SUPPLEMENTAL CASE 4
Multilevel Marketing Under Fire: Herbalife Defends Its Business Model
Introduction
Herbalife International is the third largest direct-selling multi-level marketing company. Its
product line consists of weight-management and nutrition products. These products are
not sold in retail stores. Rather, consumers interact with independent contractors to order
the products. Herbalife’s headquarters are located in Los Angeles, California, and they
operate in several countries throughout the world. The company is publicly-traded and is
both loved and hated by investors and consumers.
History
Herbalife is a company that focuses on nutrition, weight-management, and personal care
products with independent contractors in more than 80 countries. Mark Hughes founded
the company in 1980 with diet supplement maker Richard Marconi. It was created out of a
desire to create a safe alternative to other weight loss products after Hughes’ mother
overdosed on prescription diet pills. Herbalife’s first sales were made from out of the trunk
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 221
of Hughes’ car in Los Angeles, California. Two years later the company reached $2 million
in sales. By 1986, Herbalife made a name for itself on the New York Stock Exchange (NYSE).
and has since become a multi-billion dollar global company
An Internet retailer, Rbid.com, made a bid of $173 million to acquire Herbalife, but the
Mark Hughes Family Trust rejected the offer. In 2002, a group of investment firms
purchased the company and took it back to the private sector. After a ring of lawsuits
relating to ephedra-based weight loss products, the company revived itself when it was
Products
Herbalife sells weight-management, targeted nutrition, energy and fitness, and personal
care products, all of which are intended to support a healthy lifestyle. Additionally, they
offer a set of core products: Formula 1 Nutritional Shake Mix is a protein and fiber shake
with several minerals, vitamins, and nutrients that is offered in seven different flavors;
222 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
Personal care products include skin cleansers, moisturizers, lotions, shampoos, and
conditioners from a variety of different lines. Herbal Aloe Strengthening Shampoo and
Conditioner, hand and body wash and cream, soothing gel, and bath and body bar
Multi-Level Marketing
Direct selling is the marketing of products to ultimate consumers through face-to-face sales
presentations at home or in the workplace. People are attracted to direct selling for many
reasons: they like the product and want to help promote the company as well as receive a
discount on their personal orders,; it is a flexible, part-time opportunity for extra income;
and some like the social aspect of direct selling. Within the direct selling model are two
compensation models: single level marketing or multi-level marketing. Single level
marketing is when contractors make a commission off their own sales alone. Multi-level
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 223
care, cosmetics, and household items where there is a need to demonstrate the product.
The vast majority of direct sellers uses the products and learns how to properly
demonstrate them to others. Therefore, the claim that internal consumption is unethical is
refutable on the basis that the vast majority of companies that sell consumer products
encourage their employees or independent contractors to purchase their products. Many
individuals committed to these products believe in the brands for their own personal use.
Table 1: Top 10 Direct Selling Companies
Company Name and Product Line
2012 Revenue (USD Billions)
1
Alticore (Amway)
Nutrition, Beauty, Bath and Body, Home,
Jewelry, Food and Beverage, Fragrances
$11.3
2
Avon
Cosmetics, Skin Care, Fragrance, Personal
Care, Hair Care, Jewelry, Gifts
$10.7
3
Herbalife
Personal Care
$4.1
Household Appliances and Cosmetics
Natura
$3.2
224 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
Cosmetics
6
Mary Kay
Cosmetics, Skin Care, Body and Sun, Men’s
Products, Fragrance, Gifts
$3.1
7
Tupperware
Food Storage and Preparation, Cookware,
Serving Items, Cosmetics, Beauty Products
$2.6
Skin Care
Oriflame
$2.0
Belcorp
$1.9
Independent Contractors
There are nearly 3 million independent contractors of Herbalife products, one-third of
which personally use these products. Many are attracted to the low startup cost of selling
Herbalife. The startup cost for a part-time contractor is $57.75. For this price, they will
receive the mini-International Business Pack, which includes forms, applications, a tote bag,
and samples of various Herbalife products. Informational and training materials educate
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 225
Contractors enjoy discounts off products, ranging from 25 to 50 percent depending
on the level of contractorship, which they can resell at retail prices. At the Basic Contractor
level, only the yearly membership fee and a minimum purchase of product is required
every period to retain commission status. To be promoted from Basic to Senior Contractor,
a $300 purchase of products is required. If the contractor wants to progress further to
Success Builder status, he/she will purchase $580 worth of products. To reach the final top
tier of contractorship, the Supervisor level, one must purchase either $1450 worth of
Attracting and retaining contractors through promotions and technology support is
a large portion of Herbalife’s business model and is often where the most profit is made.
