Tuesday, July 3, 2012

OP-ED: Are MLMs really based on sales? Or recruitment of self-consumers?

EDITOR'S NOTE: OP-ED is an opinion on the state of the MLM / network marketing industry, and while may be based on fact, is an opinion, and often, a question that needs to be answered. 

There are many MLM companies, or network marketing companies, in the US. In fact, the best known MLM in the world, Amway, was founded in the US. However, recently some incidents have raised questions... how real is the MLM business and industry?

But wait, you say... The industry is huge! Billions of dollars in sales!

Sales to who? Affiliates? (i.e. "self-consumption")  or real customers?  To the company, it's the SAME THING. Both are sales.

But the US case laws (FTC vs. Koscot  and Weber vs. Omnitrition) are clear... sales must be to real customers, usually interpreted as OUTSIDE NON-AFFILIATE.

Even a recent case, Burnlounge, judge ruled that sales to OUTSIDE customers is a the true measure of demand. Burnlounge accounting shows that only 3% of its revenue came from outside customers, indicating that most revenue came from recruiting new "moguls" (i.e. affiliates).

So what are the stats for the big companies, like Amway, Herbalife, and so on? Do they know how many customers they have vs. affiliates?

They don't know.

Back on May 1st, 2012, Einhorn, a big hedge fund manager (best known for "short selling" stocks), asked a few questions to Herbalife's CEO and CFO about how they know if they have real customers, instead of just selling to affiliates. Herbalife's CEO basically admitted that they don't know. They supposedly have this 70% retail rule that says 70% of sales are to customers or self-consumed (by affiliate). When pressed, he and his CFO basically said "we have no idea" how much were sold to outside customers. When Einhorn asked about a previous breakdown (no longer included) filed with the SEC that says 29% self consumption, 57% small retail, and remainder sales leaders, the CFO basically admitted that a) they just arbitrarily set some numbers as brackets, and he had no idea what were the brackets or why they picked those numbers, and b) he doesn't think it's important to the investors.

Why would a CFO of something as big as Herbalife think something that fundamentally separates a MLM from a pyramid scheme is not important to the investors?

Herbalife is not alone. When Wall Street Journal interviewed Amway's CEO and President in March 2012, (scroll to 9:15 mark) Amway President basically claimed that "about 50%" of affiliates just want to buy some stuff and "sell a few to friends and family", 30% look for a little extra income, and 20% plan to treat it as income opportunity. The statement is vague enough, but he seem to have said that 50% of Amway affiliates are self-consumers, 30% small retailers, and 20% big sales leaders. 

As this is NOT sales volume, but number of affiliates, there's no telling how much of the sales is to outside customers, and how much is internally consumed, but the IMPLICATION is that there is a significant chunk of sales, which seems to be 20-30% (but less than 50%) that are NOT retail sales

MLM Opponents, such as Robert Fitzpatrick, claimed that this is a smoking gun that points to the whole industry being fraudulent, that they don't really know if they are really selling the stuff.

MLM Proponents, like the DSA, have been trying to convince the FTC to formally define "self-consumption" as perfectly legal, despite past court cases such as Koscot, Omnitrition, and now, Burnlounge.

But this really begs the question: why do affiliates join and generate NO retail sales, just do self-consumption? Clearly, they don't join for the retail profits. And since they usually have no downlines (unless the upline decided to plant a couple downlines under them) they are not going to get any sales bonus or commission either. That pretty much leave the product, or external factors (such as family and friend favor, etc.)

But this points to another thing: as MLM is supposedly about SALES, do you WANT this sort of affiliate, i.e. the self-consumer, that is NOT retailing anything? Why can't they just be customer?

There are three POVs to consider:

self-consumer POV  -- if I join and don't sell anything, I at least can buy the stuff at wholesale price instead of the marked-up retail price. (SMALL GAIN)

upline POV -- any bit of sales is good for my PV / BV bottom line (GAIN)

company POV -- any bit of sales is good for company's bottom line

So no losers here. Unlike inventory loading, self-consumer doesn't really hurt any one.

But this is dangerous in another way: instead of actually selling products, the "upline" can play the MLM as a recruiting game where you just need to recruit a lot of self-consumers.

This basically teaches the WRONG IDEA about the industry.

Is that a bad thing?

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