Saturday, January 2, 2016

$HLF v. Vemma: Pyramid Scheme Analysis; Part 6 of 6

All parts are located here.  Part 6 is also given below.

Sales to Distributors for Personal Consumption

56.  It is possible that Herbalife distributors buy products for the purposes of personal consumption.  In BurnLounge, the 9th Circuit Court noted that distributors could be “ultimate users” for purposes of the Koscot test under a narrow set of circumstances; namely, if they purchased the products for personal consumption based on consumer demand, not primarily for the purpose of participating fully in the rewards under the compensation plan for the business opportunity.  I consider it unlikely that many distributors would qualify as “ultimate users” under BurnLounge given the criteria.

57.  Herbalife’s marketing materials specifically encourage distributors to purchase product to maintain eligibility for rewards and to use as samples in connection with recruitment, and Herbalife's compensation plan strongly encourages this behavior.  People who are interested in purchasing Herbalife's product for personal consumption (including junior distributors) can obtain it cheaper from alternative outlets (see discussion in para 42, above).  Junior distributors are not entitled to any product discounts that are not available to non-distributors, so purchasers have no incentive to become distributors simply to obtain product.  Any purchases by Herbalife distributors for the purposes of internal consumption are likely incidental to the main motivation of maintaining eligibility for rewards.

Data from Actual Operations

58.  The available evidence about how the Herbalife program works in practice comes from Herbalife’s Disclosure Statements from 2013 and 2014.  The information from these sources is consistent with my findings the Herbalife likely operates a pyramid scheme.

59.  The 2014 U.S. Disclosure Statement showed that most participants achieved poor results, as would be expected based on the theoretical models previously discussed.  The Statement shows that 89% of members received a gross compensation of $0 in 2014.

60.  The company assumes that all members who did not receive discount commissions were not interested in the business opportunity and has classified them as discount purchasers.  It seems far more likely, given Herbalife’s marketing and the above discussion of the incentive structure, that many, if not most, of these individuals were interested in the business opportunity but were unable to recruit.  In other words, they are best viewed as distributors who were unsuccessful in the business opportunity, but have been redefined by Herbalife as discount purchasers.

61.  According to page 16 of Pershing Square’s presentation Side-by-Side: A Comparison of Vemma and Herbalife,

The bottom 94% of Herbalife’s U.S. Sales Leaders earned less than $2245 in 2013.
The bottom 83% of Herbalife’s U.S. Sales Leaders earned less than $303 in 2013.
The bottom 49% of Herbalife’s U.S. Sales Leaders earned less than $1 in 2013.

62.  As discussed in paragraph 18, above, pyramid schemes are often characterized by a constant churning of the base, as unsuccessful participants at the lowest level drop out and are replaced by new recruits.  According to page 25 of Herbalife’s 2005 annual report, the last time this disclosure was made, approximately 60% of the supervisors did not requalify and more than 90% of the distributors turned over.  Massive churn indicates that the vast majority of participants cannot make sufficient retail profits and only massive recruiting keeps the scheme going.

63. thru 66. - Paragraphs 63 thru 66 in the Declaration of Stacie A. Bosley Ph.D. are idiosyncratic to Vemma and do not apply to Herbalife.


67.  The Koscot test analysis is critical to the determination of a pyramid scheme, set within a marketing program with multilevel compensation.  The fundamental question, as articulated in the second prong of the Koscot test, is whether participant compensation plans grant participants the right to obtain recruitment rewards that are unrelated to ultimate users.  It is my judgment that Herbalife’s marketing program and business model meets this necessary component of a pyramid scheme and is likely to lead to widespread participant losses.  All forms of compensation are driven by recruitment or purchase volume and there is no direct connection between this compensation and retail sales or market demand.  This structure incentivizes participants to purchase product for the purposes of maintaining eligibility for recruitment rewards (inventory loading) and to encourage their “downlines” to do the same.  Company representatives continue to stress the importance of reaching and maintaining Supervisor level (or higher), and recruiting others to do the same.  Premium pricing and alternative retail outlets undermine Distributor’s ability to resell products or induce others to purchase product directly from Herbalife for personal consumption.  Company safeguards appear insufficient to ensure a minimum level of retail activity and prevent inventory loading.

68.  The anticipated result of Herbalife’s program is an endless recruitment chain, with strong emphasis on recruitment over sales to ultimate users.  At any moment that the scheme is analyzed, analysis indicates that the vast majority will be in a loss position.  U.S. disclosures corroborates these conclusions.  Internal data from Herbalife would provide additional detail on how the program operates in practice and would assist in calculating the scale of consumer injury, but I am confident it would confirm my judgement that Herbalife is a pyramid scheme.


  1. This part of paragraph 57 is wrong as it relates to Herbalife: "Junior distributors are not entitled to any product discounts that are not available to non-distributors, so purchasers have no incentive to become distributors simply to obtain product." At the lowest level of purchase, Herbalife distributors get a 25% discount, and if they buy more, on the order of several thousands of dollars, they can get up to a 50% discount. Non-distributors officially do not get a discount, but many distributors give them one, just so they can get some of their money back. For example, a 25% discount customer may be able to sell products for 50% off the full price, so instead of losing $75 on a full priced $100 purchase, they only lose $25 ($75 purchase cost minus $50 customer purchase equals $25 lost).

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  3. Regarding paragraph 60, Herbalife does not reclassify people in their database, but they conducted surveys which indicate most people (73%) joined for the discounts. However, Herbalife refused to publish the basis of the surveys (exact questions, number of people surveyed, multiple reasons for joining, raw data from the survey, etc.), which make the surveys very suspect. In fact, Herbalife has gone on record previously saying most people join Herbalife to make money, making the "I only joined for the discount" reason BS. I suspect many people joined for multiple reasons, such as to get the discount AND to make money. Also, the marketing plan emphasizes making money, not getting a discount, so it is doubtful most people would give this as their only reason for joining Herbalife. What Vemma did was change a person's status in their database from a distributor to a customer if they didn't buy certain large product orders with marketing materials (which many college students can't afford) or sponsor anybody (which is difficult given the high product prices). Since most people in MLMs are either too lazy to try very hard, chicken out after the initial purchase and/or get rejected at/near the beginning, or don't sponsor anybody even if they do put a little or a lot of effort into it, Vemma automatically reclassified them as customers after about 6-7 months to pump up their customer percentage.