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Is Avon Different From Herbalife?


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By Robert FitzPatrick :

Avon ( AVP ) has voluntarily joined the battle, aka the "fraud thesis," that has engulfed Herbalife ( HLF ) and, collaterally, other "multi-level marketing" -MLM- enterprises, such as Nu Skin ( NUS ) and Usana ( USNA ), devaluing their stocks and raising the specter of new government regulation. Avon entered this war zone by publicly resigning from the Direct Selling Association (DSA). Avon co-founded the DSA, the official voice and chief lobbyist of "direct selling." But today's DSA bears little resemblance to the DSA of Avon's history. It is now a cauldron of controversy, not credibility. It is dominated by enterprises like Herbalife and Nu Skin that never operated as conventional direct sellers. Avon appears to be distancing itself from the legally-challenged MLM-world of "unlimited" incomes, cult persuasion, and "infinite" downlines, the raw material of consumer complaints of "unfair and deceptive."

Is Avon really different from Herbalife? Or, is the public resignation from DSA another example of "re-direction" that MLMs are famous for, in this case to distract consumers and investors from looking closely at Avon , as they are now scrutinizing Herbalife and its DSA counterparts?

For those who don't connect the "fraud thesis" to Avon, it is important to know that the recent charges against Herbalife are only the latest chapter in a 3-decades long struggle by consumers against "multi-level marketing," the model Avon employs. The charge that MLM is inherently "unfair and deceptive" has roiled Main Street but, until recently, was blithely ignored by Wall Street. Without the official status of a consumer protection movement, the defensive war against MLM has been fought privately among friends, within families and at workplaces where MLMs insinuated and recruited; it flared in class action lawsuits in the 90s and 2000s and was publicly validated in SEC and FTC prosecutions stretching back to the mid-70s. Books were written. MLM exposé websites appeared. Some news media investigations were aired. Still, Wall Street ignored it. Then, in December 2012, Pershing Capital brought a megaphone to the controversy the likes of which had never been seen, a billion dollar short against Herbalife. This time Wall Street took note, and MLM gained new attention.

In October 2013, the International Coalition of Consumer Advocates , an informal network of academics, ex-regulators, writers, consumer-victims, consumer activists, whistle-blowers, and attorneys from various countries, published a comprehensive document making the case of pervasive MLM deception and unfairness and the need for the FTC to investigate and regulate "MLM."

Avon largely escaped this widening controversy. But no more. Seeing the advancing inquiries, Avon has broken ranks with hundreds of DSA-MLMs, including Herbalife and Amway, citing disagreements over the DSA's "code of ethics," supposedly the Book of Mormon for MLMs. Avon appears to be distancing itself on principles and issues that are the red meat of government regulation.

Avon Goes MLM

From my perspective as a consumer educator and advocate that has been studying and writing about multi-level marketing since the late 1990s, I can attest to the - previously - exalted and exempted status Avon occupied. During my early studies, I separated Avon from inquiries about MLM's fundamental deception. Avon's history as a true direct selling business long pre-dates the rise of MLM. Herbalife, on the other hand, hatched out of its egg as an MLM, as did Nu Skin and Usana.

But, in 2005, as its sales were lagging, investor unrest was mounting, and while MLMs were booming, Avon "went MLM," at least partially. As part of a broad turn-around strategy, Avon announced a new "Sales Leadership" program, described as " a multi-level compensation program which gives Representatives the opportunity to obtain earnings from commissions based on sales made by Representatives they have recruited and trained, as well as from their own…"

Within a few years, the hallmark MLM emphasis on financially rewarding salespeople to recruit still more salespeople, ad infinitum , was full blown at Avon. In the largest ad buy in Avon's history and delivered to the largest American television audience of the year, Avon's 2009 Super Bowl television commercial featured, not its cosmetics, but its MLM business opportunity . "To find out more about the "opportunity" the Avon ad advised, "contact an Avon representative."

