Saturday, February 28, 2015

An interpretation of the Herbalife result

The Herbalife result had three elements - two bad, one good.

The bad elements are

(a). That volume fell - and quite sharply - minus 6 percent, and

(b). There was an inventory build in the face of the volume fall.

The shorts have played these elements up - and combined they meant that the cash flow was sequentially far less good.

The good element (which the company played up) was

(c). distributor numbers and retention went up sharply.

In the past distributor numbers and volume have been very tightly correlated.

They are no longer tightly correlated.

Inevitably they will become correlated again - but the question is which direction. Will volume growth rise to match distributor growth or will distributors leave disillusioned?

On this the Herbalife debate will hinge. [The bears will argue the FTC will also be an issue - but I doubt that strongly.]

An interpretation of the results in the light of Herbalife corporate rule changes

The company implemented three core rule changes which were trialled first in Eastern Europe and which I have cross checked with some Eastern European distributors.

These are

i). Requiring that you qualify as a distributor slowly - ie there are no 4000 point success builder orders any more. Note that this rule change slows orders down.

ii). Requiring that the first qualification not be by "field sales" - you must buy from the company (note this slows orders down in Mexico and other countries for reasons that will be seen below).

iii). Requiring that if you sell via a website you do it under your distributor label (you get paid) on the site. A delivery is then made direct to the customer obviating the need for the distributor to hold any inventory - and hence allowing de-stocking of distributor inventory and thus slowing current sales.

Why these rule changes

There are several reasons they implemented these rules.

One reason is that if a distributor qualifies as say 4*$1000 orders she is more likely to stay around than a distributor qualifying by a single $4000 order. The upline can then focus training on distributors who are more likely to stick around. This means new distributors become more effective.

A second (and possibly more important reason) is that they are very good at fending off Ackman's complaints. Slowing initial orders is antithetical to inventory loading (and inventory loading a required component of declaring Herbalife a pyramid). More importantly the third rule change obviates the need for any distributor inventory - and is a complete protection against a claim that Herbalife is a pyramid.

A third reason is about control of the business - particularly in developing markets. For example, in Mexico the up-line distributors have built warehouses all over the country - there are three Chairmans Club members who own the warehouses. The Chairmans club members can distribute Herbalife to you same day anywhere in the country almost everywhere - even with crappy Mexican logistics.

This is good for Herbalife (as they get lots of sales) but they are a risk for Herbalife - in that the Chairman club members might defect to a competitor taking their warehouses, customers and downline with them.

To "own" the customers Herbalife wants distributors to qualify with sales direct from the company. They are banning "field sales" for qualification.

Moreover Herbalife is building its own warehouses over the country. As it does this its distributor warehouses are being (to a small extent) de-stocked and its own warehouses are being stocked. The de-stocking of distributor warehouse is a drain on current sales and the stocking of its own is a costly inventory build.

All of these things should (i) make Herbalife stronger and (ii) explain the falling sales, increasing inventory and simultaneously increasing distributor numbers.

And if this interpretation is correct Herbalife should come back growing volume with a vengeance.

This is a deferred growth story.



Anonymous said...

Maybe it's just as simple as:

NTRI was on huge run, growth went negative, stock imploded in 07-08.

WTW was up nicely, sales fell, stock has imploded in 2012 [and again].

HLF was on huge growth spurt, sales going negative, stock has imploded.

It's not even that cheap anymore. I mean, yes, cheaper than the market, but with negative growth that may last for quite some time and negative FX effects.

Kevin said...

Some good points here.

Just curious: Why is inventory loading necessary in order for it to be considered a pyramid scheme?

My reading of case law suggests that the key is whether or not the focus is on recruiting or product sales. If you are giving the product away for free, you won't have inventory (e.g, if you charge $5 for a pilates class and give away a shake, the shake is incidental to the business opportunity yet no inventory will build... or am I off here?). I don't see why that would have any bearing on whether or not it is a pyramid scheme.

I might be wrong here, I imagine HLF products are commoditized products. If so, there is little margin to be had on selling a commiditized product at a premium which is what distributors must do if they want to make $ from retail sales. This creates pressure to make deceptive claims, sell a biz opportunity or give something away for free (e.g., baby sitting, exercise classes, etc) in order to create that margin ... and this begs the question as to what the real "product" is that is being bought initially.

If the main objective is duplication as HLF's own materials suggest, then I would think that the ultimate goal is to recruit others to set up other clubs. Why else would they need Herbalife? If the main objective is not duplication, Why not just start a fitness or support club on their own, use a cheaper shake to give away and keep all the profits?

John Hempton said...

They LEGAL definition of a pyramid requires that purchases are not for consumption but incidental to the business opportunity.

If the purchases are by real end customers who want to consume it then it is legal. [End of story.]

Now if the purchases are by MEMBERS who self-consume the issue becomes whether they intend to self consume (ie they really purchased it to consume it) or whether they are stuck with it.

If all the sales are delivered to end customers - it is not a pyramid scheme - end of story.

If the sales are to distributors the courts have basically said unless you are stuck with it - it is not a pyramid. And for a GOODS MLM the test of stuck with it is a process of excess inventory. It requires inventory loading.


Tom Salvatore said...

