Herbalife Defends Its Business Model

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. Herbalifes 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.

This case will first discuss the history of the company from its founding to its present status, followed by a description of the types of products Herbalife offers. We then discuss multi-level marketing and the role of independent contractors in the direct-selling model. Next, we discuss pyramid schemes and why they are often confused with the multi-level marketing model. We explore Herbalife to determine whether it constitutes a pyramid scheme, as well as the reasons for why some people accuse it of being so.

This case also illuminates the role of hedge fund investor William Ackman behind the backdrop of Herbalifes business model, showing his contentions with the company as well as some of the criticisms against him. The case demonstrates that while the Ackman accusations may be the most widely known, there are other accusations (mostly referring to pyramid schemes) that Herbalife has had to face over the course of their existence. The case ends with a brief overview of Herbalifes social responsibility program and some conclusions.

 

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. Herbalifes first sales were made from out of the trunk 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

In 1999 Hughes planned to take the company back to the private sector by purchasing all of its remaining shares, but this attempt was stopped as investors sought legal action. The next year, Mark Hughes died at the age of 44 due to an accidental overdose of anti-depressants and alcohol. Christopher Pair, who was Herbalifes former Chief Operating Officer (COO), then became President and Chief Executive Officer (CEO) of the company. His reign at Herbalife was cut short as he stepped down one year later due to the boards criticism of his management style.

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 acquired by a group of venture capital firms including Whitney & Co. and Golden Gate Capital. In 2004, Herbalife was taken back to the public sector and remains on the NYSE today. Michael O. Johnson has been Herbalifes CEO since 2003. The company currently employs 6,200 people and has almost three million independent contractors throughout the world.

 

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; Formula 2 Multivitamin Complex is a multivitamin that contains over 20 vitamins, minerals, and herbs that are essential to healthy living; and Formula 3 Cell Activator promotes absorption of minerals and vitamins while improving energy levels. These three core products are at the heart of the Herbalife product line and serve as the baseline for nutrition and weight management goals.

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 immediately improve the look and feel of hair and skin. The Multivitamin line is similar to taking a multivitamin every day and includes a cleanser, toner, moisturizer, sunscreen, eye gel, and cream that are infused with vitamins for the skin. Radiant C scrub cleanser, skin booster, and body lotion renew and rehydrate the skin with a concentration of vitamin C. Other items include anti-aging products and fragrances for men and women.

 

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 marketing, sometimes called network marketing, is a compensation method in a direct selling business model wherein contractors earn income from their own sales of products as well as commissions from sales made by their recruits. However, it is not necessary for contractors to recruit other individuals to earn money. It is a choice made by the contractor if they want to increase their earnings by making a commission from the sales of their recruits. Furthermore, rewards are not given simply for recruiting another contractor. See Table 1 for the top ten direct selling companies.

Another aspect of multi-level marketing involves internal consumption, which is the purchasing of products at a discount from the firm for the contractors own use. Most retailers provide internal consumption incentives by offering discounts to employees who purchase products. Department stores, automobile manufacturers, and airline companies provide incentives such as discounts that encourage internal consumption. It is much more likely that direct selling companies will have more internal consumption than a department store such as Macys, because most direct selling companies deal with products like health 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. They want to spread the word by creating a broader sales and communication network and do not necessarily care about making a profit from the business. This is a common and legal approach for direct selling products around the world. However, some countries have restricted direct selling to single level marketing only. They believe multi-level marketing is linked to fraudulent activities such as pyramid schemes because of the belief that discounts are used to force internal consumption to purchase the product. China, for example, will allow direct selling companies to do business within their borders if they sign a contract saying they will not employ the multi-level marketing aspect of direct selling. Instead of having independent contractors recruit others, they sell their products from retail stores.

 

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 Nutrition, Weight Loss Management, Personal Care	$4.1
4	Vorwerk Household Appliances and Cosmetics	$3.3
5	Natura Cosmetics	$3.2
6	Mary Kay Cosmetics, Skin Care, Body and Sun, Mens Products, Fragrance, Gifts	$3.1
7	Tupperware Food Storage and Preparation, Cookware, Serving Items, Cosmetics, Beauty Products	$2.6
8	Nu Skin Skin Care	$2.2
9	Oriflame Cosmetics	$2.0
10	Belcorp Beauty Products	$1.9

Sources: Direct Selling News, Net Sales Comparison of Top 10, 2012,http://directsellingnews.com/index.php/view/the_2013_dsn_global_100_list?popup=yes (accessed July 9, 2013). elcorperetraactors)onsists of .

