enrolls all along the way. It makes its profits from the losses of others. Extraordinary deception is employed to cover up the losses, the pay-to-recruit structure, the impossible endless chain system, and to make false income claims which are the main tools for luring new consumer investors.

Evidence of Endless Recruitment, Not Retailing
What is the evidence that Herbalife has virtually no retail customers and is merely transferring the investment money from new recruits to earlier ones, dooming more than 90% always to lose?
  • Herbalife cannot offer concrete evidence that it has retail customers. It says it does not track retail buyers. It cannot document how many there are or who they are or anything about them.
  • The high and rapid drop-out rate of the salespeople would make it very hard for many Herbalife salespeople ever to develop retail sales. Retailing takes time to find and build a repeat customer base.
  • The basic statistics that Herbalife discloses to the US government appear to show that retailing cannot be occurring on any significant scale. For example, the overall average purchases of all the salespeople is only about $190 a month. New recruits make 25% gross profit on retail sales. That would be less than $12 a week retail profit, before costs are deducted. Earlier recruits (leaders) make a higher percentage gross profit, but still the amount could hardly justify the time and costs on such a small volume of annual sales, based on their personal purchases.
  • Then, there is the matter of Herbalife’s recruitment-based compensation plan that requires or induces large upfront purchases from new “leaders," as much as $3,000. It also offers up to 33% of the payments made by recruits to the recruiters in “bonuses and royalties.” Under that plan, Herbalife could gain nearly half its entire annual revenue just from the large upfront investments of the consumers they persuade to join as “leaders.” Then, it could get the rest from the investments that the leaders pull in when they recruit “non-leaders.” The rewards for recruiting are far more lucrative than what might be gained from retailing. In short, Herbalife can operate for years only from the investments of salespeople without any retail sales at all. The business model and pay plan appear to be based on gaining investment money and making recruitment payments, not on generating retail sales.

Herbalife Sells “Income Opportunity”, not Diet Products; Consumers Lose Money, not Weight
This is just another way of saying that Herbalife appears to be selling an “income opportunity”, not weight-loss products. What is the “opportunity” that is being sold? To those who pay Herbalife offers the opportunity to gain financial rewards for getting others to pay for the opportunity to get others to pay for the opportunity to get others… Yes, it is a riddle, because it could not work for any but a few at the top. They make money every time a new person is recruited.

A Shell Game Called, “Find the Customer”
Finally, as evidence of recruitment over retailing, there is the tricky, non-sensical and misleading “disclosure” that Herbalife makes to the SEC and its shareholders about retail customers. In the disclosure, Herbalife appears to be admitting that many of its salespeople do not sell the products or they sell minimally and only to a few friends and family. Others, the disclosure seems to indicate are full blown retailers. In its 2010 annual 10K report, Herbalife states:

“We believe that the distributors who have not attained the sales leader level can be segmented into three general categories based on their product order patterns: discount buyers, small retailers and potential sales leaders. We define discount buyers as customers who have signed up as distributors to enjoy a discount on their purchases; small retailers as product users and sales people who generate modest sales to friends and family; and potential sales leaders as distributors who are proactively developing a business with the intention of qualifying to become a sales leader. In 2010, excluding China, distributor orders for these three general categories were approximately 29%, 57% and 14%, respectively.”

Read that statement closely. You will realize that, while seeming to clarify the fundamental nature of the business, Herbalife does not reveal anything at all. Percentages of “orders”, not the sales force, are provided. But percentages (29%, 57% and 14%)
of what orders? All company orders? The percentages add up to 100%. But, 100% of what? Obviously it cannot be 100% of all orders, since they only refer to the orders of the “non-leaders.” So, if it is percentages of orders among only the non-leaders, how much of the total orders does that that sector represent? Not disclosed. Well, then, how many salespeople are in each “category” who produced these percentages of orders? Not disclosed.

The data, at first reading, seem to reveal a precise amount of orders that are “self-consumed” by one group of sales people (and therefore not retailed) or sold only to a few family and friends of another group (producing very little retailing). But without disclosing the size of these “categories” or the percentage of total company orders they produce, the data, in fact, disclose nothing at all.
Even basis for these “categories” – discount buyers, small retailers and potential sales leaders
is not disclosed. Herbalife only reports that the categories are “based on their product order patterns.” What patterns? Not disclosed. Herbalife, in other words, discloses no verifiable or quantifiable evidence related to retailing. Yet, as the Belgian court ruling and the previous class action lawsuits have shown, this is the critical factor that determines whether Herbalife is a sales company or a fraudulent pyramid scheme. That factor is carefully and cleverly hidden.

The Belgian court rejected Herbalife’s claim that its salespeople qualify as retail customers. Lacking data of
true retail sales, and weighing the evidence against retail sales occurring in significant amounts, and assessing Herbalife’s recruitment-based compensation plan, the Belgian court concluded that Herbalife is, in reality, a pyramid scheme. In a pyramid scheme, nearly all the salespeople will always be at the bottom. If you are at the bottom of a pyramid scheme, you are financially doomed.Hence, the court concluded, Herbalife’s advertised “business opportunity” is a fraud.
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