You're getting warmer John. A huge risk in LatAm is that Herbalife doesn't control the business, they sell powder to the people who do. Herbalife doesn't control the warehouse/distribution (as you point out), the Top Recruiters do. Herbalife doesn't control the tradenames (Universidad del Exito and Club Cien), a distributor does. You are living in a dream world if you think these MLM Mafia cartels in LatAm are going to submit to U.S. regulation and/or restriction on their practices to a degree that it impacts their cash flow. Period. They are the Rain Makers, the Earners. They will wait for a while and see what happens with the U.S. Gov't. If bad, they will break away and align themselves (as free agents) with another "powder maker". OmniLife, for instance, is capable of becoming the "Intel Inside" the Club Cien or Universidad del Exito business. Omnilife pay plan is a copy of Herbalife. Formerly Omnitrition (the pyramid scheme), is owned by former top Herbalife distributor Jorge Vergara, recruited by Mark Hughes and John Peterson to open Mexico. But he broke off to start his own pyramid, and become a multi-billionaire, rather than pay Mark & John and deal with U.S. regulation.

Kevin said...

THanks for your response John.

If the focus is on what % of consumption is related to pursuing the biz opportunity, I agree with you... I assume there are a lot of people in the clubs who will likely not pursue the biz opportunity. Even Ackman's last presentation showed that in the clubs, potentially up to 2/3rds of the consumption was friends/family, etc (I'm going off of memory here). That said, I'm not sure what % of consumption is coming from the club model.

I was viewing this from the perspective of those who do pursue the business opportunity: the main ways to succeed might very well be by converting the "consumers" to distributors and then to club operators. You know the numbers better than me and have met plenty of club owners. Do you think most of them can succeed with one club while charging the standard $5 per visit or do they really need to induce the consumers to eventually climb the ladder until they operate their own clubs?

If the majority of consumption is coming from the clubs and the FTC focuses on end consumption solely in determining whether or not HLF is operating within the law, then I agree with you... as there is likely a legit retail sales/consumption component even if most consumers are there for the "support" and not the shake.

However, if they focus on whether or not the biz opportunity is legitimate and it turns out the only way to really succeed is via duplication, then the biz opp may not be legal. What would happen if the incentive to convert "consumers" to distributors to club operators didn't exist? How many of these clubs would continue to operate? (not a rhetorical q... I really don't know, but you've met with tons of them).

I also wonder from a legal standpoint if it matters that those who pay the $5 door fee aren't actually purchasing the "product" per se. The end product sales might technically be coming from those pursuing the business opportunity. Apologies if I'm off here.

Tex said...


The legal question is WHO is consuming the products, real external customers or the distributors. If little to no products are being sold to external customers, it's an illegal pyramid.

Anonymous said...

"Now if the purchases are by MEMBERS who self-consume the issue becomes whether they intend to self consume (ie they really purchased it to consume it) or whether they are stuck with it."

I believe that (A) virtually all of HLF's sales are to distributors for presumed self consumption and (B) virtually all of the sales referenced in (A) are in fact not for self consumption but rather to meet the qualification hurdles that HLF sets up to become a sales leader (i.e., to qualify for the business opportunity).

Thus, in my view, virtually none of HLF's sales are bona fide sales to end users for self-consumption. How do I know this is the case? Because no rational person would buy HLF product when there is a cheaper and better product available at the local GNC or health food store (or online). It simply makes no logical or financial sense to do so.

Anonymous said...

" The end product sales might technically be coming from those pursuing the business opportunity. "

Of course that's why they pay the $5 - for the business opportunity. There's no other rational reason. HLF sells hopes and dreams, not actual product. That's why the FTC will end up shutting them down (or, in not shutting them down totally, destroying their business model by mandating that they actually play by the rules of a legitimate MLM).

Mike said...

No one from GNC is going to call you three times a week to make sure you're taking your shakes, doing your exercise and ditching the junk food. No ones going to harass you for your weekly weight loss results. This is what HLF members pay a premium for. Who is anyone else to say that has no value.

Anonymous said...

"This is what HLF members pay a premium for."

Wrong - they pay a premium for the business opportunity. Bottom line, it's ALL about the business opportunity, nothing more and nothing less. The whole "healthy lifestyle" stuff they constantly spout is just spin, meant to hide that central fact. In other words, if not for the biz opp'y, HLF would not exist, b/c they wouldn't be able to compete in the marketplace. IMO that's why they will ultimately be shut down by the FTC.

Catalyst said...

So basically you're admitting that these changes are because they are trying to guard themselves against allegations of being a pyramid?

Why did they wait until now? How much of their prior growth was due to these deceptive strategies which promoted recruitment over all else?

Obviously these changes are already starting to have a big impact, and it'll only get worse for them. It doesn't take a genius to realize the selling point of this company is the business opportunity, not the shakes which are a commodity found in any grocery shop or online supplement stores for a better price.

Regardless of the share price, though I am short, I can't see any good coming from this company except for the benefit of the execs and those at the top of the pyramid. The sooner this is shut down the better for the general public.

Anonymous said...

The shift in Mexico is likely to be rocky. I don't see why the chairman's club members would be willing to give up control / cash flow. They should just sit by? Internet penetration is lower in mexico, and most sales are through nutrition clubs. So you have supervisors selling to a large public. How are these folks going to requalify? Inside sales has a more important role in a country with more limited infrastructure. I think I might be hopping off the long bus (and I was in at 29.60). . .

Anonymous said...

Why would the prohibition on using field sales for supervisor qualifications negatively affect nutrition club owners and their uplines, Anonymous? From the club owner's perspective, club customers are just reimbursing him (with a markup) for inventory that he bought directly from HLF. That is, inventory that counted toward his supervisor requal as PPV. The fact that most nutrition club customers aren't registered with HLF is immaterial. Is there something I'm missing here?

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