September 01, 2016
Herbalife & the FTC: 4 Points to Review
by DSN Staff
The speculation started immediately. As soon as the news—Herbalife Settles with FTC—began popping up on mobile alerts and news outlets early Friday morning, July 15, observers inside and outside the direct selling channel began scrambling to understand the bigger picture. The settlement was clearly good news for Herbalife. It put a huge cloud of uncertainty behind the company; investors responded positively, and billionaire investor and longtime supporter Carl Icahn signaled his plans to substantially increase his ownership stake. But what does it mean for the rest of the direct selling community?
What it doesn’t mean is that there is suddenly a specific set of new rules by which direct selling companies must operate. It also doesn’t mean that all direct selling companies should feel comfortable adopting a “business as usual” strategy. As a settlement, the Herbalife/FTC agreement doesn’t create a new body of case law along the lines of the seminal 1979 Amway ruling. But the more than 70 pages filed with the court and the corresponding public comments by the Federal Trade Commission do provide at least a modicum of transparency into the relatively opaque view federal law enforcement has on direct selling and, specifically, companies that promote a multi-level compensation plan.
In the days following the settlement announcement, the team at Direct Selling News carefully reviewed all of the public documents and solicited input from across the direct selling community. That outreach underscored our belief that this is a unique moment in the history of direct selling, a moment of reflection and evolution that is likely to continue for some time. And, while the full implications of the settlement may not be known for months or even years, our research also revealed four areas every direct selling company should examine if they haven’t done so already.
1. Focus on Retail Sales to Customers
All direct selling companies should have a strong focus on retail sales of their products and services to customers outside the compensation plan. While some level of personal consumption by independent contractors makes sense in a direct selling model, a business built primarily on self-consumption is not sustainable. It also does not appear to be acceptable to regulators. One of the positive details in the Herbalife settlement is that it does allow the company to pay some compensation to independent business owners (IBOs) on personal consumption, a key concept the direct selling community has been advocating for years. But the settlement stipulates strict limits to this commissionable personal consumption and also prohibits IBOs from enrolling in automatic shipment programs—two indications that the FTC recognizes the concept of valid personal consumption by consultants but doesn’t consider it a blanket explanation for all purchases made by the salesforce.
Tracking those retail sales and ensuring that they include large enough profit margins to support the independent business owners also is key. In its complaint, the FTC alleged that Herbalife had a business practice that purports to offer a viable business-building opportunity but in reality incentivizes recruiting. Retail sales of product, the complaint says, are “insufficiently profitable” and instead IBOs are incentivized to recruit a downline of people who make large, wholesale product purchases.
Many direct selling companies, including most of the newer entrants to the market, largely avoid the issue of tracking retail sales by having customers place the bulk of their orders and make payments through consultants’ websites, and then they ship the product directly from the company to the buyer. In this way, consultants carry minimal or no inventory, and there is a clear record of the price paid for the product and the profit that goes to the consultant. In Herbalife’s case, the company now is required to include specific thresholds for sales to customers as part of its compensation plan. If those thresholds aren’t met, commissions are reduced.
2. Segment Independent Contractors from Preferred Customers
As was the case in other recent FTC actions, the Herbalife settlement places a great deal of emphasis on customers being distinct from those individuals looking to build a business. In the past, Herbalife recognized that a large percentage of its salesforce were actually people who simply wanted to buy the products at a discount and had no intention of selling or reselling product. The FTC, as it has in other cases, viewed this concept with suspicion, arguing that such buyers are not preferred customers but rather failed consultants. Herbalife now must keep clear delineations between the two groups. There is a category for preferred customers who can buy at wholesale or discounted pricing, but those folks are not eligible to recruit or sell product. Individuals also cannot move from one classification to the other without making a written request; there is no allowance for someone to sign up as a business builder and if, say, he or she fails to recruit anyone or earn commission in a year be automatically reclassified as a preferred customer.
“It is clear, from this and the Vemma case, that companies are going to have to come up with a new build strategy, where you sign up people as customers and then go back and later on sign them up as distributors,” says Mark Rawlins, CEO of InfoTrax Systems, a Utah-based software supplier to direct selling companies that focuses on backend operations and commissions.
3. Beware of Income Claims
As it did in other recent enforcement actions, the FTC’s complaint against Herbalife included a number of allegations of misleading representations of how much money a participant was likely to earn with an Herbalife business. The complaint specifically calls out the company’s Statement of Average Gross Compensation as having been unclear, references video testimonials that included images of expensive houses and cars, and cites examples of things top leaders have said onstage at events.