In the midst of the Great Recession, while the cosmetics industry was contracting along with national job opportunities, and while Avon's own revenue was declining, Avon used the Super Bowl to claim it could solve consumers' income problems. Avon had truly entered the world of Amway, which for years had been claiming to offer "the greatest income opportunity in the world" that was "recession proof." That Amway "opportunity" turns out to be the opportunity to recruit recruiters who gain the opportunity to recruit recruiters, etc., with money flowing from last to first.

In a Q-1 2009 earnings press release , Avon CEO Andrea Jung who had masterminded the new MLM strategy announced, "We are also aggressively promoting our Representative earnings opportunity to a wider audience. The early strength of this new recruiting effort reflects the growing relevance of the Avon earnings opportunity." She reported an advertising expense of $78 million in the first quarter, " with a shift toward Representative recruitment advertising from product advertising. " In 2009, Avon also produced info-mercials to lure sales reps, aired on the Food Network, Hallmark, ABC and Lifetime.

From Retailing to Recruiting

Attracting little scrutiny or even notice from Wall Street, Avon appeared to have officially shifted from reliance on retail market-driven revenue to sales-rep recruiting. Analysts apparently saw no contradiction in Avon's adding new salespeople and selling them inventory, even while the overall market for Avon products was shrinking. A 2009 article in USA Today , chronicled the new Avon strategy, ""Right now, our direct-selling opportunity is really the No. 1 product that we have to sell," says Geralyn Breig, president of Avon North America. With that in mind, Avon this year launched its most ambitious recruitment campaign and saw its U.S. sales force grow to more than 680,000 through March, its largest ever, Breig says."

At the end of 2009 in its 10-K, Avon reported, " Total revenue for 2009 was negatively impacted by the continued recessionary pressure, as a lower average order received from Representatives more than offset an increase in Active Representatives… "

It's important to pause here and note that Avon announced to the world that its "No. 1 product" was no longer lipstick. It was an income opportunity . And, Avon candidly informed shareholders that it intended to compensate for losses from its old "No. 1 product," cosmetics, by selling more of its new "No. 1 product," a business opportunity, which involved advertising and marketing to consumers to become Avon salespeople . The strategy was helping, Avon reported, except that the new investors in the business opportunity were not buying or selling enough of the old #1, per capita, in response to Avon solicitations for the new #1. In 2009, the number of active representatives at the end of 2009 was 3% more in the USA than the year before while revenue was down 9%.

Wall Street apparently saw no problem with Avon's making up for lagging demand for its product by recruiting more salespeople. Imagine car companies announcing the selling of many new franchise dealerships during the Recession, and informing investors that more dealers will magically increase sales - despite the economy and car market. This is because every new dealer will buy some cars and maybe sell some too! In MLM the salespeople (dealers) can be counted on to buy the goods themselves as part of the "business opportunity." And, because the Avon "dealers" are independent contractors, whatever losses they might incur after investing in Avon's shrinking market are off Avon's books while the revenue they generate remains.

No special scrutiny followed, despite the fundamental shift and despite Avon's lack of experience in executing MLM. Most telling, no discussion at all occurred about the financial plight of hundreds of thousands of women who were recruited to "offset" the sagging market demand.

MLM Avon - Incompetent, Declining, but Legal and Ethical?

In an earlier Seeking Alpha article , I recounted some of Avon's business model history and addressed the increasingly obvious fact, that though Avon converted to the MLM faith in 2005 at a time of corporate crisis, Avon does not practice MLM religiously. It is lax and it is failing. The article described Avon's disastrous acquisition and then sell-off of the jewelry product MLM, Silpada. It noted Avon's ruinous experience in China, routed by Amway, which had cleverly obtained the endorsement of Harvard University to build credibility in China, while Avon faced disgrace in bribery charges. On top of all that, Avon's MLM sales force had declined overall since its 2005 adoption of the MLM recruiting model, though it did show a short spike at the deepest point of the Recession.

Now, Avon is publicly posturing that it is a model MLM company (better than unnamed others), even if its economic performance is flagging. Avon's DSA resignation letter plainly asserts that its version of the MLM model is legal and ethical, while implying others may not be. In particular it refers to its limit of three-levels of downline-based income in contrast to others that offer the illusion of "unlimited" income based on the myth of an "infinite" recruiting downline.

