THE PENNSYLVANIA STATE UNIVERSITY

SCHREYER HONORS COLLEGE

DEPARTMENT OF FINANCE

A FINANCIAL AND STAKEHOLDER ANALYSIS OF MULTI-LEVEL MARKETING

COMPANIES

VICTORIA THACKER

FALL 2019

A thesis

submitted in partial fulfillment

of the requirements

for a baccalaureate degree

in Finance

with honors in Finance

Reviewed and approved* by the following:

Brian Davis

Professor of Finance

Thesis Supervisor and Honors Adviser

Scott Collins

Clinical Associate Professor of Accounting

Faculty Reader

* Signatures are on file in the Schreyer Honors College.

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ABSTRACT

This study explored the effect of multi-level marketing companies on three stakeholder

groups: owners of a multi-level marketing company, independent distributors of the company,

and customers, and evaluated multi-level marketing companies within the financial services

industry. In general, the study found that company owners benefit from the multi-level marketing

structure because of the elimination of risk, that independent distributors are harmed because of

unclear and misleading information, and that the effect on customers varies depending on the

type of products or services being sold. The study used the Northwestern Mutual Life Insurance

Company as a proxy for multi-level marketing companies in the financial services industry in a

case study, which found that Northwestern Mutual fulfilled all of the requirements of being a

multi-level marketing company, and that the effect of multi-level marketing companies in the

financial services industry cannot be determined by using Northwestern Mutual as a proxy,

because many different company structures exist within the financial services industry.

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TABLE OF CONTENTS

ACKNOWLEDGEMENTS ......................................................................................... iii

Chapter 1 Introduction ................................................................................................. 1

Chapter 2 Literature Review ........................................................................................ 9

Resources Advocating for Multi-Level Marketing Practices ............................... 9 Resources Advocating Against Multi-Level Marketing Practices ....................... 11

Chapter 3 Methodology ............................................................................................... 15

Chapter 4 Analysis of the Multi-Level Marketing Corporate Structure ...................... 20

Introduction to the Analysis .................................................................................. 20 Herbalife: A Multi-Level Marketing Giant .......................................................... 21 Mary Kay: Tried and True Multi-Level Marketing .............................................. 27 Northwestern Mutual: A Century-Old Provider with a Hidden Secret ................ 33

Chapter 5 Results and Implications ............................................................................. 44

Chapter 6 Conclusion ................................................................................................... 52

BIBLIOGRAPHY ........................................................................................................ 55

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ACKNOWLEDGEMENTS

I would to express my sincere gratitude to my thesis supervisor and honors advisor, Dr.

Brian Davis, for his constant support and guidance throughout the process of writing this thesis. I

would also like to thank my faculty reader, Dr. Scott Collins, for his immediate willingness to

help with the editing process.

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Chapter 1

Introduction

In 2012, billionaire hedge fund manager Bill Ackman of Pershing Square Capital

Management saw what he interpreted as a fantastic opportunity to make billions as well as bring

down one of the largest multi-level marketing firms in the world. That company is Herbalife, a

nutrition and supplements company based in Los Angeles. Herbalife bases its corporate structure

off recruiting mechanisms by independent distributors of Herbalife products who market their

businesses to other individuals who are interested in the self-paced nature of selling products.

Ackman took a billion-dollar short position in the company and went to great lengths to expose

the Herbalife as a pyramid scheme that was destined for failure.

As part of his study of Herbalife, Ackman investigated the company and interviewed

many current and former Herbalife independent distributors for his documentary “Betting on

Zero”, who discussed distributor experiences with the company (Betting on Zero). The main

topic and debate in the documentary surrounds Herbalife’s legitimacy as a company that has a

harmful multi-level marketing structure.

Understanding Multi-Level Marketing

Multi-level marketing companies are very common in today’s market, but there is a fine

line between a company with a multi-level marketing structure and a company that is a pyramid

scheme. In Ackman’s documentary, the Federal Trade Commission’s definition of a pyramid

scheme was cited, as stated by the Federal Trade Commission’s Senior Economist Peter Van

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Nat: “An organization is deemed to be a pyramid scheme if the participants obtain their

monetary benefits primarily from recruitment rather than the sale of goods and services to

customers.” Multi-level marketing, on the other hand, is defined as “a form of doing business

whereby a product or service is distributed through a multitiered structure. The structure is

referred to as a downline and, customarily, each person in the line receives some compensation

for downline sales. It is referred to as multi-level marketing, since each person can both sell

product or service and enlist down line distributors, who can establish their own sales and

distribution networks as well. The consumer who pays for the product or service is actually

providing a revenue stream that flows up through all distribution levels” (DuBoff, p. 286-287).

The sole difference between a pyramid scheme and a multi-level marketing company is that a

product or service is being sold through the pyramid distribution, which makes the company

legally profitable.

Becoming an Independent Distributor

To become an independent distributor of a multi-level marketing organization,

individuals must first connect with an existing independent distributor of the company, pay an

entry fee, and then purchase inventory to sell to customers. By connecting with the existing

independent distributor, the new recruit becomes part of that distributor’s network, or team, and

a portion of sales created by the recruit are awarded to the independent distributor who recruited

him or her, and to the distributor above the first, and so on. Distributors higher in the company

therefore get larger portions of sales and greater profit than those lower in the structure, which

gives incentive for lower level distributors to recruit others to rise in the structure. This is called

a downline.

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(tomliberman.com)

This graphic shows the hierarchy of both a multi-level marketing company and a pyramid

scheme. The single individual in Level 1 has recruited two distributors of his own, who have

each recruited two of their own, and so on. Those on the lower levels, for example Levels 1 and

2, receive more commissions from those on Levels 4 and 5, because a portion of the downline

commissions are given to the upline. Therefore, it is very difficult to succeed in a multi-level

marketing company if you are not recruited near the top of the pyramid.

Although Betting on Zero presented Bill Ackman’s case for betting against Herbalife,

there are some who advocate for the benefits of multi-level marketing companies. These

advocates argue that there is an unlimited earning potential for those who become involved in

multi-level marketing earlier in a company’s life. According to ItWorks!, a multi-level marketing

company selling weight loss and nutritional products, distributors can earn an income based on

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the work that they put into selling their products, and there is a direct correlation between their

efforts and their earnings, but there is no conclusive evidence of an average commission

structure or pay scale for multi-level marketing companies in general, as these companies tend to

be quite secretive about commissions.

In-depth research of resources on multi-level marketing companies, shows that most of

the advocates are the multi-level marketing companies’ websites themselves, or blogs with little

credibility. Scholarly sources on the benefits of multi-level marketing are in short supply, which

shows that there has not been a multitude of academic research on the multi-level marketing

structure, and the costs of such a structure are unknown on a wide scale (Betting on Zero).

Stakeholders Versus Shareholders

Determining the “value-adding” nature of multi-level marketing companies must

consider the changing viewpoints on the long-standing shareholder versus stakeholder debate.

Historically, companies have defined success as maximizing shareholder value. Shareholders

provide capital to companies as an investment and because they are rational economic actors,

they expect their investment to generate a positive return. Shareholders can select management,

so management is motivated to act in the shareholders’ best interest when making decisions.

Recently, the notion of corporate social responsibility has become quite a popular focus for

public companies, and an increased consideration of stakeholders has emerged. A stakeholder is

any party that can affect or be affected by the actions of a company, including shareholders,

employees, independent distributors, suppliers, and even the community in which a company

operates (Investopedia). The multi-level marketing structure is beneficial to shareholders because

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it shifts risk from the company to independent distributors, but since that risk is being transferred

to many individuals without much bargaining power or unification, there is the potential for

many adverse effects in different situations, which is why examining the value-adding nature of

the multi-level marketing structure is vital moving forward.

Evaluating the value-adding nature of multi-level marketing companies conclusively

requires an analysis of the structure of these companies through the accounting, financial, and

legal lenses, as these are the most pertinent to the value that shareholders and customers both

place on a firm.