 

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 the contractor on using and retailing the products, business basics, and how to build a sales and marketing plan. Alternately, if a contractor wants to work full-time, they can purchase the full International Business Pack for $89.55. This pack comes with all of the materials that the mini pack offers, but with more product samples and more information on how to run the business. Additionally, all contractors pay a $10 annual membership fee to Herbalife.

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 products in two consecutive months or $2320 worth of product in one month. Once a contractor reaches the Supervisor level, the product discount is increased from 25 percent to 50 percent and a profit can be made on sales to other contractors, which can reach up to five percent. In the event that a contractor no longer wants to sell Herbalife products, the company will buy back the remaining inventory the contractor has on hand. They also discourage contractors from inventory loading, which the Federal Trade Commission (FTC) has defined as a practice requiring one who wishes to become a contractor to make a large purchase of a large amount of un-returnable inventory.

Attracting and retaining contractors through promotions and technology support is a large portion of Herbalifes 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 also make a commission from the sales of their recruits. Most independent contractors do not have a physical store location, but practice direct selling from home. They are not employees, but businesspeople who choose how they want to operate.

 

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) in the United States. The WFDSA promotes ethical practices in direct selling globally through advocacy and strong relationships with government, consumers, and academia. The DSA also emphasizes ethics and requires that members adhere to their code of ethics (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 unlawful practices regarding recruits and customers; requires that salespeople provide accurate and truthful information about the price, quality, promotion, and other characteristics of the products; illuminates and enforces the need for a clear record of the sales made by contractors; necessitates that warranties and guarantees be fully acknowledged; requires salespeople to clearly identify themselves to customers and maintain the confidential information of their customers; has no tolerance for pyramid schemes; and provides guidelines on inventory purchases, how to report earnings, inventory loading, paying fees, and training.

 

Table 2: Direct Selling Association Code of Ethics

As a consumer you should expect salespeople to:

Tell you who they are, why theyre 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.

Explain how to return a product or cancel an order.

Provide you with promotional materials that contain the address and telephone number of the direct selling company.

Provide a written receipt that identifies the company and salesperson, including contact information for either.

Respect your privacy by calling at a time that is convenient for you.

Safeguard your private information.

Provide accurate and truthful information regarding the price, quality, quantity, 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 companys 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 commissions.

Ensure that any materials marketed to you by others in the salesforce are consistent with the companys policies, are reasonably prices and have the same return policy as the companys.

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.

Encourage you to purchase only the inventory you can sell in a reasonable amount of time.

Repurchase marketable inventory and sales aids you have purchased within the past 12 months at 90 percent or more of your original cost if you decide to leave the business.

Explain the repurchase option in writing.

Have reasonable start-up fees and costs.

 

Source: Direct Selling Association. Summary Version of the DSA Code of Ethics.www.dsa.org.http://www.dsa.org/ethics/shortcode/. (accessed July 9, 2013).

 

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 sometime over the last three months. This percentage of the population translates into 7.9 million customers, which does include Herbalifes contractors. According to the data, however, the number of contractors is approximately 550,000, indicating that the number of end users is higher than the number of independent contractors. Additionally, the study showed that those who made a purchase in the last three months tend to make Herbalife purchases consistently (approximately every two months), and that the most popular products are those having to deal with weight management (95 percent of those who made a purchase in the last three months).

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. There are no restrictions on the number of levels of recruits that contractors can earn a commission on, unlike other multi-level marketing companies. However, the levels end with the last recruit who decides not to recruit and operate on more of a single level marketing structure.

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 Securities and Exchange Commission (SEC), because it is the attempt to make profits solely by recruiting new participants, the promise of high profits rests on nothing more than a consumer or investor handing over their money and getting others to do the same. Third, the Federal Bureau of Investigation (FBI) warns that pyramid schemes can be in the form of marketing and investment frauds wherein an individual is offered a contractorship or franchise to market a particular product. The real profit is earned, not by the sale of the 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 collapse due to lack of new recruits, and is therefore unsustainable. Another important point is that a pyramid scheme that seems to offer a product will have little to no market value. The recruits are being sold on an idea or a model. Pyramid schemes can be hard to clearly identify, but the FTC has cautioned consumers with two distinct criteria. The first is inventory loading, which looks similar to internal consumption because it encourages large-scale purchases of the firms product by a distributor, and the second is a lack of retail sales. If a supposed business has both of these characteristics, it is possible that it is a pyramid scheme and not a business at all. It is for these reasons that some direct selling businesses that utilize the multi-level marketing compensation method can appear to be pyramid schemes. Because Herbalife sells not only their nutrition products but also a business opportunity, they have been accused of running a pyramid scheme.