Herbalife Now, Avon Next?

So, given Herbalife's current crisis related to its MLM structure and practices, it is appropriate now to question whether Avon's MLM methods are substantively different and if so, how? With a withering attack being waged against Herbalife and other MLMs, Avon shareholders ought to ask whether Avon could be next.

The main claims against Herbalife include:

  • Unsustainable business model, existentially dependent on a constant infusion of capital from new recruits, rather than from sustainable market-based end-user sales (pyramid).
  • Deceptive income claims that lure unwitting consumers into a business that is not viable, without pyramid recruiting.
  • Harmful "business opportunity" solicitation campaign that benefits the company and top recruiters but results in virtually all others losing money.
  • Targeting minority populations and inflicting harm on the more vulnerable.

There are also charges regarding the use of cultism leading to greater losses to believers and orchestrating bogus affiliated schemes, e.g., sales leads and nutrition clubs, causing still greater losses to the participants.

Unethical Industry Code of Ethics

Citing loss of faith in the DSA "code of ethics," Avon's resignation indicates a major change of mind. In joining with fellow members of the DSA to oppose the FTC's plan to require more disclosures from MLM companies, Avon wrote to the FTC in 2006 , "Avon fully complies with the DSA Code of Ethics and will take appropriate measures if any Representative violates the DSA Code. The DSA Code provides a self-regulatory standard, higher than that required by law and of non-DSA member companies, and as such, it clearly and unequivocally distinguishes the DSA member companies."

In the 2014 resignation letter, Avon does not cite specifically why it now objects to the Code, though the Code has been challenged by others for its evasive definition of a pyramid scheme. In June 2013, I myself wrote directly to the DSA regarding the code's wording and meaning after the DSA cited the "code of ethics" to defend DSA member, Herbalife, against pyramid allegations. I referred specifically to the Code's Section 6, "Pyramid Schemes," which reads:

For the purpose of this Code, pyramid or endless chain schemes shall be considered consumer transactions actionable under this Code. The Code Administrator shall determine whether such pyramid or endless chain schemes constitute a violation of this Code in accordance with applicable federal, state and/or local law or regulation.

In other words, the DSA does not, apparently, define a pyramid or endless chain scheme, as an inherently unfair and deceptive trade practice but merely a "consumer transaction" of which the DSA's internal "Code Administrator" would judge its legality.

At the time of my writing in 2013, the code also further elaborated on the definition of a pyramid scheme this way:

"The definition of an "illegal pyramid" is based upon existing standards of law as reflected in In the matter of Amway, 93 FTC 618 (1979) and the anti-pyramid laws of Kentucky, Louisiana, Montana, Oklahoma, and Texas. In accordance with these laws, member companies shall remunerate direct sellers primarily on the basis of sales of products, including services, purchased by any person for actual use or consumption. Such remuneration may include compensation based on sales to individual direct sellers for their own actual use or consumption."

I pointed out that, according to the Code, the DSA arbitrarily chooses which state laws its members need to comply with, notably five states that changed their laws to comply with the DSA lobbying. ( The DSA website's recently published version has deleted the names of the five states ). By extension, the Code condones or ignores violation of other states' laws, such as the "endless chain" statute of California, which is substantially different from and much stricter than the laws in the DSA-named states. Similarly, the Code ignores the definition of a pyramid scheme used by the Federal Trade Commission. Those state laws, federal court decisions and FTC prosecutions define retail sales as those sourced outside the closed recruitment chain.

(click to enlarge)

The Code adopts its own extra-legal definition of a pyramid scheme, contradicting some state laws and the definition of a pyramid scheme used by the FTC. Note the DSA's take on "where the money comes from" for recruiter rewards. DSA says it can come just from inside the chain, the closed network of new recruits. FTC says it must come from the open, external marketplace - end-users. Here's the definition the FTC used in its prosecution of the DSA member, Equinox.

