The Herbalife Compensation Puzzle

Before I went away I left people a puzzle - to force people to understand the Herbalife compensation scheme.

The puzzle was - and to quote:

Imagine you were the very first Herbalife distributor and you recruited three people and they - eventually and through their downline - recruited the millions of people who now consume and/or distribute Herbalife. 
And also presume you did nothing else for the rest of your career. You just sat there and collected the "recruitment rewards" or the "royalty checks". 
Roughly how big would your income be now? And from how many levels would you be collecting your income?

The reason that I posted this puzzle was that short-sellers (broadly defined but starting with Bill Ackman's original Herbalife presentation) have publicly said many false things about Herbalife - and one area of these falsehoods has been the remuneration scheme.

Specifically Ackman thinks that the scheme is designed to push large purchases of unsellable weight loss powder and enrich Herbalife and top distributors while defauding mostly poor Latinos.

And the guesses I have received for the answer conform to this suggestion. The typical guess was about $3-5 million per year. Christine Richard - one of the key outsource researchers for Bill Ackman was in the middle of that range (at $300,000 per month). I got one estimate of upward of $50 million per year.

These estimates are based on a false assumption - an assumption promulgated by Bill Ackman. The assumption is that Herbalife's compensation scheme is a conspiracy to enrich top distributors at the expense of middle and low level distributors.

This is to misunderstand the motivations of Mark Hughes who founded Herbalife.

Mark Hughes is a character about whom people have strong opinion. I have seen everything from a flat-out man-crush to utter revulsion. But whatever you say about him you have to confess he was a clever businessman.

He invented a monstrously complicated compensation system for Herbalife distributors - and it was invented to benefit his company and not the early distributors. He did not wake up one morning and say I will make these early distributors rich for life for just sitting around.

Mark Hughes wanted Herbalife to sell a lot of product. He did not want to pay distributors to sit around and do nothing. Indeed the scheme is designed so that if you do not stay active selling your income eventually tails towards zero.

Here is how the scheme actually works (and this is a simplification but these are the core ideas).

If you are a base level distributor you buy the product at a discount of up to 42 percent. You sell it at retail. You make a margin. 
At some point you become a sales leader. A sales leader is entitled to buy it at up to 50 percent discount. You can NEVER buy the product at a higher discount than 50 percent. 
But the sales leader is entitled to a royalty. The royalty is paid three levels deep. A recruits B recruits C recruits D recruits E then A is entitled to 5% of BCD but not E's sales. B is entititled to 5% of CDE sales. That way 15 percent more is paid out. 
This you are always entitled to - three levels deep.
After that there is a "production bonus". These are up to 7% of sales based on your level. However if someone in your down-line earns 2% production bonus then you are only entitled to 5%. And when your down-line is long and successful enough the entire 7% will be earned below you. You will be blocked and receive no income.
After that and if you are senior enough you may receive the Mark Hughes Bonus - typically 1% of all sales paid infinitely deep in the sales structure. HOWEVER if someone in the Chairman's Club is below you (and this happens) then you get blocked on that too. So you will receive no Mark Hughes bonus. 
The person I describe could never be in the Chairman's Club (to do that you need 5 people below you to make a certain level) but someone who was very early and has done almost no recruiting will almost entirely be blocked on the Chairman's Club as well.

So lets calculated the answer...

They do no sales - so they get no retail discount.
They have people three levels below them - so they receive 5% of their production - but their immediate network is either senior and doing few sales or sclerotic). This is the only income they get - and it is 5% of three levels. 
They are unequivocally blocked on the "production bonus" so they get nothing there and
They are not Chairman's Club or above because they recruited only three people - and if the recruited more they would be blocked for most of it anyway just because the very early guys have all been blocked out unless they kept growing their network. 
So all they get is 5% of three levels down - which is likely to trivial - probably less than $5000 a year.

Note the 50% plus the 15% plus the 7% plus the 1% is the famous 73% payout ratio. It all gets paid - just not to the foundation recruiter. In fact it gets paid to people they recruited, people who worked hard to build networks and make more sales.

The scheme is deliberately designed to reward active people who are growing their network not old codgers at the top. It is complex I will concede - but the complexity is designed to do almost precisely the opposite of what Bill Ackman claims it is designed to do.

How did the Ackman crowd - including Christine Richard get this so wrong?

According to the Wall Street Journal Bill Ackman's researchers are currently getting investigated for (possibly) lying to investigators about Herbalife.

