If you’ve somehow been living under a rock and never heard of Herbalife, let me give you a brief overview of the company, and what they offer.
Founded in 1980, Herbalife is a “Multi Level Marketing (MLM)” company which primarily sells nutritional supplements. As we know from the article I wrote about NuSkin, we know that the vast majority of companies which describe themselves as an MLM do so in order to avoid the label of being a pyramid scheme.
The key difference here is that a pyramid scheme is illegal, while an MLM technically isn’t. It is semantics really, and purely a legal loophole for the most part. However, I won’t let that skew my analysis of Herbalife overall – as I’m sure there are some legitimate and ethical MLM’s out there who genuinely too care about the people who work for them.
History of Herbalife
The start of Herbalife was quite a humble one. Founder Mark Hughes in 1980 began selling a weight loss supplement from the boot of his car. He claims that his idea was sparked by his mother’s inability to control her weight, and subsequent death linked to her poor health.
Even in the early days Herbalife have been hounded by controversy. In 1982, they received complaints from the Food & Drug Administration regarding the claims they had made about their products – This subsequently has meant that throughout their history they have had to change claims made about products, and ingredients being included in their products.
In 1984, the Department of Justice of Canada filed charges against the company for misleading medical claims in advertisements.
If I’m honest, you will soon see this is a bit of a pattern. Since the beggining until now, Herbalife have periodically been accused by various different high level platforms of providing either false information, or misleading claims to the users of their products.
However, these claims haven’t stopped Herbalife’s growth and success!
Continued Success of Herbalife
Despite the claims by the DoJ of Canada, Herbalife were described by Inc. as the fastest growing private company in America – Which is a pretty big claim to have! I will do a financial analysis of Herbalife’s recent financial statements later in this article. I can be somewhat sceptical about claims made by magazines like this, as the journalists generally are not financially minded (or accountants) and therefore just see the numbers at their base level. However, it can be easy to hide the reality of a company deep within the financials of a business’ accounts.
Despite the supposed rocket-ship growth of Herbalife, in 1985 the California Attorney General sued the company for making false and exaggerated claims about the effectiveness of their products. Unlike previous negative claims, this one really hit Herbalife hard and led to 800 employees being laid off that year.
The lawsuit was soon settled (without admitting wrong doing – which is a key factor), and the following year Herbalife went public on the stock exchange! This led to Herbalife being known as “Herbalife International”. Despite the IPO, Herbalife posted a $3 million loss in 1986.
By the late 80s, Herbalife was well on their way to becoming an international juggernaught – with reach expanding to Europe, Asia, and South America. This led to worldwide sales increasing to $191 million in the early 90’s. Growth continued during the 90s, and they even made a second share offering, and further increased their reach globally – now reaching 32 countries worldwide.
But all was not bright on the horison…
Death of Herbalife Founder
In 1999, Mark Hughes, the founder of Herbalife died from a suspected overdose combination of alcohol and doxepin (an anti-depressant). It was deemed to be an accident, and he was only 44 years old.
According to a report by the Los Angeles coroner at the time, the CEO of Herbalife International had been on a four-day alcohol fuelled binge prior to his death. From an investor standpoint, this doesn’t look good for a company which prides itself on promoting natural healing, health care and weight loss. He was also reportedly seeing a psychiatrist for his drinking problems, and smoked up to eight cigars a day.
The news of Hughes’ death caused Herbalife’s all time high share price of $16.25 to plummet to $9.
Life after Death
After Hughes’ death, things changed quite considerably for Herbalife:
- They were acquired by JG Whitney & Co and Golden Gate Capital in 2002 for $685 million, and returned to being a private company.
- US Banned substance “Ephedrine” was found in Herbalife products, and had to be removed
- 2004 Herbalife returned to being a Public company with another IPO – which led to the owners receiving $1.3 billion, compared to their $685m investment
- 2014, Herbalife came under investigation by the US trade commission
- 2016 Herbalife ordered to pay $200million to its distributions in a settlement by the Federal Trade Commission and agreed to change their business model
Is Herbalife a Pyramid Scheme?
What is a Pyramid Scheme?
Let’s start this off by describing the definition of a Pyramid scheme…
“A Pyramid Scheme is a business model which recruits members via a promise of payments or services for enrolling others into the scheme”
Herbalife’s Claimed Business Model
Herbalife claims to be a “Multi Level Marketing” business (or MLM). As a part of this claim, in 2016, Herbalife had to prove to the FTC that over 80% of their sales came from individuals outside of their distribution network.
In other words, they needed to show that they were actually selling products to people who used the products, as opposed to just making their “multi levels” of distributors buy their products, and making their profits from them.
Because of this investigation, Herbalife, since 2016, has had to have a third party monitor their practices to make sure they’re maintaining compliance.
The problem I see with these business models isn’t the model itself, but the fact that in order to maintain your “rank” you often need to meet certain criteria on an annual basis. This analysis from Herbalife comes every January. If you aren’t deemed to have met targets, you’re downgraded in February. This can lead to distributors buying up stock to make it seem as though they’re successful, therefore maintaining their rank. This is unhealthy, and has historically led to many individuals who are part of an “MLM” having tens of thousands of dollars of stock they cannot sell stuck in their garage.
Looking at the Herbalife Financial Statements of 2012, 88% of their distributors received no payments from Herbalife. This means that only 12% of people signed up to Herbalife made any money at all from the company. While I cannot see the specific statistics, I can see that of the 12% remaining, only 2.6% of them earnewd more than $2,216 compensation per year. This, to me, is just a stark reality of MLM companies. They promise the world, but in reality, only 2% of their distributors even make something reasonable. Even then, nobody is going to be able to life on $2,000 per year as a distributor.
