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Herbalife critics call company a pyramid scheme

A large banner of the Los Angeles Galaxy jersey with an Herbalife logo is spread on the field prior an MLS match on August 23, 2007 at the Home Depot Center in Carson, California.

The coming weeks could be crucial for Herbalife, one of America's fastest-growing companies. The nutrition-supplement powerhouse is facing allegations that its business model is really a get-rich-quick scheme. In just over three decades, Herbalife has gone from struggling startup to $5 billion in annual sales worldwide. So how has it rivaled some century-old mainstays?

Activist investor Bill Ackman's answer during a three-hour attack on the company last month sent the stock into a tailspin.

"Herbalife is a pyramid scheme," Ackman declared. He asked how a company that does virtually no advertising can sell so much of its "Formula 1" weight-loss powder. Its sales numbers come close to matching Oreos, Ackman points out, and outrank such household names as Palmolive and Clorox.

"You think about the dominance of those brands, it's remarkable," Ackman said. "The only $2 billion brand, we say, that nobody's ever heard of."

Ackman claims Herbalife makes its money from buyers at the top of what he calls a "pyramid," recruiting distributors who buy products and recruit more distributors, all in hopes of big rewards. CEO Michael Johnson -- who by some accounts was the highest-paid executive in America last year -- wasted no time delivering an angry response on CNBC.

"We're not a pyramid scheme," said Johnson. "That's a bogus accusation."

Herbalife's defensive stance has helped the stock recover some ground in recent days, says Jason Raznick, an analyst for the investor website Benzinga. The real test is likely to come January 10, when the company has promised answers at a conference for financial analysts. Raznick wouldn't be surprised to see the company sue.

"Herbalife makes money and has a lot of money to spend on lawyers," he says.

Ackman's "short" position in Herbalife shares could make a profit if the company tanks. The investment guru conceded that during his presentation last month.

"Herbalife stock goes down, we make money," he explained. "Herbalife stock goes up, we lose money."

Stephen Barrett tracks so-called multi-level marketing firms on his website, MLM Watch. He claims losing money is something that many of Herbalife's distributors are all too familiar with.

"The sad fact is that people who buy into this kind of opportunity have a very, very, very slim chance of making any significant income," Barrett says. "Most will lose money."

Ackman's online presentation includes a video clip of Herbalife's late founder, Mark Hughes, telling an early gathering of distributors they could get rich. His mantra: "Fake it, until you make it."

About the author

Bob Moon is Marketplace’s senior business correspondent, based in Los Angeles.

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