"Pyramid scheme" means a sales scheme, Ponzi scheme, chain marketing scheme, or other marketing plan or program in which participants pay money or valuable consideration to the company in return for which they receive: (1) the right to sell a product or service; and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of products or services to ultimate users. For the purposes of this definition, "sale of products or services to ultimate users" does not include sales to other participants or recruits in the multi-level marketing program or to participants' own accounts.

Avon's decision to leave the DSA on ethics grounds and to nail its complaints on DSA's front door might have been affected by this conflict between the DSA and the FTC about the very meaning and definition of a pyramid scheme. It might also have been driven by several DSA member companies such as Trek Alliance and Equinox being prosecuted as pyramid frauds by the FTC. The action against the Code might be explained by the DSA-member MLM, Your Travel Biz.com, (YTB) having been prosecuted as a "gigantic pyramid scheme" by the California AG , under that state's anti-"endless chain" statute, which the DSA Code did not include.

Or it might also be related to the recent winner of the DSA "Partnership Award," attorney Kevin Grimes, who was awarded by the DSA for his work in advising and defending DSA members and other multi-level marketing companies against the FTC. Grimes and his law firm are now being sued by a federal court-appointed Receiver for their publicized support of Zeek Rewards , which was shut down by the SEC as a large-scale Ponzi scheme.

DSA's "ethics code" may be a hypocritical sham - its wording and the actions of some DSA members show that it is - yet the question remains whether Avon itself operates at a higher standard.

Disclosures, Transparency and Due Diligence.

The DSA Code includes a requirement that earnings representations be based on a substantiated record. What about Avon's disclosures?

For the consumer or the shareholder who might want to know the historical income averages of the millions of women who have invested in Avon's Business Opportunity, here is all they have available in the public record, and this is not readily found on the Avon website,

" The 2013 Earnings of a typical Avon Leadership Representative after one year, including commissions, bonuses and profit on personal sales are: 48% earn $0-$7,999, 11% earn $8,000-$9,999, 19.2% earn $10,000-$14,999, 16.5% earn $15,000-$29,999, 5.4% earn $30,000 and above."

Does this meet the standard of a representations based on a substantiated record? Note that it does not offer a median or a mean average, but only a wide range such as 0 to about $7,999. How many earned zero? Note also that it limits the data to those "after one year." What about all those who did not last a full year? At Herbalife, that group constituted 80% of the entire sales force, according to its 2005 10-K.

The most glaring omission is the one that ignited the Herbalife bonfire. Avon offers no data at all on the income of the non-Leaders , the great majority of the sales force. How much are they making, on average? How long do they remain with Avon, on average? How much do they buy and how much of what they do buy is ever retailed? These questions are central to the Herbalife fraud thesis. No one from the financial community has yet raised them with Avon.

Payment Concentration/Money Transfer

Other telling omissions are breakouts of payment averages for each of the four "Leadership" levels. At Herbalife, this information is disclosed and its shows that 66% of all commission payments was transferred to the top 1% of the Leaders. This concentration is one key factor that makes profitable income for the bottom 99% virtually impossible. At Nu Skin, it's 82%! How much are Avon's payments to "Leaders" concentrated at the top? And, how long does the average Leaders remain with Avon, on average? At Herbalife over half disappear within a year. Without this information, how do shareholders assess Avon's success at selling what it now calls its "No. 1 product"? How does Avon verify it is offering an economic benefit to the millions of women it is soliciting to invest?

Churning and Saturation

For Wall Street investors and prospective consumer investors in Avon's "business opportunity," a crucial factor of consideration is saturation/churn rates. How many consumers - cumulatively - have already been enrolled, the key factor affecting future recruiting potential?

It turns out that, for providing recruiting and other channel information to shareholders and consumers, Avon is less forthcoming than some MLMs are that are under the gun right now for secrecy, opaqueness or obfuscation. Avon's omissions may or may not indicate ethics or legality violations, but they clearly inhibit due diligence for shareholders and consumers, and they raise the prospect that a day of reckoning for more disclosure by Avon is approaching.

