978-1337614436 Cases Herbalife Case Note

subject Type Homework Help
subject Pages 3
subject Words 1483
subject Authors Ferrell, John Fraedrich, O. C. Ferrell

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CASE 189
Multilevel Marketing Under Fire: Herbalife
Reborn Defends Its Business Model
CASE NOTES FOR INSTRUCTORS
This case introduces students to the business model of multilevel marketing. It also familiarizes them with
pyramid schemes and describes why the two are often mistaken for one another, despite the fact that
multilevel marketing is a legitimate business model whereas pyramid schemes constitute fraud. The case
focuses upon Herbalife and the attacks against it by activist investor William Ackman.
Herbalife sells weight-management, targeted nutrition, energy and fitness, and personal care products, all
intended to support a healthy lifestyle. It uses direct selling, or the marketing of products to ultimate
consumers through person-to-person sales presentations at home or online, to sell its products.
Independent distributors can become entrepreneurs by selling Herbalife products and earning
commissions with each sale. With a multilevel marketing compensation system, independent distributors
can also earn money from the sales of those they recruit. It is important for students to realize that
recruitment alone does not earn the independent distributor commissions. Rather, all commissions are tied
to selling a product, whether the product is sold by the independent distributor or by a person that the
independent distributor has recruited.
Pyramid schemes, on the other hand, are fraudulent schemes in which profits are not based on a legitimate
investment or sale of goods. People are compensated simply for recruiting others. New recruits pay a fee
to join the scheme, which they are often fooled into thinking is legitimate. The scheme depends solely on
recruiting new people to survive, and once the pool of new recruits dries up, the scheme collapses. Those
who joined the scheme at a later period lose their investments.
This case clearly demonstrates the difference between the two, yet also describes how the similarities
have led to criticism of multilevel marketing. China, for instance, does not allow multilevel marketing.
The case against Herbalife came to a head with William Ackman’s accusations that Herbalife was
operating a pyramid scheme and that most people who invested with the company did not succeed as
independent distributors. It is particularly important for students to note that Ackman made a short sale
against Herbalife of $1 billion, clearly representing a conflict of interest because he would profit from
Herbalife stock if it decreased. Ackman’s accusations did not have a long-term impact on Herbalife stock,
and he lost money on the short sale.
Internal consumption is also called into question. Ackman and other critics point to the fact that
independent distributors make up many of Herbalife’s customers. They argue that this signifies a pyramid
scheme because it is “forcing” those who want to do business with the company to purchase their
products. In reality, purchasing products upfront is not necessary, and because independent distributors
receive discounts for the products they purchase, many purchase not so much as a business opportunity
but so they can get discounted products. Others like to engage in direct selling as a part-time business
opportunity. Studies also show that a significant number of Herbalife products are in fact sold to end
consumers.
The topic of internal consumption came up in a lawsuit against the organization BurnLounge.
BurnLounge, which marketed itself as a way to sell digital music, washad been sued for being a pyramid
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scheme. BurnLounge appealed. Because BurnLounge had significant internal consumption, many direct
sellers were nervous that the court might view internal consumption negatively and put limits on internal
consumption. This would significantly impact the direct selling model. However, the ruling focused more
upon whether a legitimate product was being sold and whether distributors were getting paid more for
recruiting than for selling.
Interestingly, a two-year FTC investigation into Herbalife’s practices led the FTC to conclude that
Herbalife focused too much on recruitment and potentially misrepresented how much money independent
distributors generally earn. Herbalife paid $200 million to settle the accusations and agreed to revise its
business practices. One major change will be that the firm will differentiate between distributors who join
the organization because they want to sell Herbalife products and those who join simply to receive
discounts. Herbalife says those who only join to receive discounts will no longer be eligible to sell
Herbalife products. Both Ackman and Herbalife view the ruling as a victory. Ackman claims the ruling
supports his claim that Herbalife acts deceptively and is therefore an elaborate pyramid scheme. Herbalife
claims that the FTC’s ruling determined that it was not a pyramid scheme and its operations are
legitimate.
Additionally, the Anti-Pyramid Scheme Act was introduced in Congress in 2017. The act is supported by
the Direct Selling Association with Herbalife as a member. The bill requires compensation for only the
sale of products to end users. Inventory not sold can be returned within 12 months. Product sales is a core
requirement of the act.
This case considers many legal issues and shows what can happen when consumers and regulators do not
adequately understand a business model or activity. It is a good teaching resource that informs students
that they must carefully examine a complex case or situation before rendering judgment.
QUESTIONS AND DISCUSSION
1. Why has Herbalife’s multilevel compensation model been confused with a pyramid scheme?
Herbalife’s multilevel compensation model has been confused with a pyramid scheme because it
offers commissions on the sales of an independent distributors recruits. Pyramid schemes are based
However, many people mistake multilevel marketing as a pyramid scheme due to lack of
understanding. It is also notable that many independent distributors do not succeed in direct selling,
There are major issues with each of these accusations. First, a person is not required to purchase
products they do not want to purchase in order to join Herbalife. Independent contractors that
purchase from Herbalife do so either for the discounts offered or for resale. Additionally, in terms of
the success of independent distributors, it takes a certain amount of hard work and skill to succeed.
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2. Describe the differences between a legitimate business model and a pyramid scheme.
The major difference of multilevel marketing is that a product of value is being sold. Independent
distributors do not have to recruit others to earn commissions. They can earn commissions from their
3. How has Herbalife demonstrated social responsibility?
Herbalife has undertaken a number of social responsibility initiatives. It has a strong Business Code
of Conduct and Ethics that mandates obedience to laws and provides boundaries for gifts and
entertainment. It established the Herbalife Foundation and the Casa Herbalife Program to provide
funding and volunteerism to charitable organizations taking care of children-at-risk around the world.
The foundation also works to improve nutrition and help with disaster relief efforts. Herbalife
ADDITIONAL RESOURCES
FTC decision on Herbalife:
https://www.ftc.gov/news-events/press-releases/2016/07/herbalife-will-restructure-its-multi-level-
marketing-operations
Multilevel marketing vs. pyramid schemes:
https://www.bbb.org/phoenix/news-events/consumer-tips/2015/03/opportunity-or-scam-multi-lev
el-marketing-vs.-pyra s mid-schemes/
FTC decision on BurnLounge:
https://www.ftc.gov/news-events/press-releases/2014/06/us-appeals-court-affirms-ruling-favor-ftc
-upholds-lower-court
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