When JH Whitney and Golden Gate Capital hired Michael Johnson from Disney International, they got something Mark Hughes could never deliver: an international marketing talent. More importantly, they got corporate credibility at a high level and Global Brand Imaging. They got a little lucky too when they inherited an enormously profitable and growing Nutrition Club model in Mexico called Club 100 and Universidad del Exito. The skill was recognizing its potential, concealing its true identity/colors and exporting it around the globe as simultaneously a healthy lifestyle, a cure for global obesity, and a nutritious meal for the poor.
Michael Johnson has used his Disney resume and corporate checkbook to attract former top government officials and pro athletes as promoters and sponsors, each one making it successively easier to attract the next. He has splashed the lime green herb logo all over the world, particularly in heavily Latino populations (although it’s a strange branding campaign, since most people don’t know exactly what Herbalife sells.) Pay close attention and you’ll notice that executive leadership of Herbalife is focused, motivated and incentivized to drill into the minds of any who will listen these messages: “public confidence, sustainable businesses, long-term customers, diet and community, Weight Loss Challenge, daily consumption, rising levels of obesity, aging population, underemployed, Build it Better, Gold Standard, consumer protection, training and education, science-based nutrition, innovative products, manufacturing & technology, pilot initiatives, core values, emotional connections, authentic users, winning performance.” In case they miss any, they have the Herbalife Family Foundation and its 100 Casa Herbalife programs that feed 120,000 vulnerable children every day. How can you possibly find fault with that company?
Thankfully, the media, investment speculators, intellectually lazy or arbitrary decision makers will not determine whether Herbalife is an illegal racket. The only three words in the above paragraphs that matter with respect to the fate of Herbalife are: focus, motivate and incentive.
And the Fall…
As we heard from the Ninth Circuit Court of Appeals in FTC vs. BurnLounge, “the sine quoa non of a pyramid scheme” is characterized by “recruitment with rewards unrelated to product sales.” In Omnitrition, that court found that a MLM business was a pyramid scheme because the focus was in promoting the program rather than selling the products. The court reminded us again by stating in that ruling, “This incentive was the danger our court warned of in Omnitrition, where we stated, “The promise of lucrative rewards for recruiting others tends to induce participants to focus on the recruitment side of the business at the expense of their retail marketing efforts, making it unlikely that meaningful opportunities for retail sales will occur.” (Emphasis added)
Nutrition Clubs are a program, with a focus, motive and incentive. And they make a promise of a lucrative reward to participants. By management’s own admission, Clubs that did not follow the program were total failures.
The court went on to say the FTC presented ample evidence to support the district courts finding that BurnLounge was a pyramid scheme because (1) Moguls were required to recruit to earn all three types of rewards, and (2) Moguls were motivated by the opportunity, as evidenced by the sharp contrast in their purchase patterns versus non-Moguls, and by the fact that BurnLounge’s sales plummeted after the Mogul program was enjoined. (Emphasis added)
In (1) above, I interpret “required to recruit” as meaning incentivized by the structure of the pay plan in order to earn all three types of rewards. When sales plummet after the Mogul program is enjoined, the court is saying, the proof is in the pudding. When recruiting stopped, there was no evidence of true retail sales. Interestingly, the lower court enjoined the Mogul Program only. That is my thesis, that any intervention does not require a complete shutdown, but just the programs that violate the law.
The court also made some very logical statements, in my view, about internal consumption. In referencing Amway, they said, “some internal consumption of inventory was common…” In referencing Koscot, they said, “they could have used some of it personally…” With respect to BurnLounge itself, the court said, “participants bought packages in part for internal consumption…” “But it is incorrect to conclude all rewards paid on these sales were related to the sale of products to ultimate users.” (Emphasis added.) So the court acknowledged some internal consumption is common sense. I don’t know why everyone claimed victory or defeat on that issue.
But the court reminds us that internal or external consumption is not a determining factor in a pyramid scheme case. It is a symptom, rather than a root cause. They bring it right back to motivation. What is important is how it is structured and operates in practice.