This certainly is not the first time the FTC has gone after a direct selling company for its income claims, and the complaint should serve as a reminder to all companies to be especially wary of lifestyle claims, including lifestyle representations in the form of photography or video footage, that depict results only achieved by a few top-level earners. In an interview with Direct Selling News following the settlement announcement, U.S. Direct Selling Association President Joseph N. Mariano emphasized that the DSA’s Code of Ethics also places strict limits on income and earnings claims associated with direct selling business opportunities.
Staying on the right side of law enforcement and in compliance with the DSA Code is relatively straightforward on these points, Mariano says. “You don’t have somebody standing up and saying, ‘I make a million dollars a year,’ and you don’t create the impression that that is standard, easily done or commonly done. And you say… that we are very proud of the opportunity that we have as individual companies, that people can earn money, that they can make a career out of this, and it is going to take hard work,” he says. “We can sell what we do. We can sell our opportunity. We can sell the dream, but we also have to recognize that the dream isn’t standing in your mansion in the Bahamas. The dream is acquiring skills, of helping your family, of being able to sell product, of helping your community and having the potential to build this into a business that will help your family.” (For more on Mariano’s perspective on the Herbalife settlement, see this month’s Back Page.)
4. Be a Forceful Advocate
There is no doubt that this is a time of introspection for the direct selling channel. Companies are, and should be, carefully evaluating their business practices to ensure that they embody the best practices around customer service, marketing, product innovation and business ethics today.
This also should be a time for strong advocacy. The direct selling community—active companies as well as suppliers—must come together to share the positive stories about the channel. Direct selling is an effective go-to-market strategy for consumer goods and services companies, particularly those that benefit from a high level of personalized customer service. It also offers an effective path to entrepreneurship, one that is open to anyone regardless of background or circumstance, comes with low startup costs, offers a high degree of flexibility and provides meaningful support to those getting started in business for the first time. Yet neither of these foundational elements of the business model are widely understood, which leaves the very concept of direct selling vulnerable to misinterpretation and unfounded accusations. By supporting efforts such as the academic initiatives of the Direct Selling Education Foundation and by being vocal about the broad benefits of direct selling, active and supplier companies can work to shift public perception over time.
Strong advocacy also means pressing for more clarity and consistency from the regulatory community. Supporting a bipartisan bill introduced in the House of Representatives earlier this year, H.R. 5230, is one way members of the direct selling community can press for such change. The bill provides a clear definition of what constitutes a pyramid scheme and would go a long way toward minimizing confusion in the marketplace. It is this very lack of a clear federal definition of a pyramid scheme that leaves the direct selling community to attempt to decipher the intent of law enforcement by reading between the lines of an ever-changing body of case law, court settlements and statements by regulators. Which of the terms of the Herbalife settlement, for example, are prescriptive guidelines for all direct selling companies and which are intended as mitigation solely for Herbalife? No one outside the FTC really knows for sure.
Yet it is important that the direct selling community not wait for the regulatory community to take the lead. During her press conference the morning the settlement with Herbalife was announced, FTC Chairwoman Edith Ramirez said the FTC will be providing additional guidance to what she described as the multi-level marketing industry. “I think the protections that we have in place here are aimed to ensure that going forward Herbalife operates legitimately,” she said, “but I do think they provide important guidance to the rest of the MLM industry about what they need to focus on in order to ensure they are not engaging in unfair or deceptive practices.”
Several weeks later, as this edition of DSN went to press, there was still no word from the FTC on what this guidance might involve. A representative from the commission’s public affairs office told DSN that they have no information about the guidance that was mentioned or on when it might be. DSA staff report that they reached out to the FTC immediately following the settlement announcement and extended invitations to the FTC to meet with the DSA board and to address member companies.
Instead of waiting for additional guidance from the FTC, this is the time for even more direct selling company executives to join those within the channel who already are serving as forceful advocates for self-regulation. If as a channel we create an environment in which all companies exceed the expectations of consumers and of our independent salesforce, and we do this consistently and for the long haul, direct selling will continue to grow and prosper. LifeVantage CEO Darren Jensen put it this way: “The future of the industry is rooted in having a vibrant customer base coupled with effective and powerfully branded products.”
The Possibilities Ahead
The quote is more than 100 years old, but Avon Founder and direct selling pioneer David McConnell’s sentiment still rings true today: “If we stop and look over the past and then into the future, we can see that the possibilities are growing greater and greater every day; that we have scarcely begun to reach the proper results from the field we have before us.”
The principles underlying the FTC’s settlement with Herbalife are, by and large, concepts that can make the direct selling channel a stronger, more appealing way to sell high-quality products and services and to provide people an opportunity to earn financial rewards or even build their own business. Yet taking action today—to embrace those principles as well as to advocate for the long-term health of the channel—is critically important. There are four pillars that support direct selling: our customers, our distributors, our companies and our community. To set the firmest foundation, we must be equally strong advocates for all four.