Must-know: An overview of Herbalife’s direct selling model

Ackman’s campaign against Herbalife

The founder and CEO of Pershing Square Capital Management, William Ackman, issued a presentation about global nutrition company Herbalife Ltd. (HLF). He disclosed new evidence that focused on the company’s nutrition clubs. Ackman has been campaigning against Herbalife since December 2012. He has released numerous presentations and reports alleging the nutritional company’s multilevel marketing model is a fraud and a “pyramid scheme.”

In this part of the series, we’ll briefly go through Herbalife’s direct-selling model as outlined in the company’s regulatory filings. Other companies with the same model include Nu Skin Enterprises, Inc., (NUS), Usana Health Sciences, Inc., (USNA), Avon Products, Inc., (AVP), Tupperware Brands Corporation (TUP), and Amway.

Herbalife is a global nutrition company that sells weight management products, nutritional supplements, energy, sports, and fitness products, and personal care products.

The latest available data indicate that Herbalife sold its products in 91 countries to and through a network of 3.9 million independent members, previously known as “distributors.” Of the 3.9 million members, approximately 0.2 million were in China.

Herbalife reported first-quarter net sales of $1.3 billion, a 12% increase year-over-year. The Generally Accepted Accounting Principles net income for the quarter was $74.6 million, or $0.74 per diluted share. It was down from $118.9 million, or $1.10 per diluted share, for the same period in 2013 mainly due to a foreign exchange loss for Venezuela.

Herbalife’s product categories and revenue regions

The company’s products are grouped in four principal categories:

1. Weight management
2. Targeted nutrition
3. Energy, sports, and fitness
4. Outer nutrition.

The company reports revenue from six regions:

1. North America
2. Mexico
3. South and Central America
4. Europe, the Middle East, and Africa
5. Asia Pacific
6. China.

In China, Herbalife sells its products via sales representatives, sales officers, independent service providers, and retail stores.

The company’s mission is “changing people’s lives” by “providing high quality, science-based products to members and their customers who seek a healthy lifestyle, and it also offers a financially rewarding business opportunity to those members who seek part time or full time income.”

On the iamherbalife.com website, the company states that there is widespread consumer demand for Herbalife products. It cited Nielsen’s 2013 independent research that showed 8% of the U.S. adult population, or 19.2 million, have purchased a Herbalife product for personal use. Also, Herbalife said its market share in the meal replacement category for 2013 was 29.6% per Euromonitor International.

Why a direct-selling channel?

In its annual filing, Herbalife stated that it believes a “direct-selling channel is ideally suited to marketing our products because sales of weight management, nutrition and personal care products are strengthened by ongoing personal contact, coaching and education between members and their customers. This frequent, personal contact can enhance consumers’ nutritional and health education as well as motivate consumers to begin and maintain wellness and weight management programs. In addition, our members consume our products themselves, and therefore can provide first-hand testimonials of the effectiveness of our products to their customers, which can serve as a powerful sales tool.”

Herbalife said most members join to receive a discounted price on family products. Members also have the opportunity to profit from selling the products. Once members achieve certain qualifications, they can earn Royalty Overrides, or commissions, and production bonuses on sales made by members whom they sponsor into their sales organizations.

According to the company’s annual report, “To become a Member in most markets, a person must be sponsored by an existing Member and must purchase an International Business Pack, or IBP. The IBP is a Member kit available in local languages which typically includes product samples, a handy tote, booklets describing us, our compensation plan and rules of Member conduct, various training and promotional materials, Member applications and a product catalog.”

The company assigns Volume Points on each of its products for use to determine a member’s sales achievement level. Management uses Volume Points, which are unaffected by exchange rates or price changes, as a proxy for sales trends. The specific number of Volume Points assigned to a product, which is generally consistent across all markets, is based on a Volume Point that suggests retail price ratio for similar products.

Herbalife said in its annual filing that to become a sales leader, or qualify for a higher level, members must achieve specified volume thresholds of product sales or earn certain amounts of royalty overrides during specified time periods and must re-qualify every year. Once members become sales leaders by earning specified amounts of royalty overrides, they have the opportunity to qualify for the Global Expansion Team, the Millionaire Team, or the President’s Team. As a sales leader, members will receive production bonuses of up to 7%.

Factors driving net sales

Herbalife also said, “Changes in net sales are directly associated with the recruiting and retention of our Member force, retailing of our products, the quality and completeness of our product offerings that the Member force has to sell and the number of countries in which we operate.”

Management’s role is to provide members with a competitive and broad product line, encourage strong teamwork and member leadership, and offer leading edge business tools and technology services to make doing business with Herbalife simple. Some of the tools include company-sponsored sales events such as Extravaganza, Leadership Development Weekends, and World Team Schools. During World Team Schools, large groups of members gather, which allows them to network with other members, and learn about recruiting, retention, and retailing techniques from leading members. Members can become more familiar with how to market and sell the products and business opportunities.

Herbalife also uses event and non-event product promotions to motivate members to increase recruiting, retention, and retailing activities. These promotions have prizes ranging from qualifying for events to product prizes and vacations.

The company said, “While we continue to monitor the current global financial environment, we remain focused on the opportunities and challenges in retailing of our products, recruiting and retaining Members, improving Member productivity, opening new markets, further penetrating existing markets, globalizing successful Distributor Methods of Operation, or DMOs, such as Nutrition Clubs and Weight Loss Challenges, introducing new products and globalizing existing products, developing niche market segments and further investing in our infrastructure.”