Not only can contractors make profit off selling their own product inventory, but they can
Code of Ethics
There are strict company policies and legal requirements that contractors must abide by
that regulate product information, sales techniques, advertising, lead generation, social
media, and many related issues. These policies are guided by the principles of the World
Federation of Direct Selling Association (WFDSA) and the Direct Selling Association (DSA)
226 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
(See Table 2). Herbalife is a member of the DSA and abides by their code of ethics. This
code of ethics recognizes the importance of a fair and ethical approach to direct selling,
since direct selling requires sensitive and personal one-on-one interaction that could lead
to undue pressures placed upon consumers. The code has no tolerance for deceptive or
Table 2: Direct Selling Association Code of Ethics
As a consumer you should expect salespeople to:
• Tell you who they are, why they’re approaching you and what products they are
selling.
• Promptly end a demonstrations or presentation at your request.
• Provide a receipt with a clearly stated cooling off period permitting the consumer to
withdraw from a purchase order within a minimum of three days from the date of
the purchase transaction and receive a full refund of the purchase price.
number of the direct selling company.
contact information for either.
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 227
performance, and availability of their product or service.
• Offer a written receipt in language you can understand.
• Offer a complete description of any warranty or guarantee.
As a salesperson, you should expect a DSA member company to:
• Provide you with accurate information about the company’s compensation plan,
products, and sales methods.
• Describe the relationship between you and the company in writing.
• Be accurate in any comparisons about products, services or opportunities.
• Refrain from any unlawful or unethical recruiting practice and exorbitant entrance
or training fees.
• Ensure that you are not just buying products solely to qualify for downline
• Require you to abide by the requirements of the Code of Ethics.
• Safeguard your private information.
• Provide adequate training to help you operate ethically.
• Base all actual and potential sales and earning claims on documented facts.
business.
228 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
A 2013 survey conducted by Neilsen, a reputable global information measuring company,
showed (without interference from Herbalife) the number of end-consumers Herbalife
serves. The study, which took place online over the course of two months, sampled 10,525
consumers and was balanced in terms of demographics, income, and geographic placement.
The results indicated that 3.3 percent of the general population made a Herbalife purchase
One of the biggest arguments against Herbalife is their line commissions. Currently,
Herbalife contractors can earn commission on what every recruit below them buys or sells.
Pyramid Scheme
There are four defining characteristics of a pyramid scheme. The first, which is dictated by
the Federal Trade Commission (FTC), is that consumers or investors are promised large
profits based primarily on recruiting others to join their program. The promise is not based
on profits from any real investment or real sale of goods. Second, according to the
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 229
product, but by the sale of new contractorships. Lastly, the California Department of Justice
identifies the difference between a pyramid scheme and a legitimate multi-level marketing
plan. In the latter, money is only made through the eventual retail sale of the product to an
end user. In a pyramid scheme, the participants at the top of the pyramid earn money when
new members are recruited. Each new member is then required to recruit new participants.
As this process goes on, the possible pool of participants shrinks, making it hard for those
at the bottom to gain returns on their investments. A pyramid scheme will ultimately
Is Herbalife a Pyramid Scheme?
