According to Herbalife Ltd. executives, the firm is many things: a healthy food and nutrition company, a home for industry-leading dietary supplement expertise, and a business opportunity for millions of people worldwide.

But one thing the multilevel marketer is not, company leaders assert, is a pyramid scheme. President Des Walsh and other executives talked about Herbalife’s past, present and future during a media event June 25-26 at the firm’s Los Angeles-area offices and manufacturing and distribution facilities.

Since January 2013, the firm has fended off accusations by investor William Ackman of Pershing Square Capital Management that Herbalife inflates reported retail sales made through its network of independent distributors.

Since Ackman revealed he was short-selling Herbalife stock, expecting its value eventually would drop to zero, other investors, including Carl Icahn, have bolstered confidence in Herbalife by purchasing stakes in the company Also see "In Brief" - Pink Sheet, 18 February, 2013..

However, the firm is not out of the woods yet. Herbalife remains under investigation by the Securities and Exchange Commission and members of Congress have asked the Federal Trade Commission to look into whether the firm is operating a predatory pyramid scheme ([A#05130617008]).

Des Walsh

Photo courtesy of Herbalife

Walsh says Herbalife complies with all laws as well as the codes of conduct established by the Direct Selling Association, of which the firm is a member. Walsh added that while Ackman made no effort to visit or get to know Herbalife before attacking its business model, Icahn did his homework before taking an approximately 13% stake in the company.

Further, Herbalife claims its ongoing investments in manufacturing capacity and quality control – including its planned flagship manufacturing plant in Winston-Salem, N.C., slated to begin operations in mid-2014 – belie Ackman’s assertion that the firm books more revenue from recruiting distributors than selling product.

“If we weren’t a product-focused company, why on earth would we have bought this facility and be about to invest over $100 million in creating a state-of-the-art product facility?” Walsh said. “It defies logic. Because if you’re not a legitimate company, you basically third-party everything.”

The executive also pointed to the company’s experience in smaller markets such as Denmark, Iceland and Ireland, where Herbalife has operated for more than a decade and realized high levels of market penetration.

“If we were not a legitimate company, everybody would know about it,” Walsh said. “If it were purely about stuffing the channel, believe me, there wouldn’t be enough garages in those small countries to fill with the product that we’re shipping.”

Distributors Inspire Customers

Though Herbalife is diversifying its product portfolio, more than 63% of its product sales come from weight-management products. And the company asserts that the multilevel marketing model is the most effective means of compelling people to change their lifestyles and lose weight.

The company relies upon more than 3.2 million distributors across 88 countries to be evangelists about Herbalife’s Formula 1 nutritional shakes and other weight-management products. But the sticking power for consumers, many of whom become distributors themselves, comes from activities available through distributor-established nutrition clubs that offer fitness camps, yoga classes and weight-loss challenges.

Herbalife says Euromonitor data show Formula 1 has about one-third of the worldwide meal-replacement shake category. Though Herbalife amplifies its brand equity through professional sports team and athlete sponsorships, it is careful to keep its corporate brand in the background when it comes to product sales, so as not to undercut distributors.

For example, Cody Morrow, a 29-year veteran Herbalife independent distributor, operates Simply Nutrition, an Irvine, Calif.-based nutrition club that serves as a base of operations for wellness coaching and nutrition classes. The club stocks Herbalife shakes, aloe drinks and other products for enrolled members – not for retail sales – but there is no external Herbalife signage at the club or Herbalife branding on its website.

Morrow said marketing Simply Nutrition as an Herbalife outlet would “degrade the network” of distributors and violate Herbalife’s distributor guidelines. If consumers believed they could simply purchase Herbalife products from any distribution location, rather than from the specific distributor who recruited them, the social component of weight management and wellness activities also would be undermined, Morrow added.

Vasilios “Bill” Frankos, Herbalife’s senior VP of global product science, safety and compliance, said the nutrition clubs’ holistic and social approach toward weight loss “offers something you can’t put in a bottle.”

Frankos says that, unlike FDA’s thus far unsuccessful attempts to publicize healthy diets and food options in the face of climbing obesity rates, Herbalife actually is motivating people to replace fast food meals with nutritional shakes and supplements.

“We’re not selling a magic pill. Moving away from the ‘magic pill’ is something the dietary supplement industry has had to deal with,” said Frankos, who joined Herbalife in 2010 from FDA, where he was director of the Division of Dietary Supplement Programs Also see "Herbalife's Frankos Sees GMP Challenges In New Light After Leaving FDA" - Pink Sheet, 19 July, 2010..

The social component that drives consumption of its products has helped Herbalife increase distributor retention rates from about 30% to more than 50% in the past eight years, and toward the company’s goal of 70%, Walsh said.

The communal aspects of nutrition clubs go hand-in-hand with the daily consumption model that now accounts for between 34% and 41% of Herbalife’s business, and has enabled the firm to pick up customers who could not otherwise afford to buy a monthly supply of product Also see "Herbalife Rides Daily Consumption To Q2 Earnings Jump, Revised Guidance" - Pink Sheet, 9 August, 2010..

The company has reaped the financial rewards of adopting this business model in recent years, and reported 2013 first-quarter sales growth of 16.5% to $1.12 billion ([A#05130506006]).

Clarifying The Business Model

Walsh maintains Herbalife is selling only about $1 worth of product per person annually across its current markets – about 6 billion people in all – so the firm sees plenty of room for further growth.

But in light of the reputational and stock price damage inflicted by Ackman’s accusations, Herbalife leaders “need to do a better job of educating people about our business model,” Walsh said.

“The reality is, if people knew the real Herbalife and knew the rationale for going to market in the way that we do, then I think there would be far less of a market reaction. The market reaction was an emotional response based on a lack of understanding.”

The company is implementing changes to make its business model clearer to investors and other stakeholders, including re-categorizing “distributors” who purchase Herbalife products for their own consumption. Additionally, analytics expert Monica Wood has been hired as Herbalife’s first VP of consumer and distributor insights, to help mine distributor data ([A#05130624008]).

Though the firm’s share price is down significantly from a high of about $72 per share set in April 2012, it has recovered from the drop associated with Ackman’s actions and closed at $46.39 on July 2.

Herbalife Pushes To Counter Pyramid Scheme Narrative

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