Accounting Lens

Evaluating multi-level marketing companies through an accounting lens provides

intriguing insight into how these companies operate and how they are usually successful

according to their financial statements, despite an underlying pyramid structure. The most

prominent accounting insight is that since distributors of multi-level marketing companies are

not technically employees of the companies (thus why they are called distributors or independent

distributors), the inventory that the distributors purchase from the company to sell to customers

can be recorded as sales instead of inventory, even if the distributor has not yet sold the products

to customers (Taylor, Jon M.). For the company, this is a successful strategy because distributors

are required to purchase a certain amount of “inventory” to continue working with a multi-level

marketing company, and revenue from products is always high because distributors are required

to always hold a certain amount of inventory, which is appealing to shareholders. However, if for

whatever reason a distributor is unable to sell its products, such as a lack of demand for the

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product or the product expired, that distributor will take the loss instead of the company. And in

the case of companies who produce products with expiration dates, such as weight loss or

skincare products, distributors will need to monitor the viability of their products and purchase

more if products stay in their inventories longer than the expiry date. Ignoring ethical standards,

multi-level marketing companies both protect themselves from revenue losses and guarantee a

steady stream of sales revenue using this method (Betting on Zero).

Financial Lens

Although some high-profile investors like Bill Ackman believe that the underlying

structure of multi-level marketing companies predestines them to ultimately fail in the eyes of

shareholders, many multi-level marketing companies have had generally consistent growth in the

price of their shares, signifying shareholder confidence in the companies. For example, Herbalife

(HLF) shares have grown in value by 134.6% since the inception of the company, with a dip

during the Financial Crisis in 2008 and a dip when Ackman announced his short, although the

share price quickly recovered and began to rise shortly after (Marketwatch). This growth is due

in part by the inventory as sales strategy that Herbalife utilizes, but also may be a result of

shareholder confidence that the company could survive an attack by such a high-profile investor

as Bill Ackman.

Shares of Avon (AVP), on the other hand, showed growth in the first decade of the

century, but steadily decreased in value after 2010. From 2000 to the beginning of 2010, there

has been a 49.9% growth in Avon’s share price, but from January 2010 to the present, there has

been a 91.4% decrease in the price of Avon shares. Overall, from 2000 to the present, there has

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been an 87.4% decrease in the share price. This reflects severe earnings losses for the company

over the past several years (Marketwatch).

It is clear that multi-level marketing stocks are evaluated in the same way as other

companies by shareholders, including positive reactions to increased earnings and positive media

attention, and negative reactions to earnings losses and negative media attention. Overall,

shareholders seem to not mind the pyramid structure of these companies as long as fundamental

analysis shows that a company is profitable.

Legal Lens

By definition, multi-level marketing companies are legally allowed to operate by the

Federal Trade Commission if their compensation structure is based on actual sales of product to

outside consumers rather than “wholesale purchases or other payments by its participants”

(Business Guidance Concerning Multi-Level Marketing, FTC). This means that even if a product

is being sold and the company does not outwardly appear to be a pyramid scheme, a multi-level

marketing company could be out of line with FTC regulations because the compensation

structure is such that distributors earn more from recruitment and sales to recruits. Also, the FTC

mandates that a company cannot force distributors to purchase a minimum amount of the

product, or actively seek new downline distributors to make a profit (DuBoff, 98). However, the

FTC does not establish a one-size-fits-all determination on the legality of different multi-level

marketing companies, but rather evaluates them individually on a case-by-case basis (FTC).

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There are ample cases of multi-level marketing companies involved in lawsuits relating

to their pyramid structure. Herbalife, for example, was involved in a class-action lawsuit relating

to the accusation that distributors were financially rewarded for recruiting other distributors

instead of for selling the Herbalife product. Before reaching trial, the lawsuit reached a

settlement (Betting on Zero). Koscot Interplanetary was another multi-level marketing company

which was sued by the Federal Trade Commission and resulted in a decision which requires that

most of the commissions that independent distributors receive from multi-level marketing

companies should be from the sale of goods to the “ultimate user” instead of the sale of

distributor memberships to the company (in other words, proceeds from the creation of the

downline) (Business Guidance Concerning Multi-Level Marketing).

Interestingly, there are financial services companies that also are structured as multi-level

marketing companies, and with these companies, there is an additional legal layer. A financial

manager can have either an agent or fiduciary relationship with a client. In an agency

relationship, the financial manager advises the client, but is not necessarily held to the standard

of acting in the client’s best interest if there are opportunities for the manager to make more

money by acting differently. On the other hand, a fiduciary is legally bound to act in the best

interest of a client, even if it means that the company that the manager represents or the manager

himself loses revenue (U.S. News and World Report). This study examines the extent to which

financial services companies utilizing the multi-level marketing structure are adding stakeholder

value, and the extent to which these companies fulfill their fiduciary duties

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Chapter 2

Literature Review

Resources Advocating for Multi-Level Marketing Practices

Introduction

Although multi-level marketing companies seem to be growing in number and prevalence

in today’s economy, analysts who are bullish on these companies are often found in independent

blogs or websites supported by the companies themselves. Obviously, the websites of multi-level

marketing companies tout the supposed compensation and quality of life benefits of being a

distributor to recruit more people. More importantly, disclosures about the possibility of losing

money are nowhere to be seen. This is understandable, as these companies exist, like most

companies, to generate a profit and enhancing shareholder value.

Conflict of Interest

An issue with using independent blogs for information about multi-level marketing

companies is that the information presented is almost always positive, and details about how an

independent distributor has a significant chance of losing money is almost never mentioned,

except perhaps in comments made by disgruntled ex-independent distributors which creates a

conflict of interest for those researching the possibility of joining a multi-level marketing firm.

For example, many of these blogs rate multi-level marketing companies based on ambiguous

“user ratings” (Best Company), and in the case of multiplestreams.org, the author of an article

ranking of multi-level marketing companies alleges that although a particular company had “a

nasty lawsuit that seemed to divide the company”, it was one of “the better skin care options in

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network marketing”. Upon further investigation, the lawsuit involving the company, Nerium

Biotechnology, Inc. was in regard to breaches of fiduciary duties by Nerium to its distributors

(Marketwatch) - not a situation that many potential distributors would want to see while looking

for a company to work with. It is also interesting to note that the title of this article referenced the

top multi-level marketing companies of 2019 while being published in 2017.

Misleading Headlines

Another off-putting aspect of these independent blogs is that several use unprofessional

headings within their menus, which further deteriorates their credibility. For example, the

website mlmcompanies.org simply provides the two headlines, “WTF?” and “Contact” for users

to navigate their site. To those who are attempting to research the role of a distributor, this is off-

putting and unprofessional.

A More Balanced Approach

Although most of these blogs seem to lack any sort of credibility in terms of providing

adequately balanced information regarding the structure and value of multi-level marketing

companies, Best Company is one of the few blogs that does include a list of the “Good, Bad, and

Bottom Line” for the multi-level marketing companies that it reviews, instead of providing solely

glowing reviews. And while not an independent multi-level marketing blog, Investopedia’s

article on the business structure approaches the subject more factually, presenting the structure of

a typical multi-level marketing company in an unbiased manner with a clear list of advantages

and disadvantages, although the article makes sure to note that the “Federal Trade Commission

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advises that single-tiered network marketing operations tend to be more reputable than multi-tier

schemes” (Investopedia).

Since there are very few resources with the independent credibility to be able to make an

unbiased analysis of multi-level marketing companies, an analysis of multi-level marketing

companies must be constructed using these blogs and websites of questionable credibility.

Resources Advocating Against Multi-Level Marketing Practices

Many more credible sources advocate against multi-level marketing companies and their

practices, including official United States government agencies.

The Federal Trade Commission’s Warning

The Federal Trade Commission has several articles on the topic, all of which are riddled

with caution about joining these types of companies. The main issue that the Federal Trade

Commission sees with this type of company structure is the fact that multi-level marketing

companies operate, and are often successful in terms of creating shareholder value, by ignoring

outside consumer demand -- which ultimately harms those independent distributors who have

already invested an amount of money in the opportunity and who do not want to abandon what

they have invested. According to the FTC, consumer demand is ignored because when a

distributor realizes that it is not profitable to sell the product to outside consumers, the distributor

turns to recruiting others into the company and selling products to those new distributors, who

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are pressured to buy products by the company (Business Guidance Concerning Multi-Level

Marketing, FTC).

In their article “Multilevel Marketing”, the FTC warns potential distributors to carefully

evaluate the products being sold, for example if they are “quick fixes” or advertise “miracle

ingredients”, which companies like Herbalife and ItWorks! claim to sell. The FTC suggests that

potential distributors also do internet searches with the company name and the keywords

“review, scam, and complaint” to determine if the company is credible. The FTC also states that

if the money that a distributor makes is based on the “number of people you recruit and your

sales to them” (Multilevel Marketing, FTC), then the company’s business plan is most likely not

legitimate.