How to Spot a Pyramid Scheme
Is Herbalife a Pyramid Scheme?
We’ve already noted that very few people who join Herbalife as a distributor will ever make any money. If they do, it is likely to be so little that they cannot support their family on the amount made.
The primary source of income for distributors is by recruiting other distributors and selling them products which they can sell. Effectively treating stock as though it is a hot-potato, and passing it down and down until some poor person at the bottom cannot find anyone to recruit and sell product to.
Admittedly, there are instances of selling product to individuals who are not distributors. However, Herbalife (and others) infamously have seen distributors use this method in order to maintain their rank and status within the company, as well as produce income for themselves.
Simply put, Herbalife’s incentive structure has a key focus on rewarding recruiting rather than the sale of products to retail customers. It lures in new distributores by promising easy and quick riches and living the entrepreneurial lifestyle. However, as we have seen, according to their 2012 financial reports, 88% of distributors do not make a single penny from their role.
Based on this, it is hard not to come to the conclusion that Herbalife is indeed a Pyramid scheme.
Herbalife Refute Being a Pyramid Scheme
They make many an argument as to the reasons they are not a Pyramid Scheme, but let me break down some counter-arguments:
Claim 1: Recruiting isn't the key to growth of Herbalife
Herbalife CEO Michael Johnson who was CEO between 2003 and 2007 states that “Recruiting is the fundemental part of the growth of this company” – “We’re still a recruiting company, and we’re never not going to be”.
Claim 2: We have a real product, it cannot be a Pyramid Scheme
By definition, Pyramid Schemes often have real products which they sell. The illegal business which doesn’t is often known as a ponzi-scheme.
Claim 3: We have lots of retail customers!
Herbalife has the ability to track and provide details of their retail customer base. However, they purposely avoid doing so. When asked for the detail here over the years, they have provided very different answers, or generally tried to avoid the question:
- May 1, 2012: “we don’t have visibility to that level of detail. . . . So, well, again, going back to our 70% rule, we believe that it’s that 70% or potentially in excess of that.”
- This seems a little vague? That 70% figure seems like a complete guess, and likely vastly inaccurate in reality
- May 2, 2012: “We don’t track this number and do not believe it is relevant to the business or investors.”
- This was filed to the SEC. I’m not sure how they can believe this figure is not relevant to the business or investors? Imagine Apple turning around and saying “Don’t worry, we’re doing REALLY well, we’ve made LOTS of retail sales. You want proof? Oh don’t worry, just trust us…we’re doing well, we don’t need those statistics.
- December 19, 2012: Percentage of sales to buyers outside Herbalife’s distributor network? “90% – Absolutely.”
- Statement made by CEO Michael Johnson. The same Michael Johnson who was heard in a distributor meeting stating that Herbalife’s focus is Recruiting Distributors…not retail sales. He later claimed that his quote was misstated.
Herbalife Bill Ackman Controversy
In 2012, Billionaire Hedge Fund manager Bill Ackman placed a bet (shorted the stock) that Herbalife share prices would plummet.
Ackman had claimed that Herbalife was a crooked Pyramid Scheme, and expected them to no longer exist in the future. At the time, when this was announced, the Herbalife share price dropped 20% in three days. However, it did eventually rebound.
Unfortunately for Ackman, a competing Hedge Fund manager Carl Icahn took the opposite view and bought up 26% of Herbalife, which caused the share price to rocket up.
Carl Icahn made almost $1 billion profit from his investment in Herbalife, meanwhile Ackman lost close to $1 billion from the gamble on Herbalife share price going down.
This doesn’t necessarily prove that Herbalife isn’t a Pyramid scheme. If your question is “Are Herbalife a legitimate business”, then the answer is yes. I have never claimed that most of these MLM companies are legitimate businesses. I do not agree with their practices and think that they prey on the naive and desperate in order to grow their business. However, the model does work to produce a profit for the owners at the end of the year. That is all Carl Icahn as an activist investor cares about. He saw a business which had the potential to make him money, and he bought shares. Unfortunately the sad reality here is that you’d likely make more money by investing in Herbalife than by selling their actual products and being a distributor.
Herbalife is a Cult
I’ve read stories of people claiming that Herbalife has some cult-like behaviour involved within their groups.
There are some official Herbalife songs, which are played without fail to begin the meetings and seminars. Which makes it feel like some sort of stereotypical brain wash cult that you would see in comedy films from the 80s/90s.
You apparently have to report to your “sponsor” each week to let them know what your progress was that week. Keeping a tally of your progress, including every person you had spoken to, every flyer you have given out and invitation you had provided. Apparently if these numbers didn’t match up to reality, you would be in trouble and ever aspect of your time as a Herbalife distributor is dissected and analysed.
u/doublecultsurvivor on reddit described their experience of working with Herbalife, which I found incredibly interesting. The crux of it is that it seems working for Herbalife isn’t as easy as they like to claim – easy riches it definitely isn’t.
Despite many of the products making them physically ill, the cult-like marketing of Herbalife meant that u/doublecultsurvivor persisted in using and selling the Herbalife brand.
She even mentions stories of the higher up members of Herbalife lying and ruining reputations of people who no longer wanted to be associated with the brand. It sounds somewhat like the stories you hear about Scientology!