 

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 most of the money. The accusation is a result of the confusion that comes from the way their earning structure operates. Ackman argued that Herbalife recruits contractors under false beliefs that they can earn the income of those at the top by selling the product, and that the real money comes not from selling the product, but from recruiting other contractors. His reasoning is that contractors earn rewards for every member they recruit, as well as every member the recruits recruit. However, the term rewards is misleading. In 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 marketers in that many of its contemporaries have a cut-off point on what level of recruits a contractor can continue to earn compensation from. Herbalife does not have a cut-off; distributors can earn compensation on recruits indefinitely. While this characteristic is different from other multi-level marketing companies, this is not enough to classify Herbalife as a pyramid scheme.

Another contention of Ackmans 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 and use the product and see it as high-quality and reputable. For example, the Los Angeles fire and police department officers use Herbalife products in their fitness centers, and it has even been adopted by some Chinese Olympic teams. Additionally, the results of the survey mentioned earlier showing that the number of end users is larger than the number of independent contractors is the biggest defense Herbalife has against the accusations that they are operating a pyramid scheme. Herbalife reveals that they are using a valid and successful business model, which is producing profits that are directly related to product sales and has allowed them to expand globally. Ackman, however, has made claims to invalidate the results of the survey. He claims that the survey contradicts two others that were released by the company and that Herbalife refuses to make the details of the process public knowledge so they can be scrutinized. He also claims that the sample was too small so that the results are overly optimistic, and he takes issue with the fact that there are not enough specifics in the survey (e.g. prices consumers paid and an itemized breakdown of the products purchased).

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 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. Herbalifes 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 discrepancies can be explained when the types of contractors are analyzed. There are those that sign up only to get the contractors discount on the product because they want the product for personal use; those who only want to sell the products as a source of additional income; and those that want to sell as a full-time job. Furthermore, every kind of direct selling business requires a large amount of effort to make a large amount of profit. Even with businesses like Herbalife, if a contractor wants to make a living from distributing, relationships with customers must be maintained, an investment in advertising must be made in order to get new recruits, and relationships with recruits must be maintained to encourage them to make as many sales and new recruits as possible. Many who begin in any direct selling business are either not willing, or lack the business knowledge, to put in that much effort. And those who sign up for this opportunity as a side job only work part-time or less according to how much extra money they want to make.

 

Criticism Against William Ackman

In accusing Herbalife of operating a pyramid scheme, William Ackman bet against their stock to the amount of $1 billion. Ackmans 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 Herbalifes stock price dropped, Ackman continued to profit off the company. Although he pledged to give any profits from the short sale to charity, this still remains a conflict of interest. Shortly after Ackmans accusations, another hedge fund investor, Carl Icahn, came to the defense of Herbalife and became a majority shareholder and board member. This helped boost investor confidence in Herbalife, and their stock slowly began to recover. However, the state of Herbalife was still uncertain amid accusations, investor uncertainty, and Herbalifes strong stance that they were not 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 upgraded their guidance and made an ad campaign refuting Ackmans claims. The company did not devolve as is expected of pyramid schemes; instead, its stock price recovered from $24.24 when Ackman made his accusations to over $70 a share by the end of 2013. Within a five-year period, the Securities and Exchange Commission has investigated Herbalife operations twice. Both times it ended its investigations without taking action, and regulators have not found indications of wrongdoing. Prominent investors including Carl Icahn have invested in Herbalife, indicating Herbalifes financial and regulatory integrity.

 

The Controversy Continues

Despite the companys 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 Herbalifes 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 company is targeting vulnerable groups. These groups include low-income Hispanic immigrants and low-income African Americans. The allegations against Herbalife include aggressive recruiting techniques, promises of getting rich with minimal work, and taking advantage of people with little or no business experience.

