If It Sounds too Good to be True......

The subject of Multi Level Marketing (MLM) comes up every now or then. Are these companies pyramid schemes that barely meet the test of legality or are they a legitimate method of direct marketing products through personally developed networks? Lately two hedge funds are locked in a noisy struggle over Herbalife (hlf), a MLM distributor of weight loss products. Bill Ackman is shorting the stock. He claims Herbalife is “an inherently fraudulent company.” Of course if the stock drops he makes money. In the other corner Dan Loeb has bought an 8% stake in the company driving the price higher. In less than a year the price of Herbalife shares rose to $73.00 then dropped to $24.24. Since then they have risen to $39.00.

An outside expert with no dog in the fight, Vitaliy Katsenelson, chief investment officer at Investment Management Associates, concludes that Herbalife is just a lousy company that sells an overpriced product using a bad business model. In an interview broadcast on Yahoo.com, Katsenelson reports, “He has been to Herbalife's clubs and came away unimpressed. For one thing, most of the people were there, in his words, "just to sell the product to each other." For another, the product itself seemed overpriced for what you're getting. "Most people get into Herbalife not because they want to consume the product but because they want to sell it to their favorite mother-in-law."

I first ran into MLMs back in the late 70s. A few of my friends became involved in Amway and some of their early competitors. Some of these people were just looking for a way to make an extra few bucks on the side. Some of them had dreams of a vast downstream sales force generating so much money they would never need to work a day for the rest of their lives. All of them dropped out of these businesses because they either didn’t make any money or could earn more extra money with a couple of hours of overtime than peddling soap door to door.

After watching this fad come and go, I concluded that MLM schemes had a fatal flaw. I termed it the Amway fallacy. At the end of the day if anybody in the pyramid is going to make any money, somebody has to sell soap, door to door, and that is hard work. I have since learned the mathematics of the MLM pitch are impossible. Robert Patrick, a consumer advocate, observes that if one distributor signs up 5 new distributors, then each of those people sign up five more, within 13 iterations there are more salespeople in the pyramid than live on the planet Earth.

None of this would much matter but innocent people are losing large amounts of money chasing impossible dreams. All the commotion in the stock market has triggered some investigative journalism. It appears that Herbalife may be awfully close to the charges leveled by Bill Ackman. The real test that separates a pyramid scheme from a legitimate marketing organization is the importance of product. If the commissions are structured so that most of the distributor’s income is generated by the sale of a product, it is a legitimate company. For years Avon was the gold standard of this kind of marketing. Now it appears they may be drifting away from their foundational ethics. A quick check indicated that Mary Kay Cosmetics and Tupperware are still generally considered ethical organizations. Undercover cameras at Herbalife recruiting seminars record a sales pitch as well as a commission structure that emphasizes building a sales pyramid over selling a product. If the product is an “incidental” part of the business model then legally that company is considered a fraudulent pyramid scheme. Needless to say, proving this definition of fraud in a court of law is currently a very difficult challenge.

Understand that 99% of the people who get involved in any of these schemes lose money. That figure comes from a number of consumer advocates who are calling for more Government oversight. Your odds at generating a net profit in a MLM business are not much better than playing the slot machines in Las Vegas. There are people who make money in these businesses, but they are very rare.

Often these companies are not only selling their legitimate product to their distributors, but they are also selling, sales leads, brochures, training courses, motivational lectures, and conventions to their distributors. These meetings seem to have taken a page from tent evangelism. The participants sing songs and chant slogans worshipping the golden dreams promoted by their company. Successful salespeople give their testimonials of BMWs in the driveways of their mansions. Then the featured sales evangelist works the audience into a state of feverish excitement.

If you get involved in one of these schemes, do not do it with borrowed money. Many of the sad stories found in Herbalife Under Fire: Clubs, Hopes and Losses by Herb Greenberg were complicated by credit card debt. Distributors desperate to reach some kind of reward became what is termed, “garage qualified.” They borrowed money and bought a garage full of product in order to meet their sales quota.

If it sounds too good to be true, it probably is too good to be true.

The following link is for the trailer of Change Your Life a comedy satirizing the weird world of MLM organizations.

Change Your Life (official trailer)