Multi-level marketing companies (MLM) offer a “business opportunity” that is really little more than a product-based pyramid scheme. They offer a product that looks viable, but in reality the whole purpose of the scheme is to recruit new distributors. Those distributors are brought in for the primary goal of recruiting more new distributors.Distributors are recruited with promises of unlimited income potential as well as financial freedom and the independence of being their own boss. While those are theoretically possible, the fact is that only a tiny, tiny fraction of all distributors will ever achieve such results. And those “results” are only achieved because massive numbers of distributors below those “successful” people have put money into the system (with almost no hope of ever turning a profit themselves).

MLMs are all largely the same. They have different products. They call their schemes different things (network marketing, dual marketing, direct sales, binary system, other flowery names meant to deflect attention away from the scams they truly are…). But the bottom line for each of these MLMs is that they depend upon massive recruitment of new distributors in order to replace those who leave the system. Distributors leave MLMs quickly and in large numbers because of the guaranteed failure of almost everyone in the system.

Barry Minkow and his Fraud Discovery Institute recently wrapped up an investigation of Usana Health Sciences and submitted the results to the Securities and Exchange Commission (SEC) and the Federal Bureau of Investigation (FBI). I worked with Barry and team on this investigation, with my role including analysis of SEC filings (financial statements and related discussions and notes), general research, and assistance in preparing and editing the final report.

The Wall Street Journal has reported on our investigation with their article Usana Sales Plan Draws Fire From Felon Turned Gumshoe. Excerpts from the WSJ article:

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But the Salt Lake City-based company’s unusual sales system is drawing a skeptical review from Barry Minkow, the convicted stock-fraud felon turned private investigator who has bought “put” options on Usana’s shares in a bet the price will fall. Usana traded yesterday at $58.77, down 24 cents, at 4 p.m. on the Nasdaq Stock Market and now has a market value of about $1 billion.

Mr. Minkow is no ordinary gumshoe. After serving jail time in the 1990s for stock fraud in the ZZZZ Best debacle, he became a Christian pastor, founded a San Diego company that hunts for other potential frauds and has won praise from the Federal Bureau of Investigation. He recently helped expose Pinnacle Development Partners, an Atlanta real-estate marketer whose founder has been indicted.

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Mr. Minkow says the company’s sales model is unsustainable because it requires the constant recruitment of new associates. Eventually, he argues, the company will run out of distributors, who will face long odds selling products or recruiting new disciples. Usana’s major product, a multivitamin, is far more expensive than rivals.As of the end of 2005, only 37% of Usana’s associates had ever earned a commission, according to the company’s latest figures. Among those who had been paid, the figures show, 87% didn’t earn enough to cover the $116 they have to purchase or refer each month to qualify for commissions.

Usana says this kind of analysis misses the point. “The inherent goal isn’t about coming in to, quote, break even,” says Fred Cooper, the company’s executive vice president of operations. Most associates are interested in purchasing the vitamins without commissions, Mr. Cooper says, and most distributors view what they can earn as a vitamin discount, not as a path to profits.

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In the past, the distinction between a pyramid scheme and a legitimate multilevel marketer has come down to a formula devised by the Federal Trade Commission.

That test looks at how much of sales are “retail,” or sold to end users. Applying the formula to Usana, the company would escape classification as a pyramid scheme if at least 63% of its sales were “retail.”

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Mr. Minkow has sent a critical 500-page report on Usana to the Securities and Exchange Commission and the FBI. According to people familiar with the matter, the FBI plans to question the company. Neither the SEC nor FBI would comment.

Our investigation found the following problems with Usana and the “business opportunity”:

• As with most MLMs, the products are overpriced because of the commissions that must be paid out to several levels. While MLMs often tout that they offer savings to consumers of their products by reduced advertising and distribution costs, the fact is that the multiple levels of commissions usually require the products to be priced unreasonably high. For example, WSJ pointed out that one of Usana’s most popular products has a suggested retail price of $40 for a 28-day supply. An equivalent product can be found at GNC for $17 for a 28-day supply. That makes Usana’s price 135% higher than the competitor’s product. (We actually did several of these comparisons, and Usana’s products, even at wholesale pricing, were much more expensive than comparable products available in stores and on the internet.)
• Massive failure rates of distributors are not disclosed. If potential distributors knew that their chance of actually turning a profit in the MLM was something less than 1%, do you think they’d ever sign up?
• The company’s reliance on constant recruiting of new distributors is not disclosed. Without a constant influx of new distributors, Usana’s sales would decline quickly because of the rapid turnover of distributors.
• Average “earnings”(commissions or incentives paid to distributors) are reported by Usana, but they fail to point out that the vast majority of commissions are paid to an extremely small fraction of distributors at the top of the pyramid. If those few hihgly paid distributors were removed from the equation, the average earnings for the remaining distributors (which include almost ALL of the company’s distributors) would be dramatically lower.

Our report is lengthy, and details the deception of both potential distributors and stock market investors. You see, Usana is a public company, and that means the company is required to make disclosures regarding material (i.e. important) facts of the company. Do you think it’s important for investors to know that Usana relies on the constant recruitment of new blood? Usana apparently doesn’t. Do you think it’s important for investors to know that almost all distributors will lose money? Usana apparently doesn’t.

The WSJ report illustrates one of the most telling points, attributing the following to Usana’s executive vice president of operations, Fred Cooper: “…most distributors view what they can earn as a vitamin discount, not as a path to profits.”

Really, Mr. Cooper? I thought you were selling a “business opportunity”???? Now you’re saying that most of your distributors don’t join the company for profits? Oh, and I believe we de-bunked your myth of the vitamin discount in the point above which pointed out how overpriced your vitamins are.