Number of people involved in Direct Selling (in Millions). Source: DSA’s Growth & Outlook Survey, Salesforce Statistics.
By David Rauf
“Segmentation is a critical part of understanding the FTC’s view of what is legal and what is not.”
—Larry Steinberg, partner, Buchalter
“From an industry perspective, people in the regulatory community clearly had a hard time seeing how the model worked. Segmentation will help to better demonstrate who is using the product and who is buying the product.”
—Joseph Mariano, president, DSA
A growing number of companies in the U.S. direct selling channel are segmenting their salesforce, a process disrupting the decades-old traditional multi-level marketing (MLM) model of encouraging everyone who purchases a product to sign on as a distributor. Until recently, from a company tracking perspective, there was little difference between people who truly wanted to build a business and those who only wanted to buy product at a discount.
Not long after Herbalife settled its landmark case with the Federal Trade Commission (FTC), executives at Mannatech decided to revamp the company’s compensation plan. Mannatech CEO Al Bala says the nutritional supplement maker saw the writing on the wall: Its business model could draw scrutiny in a landscape where regulators were focusing on how direct sellers differentiate between participants who join simply to buy products at a discount and those who join for a legitimate business opportunity.
At the time, Mannatech sold what it called a best-value pack, and Bala says the practice gave the appearance of “front loading” because there was “such a high value to the pack that most people were being recruited or brought on board as associates even though they just wanted to be customers.” Another issue with the company’s old compensation plan, Bala says, was concerning payouts for selling those packs, a perk that “gave the optic people were being paid for recruiting.”
“We started reading the tea leaves and realized that could cause some problems,” Bala says. “In both situations, the FTC could take a really dim view because it went against some of their principles.”
Bala says the nutritional supplement maker eliminated the best-value packs as a result. The company also changed its basic registration package for associates, which now provides “access to the back office for a few months, a welcome kit and that’s it.” Bala says there’s also no commission paid for signing up new associates, and associates now have to renew their status annually.
Regulatory Pressures Are Forcing Change
Changes like those Mannatech has put into practice are becoming more widespread as a result of the regulatory scrutiny in recent years, highlighted in the high-profile cases involving Vemma and Herbalife. “Segmentation” has emerged as a defacto way for companies to point out their customer base to the FTC and the general public.
“For us, this was strictly to be able to align ourselves with what we saw coming through the FTC,” Bala says. “We’re now creating an initial barrier, and the customer has to make a conscious choice to become an associate.”
Larry Steinberg, partner at Buchalter who chairs its Multi-Level Marketing Practice Group, says there is at least one lesson that the Vemma and Herbalife consent decrees unequivocally teach: Companies that correctly categorize distributors and customers will be in a stronger position if they are placed in the position of explaining their business models to regulators.
“What the FTC said to Herbalife and Vemma is if each of those companies follow their respective settlements then we agree you are not operating as an illegal pyramid,” he says. “Up until that time the FTC had never blessed an MLM model as being unequivocally legal.”
But Steinberg says even though the consent decrees from the two cases are “certainly interesting and useful,” they still offer limited guidance to other companies in the direct selling industry because “they clash in their specifics.”
Guidelines issued by the FTC in January 2018 for the MLM industry, Steinberg says, are actually more helpful. On the issue of looking at whether an MLM company is potentially engaging in a pyramid scheme, the FTC guidelines say, “at the most basic level, the law requires that an MLM pay compensation that is based on actual sales to real customers, rather than based on mere wholesale purchases or other payments by its participants.”
“Segmentation is a critical part of understanding the FTC’s view of what is legal and what is not,” Steinberg says. “And we’re now starting to get some guideposts. We’re starting to see something from which we can extrapolate to help guide companies to stay on the correct side of the pyramid line.”
But he adds, “The FTC guidelines aren’t burdened by having to set down bright-line rules specific to a company’s business model. The FTC has exploited that uncertainty. They love the fact that the rules are vague because that gives them maximum prosecutorial discretion.”
