Is a "direct-sales" method a pyramid scheme?
Is Amway a pyramid scheme? Are Girl Scout cookies a pyramid scheme? Is Herbalife? That's the question being asked as one prominent hedge fund targets Herbalife for its direct sales techniques. The investigation has spooked investors and halved the stock price.
But at its heart the question is solid: Direct sales--where a company sells a sales package to a consumer, who then sells the products to friends and neighbors--always look a bit fishy. The company's method places all the risk on their consumers and takes nearly all the profits themselves. But is this any different than any other franchising system?
Under a fast food franchise system a local owner pays rent to Fast Food Giant and buys her products solely from them. She accepts the risk. Does this make Quiznos or Subway pyramid schemes?
Or take the comic book direct market: DC and Marvel and Image sell to comic shops who assume nearly all the risk in this venture. Are comic books a pyramid scheme?
Fun fact: The Michael Johnson in this article is my uncle. We used to call him Uncle Monkey when we were kids.
At the center of the controversy is this: Herbalife sells nutritional supplements with a direct-selling method, by using a network of independent distributors. Those distributors then sell the products and make money with those sales, as well as getting commissions from other people they set up in the business.
Critics of Herbalife says that model really only rewards those on the top of the pile, while the people below get short shrift. But to counter that, Herbalife’s president says that 80% of the 100 top earners are people who make more than the distributors above them, calling the business a “meritocracy.”
Herbalife has worked that way for 32 years, and it claims it’s a “legitimate company, with legitimate customers.”
“Girl Scouts sell cookies on a direct-selling method, and nobody attacks them,” added CEO Michael O. Johnson.
The company’s executives set out to tell their side of things in an hours-long presentation to investors and analysts yesterday morning. In December, a hedge fund manager for Pershing Square Capital Management dubbed Herbalife a pyramid scheme and said he was betting against its stock.