Herbalife – The Upside Down Funnel

Overview

Herbalife is a global nutrition company that sells weight management, targeted nutrition, energy, sports & fitness, and other nutrition products.  Unlike a traditional consumer product company, Herbalife distributes its products through a global network of four million “members”. (1) In effect, it is a direct sales multi-level marketing program (MLM) in which members are compensated both for the sales that they generate and the sales that the people they recruit generate.  Herbalife’s business model, which is supposedly focused on sales of products to retail customers, is misaligned with its operating model, which drives sales within the Herbalife network and rewards members significantly more for recruiting new members than for retail sales.

Business Model

Herbalife’s business model is simple: develop nutrition products and sell as many of them as possible to retail consumers.  The company sells over 150 products which through variation total more than 5,000 SKUs. (1)

Secondarily, Herbalife’s goal is to create a sustainable income for its direct sales members (and therefore itself).

Operating Model

Herbalife members purchase product from the company at a 25-50% discount to retail price for either personal consumption or sale to retail customers.  If they sell the product directly to a retail customer at full price, then their profit is equal to their 25-50% discount. (2) Additionally, members are encouraged to recruit new members to sell on their behalf.  They are incentivized to do this because they can earn commissions on their recruits’ sales.  For example, if someone I recruit makes a sale, not only do they get that retail profit, but Herbalife will give me a cut of the money that my recruit paid them for the product. (2)

While initially this operating model would seem to be in alignment with Herbalife’s business model because it drives sales, those sales aren’t to retail customers.  As outlined in Pershing Square’s 2013 “Robin Hood in Reverse” presentation, in response to an inquiry about what percent of the company’s overall sales are to retail customers, Herbalife responded:

“We don’t track this number and do not believe it is relevant to the business.” (3)

One would think that if Herbalife’s members/distributors aren’t selling to retail customers then they wouldn’t be incentivized to stay in the program.  In fact, Herbalife members earn more than 10 times as much from Recruiting Rewards as they do by selling products to retail customers. (4)

So if Herbalife’s operating model isn’t set up to drive sales to retail customers, then surely it must create sustainable income for its members through commissions on sales to other members?

The economic reality is that 89% of members receive $0 in gross commissions. (4)

Conclusion

Herbalife is parading around as a retail nutrition company when in fact it is a recruitment firm.  Its business success is not predicated on selling its products to end consumers, but rather, continually recruiting new members to maintain or grow its captive base of consumers.  The company’s members are more incentivized to recruit than to sell and while recruiting by its very nature might increase sales, it is unsustainable.  Otherwise, Herbalife’s member network would eclipse the total world population.

Sources

(1) Herbalife 10-K http://edgar.sec.gov/Archives/edgar/data/1180262/000119312515065723/d827286d10k.htm#tx827286_13

(2) Who Wants to be a Millionaire – http://www.factsaboutherbalife.com/media/2013/01/Who-wants-to-be-a-Millionaire.pdf

(3) Robin Hood in Reverse – http://www.factsaboutherbalife.com/robin-hood-in-reverse/

(4) Vemma Comparison – http://www.factsaboutherbalife.com/media/2015/09/Vemma-Comparison-v11.pdf

 

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4 thoughts on “Herbalife – The Upside Down Funnel

  1. Given our interest in activist investors, nice choice for a company to research. But what about considering the argument that them “members” themselves are the end consumer? After all, if they are purchasing it at a discount, perhaps it is for personal use? I suspect Herbalife already books their profit the moment they sell to a “member”. I guess ultimately it depends on whether you believe they view their distributors as customers or middle men.

  2. This is very interesting. I agree with Rahul that it ultimately depends on who they view as their end consumers: members or retail consumers. If it is the former, and to your point in the last paragraph, they could be viewed as “stuffing the channel” and artificially increasing sales – this is why Ackman shorted it in the first place. Another interesting facet of the HLF model revolves around their physical store presence. I haven’t done a ton of research, but I have read about some pretty sketchy “storefronts” and “seminars” put on my HLF members. Thanks for the post!

  3. You have to be an active distributor to understand the Herbalife marketing plan. In Herbalife you do not get anything for signing a new distributor, not even 1 volume point (if you know how international MLMs work you will know what a VP is). We do sell to retail customers at RSP and get the 25-50% profit. As a member you get 25-50% discount depending on your level in the marketing plan (all MLMs do). Some people sign as members so as to get the 25% discount on their products. These people do not get any commissions from the company. Dan sounds like someone who does not have a clue what multi-level marketing is.

  4. Yes, distributors are customers. In all MLMs.

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