Fudan University presentation on MLM and pyramid schemes

7/26/2019 Fudan University presentation on MLM and pyramid schemes

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W I L L I A M W K E E P , P H D

P R E S E N T A T I O N F O R :

S C H O O L O F M A N A G E M E N T

F U D A N U N I V E R S I T Y

S H A N G H A I , C H I N A

Multilevel Marketing and IllegalPyramid Schemes: Current

Controversy and Historical Context


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AGENDA

1.

Motivation for Interest: Current News andRegulatory Action

2. Historical Thread: Traditional Direct Selling toMultilevel Marketing

3. Fraud Connection: Ponzi Schemes to PyramidSchemes

4. Confluence: Multilevel Marketing & PyramidSchemes

5. Critical Issues in the United States

6. Present Actions and Inactions

7. Conclusions and Questions


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Motivation for Interest

Nu SkinNu Skin and the short-sellers

Fortune October 26, 2012

Nu Skin fined more than $500,000 over Chinasales practices

Financial Times March 24, 2014

Skincare products maker Nu Skin settles classaction suit

Reuters Feb 26, 2016


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HerbalifeAckman Outlines Bet Against Herbalife

The New York Times December 20, 2012

Herbalife Discloses Civil Investigation by FTC

Bloomberg March 12, 2014

Herbalife Says FTC Settlement DiscussionsInclude Large Fine And Injunctive Relief

Forbes May 5, 2016


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AvonUS watchdog fines Avon $135m for China bribes

BBC December 18, 2014

Lackluster Avon Explores Makeover

The Wall Street Journal April 27, 2015

Avon Could File For Bankruptcy

MSN May 30, 2016


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Avon: Direct Selling Pioneer

!

Avon Products

!1886: California Perfume Company founded

!1914: First international office -- Montreal

!1920: Sales = $1M; 1926 sales = $2.2M

!1931: Named changed to Avon

!1946: Company goes public

!1967: Most profitable company in US (Forbes, 1968)

!1975: the worlds largest cosmetic and fragrancecompany (NYT, 1975)


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Direct Selling Expansion

!

Products: brushes, groceries, radios, sewingmachines, phonographs, musical instruments,vacuums, cosmetics, apparel, chinaware, cooking

utensils, books, televisions, furniture, automobiles! Mid-1920s: estimates of annual direct selling

ranged from $300 - $500 million

!

Fuller Brush Company (1906) reported sales in

1923 of $15M, dropped to $10.3M in 1929 in theface of increased competition

Source: Friedman, 2004


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Success and Concerns

!

1stwoman millionaire in U.S.: Madam C.J. Walker,African-American, entrepreneur (Peiss, 1998)! Hair treatments and cosmetics sold through a agent-operator

network to African-American women

! 1930s: 27 Eastern colleges - including Harvard,Dartmouth, Princeton, Yale, Williams, Brown,Columbia, and MIT - signed a statementdiscouraging the practice of door-to-doorsalesmen trading upon their college connections tomake sales (The New York Times, 1932)


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Industry Growth and Stagnation

!

1950-1963: Industry sales estimates vary from $1Bto $7B, one report claimed 5% of retail sales

!

Party Plan: Moves direct selling from door-to-doorto social events and workplace relationships

!

1970s-1980s: Industry sales estimates go from $6B

(1974) to $9B (1980) to $8.5B (1984)

! Mid-1980s brings industry-wide stagnation amongtraditional, single-level direct selling companies

Sources: Keep and Vander Nat, 2014


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Multilevel Marketing (MLM) Direct Selling

Multilevel Marketing Downlineand Compensation Structure

John

Commissions/Overrides / | \Level 1: (15%) Allan A2 A3

/ | \ |

Level 2: (10%) B1 B2 Bill B4. B9/

Level 3: (5%) C1 C2 C3, Cathy C26, C27



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The Rise of Multilevel Marketing

!

1945: Nutrilite multilevel marketing model (MLM)

! 1951: U.S. FDA injunction prohibiting 15,000door-to-door salesmen from making extravagant

therapeutic claims for Nutrilite (The New York Times, 1951)!

1956: Shaklee adopts MLM model

! 1959: Van Andel and DeVos found Amway

!

1980s-1990s: Sunrider, Herbalife, Advocare, NuSkin, Melaleuca, USANA, ACN, Mannatech, etc.



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1991-2014: Industry Size and Growth

0

2

4

6

8

10

12

14

16

18

20

0.0000

0.0020

0.0040

0.0060

0.0080

0.0100

0.0120

0.0140

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

U.S. Direct Selling Sales/Total Retail Sales;# Direct Selling Sales People;

Direct Selling Sales/Sales Person

Sales/US Retail (excludes automobile related sales) # Sales People (in millions) Sales/Sales Person (in thousands)


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Fraud Connection

!