In 2012 Herbalife was accused of being an elaborate pyramid scheme by hedge fund
manager William Ackman. Accusations against Herbalife included the following: 1) the
majority of contractors for Herbalife lose money, 2) Herbalife pays more for recruiting new
contractors than selling actual products, and 3) only the top 1 percent of contractors earn
230 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
a multi-level marketing compensation method, contractors earn a commission on the sales
of their recruits that is directly related to product sales. The term “rewards” implies that
there is some amount of money given for simply recruiting. But this is not how Herbalife
pays its contractors. Herbalife does operate a little differently than other multi-level
Another contention of Ackman’s is that when an individual goes to purchase
Herbalife products, he or she is more than likely going to be given an opportunity to
distribute the products themselves. He argues that the only thing keeping this company
running is new recruits, and that they will soon run out of available people to recruit into
the business. He points to the fact that Herbalife has entered new countries after recruiting
new members in another. However, there are many consumers and organizations that buy
There is also a criticism that a large number of contractors are not successful in
selling their products. The ease of entry and extremely low cost of becoming a contractor
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 231
makes it possible for those with little experience to enter the business. Even if they are not
successful at direct selling, the cost of entry is less than $100 and they still have products
that they can consume. Herbalife’s records show that only 1 percent of its registered
contractors will make $100,000 from the business in their lifetime. Ackman has argued that
the numbers that Herbalife reports are false. He estimates their retail sales to be only 3
percent of their revenue, while the rest is made by recruiting practices. These
Criticism Against William Ackman
In accusing Herbalife of operating a pyramid scheme, William Ackman bet against their stock
to the amount of $1 billion. Ackman’s hedge fund company, Pershing Square Capital
Management LP, earned more than $200 million in profits on his bet against Herbalife. For
this he faced some criticism. As Herbalife’s stock price dropped, Ackman continued to
232 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
operating a pyramid scheme. Pyramid schemes take some time to reveal themselves, so it
was just a matter of waiting until Herbalife crumbled or succeeded before anyone could be
certain about its future.
In 2013, Herbalife seemed to prove their critics wrong. After the accusations,
Herbalife took steps to defend the validity of their business model by clarifying the wording
on all of their materials so as to avoid confusion about pyramid schemes. They also
The Controversy Continues
Despite the company’s recent success amid allegations, the allegations continue. Special
interest groups such as the Hispanic Federation and the National Consumers League are
taking issue with the company and urging the Federal Trade Commission (FTC) to
investigate Herbalife’s operations. Not only are they continuing the claim that they are
operating under a pyramid scheme, but they are furthering the argument to say that the
The claims arose from the proliferation of nutrition clubs that have been established
in Latino/Hispanic communities in Southern California. The popularity of these nutrition
clubs originated in Mexico, which is where most of the immigrants in Southern California
migrated from. Herbalife claims that the nutrition clubs started arising in these areas
because the Hispanics saw how successful they were in Mexico and wanted to import the
Another issue with these clubs is that owners are operating them out of their homes
and making and selling shakes. The Los Angeles Department of Health has closed some of
these clubs as it is illegal to make and sell food items out of one’s home. These clubs have to
follow the same regulations as restaurants, requiring permits and other sorts of time-
consuming and expensive governmental red tape. Critics claim that Herbalife does not
adequately train their contractors in areas such as business and laws so they are destined
Herbalife’s Social Responsibility
Herbalife is proud of their Corporate Social Responsibility program and believe it best
sums up their top value of doing what is right, honest, and ethical. Beginning with
Corporate Governance, Herbalife’s corporate social responsibility methods and polices
relate to the directing and administering of their short and long-term goals. They are put in
234 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
their greatest asset, and their Corporate Code of Business Conduct and Ethics reflects this.