And they have told untruths about the Herbalife compensation scheme.

But the scheme is complicated - and they looked at the scheme and saw what they wanted to see (ie evidence of a pyramid scheme benefiting the very top) and not what is actually there (a scheme designed to incent sales).

This was self deception - but it was self-deception aided by some Herbalife distributors who say you can build "residual income" by recruiting a large network. When distributors talk about sustained residual income they are not telling the truth.

Still there are resources on the web that help you understand it. There is one distributor who is trying to sell MLMs that are not Herbalife - arguing that there is a "flaw" in the Herbalife system that denies you residual income. They want to sell you an MLM that really is a pyramid. To quote...

Now it’s down to infinity until the next level ranking Distributor at your level reaches your level. So if I’m a President’s Team member or a Millionaire Team member and I have somebody underneath me that hits Millionaire Team member, then I’m blocked off of that production bonus.
Now how the production bonus works with the Herbalife Compensation Plan is let’s say I’m a GET Team member and I have 20,000 organizational volume points, I get a 2 percent production bonus.  I’m going to get 2 percent all the way down to infinity until somebody reaches the GET Team status underneath me. Once they reach the GET Team status underneath me and if I’m GET Team myself, not advancing to Millionaire Team status yet, let’s use that as an example, then I would be cut off or the breakaway of my production bonus would take place.
So the only time that you earn production bonus is when people are not at the same level as you. So if I’m a President’s Team member and I am earning a 6 percent production bonus, and I have somebody underneath me and my team that is a Millionaire Team status, the Millionaire Team status member would get the 4 percent production bonus and I would get 2 percent because there’s a total of 6 percent paid out, and that 2 percent production bonus I would earn until that person reaches the same rank. In the example, if I was President’s Team, once they reach President’s Team, I would be cut off from that production bonus.
One of my main things that we teach here at XXX is that you should never be penalized for developing leadership. You never should be in the fear that your income is going to drop based on someone advancing to a higher rank.

This is one of the key reasons of course why Herbalife is not a pyramid scheme. Any new member can reach the higher level - though very few do. It is really hard to develop an organisation that sells hundreds of thousands of dollars worth of Herbalife per month. Though every month in the US a few more people get inducted into the President's Team. And every month upper level distributors have their income reduced somewhat.

This is not the pyramid scheme Bill Ackman told us about.


Disclosure: The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog ...

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Scott Johnson 9 years ago Member's comment


What is your reference document for all of these claims? However, your claims do explain why John Peterson put a bullet through his skull a couple of years ago after HLF outlawed the lead generation tool scam, as he was no longer making much money from HLF since he was so high in the distributor pyramid and most of it was from the tools. Are you claiming HLF caused John Peterson to kill himself?

Rene Porcile 9 years ago Member's comment

Scott >> "John Peterson was no longer making much money from HLF since he was so high in the distributor pyramid and most of it was from the tools"

Rene >> Your comment is worthless Scott - think about it. His partner (ex-wife) in HLF is #1 in the world for the last 5 years. Makes millions a year - go figure!

Hey, has the FBI cotacted you yet?

As you know the FBI, Preet Bharara, Grand Jury are ready to pull the plug on Ackman. Good luck in your future project...

Scott Johnson 9 years ago Member's comment

I'm just agreeing with what John said. So if you're right, he's full of it, right Rene? The FBI has not "cotacted" [sic] me yet, but you better ask John Hempton that question, he's the one who said there's no money at the top. I happen to agree with you, PLUS they're still making the tool scam money, take THAT to the FBI, Rene. Nobody has said Ackman has done anything wrong, only that some of the people working with/for him MAY have said some untrue things. You better watch out for the FBI knocking on YOUR door, Rene. After all, I'm a nobody, but YOU are a high level, influential HLF member. Good luck in your future jail cell...

Rene Porcile 9 years ago Member's comment

John Hempton, Excellent overview and strong points on were Ackman made errors. Most likely those errors made on purpose to help his thesis, of course.

HLF will continue grow and strive because HLF is within the laws and regulations!!!

1) Millions buy HLF everyday for the healthy benefits & savings!

2) No inventory loading*

3) No payment for mere recruiting

4) Excellent Return Policy**

5) Commissions are paid related to product sales only

6) Good customer service. Small # of complaints

7) In business 34 with annual sales over 5 Billion.

8) Many members make more money their sponsor.

i) This is impossible in a pyramid scheme.