Attention from the Investing Community

As mentioned in the introduction, a high-profile opponent of multi-level marketing

structures is the billionaire investor, Bill Ackman. As opposed to the FTC’s regard for ignoring

consumer demand, Ackman takes a more human approach in the sense that he believes that

multi-level marketing companies should not be allowed to operate in the market because they,

much more likely than not, financially harm those involved. According to his film about his short

position of Herbalife, “Betting on Zero”, Ackman found, from interviewing current and former

distributors of Herbalife, that although it was possible for them to profit from their employment

with the company and that there were a select few who had made a small fortune for themselves

through their efforts, the clear majority of distributors were making very little or just breaking

even, and some had even lost significant amounts of money. On average, only 17% of

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distributors at Herbalife were even eligible to earn a profit from the company because a

distributor must have both product sales and a downline of distributors under them to begin to

receive money from the company, and just over 47% of those earn an income of $1000 or less,

before expenses like product inventory are factored in (Betting on Zero).

Targeting the Hispanic Community

One group that Ackman described as particularly adversely affected by Herbalife’s

“every man for himself” business practices is the Latino community in the United States. The

Herbalife business structure is such that each individual is responsible for his own success

financially, and the Latino community is specifically targeted by independent distributors to

become Herbalife employees, but many of these individuals are immigrants who do not have a

full knowledge of company practices and the legality of such companies in the United States, and

more importantly, they are largely not aware of the significant financial risk that they are taking

by buying into the company to become distributors. And although a staggeringly high percent of

these immigrants has suffered losses that amount to their entire life’s savings, legal proceedings

are often difficult because many of these immigrants are undocumented (Betting on

Zero). Preying upon those in the Latino community, and other immigrant communities, who are

unaware of the risks involved is an example of the poor business ethics of Herbalife.

Widely Circulated News Sources

Prominent business news sources have reported on the negative consequences of joining

a multi-level marketing company, specifically on the concerning statistics of income levels

related to independent distributors of multi-level marketing organizations. In its 2008 article, “A

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Drink’s Purple Reign”, Newsweek reported that “fewer than 1% [of independent distributors]

qualified for commissions and of those, only 10% made more than $100 per week” at MonaVie,

a company that sold dietary and health products and has since closed. USA Today reported in its

article “MLM or ‘Pyramid?’ Sales People Find It Hard to Earn Much”, that “it can be very

difficult, if not impossible, for most individuals to make a lot of money through the direct sale of

products to consumers. And big money is what recruiters often allude to in their pitches”. Later

in the same article, a former independent business owner (which is a similar role to the

independent distributor) of the company Amway stated that, “you’d be hard-pressed to find

anyone making over $1.50 an hour, the primary product is the opportunity.”

The problematic structure of multi-level marketing companies is gaining more attention

from these more credible and powerful sources, which presents an intriguing basis for

comparative research on the topic of which companies, if any, are more valuable to stakeholders.

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Chapter 3

Methodology

The choice of topic for this thesis emerged out of an interest in the business model of

companies selling beauty products and business opportunities through college-aged Instagram

users, and my experience last year interviewing for a financial advising internship with

Northwestern Mutual Life Insurance Company. After completing the interview process with

Northwestern Mutual, I realized that there were some similarities in the way the financial

advising position at Northwestern Mutual and business opportunity with the Instagram-promoted

company were presented, including many grandiose promises about commission potential and

the encouragement to build and leverage a strong personal network to succeed in each business.

While pondering these similarities, I grew more interested in the effect of the multi-level

marketing business structure on stakeholders in the business, including customers, shareholders

in public multi-level marketing companies, and most importantly, the independent distributors.

As a more risk-averse individual, I wondered why anyone would take such a financial risk as

purchasing the required inventory to become an independent distributor for any of these

companies, as I found quite a few negative reviews of the system after completing an online

search. However, these business models have survived for decades, which suggests that the

prospect of working as a distributor at these companies is alluring to many people in the job

market.

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After my initial aversion to the multi-level marketing structure, I developed a number of

research questions:

1) What effect does this business structure have on each of the three main stakeholder

groups (customers, distributors, and those who own the company, including private

owners, shareholders, or policy owners in the case of Northwestern Mutual)?

2) Is there any way to guarantee profitability as an independent distributor and will that

guaranteed profitability vary at different companies?

3) Do these companies produce their products to conceal an underlying pyramid scheme,

or does the company actually value the products that it offers?

4) Should the Federal Trade Commission monitor multi-level marketing companies

more closely considering the plethora of lawsuits that this business structure has been

involved in?

5) Even with increased monitoring from government bodies, should there be an

increased amount of regulation, or should potential independent distributors be

responsible for thoroughly researching the opportunity to determine if it is right for

them?

6) And finally, why do companies choose the multi-level marketing structure over a

traditional sales model?

This thesis seeks to investigate the financial effects and the effect on the quality of life of

stakeholders of Northwestern Mutual Life Insurance Company in comparison to the effects on

stakeholders of established multi-level marketing companies to determine the value of multi-

level marketing firms to the economy.

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This study examines two widely accepted, well known multi-level marketing companies

as a template that will be used later to develop a comprehensive analysis of Northwestern

Mutual. These companies are Herbalife and Mary Kay. I chose these companies because they

have quite different reputations in the multi-level marketing industry, as Herbalife has been

riddled with lawsuits and its product quality has been questioned by nutritionists, while Mary

Kay has generally been highly regarded by its distributors, many of whom have been working as

a distributor for many years. Also, since Northwestern Mutual is a mutual company (refer to

page 34), I wanted to show the differences in the way that a multi-level marketing structure

operates in private and public companies both, instead of solely assessing public companies. I

assessed all three companies on the following issues: fundamental company analysis, regard for

the products that the company produces, recruitment of new independent distributors (called

“financial advisors” at Northwestern Mutual), compensation of independent distributors, and any

lawsuits relating to the multi-level marketing structure of the company.

Multi-level marketing companies are extremely secretive about their operations in

general, so there a great deal of murkiness in the information provided by each company.

Because company sponsored websites could not provide a holistic picture of the recruitment and

compensation situations, I relied on independent blogs for some information, especially

information about recruitment incentives for current distributors and downline compensation

plans.

I chose Herbalife as a public company to examine. overall, it has undergone much

scrutiny from nutritional experts and investors alike. Because complaints against Herbalife are so

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widely publicized, information from both the company and from outside sources was readily

available, but there was some conflicting information regarding the compensation structure of

independent distributors from different Herbalife sources which made it more difficult to

determine the correct compensation plan. Some information regarding recruitment of Herbalife

distributors was provided by Herbalife, but in general that information came from either Bill

Ackman’s documentary, Betting on Zero, or from recounts from current or former distributors on

personal blogs. To determine the product quality of Herbalife, I relied on various nutrition

websites that assess the quality of a wide variety of brands similar to Herbalife.

Mary Kay was chosen as a private company to investigate. Known for its quality beauty

products and the legend of a pink Cadillac if an independent distributor exceeds sales goals, the

company is generally well regarded by customers and independent distributors alike, but Mary

Kay itself publishes next to no information about its operations. Because of this, I principally

relied on blogs created by current and former independent distributors for information about

compensation and recruitment. Mary Kay sells products on Amazon, and I used the reviews on

Amazon for a selection of popular products to determine product quality.

Although Northwestern Mutual is not widely thought of as a multi-level marketing

company, I investigated the company in the same manner as Herbalife and Mary Kay. I delved

into slightly more detail about the company fundamentals and products, as Northwestern Mutual

is a mutual company, which is not an extremely common company structure, and as

Northwestern Mutual primarily sells insurance products, which are misunderstood by many and

are more complex than beauty products or nutrition supplements. The stakeholder analysis was

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conducted differently, because in mutual companies, policy owners (customers) are also owners

in the company like shareholders, which changes the company dynamic in terms of the balance

between creating shareholder value and serving customers, while also considering the financial

advisor role.

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Chapter 4

Analysis of the Multi-Level Marketing Corporate Structure

Introduction to the Analysis

Northwestern Mutual is a reputable financial services company offering insurance and

financial management services to customers across the United States; however, the company is

unique because the corporate structure of Northwestern Mutual closely resembles that of a multi-

level marketing company. This paper will use Northwestern Mutual as a proxy for analyzing the

financial and stakeholder performance of companies using the multi-level marketing structure

within the financial services industry by comparing Northwestern Mutual to two very different,

well-established multi-level marketing companies with different products, reputations, and legal

issues.

