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.
48
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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