1920: Charles Ponzi nets $5K in February frominvestment scheme ($59.8K in 2016), in May henets $420K ($5M in 2016)

!

November 1920: Ponzi pleads guilty to fraud!

March 2009: Bernie Madoff pleads guilty torunning massive Ponzi scheme over 20 years

! Chain Letter: send a certain amount of money--usually $5--to the person at the top of the list, andthen eliminate that name and add yours to thebottom (U.S. Postal Service)


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Basic Pyramid Scheme

Source: Wikipedia


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Multilevel Marketing & Pyramid Schemes

!

Pyramid salesthat work on the chain-letterprinciple, involving an ever increasing number ofparticipants are currently the number one

consumer fraud in the metropolitan area(NYT,1973)

! 1970s:Holiday Magic,Koscot, andDare to be Great

! Koscot (1975): participants pay money in return for

which they receive (1) the right to sell a product and (2)the right to receive in return for recruiting otherparticipants into the program rewards that are

unrelated to the sale of product to ultimate users


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Product-Based Pyramid Scheme

InvestmentPyramidScheme

Product-BasedPyramidScheme

Legal MultilevelMarketing(MLM)

Single-LevelDirect Selling

Wealth Transfer: Recruitment-

driven investmentsfund rewards to

current participants

Wealth Transfer:

Recruitment-driven fees and/or purchases fund

rewards tocurrent

participants

Recruiting and rewards for recruitment were integral to BurnLounges businessstructure, and there was ample evidence that Moguls were meant to be, and were,

primarily motivated by the opportunity to earn cash rewards for recruitment.


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An MLM Not A Pyramid Scheme

!

FTC v. Amway (1975-1979)!

150 witnesses

!

1,000 exhibits

!

7,000 pages! 4 years

!Amway found not to be a pyramid scheme

!Amway Safeguards

! 70% rule! 10 customer rule

!

Inventory Buy Back


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MLM Pyramid Schemes Actions Post-Amway

!

1996 - 2016: Equinox, Five Star Auto Club,Fortuna Alliance, Gold Unlimited, JewelWayInternational, International Heritage Inc.,

Webster v. Omnitrition, Fortune Hi-TechMarketing, BurnLounge, Vemma, etc.

! FTC actions since 1996: 24 pyramid scheme

complaints, 3 wins, 21 settlements (eachoperation dissolved)


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Multilevel Marketing & Pyramid Schemes

!

Modern pyramid schemes generally do notblatantly base commissions on the outrightpayment of fees, but instead try to disguise thesepayments to appear as if they are based on the sale

of goods or servicescommissions are funded bypurchases made to obtain the right to participate inthe scheme. (FTC, 2004)

!

FTC Fraud Survey Report 2004:

! # incidents 2.55M (1.2M 3.85M); Mean loss = $100! By far the least likely among victims of ten forms of

consumer fraud to complain


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BurnLounge Appellate Court

!

rewards BurnLounge paid were primarily forrecruitment

! when participants bought packages in part for internalconsumptionthe participants were the ultimate users

! rewards BurnLounge paid for package sales were not tiedto the consumer demand for the merchandise in thepackages

!

Quoting FTC expert: pyramid scheme is an organizationin which the participants obtain their monetary rewardsprimarily through enrolling new people into the programrather than selling goods and services to the public.


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Present Actions and Inactions

!

TruthinAdvertising.org documents complaints:! Consumer complaints on 60 MLM companies, including numerous

members of DSA (e.g., Vemma, Advocare, Jeunesse)

! https://www.truthinadvertising.org/tinas-list/

!

ESPN magazine expos of Advocare! Advocare spokesperson Drew Brees defends business model

! http://espn.go.com/espn/feature/story/_/id/14972197/questions-surround-advocare-nutrition-empire-endorsed-saints-qb-drew-brees

!

Herbalife:

! 2 year-old FTC investigation of continues! Ackman short position continues

! Questions regarding Distributor Earnings Statements

" Top Earners Persistence Opaque


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Present Actions and Inactions

!

H.R. 5230 introduced in House of Representative! Industry-sponsored bill removes need for direct selling

representative to sell outside distributor network

!Aggressive lobbying effort by DSA, Amway, Herbalife, Mary Kay

! Bill opposed by: National Consumer League, Consumer Action,Consumer Federation of America, Consumer Watchdog, U.S.

PIRG, and League of United Latin American Citizens


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Conclusion and Questions

!

Conclusions: Investor, media, and political interestin MLM industry and pyramid scheme problemhigher than in many years. Legislative action

possible. Presidential election may have impact(Trump associated with the MLM company ACN)

! Questions?


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Thank You!

Documents

Fudan University presentation on MLM and pyramid schemes