Some companies have taken the lessons from Vemma and Herbalife to heart, Steinberg says. They’ve stopped signing up everybody as distributors and, instead, require a two-step process and a separate application form to become a distributor.
“In these companies where the initial application is to become a customer, the barrier to move from customer to distributor is very low,” he says, “but the default, which used to be that everyone automatically becomes a distributor, is 180 degrees from what it was.”
Steinberg says it takes some effort to convince a company who is used to making everyone a distributor to change that presumption, but that hesitation is par for an industry going through evolutionary changes. “The smarter companies have learned from that. It would be wise for companies to categorize their people appropriately and maintain a database,” he says. “This way, when the FTC comes knocking you have a story to tell.”
Joseph Mariano, president of the Direct Selling Association (DSA), says the push for segmentation was not driven solely by legal and regulatory concerns. He says the conversation has been happening internally for years about how to get a better gauge on the industry’s salesforce. But he agrees segmentation could help regulators better understand the direct selling industry.
“From an industry perspective, people in the regulatory community clearly had a hard time seeing how the model worked,” he says. “It was difficult for a regulator to establish if there was legitimate use of a product going on, and segmentation will help to better demonstrate who is using the product and who is buying the product.”
However, Mariano says it’s important to note that if a company decides against segmentation “it’s not some indication that there’s a reporting or regulatory issue.”
“What’s critical, of course, is the company is ensuring real people are using its product and real commerce is happening,” he says. “If segmentation can better demonstrate a real person is using the product and there are no abuses going on, then it helps.”
Segmentation Changes the Numbers
Though still early in its widespread implementation across the domestic direct selling channel, segmentation has already had an effect on industry figures. As the segmentation of sellers and preferred customers is becoming more common across the channel, it has likely reduced the top-line number of contractors.
The U.S. direct selling salesforce shrunk by about 2 million people to 18.6 million in 2017, marking a roughly 9 percent decline. Full-year figures for 2018 will be unveiled at DSA’s 2019 Annual Meeting.
The DSA’s Growth & Outlook survey for 2017 says that downward shift is “likely tied” to companies segmenting their salesforces by moving those who are primarily purchasing products and services at a discount, and not selling or sponsoring, to preferred customer programs outside the network of independent representatives.
In its annual Growth & Outlook Report, the DSA estimated that 5.6 million distributors involved in direct selling in 2017 were either full time or part time. The association also reported that 4.1 million people who counted as part of the direct selling salesforce were simply purchasing products or services for personal use. Another 9 million had become inactive that year.
For the first time, the DSA is defining three categories of direct sellers for the purposes of reporting on segmentation trends. Mariano says it marked a more defined and precise data-gathering process by the DSA, calling it a process that is still evolving.
Those three categories include: Full-Time “Business Builders,” working in direct selling 30 or more hours a week; Part-Time “Business Builders,” working up to 30 hours a week; and “Discount Buyers” or “All Others” for those working less than one hour per week in the business.
Mariano says the motivations of people who get involved in direct selling continue to be multifaceted, making it a challenge to accurately characterize and classify the industry’s salesforce.
Previously, DSA might have asked a question or two in its Annual Growth & Outlook Survey about how many hours a distributor dedicates to direct selling, but “we hadn’t defined or agreed on those three categories,” Mariano says.
There had been some confusion over segmentation definitions in the past, and individual companies had come up with their own segments. Added to this is the fact that companies have limited visibility into the number of hours their salesforce spends on the business.
Global Data Collection
“We’re hoping to develop a uniform approach across the industry, so reporting can be consistent,” Mariano says. “We’re responding to observations that we didn’t have the best characterization of these folks. We recognize that was true.”