Herbalife, Inc. is the first multi-level marketing company that will be examined. The

Herbalife stock, HLF, has performed as expected in relation to news about the company as other

non- multi-level marketing companies, but the company’s relationship with independent

distributors and product quality had been heavily scrutinized throughout the life of the company.

Mary Kay, Inc. is the second company that will be investigated. Mary Kay is a privately owned

multi-level marketing company, but has been praised for its method of incentivizing and

compensating distributors, and its products have been regarded as high quality for many years.

To adequately identify the terms of comparison, we will go into further detail about

Herbalife and Mary Kay in terms of their company fundamentals, consumer regard for their

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products, recruitment tactics, compensation of distributors, and any related lawsuits that arose

from the companies’ multi-level marketing practices.

Herbalife: A Multi-Level Marketing Giant

Herbalife is a publicly traded multi-level marketing company selling nutrition and

supplement products based in Los Angeles, California. Founded in 1980, the focus of the

company is the “business opportunity” of becoming an independent distributor of Herbalife

products, and in turn sharing the business opportunity with other potential Herbalife independent

distributors, which creates a monetary incentive for existing distributors. The 2018 annual report

states, “Our success is due to...our laser focus on our growth strategies – creating products that

help our distributors increase sales to their existing customers, appeal to new customers and,

importantly, attract new distributors to the business” (Herbalife Annual Report). As of 2018,

there were 486,369 independent distributors selling Herbalife products around the world.

Fundamental Analysis of Herbalife

Currently, Herbalife has a market capitalization of $5.52B with a share price of $38.96.

Earnings per share have not grown significantly, hovering around the $1.50 to $2.00 mark over

the past five years, and were up 57% to $2.12 in 2018 from 2017. Return on assets in 2018

averaged 7.76%, profit margins averaged 6.04%, which is positive in terms of company

management. However, per the Herbalife’s 2018 10K statement, return on equity for 2018 was

192.8%, which was largely due to dip in the first quarter of 2018. Historically, shareholders in

the company have responded positively to the successes and negatively to shortcomings within

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the company, and there does not seem to be any speculative shareholder action related to trading

Herbalife shares, aside from Bill Ackman’s short, which was discussed in the introduction.

Quality of Herbalife Products

Herbalife sells a variety of health products that range from weight loss products to energy

supplements to meal replacements. According to the company’s annual report, Herbalife’s top

selling products in 2018 were from their weight management line, which includes meal

replacement shakes, protein drinks, and snacks. Other top selling products included those from

Herbalife’s targeted nutrition line, which includes vitamins and supplements, and Herbalife’s

facial, skin, and hair care. Over the past several years in the United States, a healthy lifestyle

trend has emerged, where consumption of products designed to increase the well-being of buyers

has increased dramatically. For companies producing these products, there is not much

information about the actual benefits of these products across the board. However, according to

studies conducted on weight management products, Herbalife shakes and drinks supported an

initial and quick loss of weight specifically for women, but the weight loss did not seem to be

sustainable over the long-term (Healthline). Customers seem to appreciate the wide selection of

flavors of Herbalife products, which is much more diverse than other weight loss companies

(Nutrition You Can Use). And of course, the highest-selling Herbalife product is the business

opportunity of becoming an Herbalife independent distributor, which is touted by the company

as being a fantastic, high grossing opportunity, but it has been scrutinized by many high-profile

individuals and groups as taking advantage of those who have less information available,

especially non-English speaking minorities.

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Recruitment of New Herbalife Distributors

Independent distributor recruitment is conducted via sponsorship by an existing Herbalife

distributor. Existing distributors are encouraged to find others who are interested in the business

opportunity to build their downline, and are given materials by Herbalife to entice the potential

recruit, including claims about the freedom of working on one’s own schedule, the possibility of

unlimited compensation, and the promise of extravagant vacations and bonuses if a new

distributor works hard enough (Herbalife). If a person wishes to become a distributor, but does

not know of an existing distributor to sponsor them, they will be connected with a distributor via

the Herbalife website, and they will become part of that existing distributor’s downline. The new

recruit begins as a bottom level distributor with a product discount rate of 25% and is encouraged

to purchase as much product as possible from Herbalife to begin to sell to those in their

community. Herbalife does not disclose the location of other distributors, so new distributors are

unaware of the potential competition they face in their communities from existing, well

established Herbalife distributors (Betting on Zero).

The retention rate of North American distributors from all levels of the business from

2017 to 2018 was 65.9%.

Compensation of Herbalife Distributors

According to a report on distributor compensation published after the end of 2018,

Herbalife distributors make money through two vehicles. The first way to earn money is the

spread between the price at which the distributor purchases a product from Herbalife and the

price at which the distributor sells the product to an outside customer. When an individual first

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begins working with Herbalife as a distributor, they purchase Herbalife products at a 25%

discount from the suggested retail price, before taxes and shipping fees. Distributors can sell the

product at whatever price they choose, but compensation advertisements from Herbalife are all

based on the distributor’s ability to sell at the suggested retail price. As distributors purchase a

higher dollar amount of products from the company, they are eligible for larger discounts, which

can amount to up to 50% for those distributors who purchase the most product. After factoring in

taxes, shipping fees, and other expenses related to the resale of products, the spread that new

distributors earn is not very significant. Shipping and handling is paid to Herbalife instead of an

independent transportation company, and is recorded as a line item in Herbalife’s financial

statements. For 2018, the shipping and handling income was reported as $248 million, and was

factored into net sales. As 2018 saw 486,369 global independent Herbalife distributors, on

average each distributor paid $509.90 in shipping and handling costs (this does not account for

the fact that each distributor purchases a different amount of Herbalife product, so shipping and

handling costs for each distributor varies widely in reality).

The second way that a distributor can earn money is by receiving a percentage of the

proceeds that are paid to Herbalife from distributors in the downline. In its 2018 Statement of

Average Gross Compensation, Herbalife claims that a distributor cannot make money by

recruitments only. However, this statement notes that a distributor makes money from all sales

Herbalife makes to a downline distributor, and according to a 2018 revenue statement from the

company, the distributor “starter packs”, or fees paid to Herbalife when an individual decides to

join as a distributor, are considered sales, and thus upline distributors do earn money from the

recruitment of downline distributors.

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Although Herbalife releases a Statement of Average Gross Compensation for each of its

markets annually, there has not been any comprehensive reporting about the average percentage

of compensation that is derived from sales related to downline recruiting fees or materials versus

the average percentage of compensation based on downline product sales. This makes it

extremely difficult to determine if Herbalife distributors indeed derive more commission from

fees related to recruiting than from product sales, which would definitively classify the company

as a pyramid scheme.

Also, according to the footnotes of the 2018 annual report, the company caps distributor

compensation outstanding if the company experiences certain “contingencies”, which constitutes

situations of litigation against the company. Litigations described in the report were mostly

surrounding the business structure of the company by various foreign governments, but were also

related to claims about Herbalife products. As a company that experiences a fair amount of

litigation, this is clearly unfair for hard working distributors who have no control over the

business practices of the company but who will be penalized for litigation that the company

incurs. However, it is important to note that while this is a possibility, the report stated that it did

not anticipate a cap on compensation because of litigation in 2018.

Lawsuits Regarding the Herbalife Company Structure

In 2015, a court in Los Angeles, where Herbalife has its global headquarters, settled a

class-action lawsuit brought on by over 7,000 former Herbalife distributors who claimed that

distributors make more money from recruiting new members than by selling products, thus

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rendering Herbalife a pyramid scheme. Herbalife settled for $15 million which was paid out to

those who claimed to lose money from their involvement as distributors, and Herbalife was also

required to pay for product returns and attorney fees of those who brought on the lawsuit (My

News LA).

Perhaps the largest legal trouble that Herbalife has gotten into recently is its settlement

with the FTC in 2017, where it agreed to “fundamentally restructure its business”. The FTC used

the settlement money to provide restitution to almost 350,000 ex-distributors who lost a

significant amount of money because of misleading statements released by Herbalife regarding

the compensation structure of being a distributor. The restitution totaled close to $200 million in

total refunds, and the average size of a payment was between $100 and $500.

As recently as September, 2019, Herbalife settled with the US Securities and Exchange

Commission over misleading and false claims regarding its China operations (Reuters).

Stakeholder Analysis of Herbalife

Key stakeholders of Herbalife include shareholders, customers, and independent

distributors, and each of these groups is affected differently by Herbalife’s business practices.