Recruiters and Reps

Herbalife first found itself in the spotlight when it was pointed out that it had ceased disclosing the sectors of its "non-Leaders" according to their sales orientation - discount buyer, small retailer, or potential Supervisor. It had also stopped disclosing the "turnover" rate of its non-Leaders, last reported in 2005 at 90%.

Avon, on the other hand, has never disclosed the relative sizes of its Leadership (recruiter) sectors and its non-Leaders (non-recruiting Sales Representatives). It has never disclosed how much of total revenue each of the two sectors, the Recruiters and the Reps, accounts for. It has never revealed how much is "self-consumed" and how much is retailed, the questions that are causing Herbalife's very legality and future existence to be challenged.

Avon has even stopped disclosing how large its USA sales force is. The last hard number disclosed of end-of-year "active" distributors in the USA was in the 2008 10-K. After that, Avon only offered a percentage of annual "change," positive or negative, from the year before, for "North America" without providing an actual number. Using earlier disclosures of the USA sales force and then computing the percentages of increases or decreases, in the eight years since Avon converted to MLM, North American revenue has dropped 43% while its USA sales force has declined 24%. The data seem to show Avon's strategy of offsetting market-based decline with intensified recruiting has been effective. If recruiting had dropped as much as revenue has, the losses would have likely been much greater. Good for Avon, but what about the countless sales Reps that were churned during those years?

Income Opportunity, or Not?

The question facing Herbalife is what about the economic fate of those consumers investing in its "business opportunity"? Is Herbalife profiting at their expense? The same question can be posed to Avon regarding consumers it is using as "offsets" to lagging demand. Did they join with enough information to make a valid investment decision? Was the business proposition fair? Was income deception employed to bring them in? And, once they are in, does the compensation plan give them a fighting chance? How many have ever made a net profit? Most important, how many were recruited in total during those last 8 years and how many quit?

Astute readers may have noticed that the 2009 total of active Avon distributors is 471,000, but Geralyn Breig, president of Avon North America at that time, told USA Today that Avon's U.S. sales force grew to more than 680,000 through March of that year. How to account for the huge discrepancy? It may be that Ms. Breig (who no longer works for Avon) was counting all recruits, those active and non-active, or did 207,000 quit or get terminated by year-end? The wide variance reveals how important full disclosure about recruiting figures is, if selling the "business opportunity" really is the "No. 1 product." The market for Avon sales reps is clearly more limited than the market for cosmetics is, and if millions of women already tried and failed at Avon's "business opportunity," the market is further diminished for each new recruit.

Endless Chains and Exponential Expansion

Avon has touted its three-level downline plan, as a beacon of legality and ethics, however, unlike Herbalife's, Avon's plan has not been subjected to a close review. A few points are worth considering for both consumers and shareholders.

Avon's Policies and Procedures shows payment bonus overrides based on purchases and sales of a maximum of three generations of recruits and the plan offers escalating rewards to four levels of ascending Leadership roles, Senior Executive Unit Leader, Executive Unit Leaders, Advance Unit Leaders, Unit Leaders. Below those four levels are the non-Leader Representatives who are single-level direct sellers.

The depth of each new recruit's personal downline may be limited, as Avon has publicized, but Avon's sales chain is unbounded by time or physical space. Each new "Leader" is always authorized and incentivized to extend the chain, forever . Avon's sales chain is endless . The Policies and Procedures explains that each new "Leader" is authorized to extend the chain without regard for diminishing markets, the number of existing or previous Representatives in any area. Avon itself sits at the absolute top of a chain that never stops "extending." Every dollar from the "last ones in" flows directly to Avon.

Does the latest recruit really have the same chance as those from the start? Does the market "opportunity" never diminish no matter how many Representative join up?

Recruitment-Driven

Without study, Avon's three-level structure would seem to mean that a Leader (only Leaders can recruit) can recruit another Leader (1st generation) who recruits another one (2nd generation) who recruits one more (3rd generation). That's the end of the "downline," for the first recruiter who gains overrides on sales and purchases of all those three levels of recruits below her - a linear and limited plan, simple and straightforward.