9) Illegal MLM's or pyramid schemes fail within 10 yrs.

10) 31% of sales to NON-member addresses - 32% by volume

* Members can become supervisors over a 12 month period. Monthly purchases are cumulative until 4k volume is reached. Maximum fiirst order is around 1,000 USD, so new member can test the waters.

** HLF Gold Standrad:

Member can return products for a full refund within 1 year of

purchase, Free shipping back to HLF. Introduced in 2013 and in current Q1

2014 HLF had the lowest product return in history 0.2% - before Gold Standard returns were at 0.5% (Very small indeed).

David Thornton 9 years ago Member's comment

Rene Porcile's method of recruitment and snake oil salesmanship.

Rene Porcile 9 years ago Member's comment

Has the FBI contacted you yet? Too bad you got busted by police after beating your wife. She left you and went with someone in MLM - forgive her and your self - that's the best thing to do! Find a good church, etc...

Also, remember extortion is not a good thing. Leave businesses alone!

Rogier Fentener Van Vlissingen 9 years ago Contributor's comment

Well, congratulations, John. It seems you missed your calling as an MLM-distributor. You certainly have mastered the art of explaining why your MLM is not a pyramid scheme, which is what they all must do to get around the law. However getting around the law is the business for lawyers, and MLM lawyers enjoy the most steady earnings of anybody in the pile, because all MLM must try to foil pyramid prosecutions in one way or another...

Regulators in America has become completely wrapped around the axle by the absurdity known as the Amway '79 ruling, which is the legal progenitor of the explosive growth of MLM that started in the 80's and 90's, and at the foundation of the original design of the Herbalife plan. In spite of all the noise however, MLM is still an insignificant portion of American retail sales, because it is wearing itself out. It is not a business, it is at best a hobby, as the Small Business Administration knows, because it will not lend to SBA distributorships. Another clear case of the left hand not knowing what the right hand is doing, but eventually these government agencies might talk to one another.

The pyramid issue is economically very easy: If the plan provides maximal earnings for recruiting, not selling, people will recruit, not sell, and the only way to maintain the appearance of sales is by conscripted consumption. People are simply buying their paychecks. But since the product is over-priced, and 99.5% or better lose money on there distributorship, this means that 99.%% of consumers are over paying for the product, and that in turn explains the nearly 100% churn rate in the customer base. Of all the weak links in MLM, the pyramid sales aspect is the most convoluted because of some judicial errors, such as the Amway '79 case, which is however full of holes, eventually likely to be overturned.

The other weak areas are that the extremely restrictive distributor agreements that are common in MLM, such as the 120-page or so Herbalife agreement, make a mockery of the 'independence' of the 'independent' distributors, and some day the labor department may wake up and start to take exception. Along with this, the IRS treats MLM-distributorships as businesses, but my odds are better playing the colors in roulette, which gives me 50/50 odds. Gambling however is treated as a hobby not a business, and deductions are allowed only up to the level of any earnings. Since the odds are far worse in MLM it would seem to be only a matter of time before deductions of business losses in MLM are disallowed. At that point, you can then also no longer call it a 'business opportunity,' for it is a hobby, and any company promoting it as a business opportunity would be promoting tax-evasion.

The country of Bahrain has just outlawed MLM completely, including the renting of facilities to MLM events. It is likely other countries may follow the example, for the understanding that MLM is a criminal racket and not a business is growing around the world, and several countries are looking into the issue. No one can predict what will take down MLM in the end, but we are likely closer to the end then to the beginning of this bizarre legal aberration, which was only enabled by lawyers who failed economics 101. Eventually however, the law will have to address reality, lest, the US wants to become Albania.

David Thornton 9 years ago Member's comment

CrimeBustersNow - Never mind the 50/50 propositon on the colours Rogier; the odds are still better on any individua number 1/37 or 1/38 depends on whose wheel one is paying. Still better than 1/99+

David Thornton 9 years ago Member's comment


Two questions...

1. Suppose in realty there is no such thing as "infinity" to work from; as in... "I’m going to get 2 percent all the way down to infinity???"

2. How do the unsophisticated, and especially the youth turning 18 every year, some still in high school that MLM admittedly targets, supposed to understand this complicated B.S. before untrained incompetent MLM bull-shitters (The Blind Leading the Bind) coerce them into signing up.

A law should exist, such as in marriage separations and division of property rights stating that no one is allowed to enter MLM without producing a certificate of independent legal advice.

Canadian - David Thornton