Meanwhile, direct selling associations globally are also collecting segmentation data. That effort is being led by the World Federation of Direct Selling Associations (WFDSA). Since 2013, the WFDSA has asked selected test countries for segmentation data. As of this year, every country that receives the annual survey—over 40 of the more than 60 in all—is being asked segmentation questions in the WFDSA’s survey, according to Judy Jones, who chairs the organization’s Global Research Subcommittee.
Jones says the goal is to help “paint a picture of the direct seller” through the data.
“We hope to assist DSAs to develop a comparable and consistent story around the world and to develop stats beyond the individual country level—to have global and perhaps regional stats,” she says.
Mariano says the effort by his association to gather segmentation data is still a “work in progress” as the the group continues to refine its data analysis and reporting to “best reflect what the industry is doing.”
“Hopefully, it will serve as a template for companies to consider as they report their own data,” he says. “But the point of DSA gathering and providing this information is not to suggest companies change their compensation plans. Having accurate data and a better understanding of the salesforce is critical to competing in the marketplace.
Opinions on the Need to Segment Remain Mixed
It’s still unclear how many companies in the domestic direct selling channel are reclassifying sellers and preferred customers—or are even considering it. Industry veterans say they believe most companies are changing how they do business in some way to align with the current regulatory landscape.
But Steinberg, the lawyer for Buchalter, says there’s an old guard mentality resistant to segmentation that permeates the direct selling industry.
“The industry is full of old MLM-ers; people who founded a company 20 or 30 years ago. They grew up in the industry … and their old-school view is that everyone should be a distributor because even though they might not be interested in recruiting a downline or selling products now, someday they might become interested,” he says. “They need to let go of that vestige that everyone needs to be categorized as a distributor because it can backfire and ultimately harm the company if they need to withstand regulatory scrutiny.”
Modere CEO Asma Ishaq says it’s not a surprise that some companies are resistant to change. “The channel will get there, but it’s going to take time,” says Ishaq. “Many of these businesses are extremely complex; they have a rich history and an obligation to preserve the business opportunity they’ve been providing to their field for a long time.”
She adds, “This is a paradigm shift. It takes time to learn, and businesses can face risk in moving too quickly.” Ishaq says Modere moved to change its compensation plan to include segmentation in 2015. “The regulatory issues that arose and the evolving social commerce channel compelled me and our company to listen.”
According to Ishaq, segmentation can allow a company to market itself better, aside from the ability to satisfy regulatory criteria. “We can speak business to people who want to be in the business and speak value to consumers who are most interested in the quality of life improvement that our products create,” she says. “That means we’re not pitching people with unwanted opportunities.”
At Herbalife, CEO Michael Johnson told analysts during a recent call the the company is performing “really well” in the countries where it has implemented segmentation, highlighting successes in the U.S. and India.
Johnson says he thinks it is an “indication that we can continue to implement segmentation successfully in markets where our distributors wanted it.”
“Segmentation provides Herbalife Nutrition and our distributors with improved visibility to those who joined to pursue the business opportunity or to those who joined simply to access the products at a discount,” he says. “We believe there are numerous additional benefits of segmentation, including an improved customer experience through personalized product-oriented communication, a simple low-cost lineup and a natural progression for those who eventually choose to become business builders.”
Meanwhile, at Mannatech, the process of implementing segmentation is still ongoing. Bala says the company is still going through “purging operations.” In the short run, he says putting segmentation into place caused the company to report lower numbers of new associates, but that has rebounded now that they are comparing data with segmented associates and customers.
“In retrospect, what we previously thought was a recruiting figure was actually a fictitious number,” he says. “When you think of recruiting, you think of someone building a business. We ended up with a lot of people in our database that we called distributors who weren’t selling the product. It gave us a very false indicator of what future business will be.”
Bala says he credits segmentation with helping the company understand its daily business better.
“The value that segmentation brings is that we can communicate properly based on the actual needs and desires of a customer or associate,” he says. “We were looking for a change. We wanted a change. And we knew it would put us on better regulatory footing and also fix how we target our communication.”
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