For shareholders, as discussed at the beginning of the chapter, it seems that earnings per share

fluctuates appropriately with net income as evidenced by earnings reports in recent years, and

that share price responds rationally to the market, so shareholder wealth is apparently being

created by the company.

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Customers seem to have mixed positive reviews of Herbalife products, as evidenced by

online review websites. Consumer Affairs is one such site, and on average, consumers have rated

Herbalife products as three out of five stars, with the number of votes for one through five stars

being about equal. Some customers are strong supporters of the weight loss they have achieved

through using the products, and some are skeptical of the efficacy of ingredients. Overall,

Herbalife seems to be on par with companies that offer a similar product selection (Consumer

Affairs).

There is a wide range in opinion concerning company from current and former

independent distributors about the fairness of the compensation structure, and the amount and

severity of litigation brought against the company is certainly concerning. While Herbalife

consistently reports large revenue and net income results for all of its markets, these results are

largely attributable to the sale of product that distributors must purchase to be a part of the

Herbalife distribution team. As there is no clear evidence that the monetary incentive to recruit

new distributors is stronger than the incentive to sell Herbalife products, we cannot conclusively

claim that the company is a disguised pyramid scheme. If not a pyramid scheme, Herbalife has

constructed a business model that takes clear advantage of the fact that independent distributors

must purchase directly from Herbalife to generate income from the sale of products, and that

distributors do not want to lose their initial investment if they are unable to sell products.

Overall, as Herbalife is a public company and must disclose information to shareholders,

Herbalife shareholders are treated fairly. Herbalife customers are participating in a market where

health products often do not deliver what is promised, but that is not a problem specific to

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Herbalife. Independent distributors are treated extremely unfairly by Herbalife, as they are taken

advantage of financially.

Mary Kay: Tried and True Multi-Level Marketing

Mary Kay, Inc. is a multi-level marketing company that sells cosmetics and skin care

products and is based in Addison, Texas. Founded in 1963, the company now has several million

independent distributors selling Mary Kay products in 40 countries around the world. Mary Kay

is involved in several corporate social responsibility initiatives specifically targeted toward

females. Through the Pink Changing Lives initiative, a portion of the sales of specific Mary Kay

products are donated to the Mary Kay Foundation, which supports female cancer and domestic

violence victims through grants and donations to research programs and shelters (Mary Kay

Foundation). The company is also known for its incentive packages for outstanding distributors,

of which the top incentive is the trademark pink Cadillac.

Fundamental Analysis of Mary Kay

Mary Kay is unique because it is a privately owned company. Because of this, Mary Kay

is not required to release much information in terms of company fundamentals to the public. The

only information relating to the inner workings of the company that Mary Kay released in 2018

was that the company generated nearly $3 billion in wholesale orders in 2018 (Mergent

Intellect), and that there are approximately 3 million independent distributors of Mary Kay

products worldwide.

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Quality of Mary Kay Products

Mary Kay products are generally well regarded by customers, as reviews on ecommerce

platforms like Amazon suggest. Of 48 different Mary Kay products sampled on Amazon, only

one product earned a collective review of less than four stars out of five. Mary Kay also makes a

point of testing their products to remove any impurities. A team of eight scientists spearhead the

company’s product development team, and have a comprehensive list of harmful chemicals that

are never incorporated into any products.

In terms of cost, Mary Kay products are generally moderately priced in comparison to

other similar beauty brands such as Clinique and Bare Minerals, but are priced above drugstore

brands such as Maybelline and Revlon (Amazon).

In addition to the quality of products that the company offers, Mary Kay also provides

customers the option to purchase products online from the Mary Kay website and on Amazon,

which is an option that is not available with many other multi-level marketing companies. On the

Mary Kay website, products are still sold through local independent distributors, who are found

by the customer inputting their zip code in the website, but the Amazon Mary Kay store does not

require a distributor to sell products (Mary Kay). This feature of the company shows that Mary

Kay places more of an emphasis on product availability than the business opportunity.

Recruitment of New Mary Kay Distributors

Recruitment of Mary Kay distributors is conducted much like the recruitment of new

Herbalife distributors. The startup cost of becoming a distributor is $100, which includes a

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variety of product samples, and in order to sell actual product, distributors must purchase product

inventory. If an individual wishes to become a distributor and knows someone who will sponsor

them, they can register on the Mary Kay website. If not, the Mary Kay website provides the

prospective distributor with a list of existing distributors who are located near the prospective

distributor. Unlike Herbalife, Mary Kay provides prospective distributors with a large amount of

information about potential sponsors, and does disclose the location of potential sponsors. This is

helpful because while choosing a sponsor who is in close proximity, the new distributor can see

where existing distributors are selling as well as the specialties of existing distributors, which

eases planning for competition.

The 2018 turnover rate for Mary Kay distributors was 68.6%, like that of Herbalife.

Compensation of Mary Kay Distributors

Because the company is private, there are not any public documents that release

definitive average compensation amounts of independent distributors in the 70 markets in which

Mary Kay operates. The Frequently Asked Questions section of the Mary Kay website is careful

to state that the amount that is possible to make as a distributor is dependent on personal goals

and the amount that distributors are willing to put toward the development of their business, as

many other multi-level marketing brands state (Mary Kay). The process of how distributors are

compensated is much like Herbalife, where distributors purchase an inventory for a reduced cost

compared to the suggested retail price, and sell the product for a higher amount and earn the

spread, minus sales taxes.

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Another factor that is not publicly published by the company is the percent discount that

distributors receive for purchasing inventory, but several blogs of current and former Mary Kay

distributors claim that a 50% inventory discount applies when a distributor places an order of at

least $225 every three months.

To receive commissions from the company, a distributor must be active in selling

products, and the distributor must also have at least one active recruit also selling products (Mary

Kay). In this structure, distributors who have not yet recruited a new distributor of their own will

not be eligible to receive commissions from Mary Kay. However, contrary to other multi-level

marketing companies’ typical compensation structure that is based on the sales of those in the

downline, Mary Kay distributors earn the same level of commissions across the structure of the

company, which are based on sales of the actual product. A distributor further in the “downline”

of the company will not make any less than one who is father up when selling the same amount

of products (CNN). Also contrary to similarly structured companies, all sales commissions come

directly from Mary Kay as opposed to coming from downline distributors’ dues and fees, and

compensation from recruiting new distributors is awarded in the form of yearly bonuses from

Mary Kay. There is no public information from Mary Kay concerning if a distributor is paid any

amount of money to recruit new distributors, but per blogs by current and former distributors,

commissions based on recruitment range from 4% to 13% on the sales of the downline, paid

directly by Mary Kay and not taken from the net income of downline distributors (Indeed).

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Lawsuits Regarding the Mary Kay Company Structure

In 2002, a lawsuit was brought against Mary Kay regarding its termination of a contract

with a pregnant woman battling breast cancer. According to the woman, Mary Kay refused to

lower her sales quota for the several months that she was receiving treatment for cancer while

battling for unborn her unborn child’s life, and after missing her quota, Mary Kay terminated her

as a distributor. Mary Kay argued that since the woman was technically an independent

contractor and not an employee of the company, she had no right to sue. Ultimately, the court

ordered Mary Kay to pay $11.2 million in damages because in cases of medical discrimination,

independent contractors and company employees have the same rights (SF Gate).

Stakeholder Analysis of Mary Kay

Key stakeholders of Mary Kay are customers and independent distributors. Customers

seem to value Mary Kay products as high quality, and there is a continued demand for the

products. There are mixed accounts of the independent distributor experience at Mary Kay.

Many individuals have been working as independent distributors for decades and believe that

their jobs are valuable in terms of making quality products available to their network. Others

believe that the stipulations required to remain active as a distributor, such as the inventory

purchasing requirements, mean that they are losing money on products that will not be able to

sell and that will eventually expire. Compared to the accounts of Herbalife distributors, it seems

as if Mary Kay does provide more transparency and fair compensation to its distributors.

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Northwestern Mutual: A Century-Old Provider with a Hidden Secret

Northwestern Mutual is a financial services organization offering investment vehicles,

retirement and education planning, estate planning, and it provides a wide selection of insurance

products, including life insurance, disability insurance, and annuities among many others. The

company was founded as the Mutual Life Insurance Company of the State of Wisconsin in 1859,

where it handled life insurance claims for businesses throughout the Midwest (Northwestern

Mutual).

