978-1337614436 Cases Herbalife Case Note

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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

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 distributor’s 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.

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

.