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 idea to the United States. Others claim that these clubs are harming the community because they turn out to be too costly for those who run them and end up losing more than they bargained for. Congresswoman Linda Sanchez, who represents Southern California, has written a letter to the FTC asking them to investigate Herbalife. She cited the intense media coverage and outreach from special interest groups and constituents as reasons for an investigation. New York City Councilwoman Julissa Ferreras has also written to the FTC advocating for an investigation.

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 ones 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 to fail. Herbalife, on the other hand, refutes those claims and states that they encourage their contractors to abide by their local laws.

Desmond Walsh, President of Herbalife, maintains that the company does not target specific demographics and that the rise of nutrition clubs in Latino/Hispanic communities is a result of immigrants seeing the business opportunity and importing the clubs from Mexico. In February 2013, it was reported that Hispanics make up 60 percent of Herbalifes customer base. One reason may be because they are good at direct selling because of their large network base and relationship-building tendencies.

 

Herbalifes 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, Herbalifes corporate social responsibility methods and polices relate to the directing and administering of their short and long-term goals. They are put in place to ensure accountability and economic efficiency for their stakeholders. Herbalife is proud that because of these polices, they have met independence criteria almost one year early and meet all NYSE-listed public company requirements for transparency.

Their ethical culture allows them to uphold the highest ethical standards in the operation of their company. CEO Michael Johnson has said that Herbalifes reputation is 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 the government. Herbalife encourages obedience to laws and sets boundaries on gifts and entertainmentdescribing the difference between small gifts and bribes. They discourage conflict of interest situations as well as insider trading. Herbalife offer three methods of reporting unethical behavior: through its hotline, website, or contacting the companys General Counsel. Individuals who do not comply are disciplined, suspended, or terminated. Herbalife also requires annual ethics training for all employees worldwide.

Another aspect of their Social Responsibility program includes Herbalifes philanthropic efforts. The Herbalife Family Foundation (HFF) and the Casa Herbalife program, founded in 1994 by Mark Hughes, provide funding and volunteerism to charitable organizations taking care of children at-risk around the world. HFF works to improve nutrition and help with disaster relief efforts. Herbalife has also partnered with the Global Alliance for Improved Nutrition (GAIN) and DSM Nutritional Products, a producer of vitamins and nutrition ingredients, to help deliver nutrients to women and children around the world. This partnership is under the umbrella of GAINs Future Fortified campaign.

Lastly, as a part of Herbalifes 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 health insurance costs. The company has even been recognized byMens Fitnessmagazine as One of the 15 Fittest Companies in America. Through environmentally-conscious initiatives such as Live Green and the 3Rs (reduce, reuse and recycle), Herbalife makes their effect on the environment a priority.

 

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. They sponsor several professional athletes, teams, and sporting events. They are also proud of their Corporate Social Responsibility initiatives. Herbalife appears to be a successful company. However, the challenges they face are likely to continue. Trust in 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 supplements, jewelry, and clothing may be similar in both the retail store and in direct selling. Critics of direct selling fail to recognize that a direct selling company does not have the overhead of a bricks-and-mortar store in an expensive location or an organization with many management levels that receive compensation for their performance. A direct selling company is a very flat organization with low overhead, with compensation systems for the network of sales contractors that make the product available to final consumers. The concept of internal consumption, which exists in nearly all businesses, is considered questionable by many critics who fail to understand that there is nothing illegal or unethical about the practice. The strong compliance efforts of the direct selling industry to police itself have been the industrys growth engine. A culture of ethics and compliance 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. All businesses have compensation methods that reward sales managers and higher-level managers, including the CEO, for performance. All businesses have to produce revenue, and the marketing function is exclusively in charge of developing sales. However, companies should maintain total transparency concerning how their sales incentive model works, and there should be due diligence to ensure that sales contractors are not exploited in any way. While Herbalife has overcome many challenges and continues to have loyal contractors throughout out the world, Herbalife will have to remain proactive in addressing obstacles and allegations from critics.

 

Questions

1. Why do direct sellingcompanies 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

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[[Footnote Starts here]]

* O.C. and Linda Ferrell, 2014. This case was prepared by Michelle Urban for and under the direction of O. C. Ferrell and Linda Ferrell. Special thanks to Gerald Albaum for his assistance in developing the case. This case was prepared for classroom discussion rather than to illustrate either effective or ineffective handling of an administrative, ethical, or legal decision by management. All sources used for this case were obtained through publicly available material.

[[Footnote Ends here]]

2015 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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