Currently, the classification of Northwestern Mutual as a multi-level marketing company

is not generally discussed. This could be for a variety of reasons, the foremost being that in the

financial services industry, the multi-level marketing denomination subjectively diminishes a

company’s credibility and reputation among its competitors. However, there are several

characteristics of Northwestern Mutual that suggest that it could and should be classified as such,

including striking similarities between the recruitment and compensation processes of financial

advisors at Northwestern Mutual and those of companies like Herbalife and Mary Kay.

Fundamental Analysis of Northwestern Mutual

Northwestern Mutual is unique in that it is a mutual company instead of a traditional

public corporation with shareholders or a traditional private company. Mutual companies are

common in the insurance industry and are structured in such a way that the company’s customers

act as part owners in the company, like shareholders in a traditional public company. Customers

are paid dividends or receive premium reductions, the size of which is usually based on the size

of their policies (Investopedia).

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The clear advantage of a mutual company is that customers have voting rights, so they

are directly involved in the decision-making processes of the company. They have the power to

change leadership and affect changes within the company as shareholders do in public

companies. While management of public corporations have the obligation to create shareholder

value, management of mutual companies have the obligation - and strong incentive - to create

value for their customers. A disadvantage of this corporate structure is the threat of

demutualization to customers, which is when a mutual company reorganizes into a publicly

traded company in order to raise more capital, typically because there are an unusually high

number of insurance claims to be processed. Customers who previously had voting rights and

ownership in the company may or may not receive compensation in the form of shares,

depending on the form of demutualization. After demutualization, if customers did not receive

shares of ownership in the company, they will typically not receive the same premium reductions

or dividend privileges as they did before the restructuring (Investopedia).

The Northwestern Mutual Foundation is the company’s primary corporate social

responsibility initiative, and it serves to provide capital for childhood cancer research

(Northwestern Mutual).

Like Mary Kay, the classification of Northwestern Mutual as a private company relaxes

many of the requirements of financial reporting, although there are financial documents available

for policy owners to reference when submitting their proxy votes. According to the 2018 annual

report, Northwestern Mutual earned a total revenue of $28.5 billion and a net income of $783

million, which is down from $1.01 billion in 2017, mostly due to increases in commissions and

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policy owner dividends paid in 2018 (Northwestern Mutual). The two main product categories

offered by Northwestern Mutual are insurance products and investment products. In 2018, the

amount of insurance products significantly outweighed the amount of investment products, as the

portfolio of insurance products reached over $18 billion, while the portfolio of investment

products (total assets under management) only reached $128 million.

Quality of Northwestern Mutual Products

As stated, the two main product categories for the company are insurance products and

investment products. Insurance products include life insurance, disability insurance, long-term

care insurance, and annuities. Life insurance is the largest selling product, according to

Northwestern Mutual’s 2018 annual report, and the product that financial advisors are most

encouraged to sell, per Glassdoor. The three life insurance options offered are whole life

insurance, term life insurance, and universal life insurance.

People choose to purchase life insurance because of the risk that they might die when

they are providing for loved ones. Whole life insurance coverage is for a policyholder’s entire

life, and premiums are paid either until the policyholder dies or decides not to continue paying

them because they have become too expensive. Term life insurance covers a predetermined

portion of time, and is typically purchased by those who have young families to protect against

the loss of income after a tragic event, according to Nerdwallet. Universal life insurance is

similar to whole life insurance in that it covers a policyholder for the duration of their life, but it

offers more flexibility in terms of premium payments. Whole life insurance and universal life

insurance have a cash value, while term life insurance does not, which means that the policy can

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accumulate interest like a savings account. Policyholders can borrow against this cash value, but

in the event of the death of the policyholder, beneficiaries will not receive more than the death

benefit, which is what the policy initially was meant to provide (Investopedia).

Northwestern Mutual financial advisors are motivated financially to sell these life

insurance policies, but the consensus among financial advisors (those who do not work at

Northwestern Mutual) is that whole and universal life insurance are usually not smart choices for

the average American. Nerdwallet states that the only situation where someone should consider

purchasing whole life insurance is if they are a high-net worth individual who has already maxed

out all of their other savings vehicles, including their 401k’s and IRA’s, and who is interested in

the estate tax advantages that life insurance offers. Term life insurance is a more appropriate

option for those who are not considered high-net worth individuals, but who are concerned with

how their families will be able to financially fare in the event of their death (Nerdwallet).

Nerdwallet also states that nearly 88% of life insurance policies do not pay a claim, for a

variety of reasons. For term life insurance, policies usually will not pay claims because when the

end of the term is reached, the policyholder is still alive. For whole and universal policies, claims

usually are not paid because the policyholder has stopped premium payments for whatever

reason.

Every customer of Northwestern Mutual is unique in their financial situation, and there is

no product that is wholly good or bad for every customer, although financial professionals seem

to agree that whole and universal life insurance are not the best options for most people. When

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Northwestern Mutual financial advisors are financially motivated to sell whole or universal life

insurance to a large percentage of their customers who may not be well-suited to purchase these

products, the products themselves become inferior.

One metric to quantify consumer regard for Northwestern Mutual products is to consider

the turnover rate of customers, but the fact that customers are part owners in the company

undermines the effectiveness in using a turnover rate to evaluate customer satisfaction.

According to the 2018 annual report, 96% of customers stayed with the company in some

capacity, although the annual report does not provide any insight into which policy offerings had

the highest and lowest retention rates, or if the majority of these customers were investment or

insurance customers.

Recruitment of New Northwestern Mutual Financial advisors

To determine similarities and differences between traditional multi-level marketing

companies and Northwestern Mutual, the financial advisors position at Northwestern Mutual will

be examined in comparison to independent distributors of multi-level marketing companies.

Northwestern Mutual begins the recruitment of new financial advisors in a similar

fashion to other companies, via a traditional interview rounds. Based on my personal experience

with the financial advisor interview process at Northwestern Mutual, the purpose of the first-

round interview is to generally screen a candidate to determine if they possess the personality

type and professionalism required of someone working in the financial services industry. The

second-round interview focuses on more behavioral and situational questions, including typical

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scenarios regarding how a candidate would handle a dissatisfied customer, a mistake on the

candidate’s part, or about the candidate’s organizational and time management skills. At the end

of the second-round interview, if the candidate will be advancing to a third round, the candidate

is asked to complete several worksheets prior to the third interview, including a worksheet which

asks the candidate to compile a large list of those in the candidate’s “network”, or those people

the candidate knows and could call on for business. The third-round interview occurs at the

office where the candidate would work if hired.

If a candidate is hired prior to finishing an undergraduate degree, he or she is expected to

prepare for a life and health insurance license examination before beginning work as a financial

advisor. Usually, one would expect that an employee with the title of “financial advisor” might

be required to hold investment licenses or become a Certified Financial Planner prior to

beginning a position. As this suggests, financial advisory is not the main function of the job -

instead, the main function is selling insurance, although Northwestern Mutual does allow for

advisors to obtain investment and planning certifications after working for some time. In fact, the

sale of life insurance is the only component that counts toward the annual quota that financial

advisors must meet (Glassdoor). This assertion about Northwestern Mutual certainly makes

sense in light of the fact that assets under management for financial advisory services only

comprises 0.7% of the total insurance portfolio business (Northwestern Mutual).

Although the company does not publish turnover rates for advisors anywhere in its

literature, Glassdoor reports that the turnover rate for advisors year over year is between 80%

and 90%, a staggeringly high statistic.

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Compensation of Northwestern Mutual Financial advisors

When financial advisors join Northwestern Mutual, they are classified as Form-1099

contractors for Internal Revenue Service purposes. Per the Internal Revenue Service, the

classification of an independent contractor versus an employee of a company depends on the

amount of control that the company exerts over the work of the individual in question in terms of

the behavior of the individual, the level of financial decisions made by the individual, and the

relationship of the company (and possibly other companies) that the individual reacts with. The

more control a company has over the individual, the more likely the individual is to be classified

as an employee. Less control by the company means that the individual is more likely to be

classified as an independent contractor (IRS). Companies, not the IRS, decide the classification,

although employees/independent contractors may contest the decision if applicable.

A great deal of responsibility is removed from Northwestern Mutual because financial

advisors are considered independent contractors. The most important implication of this

classification is that financial advisors at Northwestern Mutual are not salaried and work fully on

commissions, like established multi-level marketing companies. Also, Northwestern Mutual is

under no obligation to supply benefits to its independent contractors, although the company does

provide some health insurance benefits. Financial advisors are financially responsible for funding

their office spaces, printed materials for clients, and travel (Glassdoor).

