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Network marketing is in the midst of a rapidly advancing Orwellian era. It’s been slow to develop, starting in 1996 when the Ninth Circuit Court of Appeals issued its decision in Webster v. Omnitrition, but it’s snowballed in the past two years. Today the snowball grew exponentially with the announcement that the Federal Trade Commission and Herbalife have reached a settlement agreement.
Watch for detailed updates and analysis on the settlement. We’ll break it down into many little pieces to determine how it will impact your business. But today we just have time for a broad sweep so I’m just going to address some critical topics.
The obvious first question is: “Does this settlement affect my business?” It’s certainly an important question. After all, the FTC was investigating Herbalife and analyzing Herbalife’s program, so why should it apply to any other company? The answer is two-fold. There’s the technically correct answer, and the real-world practical answer. The technically correct answer is that the FTC settlement with Herbalife has no binding impact on any other network marketing business. The real-world answer is quite different. The changes that Herbalife must implement offer a clear roadmap to the standards that the FTC expects all direct sellers to conform, and those are the standards that it will pursue in future cases against direct sellers.
There’s no law that requires direct selling companies to adhere to all of requirements in the Herbalife settlement. But those who stick their head in the sand and ignore the messages in the Herbalife settlement agreement do so at great peril. By now you’re certainly wondering what the settlement agreement requires. Here’s a high level summary of the most critical issues that will impact every network marketing program:
Note: See an overview of how this settlement affects network marketers, and watch out blog for detailed analysis and updates.
Herbalife International of America, Inc., Herbalife International, Inc., and Herbalife, Ltd. will restructure their U.S. multi-level marketing business operations and pay $200 million to compensate consumers to settle the FTC complaint that the Herbalife companies deceived consumers into believing they could earn substantial money their products.
The FTC complaint also charged that Herbalife’s compensation structure was unfair because it distributors were rewarded for recruiting others to join and purchase products in order to advance in the MLM program, as opposed to actual retail demand for the product, causing economic injury to many distributors.
I went to a Grateful Dead concert in 1976. The band was at the height of cool at the time as they represented the counter-culture movement from the Haight-Ashbury district of San Francisco. Although I had been to a number of concerts before seeing the Dead, this concert was different because it was the first (and to this day the only) concert where I witnessed security personnel hauling stoned audience members out throughout the show like it was a revolving door, and I saw medical personnel take at least six overdosed people out on stretchers.
This was obviously a common occurrence at Dead concerts. I vividly recall that right after their first number (Truckin’), Jerry Garcia (lead singer for those of you not old enough to have a touch of grey) announced “Hey people, have a great time, but don’t do any stupid sh**!” Such profound wisdom in such a simple statement!
I don’t think Jerry Garcia’s admonition resonated with the audience that night (shocking, right?), but it should resonate loudly with direct sellers. I look back on the FTC’s last four pyramid actions, Vemma, Fortune Hi-Tech, Burnlounge and Trek Alliance, and in each case we can point to stupid things that that landed the defendants in the FTC’s cross-hairs. We can (and will) closely analyze compensation plans, compliance and marketing nuances that the FTC charges render MLMs pyramid schemes. But there’s a place for analysis, and a place for common sense. Let’s put common sense first, because it’s unquestionably the first and best defense against finding your business in the line of regulatory fire.
Fortune Hi-Tech Marketing and additional defendants, settling claims by the Federal Trade Commission and three states that it operated an illegal pyramid scheme, have agreed to be banned from multilevel marketing and surrender at least $7.75 million in assets.
The surrendered assets will be used to compensate consumers enrolled in pyramid scheme. The original complaint, filed by the FTC and the states of Kentucky, Illinois and North Carolina, alleged that in addition to operating an illegal pyramid scheme and making false earnings claims, Fortune Hi-Tech Marketing provided consumers with false and misleading materials for recruiting new participants.
So your company has great products (or services). You’ve searched for the best of the best and you regularly lay out a significant chunk of change for R&D and inventory. You take great pride in what you offer and try to take the message to the sales force about the benefits of your products. To you, the benefits and value are obvious. But is this why your distributors buy the products? This seemingly simple question has considerable ramifications from both marketing and legal perspectives.
Unfortunately, the product message can be overwhelmed by the hoopla and hype surrounding the riches that will flow from being a distributor (I use the phrase “hoopla and hype,” but feel free to insert your favorite colorful phrase of choice!). If the real message is that one should purchase the products because they are the gateway to participating in the compensation plan, then what is actually being “sold” is the income opportunity rather than a bona fide product or service. The truth is, if people are really buying the products simply to access the compensation plan, you would be better off saving your money and selling “pixie dust” rather than spending a fortune on product development and inventory.
Of course, the reality is that most direct selling businesses offer high-quality merchandise that confers excellent consumer benefits. However, their compensation plans are designed so distributors’ monthly auto-ship orders satisfy distributors’ personal volume quotas, thereby keeping them “active” in the compensation plan for the month. Therefore, the products serve dual purposes by: (1) providing superior product benefits; and (2) protecting compensation plan qualification. But as indicated, the first of these benefits can become overwhelmed by the hype surrounding the compensation plan. If the real sales pitch is about earning riches, the product purchases are vulnerable to attack as “participation fees” incidental to earning compensation. The Federal Trade Commission expressed this position in its 2004 Staff Advisory Opinion – Pyramid Scheme Analysis by stating:
The critical question for the FTC is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture.
In the FTC’s recent case against Fortune Hi-Tech Marketing, Inc., the FTC argues that the defendant’s products were simply a proxy for participating in the company’s compensation plan. In the Commission’s Memorandum in Support of its Ex Parte Motion for a Temporary Restraining order with Asset Freeze, Appointment of a Receiver, Other Equitable Relief, and an Order to Show Cause Why a Preliminary Injunction Should Not Issue (wow – what a mouthful!!!), in reference to the defendant’s product and service package bundles, the FTC states: “It is very unlikely that representatives would ever purchase any of these products and services except to remain “qualified” for recruitment bonuses.”
This returns us to the original question: “Why are your distributors buying your products?” The answer of course, is that there are usually multiple reasons. History teaches us that distributors oftentimes focus on the money that can be made under a compensation plan as their primary recruiting and selling mechanism. If the product purchases are presented as the means to accessing or remaining active in the compensation plan, the FTC will use this as evidence that the product purchases are primarily participation fees and not bona fide product sales to end-user consumers.
If the FTC wants to bring an action against your company alleging it is a pyramid scheme, this analysis will form one of the cornerstones of its argument. The message to you as corporate executives is that you must ensure that the financial message does not become the principal selling point behind your products. Rather, the product features, benefits and/or value must be the primary reason why distributors buy your products. This of course leads back to offering products with great quality and value, and of course effective non-financial marketing techniques.
Spencer Reese will present on key legal elements for network marketers at the February 21-22 Direct Selling Symposium in Salt Lake City. Learn how to run your network marketing business legally and ethically.
Not a week goes by that I’m not asked by an MLM marketer if their plan is legal. Sometimes the question is slightly different (“Is my plan a pyramid?”), but those asking still expect an answer based on a review of their compensation plan as it is presented on paper.
This highlights the overwhelming misperception among network marketing executives that they have nothing to worry about so long as their compensation plan is not a pyramid. In fact, regulators rarely initiate actions based on the plan’s structure. In determing if a company is engaging in unfair or deceptive consumer practices, they look first at the conduct of the company and its sales force.
In the last decade all of the major FTC lawsuits against network marketing companies were initially instituted under the broad umbrella of deceptive trade practices.