They encourage fair interactions and good judgment between any persons associated with
the company and customers. There are guidelines set in place as to how contractors and
employees of Herbalife should interact with suppliers, competitors, business partners, and
Lastly, as a part of Herbalife’s Corporate Social Responsibility program, they engage in
Employee Wellness and Live Green environmentally-conscious initiatives. The company
encourages and incentivizes their employees to become and stay healthy and participate in
fitness activities. Such incentives include complimentary products and lower individual
Conclusion
Although Herbalife has faced allegations over the years, it continues to be successful. As of
2012 the company reached worldwide net sales of $4.1 billion, and their products are
exclusively sold by nearly 2.3 million independent contractors in 80 different countries.
business is at a low point in our society. Marketing is often seen as a part of business that is
suspect. A direct selling firm is focused on personal selling to distribute all of its products.
Although contractors get relatively high commissions for their sales efforts, they do not
have the overhead expenses that a retail store with a building, fixtures, utilities, and other
expenses requires. Therefore, the markup on products such as cosmetics, nutritional
permeates the industry.
On the other hand, some direct selling companies have been associated with inventory
loading, sometimes called garage stuffing, when sales contractors are encouraged to buy
more products than they can consume or sell. This ethical breach has nothing to do with a
company being a pyramid scheme just because it uses a multi-level compensation method.
Questions
1. Why do direct selling companies receive accusations about unethical conduct?
2. Why should it matter whether contractors sell the product or use it themselves?
3. What are the ethical issues of short-sellers who make accusations unproven to push
the price of stock down?
Sources
Herbalife Ltd., Hoover’s Company Records – In-depth Records, April 17, 2013; “PYRAMID
SCHEME,” Funk & Wagnalls New World Encyclopedia, EBSCOhost (accessed April 20,
2013); Steve Schaefer, S. (2012). Ackman Takes Ax To Herbalife, Company Says It Is ‘Not An
Illegal Pyramid Scheme’,” Forbes, December 20, 2012,
http://www.forbes.com/sites/steveschaefer/2012/12/20/ackman-takes-ax–to-herbalife-
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 237
Major Upside As Nu Skin Launches New Product,” Beta Fool, June 14, 2013,
http://beta.fool.com/traderzach/2013/06/14/capture-50-profits-as–nu-skin-launches-
new-product/37167/?source=eogyholnk0000001 (accessed June 17, 2013); Steven Pfiefer,
“Latinos Crucial to Herbalife’s Financial Health,” Los Angeles Times, February 15, 2013,
http://articles.latimes.com/2013/feb/15/business/la-fi-herbalife-latino-20130216
http://www.forbes.com/sites/nathanvardi/2013/05/21/carl-icahn-and-herbalife-are-
crushing-bill-ackman/ (accessed June 17, 2013); Stuart Pfeifer, “Herbalife shares Surge
Past Price When Ackman Made Allegations,” Los Angeles Times, May 6, 2013,
http://articles.latimes.com/2013/may/06/business/la-fi–mo-herbalife-stock-price-
20130506 (accessed June 17, 2013); Steve Schaefer, “Herbalife Posts Record Results,
Raises Guidance,” Forbes, April 29, 2013,
http://www.forbes.com/sites/steveschaefer/2013/04/29/herbalife-posts-record-results-
raises-guidance/ (accessed June 17, 2013); Agustino Fontevecchia, “Investors Side with
Carl Icahn: Herbalife Soars After Epic TV Battle with Ackman,” Forbes, January 25, 2013
http://www.forbes.com/sites/afontevecchia/2013/01/25/investors-side-with-carl-icahn-
238 Supplemental Case Error! Unknown document property name.: The Playskool
Travel-Lite Crib
by Herbalife to United States Contractors in 2012,” 2012,
http://opportunity.herbalife.com/Content/en-US/pdf/business-
opportunity/statement_average_gross_usen.pdf (accessed June 17, 2013); Yahoo! Finance,
“Herbalife Says Survey Indicates 7.9M Customers in the U.S.,” June 12, 2013,
Supplemental Case Error! Unknown document property name.: The
Playskool Travel-Lite Crib 239
[[Footnote Starts here]]