Compensation for Northwestern Mutual financial advisors is fully commission based,

without any base salary. A mentor, called a “joint work partner” is assigned to new financial

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advisors, who helps the new financial advisor with prospecting visits and closing deals - with a

price tag of 50% of the commission that the new financial advisor earns (Glassdoor). Also,

according to several former financial advisors on Glassdoor, if a contract is cancelled by a

policyholder within one year of the policy being created, financial advisors must repay

Northwestern Mutual for any commissions they earned from the cancelled policy in the past

year, rendering all of their work for that client uncompensated.

Lawsuits Regarding the Northwestern Mutual Company Structure

Aside from lawsuits regarding Northwestern Mutual products, the prevailing claims

regarding the company structure relates to the supposed misclassification of financial advisors as

independent contractors.

In 2009, three former financial advisors filed a class action lawsuit of $200 million

against Northwestern Mutual under the Fair Labor Standards Act that alleged that financial

advisors were misclassified as independent contractors, which disqualifies advisors from many

labor law protections, including overtime benefits and minimum wage laws. The plaintiffs stated

that they were misclassified because financial advisors have little discretion in business

decisions, and they “are required to secure management approval before making decisions; and

do not have the authority to make independent choices relating to management, management

policies or general operations” (Sanford Heisler Sharp, LLP). This case is still pending after

being moved to several different courts in multiple states.

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In 2012, a similar lawsuit was filed by Joseph Rose against Northwestern Mutual in New

York for the violation of New York labor laws, including minimum wage and overtime laws. In

this suit, the court found that the plaintiff had full awareness that he signed documents pertaining

to his status as an independent contractor, and Northwestern Mutual did not have adequate

contact with the plaintiff to supervise his work to be classified as an employee of the company

(Justia).

A 2019 case is still pending in New Jersey regarding the misclassification of financial

advisors as independent contractors (Justia).

Stakeholder Analysis of Northwestern Mutual

Key stakeholders at Northwestern Mutual are policy owners and financial advisors, as the

policyholder designation encompasses both customers and those who have ownership shares in

the company.

The policy owner perspective of Northwestern Mutual is intriguing because while life

insurance sales are pushed by management, which could be detrimental for policy owners

depending on individual circumstances, they are also part owners in the company because it is a

mutual company. They have voting rights which allow them an element of control to make

decisions that affect the management of the Northwestern Mutual and to change company

policies that they deem unfair. Northwestern Mutual does not provide any public data on the

percentage of policy owners who return their proxy votes, so the effectiveness of promoting

policy owner interests because the mutual company structure cannot be fully determined, but

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policy owners are more protected in this structure than they would be with a private company

where they had no input.

A fascinating issue for policy owners is the risk of over insurance, which occurs when an

individual purchases a policy with unnecessarily excessive coverage. Over insurance is not only

a waste of money for a policy owner, it is also a drag on the economy. On a whole economy

scale, when money is tied up in in over insurance, that money will never be paid out because the

risk that the policy owner bears is less than the risk that he or she is insured for. Because of this,

it cannot be used to purchase other goods and services or to invest, which grows the economy.

There is also a flip side to over insurance - Northwestern Mutual policy owners are paid

dividends based on earnings, so an increase in earnings due to over insurance would mean an

increase in dividends to policy owners. Northwestern Mutual does not publish a public record of

dividends paid, nor does it publish any type of metrics on over insurance, but if the excess

premium is more expensive than what the policy owner receives as an extra dividend, the policy

owner is losing money.

In terms of the financial advisor perspective, every individual who works for the

company is different in their preferences and strengths. A certain new financial advisor may

begin working for the company who loves the commission structure and the challenge of

constantly selling to make a living, and who views the mentorship program as a learning

experience. Another new financial advisor may be extremely disgruntled with the lack of

transparency through the hiring process and the fact that he or she must share hard earned

commissions with a mentor, which might prevent him or her from seeing much compensation for

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the first several months of working. Or, a new financial advisor might fall somewhere in

between. The workforce is made up of people with diverse preferences and expectations, and

stating that the established Northwestern Mutual financial advisor structure is inherently bad is

an untrue assertion.

However, it is fair to state that the lack of transparency in the hiring process, including

how the position is advertised as a financial planning and advisory role, is concerning and

presents the question of whether other processes within the company are as dishonest.

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Chapter 5

Results and Implications

Is Northwestern Mutual a Multi-Level Marketing Company?

The definition of a multi-level marketing company mentioned in the introduction

provides four metrics for a company to be considered a multi-level marketing company:

1. Presence of a downline, which is constituted by recruited distributors

2. Each distributor in the line receives downline compensation

3. Each distributor can sell products and enlist downline distributors

4. Revenue from customer purchases flows up through the distribution levels

Northwestern Mutual shows characteristics of all four of these metrics. First, the concept

of “joint work partners”, or those mentors who recruit and train new financial advisors, covers

the first metric. Those who sponsor new financial advisors are higher in the distribution level,

and new financial advisors constitute the mentors’ downline. The second and fourth metrics are

covered by the commission sharing arrangement of joint work partners, where new financial

advisors split the commissions that they earn from selling policies to customers evenly with their

mentor. These metrics are reinforced by the fact that when a newer financial advisor decides to

leave Northwestern Mutual to pursue other opportunities, their mentors receive their book of

business, as well as the commissions from all of their former clients (Glassdoor). The third

metric is covered by the fact that financial advisors are encouraged to sell insurance policies,

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which are the main product offerings of Northwestern Mutual, and that they can recruit new

financial advisors who they will mentor.

In addition to complying with the definition of a multi-level marketing company, there

are other characteristics of Herbalife and Mary Kay that seem to exist in mainstream multi-level

marketing companies, including extravagant promises regarding distributor compensation and

misleading descriptions of the actual job of being an independent distributor.

The most obvious of these similarities between the recruitment of Northwestern Mutual

financial advisors and those of recognized multi-level marketing companies is the constant

stream of extravagant promises to potential advisors. These promises relate to the flexibility of

owning your own business and earning an uncapped commission. While these statements

themselves are not false, they are extremely misleading. Entrepreneurship is an attractive career

path for those who scorn the idea of spending much of their time working for corporate America.

But there are many barriers to building a business from scratch, such as the lack of upfront

capital, the lack of a consumer base, and many others. To eager recent graduates, being backed

by a well-known corporation like Northwestern Mutual remedies these risks while seemingly

still allowing for independence, however they are not made aware of hidden responsibilities and

stipulations by the company.

For example, Northwestern Mutual as does not provide its advisors with an office space,

advisors are responsible for finding and paying for a space to work, as well as paying for the

utilities for the office. They are also responsible for their own commissions, which can vary

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based on many factors, including location, the size and demographic of the advisor’s network,

and the type of products being sold. Although there is not a “starter fee” that is explicitly

required to join Northwestern Mutual as an advisor, the fact that advisors do pay for their own

supplies and office building rent is a similar concept.

In addition to this, another issue relating to misleading promises is that financial

advisors are expected to sell insurance as the majority of their quota from the company. This

might not raise many red flags other than the argument that life insurance is only a suitable

investment for only a small subset of the population, but the job of a financial advisor is typically

not the same as the job of a licensed insurance agent at most other companies, and advertising

the position as such without transparency leads to mistrust from employees, and most likely

contributes to the exceptionally high turnover rate for financial advisors. Also, this calls into

question the fiduciary duty that financial advisors have to their clients.

There are few differences between Northwestern Mutual and established multi-level

marketing companies despite all of the similarities. Aside from the misleading marketing

material for the recruitment of new financial advisors, the recruitment process at Northwestern

Mutual is not overtly similar to recruitment at established multi-level marketing companies. For

example, recruits do not have to pay a “starter fee” to become advisors, nor do they post on

social media about the benefits of joining the financial advisor team at Northwestern Mutual.

Recruitment is largely like a typical hiring process at any other non- multi-level marketing

company, where the candidate must interview with the company.

47

A final consideration is that financial services companies are intrinsically different from

the consumer discretionary companies in which multi-level marketing structures are usually

manifested. Financial services companies have regulated capital structures and many more

regulations than companies in other industries in general. Fiduciary rules dictate that those

financial services companies who call themselves fiduciaries act in the best interest of the

customer regardless of profitability. Northwestern Mutual Wealth Management Company is a

fiduciary, but it is a subsidiary of the Northwestern Mutual Life Insurance Company, which is

not. More importantly, the products and services that financial services companies provide are

usually less understood than companies that sell makeup or nutrition supplements, and thus

consumers implicitly trust financial services companies more than they would other companies

(aside from the effects of the Great Recession). This would explain the increasing levels of

insurance policies sold and the lack of any apparent changes in management or company policy

by policy owners at Northwestern Mutual.