There are a few catches, however, and some multiplying factors. To become a Leader requires an additional payment to Avon, approximately $60. But, crucially, no Leaders in the above example earn anything at all from any other Leaders until they themselves have recruited 5 Representatives each. Each one has a maximum of six months to find her five. If the five are not found, the Leader status and any recruits the Leader did succeed in getting are taken away. From Avon's Policies and Procedures : "If a new Leadership Representative has less than 5 recruits after the first 13 campaigns, she will be removed from the Leadership Opportunity and will lose her Downline."

After the five are established, they must be maintained - every two weeks , which is the duration of a "campaign," - along with several hundred in personal sales and over a thousand in group sales. To ascend the Leadership ladder involves escalating recruiting requirements including recruiting others who must themselves meet recruiting requirements. If status is lost, benefits flow up the chain. Avon has touted the feature that each level must maintain personal sales quotas. Those sales requirements are additional to recruiting quotas.

To get a sense of the recruiting-push injected into the three-generation system, a Senior Executive Leader must have recruited at least 20 active Representatives . Nine of them must be Unit Leaders, meaning they each have at least 5 active recruits in their own downlines. Of the nine Unit Leaders, 2 must be Executive Leaders, who each must have 20 active recruits enrolled , seven of whom must be Unit Leaders who must each have at least 5 active recruits .

So, while Avon's plan appears linear and limited, in reality it is explosively "leveraged" (5x5x5, etc.). Some of Avon's success stories are Leaders with thousands of recruits in their downlines. How many others could actually duplicate this?

All new Avon Representatives are encouraged to invest in the recruiting program as soon as they sign up as Leaders, putting them on a treadmill of recruiting, yet, these consumer investments of time, money and social capital, which always accrue to Avon, enjoy no legal protection. As noted, failure to gain or to maintain the required recruits in the required time frames can lead to total loss with accrued equity transferred to the upper levels. The entire distributorship itself is not protected by territory. Accumulated good will, no matter how long it has been developed, has no legal protection. As the Avon Sales Rep Contract explains, "Either party may terminate this Contract, with or without cause, at any time . "

Fairness, Deception and Minorities

Though the potential for income as an Avon Leader is "exponential," just as it is in all other MLMs, unless some historical data are disclosed on "churn" rates, the potential "expansion" opportunity could be illusory. Currently the vital factors of market limits and saturation, historical success rates of Representatives or current average incomes remain undisclosed and unavailable also to shareholders.

Herbalife holds itself out as an advocate for the Latino community , which is now over 60% of Herbalife's sales force in the USA. Avon publicly claims to be an advocate for women . Avon calls itself " the company for women." Women are likely near 100% of Avon's sales force. On its website Avon tells of the Avon Foundation for Women , a global philanthropy focused on breast cancer research and domestic and gender violence.

Author and market researcher Christine Richard spent a year or more examining Herbalife's claim to economically develop the Latino community with Herbalife "nutrition clubs." She found Herbalife's economic program for Latinos to be a financial trap . Aggregate hard data on Herbalife compensation show a 99% loss rate. Meanwhile, Herbalife engages in much publicized charitable giving in the Latino community.

Without diminishing Avon's charity programs, the time may be near when Avon is asked to account for its economic development claims regarding women . How many women have gained financially? How many have lost? Does the business opportunity offer a viable income opportunity, based on sales, not just recruiting of recruiters? Is there data beyond selected "testimonials" that could answer those questions?

Shareholders may one day ring Avon's doorbell to ask for the same kinds of disclosures that Herbalife is now under pressure to produce. Women may also ask Avon, not for charity donations, but for a net accounting of their own investments in Avon's MLM "business opportunity."

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

See also Medical Marijuana Inc's Stock Price Benefits From A $60M Mistake In A Yahoo Blog on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.





This article appears in: Investing , Stocks
Referenced Symbols: AVP , HLF , NUS , USNA



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