The court continued, “Whether the rewards are related to the sale of products depends on how BurnLounge’s bonus structure operated in practice. (See Omnitrition, 79 F.3d at 781.) In practice, the rewards BurnLounge paid for package sales were not tied to the consumer demand for the merchandise in the packages; they were paid to Moguls for recruiting new participants. The fact that the rewards were paid for recruiting is shown by necessity of recruiting to earn cash rewards and the evidence that the scheme was set up to motivate Moguls through the opportunity to earn cash.
Nutrition Club sales are not tied to consumer demand. Without the program requirement to bring an endless stream of new recruits there would be little natural demand. That is not to say there wouldn’t be some consumer demand. But as management admits, not enough to sustain a Club and so the product fails in the marketplace without an effective and sustainable retail delivery method. (If the market is not large enough, there is now law that says consumers are entitled to a market for their product. I used to watch a TV show, then it disappeared in the middle of the season. I went online and discovered I was one of a small group who loved it. I had to get over it. I watch something else now.)
Back again to the issue of motivation, Burnlounge appealed on the basis that the FTC didn’t present enough evidence to make its case, argued that the motives of those buying Burnlounge packages were not clear and that in situations where a buyer’s motives are mixed (the buyer is interested in the business opportunity and the music), the buyer should be considered an “ultimate user”.
During aural argument in the BurnLounge appeal, at about the 12-minute mark, the court asked a very telling question:
“Why wouldn’t the logical test be whether the sale would have occurred but for the business opportunity? Well, I’m not going to throw out the package. I’ll listen to the tapes and I’ll read the magazine, but would I have bought this otherwise?”
That’s an interesting question from the 9th Circuit Court of Appeals, hometown to Herbalife.
For the record, the court used the word “focus” eleven times, “motivate” five times, “incentive” three times and “encourage” one time. They used the word “intent”, zero times.
The FTC is right now scrutinizing Herbalife’s Nutrition Club and asking “whether sales would have occurred but for the business opportunity?” Would the “customers have bought the shakes otherwise? “
The training for the business opportunity is a Supervisor installment plan for those who can’t afford the buy-in. We need to just be honest and intelligent enough to admit that. The Feds and the Court will see through that like a mafia racket. If these “recruits in training” and their family and friends were not coming to support them, the only people coming to Clubs would be real estate brokers and prospective tenants.
Club 100 and Universidad del Exito is a Program and the products are incidental. The Focus, Motivation and Incentive of Nutrition Club Supervisors is to recruit participants and focus, motivate and incentivize them according to the program to recruit more participants with the promise of moving through the program and the promise of graduation (a reward) and future lucrative monetary rewards. There is no way Club 100 and Universidad del Exito pass even the smell test. By management’s own admission, Clubs that did not follow the Program failed quickly.
The same way a Supervisor who tries to make it on retail sales churns out quickly, Nutrition Clubs that try to make it on retail sales fail quickly. Recruiting is the only model that succeeds. For nearly ten years, Herbalife was able to hide the dominance of its recruit driven sales at Nutrition Clubs behind an illusion of “daily consumption.”
The FTC Commissioners voted to open a formal investigation. Almost certainly, it will include an expert analysis and recommendation by Dr. Peter Vander Nat. I believe it is a virtual certainty that Dr. Vander Nat will conclude that Herbalife’s Nutrition Clubs and Sales Leader/Supervisor Programs are pyramid schemes. The FTC will then have a decision to make. Do they break with all historical FTC and regulatory precedent or do they follow all that precedent and go straight to court seeking a temporary injunction? A temporary injunction would require Herbalife to stop recruiting participants in Nutrition Clubs and Sales Leader/Supervisors and paying any rewards related thereto. If/when that happens, sales will plummet and Herbalife will be toast.
We are going to find out if several people in our government have the backbone to stand up to a well connected and well financed global corporate predator.
First up is Dr. Vander Nat. Then five Commissioners at the FTC. Then the District Court.