Northwestern Mutual fulfills all of the requirements of being a multi-level marketing

company which were set forth in this thesis. If Northwestern Mutual is indeed to be used as a

proxy for all multi-level marketing companies in the financial services industry, customers are at

risk for purchasing products that may not be useful for them, which wastes money and produces

a drag on the economy. The effect on independent distributors varies by the individual

preferences of each distributor, but the promises made during the hiring process are unclear and

may lead to disgruntled distributors once they begin working. This may also lead to a decrease in

productivity and quality of work, and a breach of trust in the brand that Northwestern Mutual has

created.

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It is important to note that not all companies in the financial services industry are mutual

insurance companies, but also that most companies in this industry are structured as public

companies with employees instead of independent contractors, so there is not a large pool of

companies structured like Northwestern Mutual to examine. Further research could be done to

determine the effect of multi-level marketing companies that are not mutual insurance companies

if those companies form in the future.

Consequences: Risk Transfer

The concept of multi-level marketing overall is essentially a risk transfer from the

company to the independent distributor. Instead of companies bearing the risk that products will

not sell, they motivate independent distributors to purchase inventory, which is the sale of

products from the company, and where the risk for the company ends. Distributors are motivated

to purchase inventory in a variety of ways, including discounts on inventory as their volume of

purchases increases, or the company flat out requiring distributors to purchase a certain dollar

amount of inventory in a set period to stay “active”.

The risk is arguably larger for the independent distributor than it is for the company on a

per-distributor basis. If the company does not meet sales expectations and holds more inventory

than it can sell, earnings will go down, shareholders will be disappointed, and stock price will

fall, but distributors will not unknowingly risk losing a potentially large investment in inventory

and their involvement in a multi-level marketing company. In the case of the independent

distributor who is convinced that entering into the “business opportunity” will be profitable

49

enough to spend his life’s savings on materials and inventory, and does not meet sales

expectations, that distributor loses all of his money. This is especially common in products that

expire.

Independent distributors are willing to take on this risk because, much like shareholders

in a corporation, there is an unlimited upside potential with commissions, and the downside is

limited to the initial investment in startup kits and inventory. Multi-level marketing companies

use this logic to their advantage with their marketing materials that make claims about

extravagant bonuses and airing infomercials showing top performers on vacations.

Consequences: Regulation of Information

Since Herbalife is a publicly traded company, it is required to release certain information

so that shareholders can make informed decisions about whether to trade and how to vote.

However, Mary Kay and Northwestern Mutual are not held to the same standards. Mary Kay

releases almost no public information about compensation, and those who are interested in

becoming an independent distributor should connect with an existing distributor before any

information is released. Northwestern Mutual publishes an annual report, but it is not as

comprehensive as annual reports published by a public company, because it does contain a

breakdown of income from different insurance policy types or investment products, net income,

or much other relevant information.

In all companies, even publicly traded companies that are required to have more

transparency, an information asymmetry problem exists. Management always has more

50

information than shareholders, customers, and even other employees within the company. In

some cases, this is beneficial, specifically when there are trade secrets involved, but when

individuals are making the decision whether or not to become independent distributors, they are

at a significant advantage in terms of the information provided by the company. One can make

the argument that a potential independent distributor is responsible for gathering all information

and for acting in his or her own best interest, but the information put forth by the clear majority

of multi-level marketing companies is much too misleading for an optimistic looking for a new

opportunity.

Because of this, the Federal Trade Commission must come out with clear standards of

information that multi-level marketing companies must present to potential independent

distributors so that these individuals can make a more informed decision based on facts and

statistics, instead of grandiose and misleading promises. These standards should include that

every multi-level marketing company, regardless of whether it is public, private, or otherwise,

must release unambiguous compensation information on an annual basis. In addition, instead of

evaluating these companies on a case-by-case basis, the FTC should conduct routine audits of all

companies with characteristics of the multi-level marketing structure to determine if the

information presented to distributors is sufficient for prospective distributors to make informed

decisions.

Routine audits would certainly create additional costs for the agency, but moving

forward, they will be beneficial as the number of multi-level marketing companies in the United

States has grown by 10% in the past ten years (Direct Selling Association). With no new

51

regulations in place or apparent barriers to entry into the multi-level marketing market, more of

these types of companies will appear, and more people will be attracted to the grandiose

promises of being an independent distributor. Without routine audits or other regulations on

multi-level marketing companies, more class action lawsuits regarding compensation of

distributors and company structure will ensue, and more people will lose their savings because of

vague information about becoming an independent distributor. In addition to this, the Federal

Trade Commission must actively seek and audit companies like Northwestern Mutual who do

not advertise themselves as multi-level marketing companies, but clearly structure themselves as

such and take advantage of their independent contractors as multi-level marketing companies do

of their independent distributors.

52

Chapter 6

Conclusion

This thesis investigated the various effects on stakeholders of Northwestern Mutual Life

Insurance Company in comparison to the effects on the most important stakeholders of

established multi-level marketing companies to determine the value of multi-level marketing

firms to the economy as a whole and more specifically, the value of multi-level marketing firms

in the financial services industry. The stakeholders included the owner(s), customers, and

independent distributors, and the companies that were examined included Herbalife, Inc., Mary

Kay, Inc., and the Northwestern Mutual Life Insurance Company.

The study found that company owners, regardless of if the company is public, private, or

otherwise, generally benefit from the multi-level marketing structure because of incentivized

product sales and the transfer of risk to independent distributors. Because distributors are

independent contractors and not employees of a multi-level marketing company, they are

required to purchase inventory before they make sales to customers. They are motivated by the

company by discounts and bonuses based on the amount of product that they purchase, so there

is no reliance on actual sales to unpredictable customers for revenue. Independent distributors

assume the personal risk of product sales to customers, and because of incentives, they are much

more predictable in their purchasing patterns.

53

For that same reason, independent distributors are harmed by the multi-level marketing

structure because of the increased risk they take on when purchasing products that may not sell,

especially products that expire. Distributors are also largely misled by marketing materials

designed to entice individuals to join a downline, and usually are required to split commissions

with their upline sponsors. Finally, independent distributors do not earn a salary, which presents

the additional risk of inconsistent income. Some distributors enjoy the challenge of earning

commissions, but others are misled by the ambiguous promises made by multi-level marketing

materials during the recruitment process.

The effect on the customer stakeholder group varied by the type of product being sold

and the company backing the product. Herbalife products seemed to have mixed reviews, with

some customers claiming that the products aided them in their weight loss journey, while others

complained that the products were of low quality. Mary Kay products earned higher reviews by

customers, as many claimed that the products helped to clear their skin. Northwestern Mutual

products, specifically the life insurance products, are heavily scrutinized by outside financial

professionals, but there is low policy owner turnover, which indicates satisfaction but could also

be a result of the mutual structure of the company.

After performing a case study on Northwestern Mutual, it was determined that

Northwestern Mutual meets all of the qualifications to be considered a multi-level marketing

organization, but that it was not the most effective proxy for the entire financial services industry

because most financial services organizations are not mutual companies, and thus they are

structured differently.

54

Finally, it was determined that instead of the Federal Trade Commission performing

case-by-case investigations of multi-level marketing companies to determine if companies are

taking advantage of independent distributors, the agency should establish an audit program for

all known multi-level marketing companies, and actively search for companies like Northwestern

Mutual who do not consider themselves part of the multi-level marketing industry, but show all

of the characteristics of a multi-level marketing company.

In conclusion, Northwestern Mutual does indeed show all the characteristics of a multi-

level marketing company, and that these characteristics are both unfair to financial advisors and

have the potential to breach customer trust. Further research into whether there are any other

companies within the financial services industry that could be considered multi-level marketing

companies would be extremely beneficial, as multi-level marketing companies clearly prize

revenues and risk reduction over the treatment of independent contractors and customers, which

would be detrimental perhaps to the entire economy since the financial services industry is such

an integral component. If any other companies are found to have a multi-level marketing

structure, an investigation into their compliance with the many regulations that govern the

financial services industry would be extremely beneficial not only to distributors, but to the

thousands of customers who entrust these institutions with their savings and their vital life

decisions like retirement, education planning, and succession planning.

55

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