'Pyramiding' fallout still taking its toll on multilevel marketing firms (BusinessWorld)

Published in the November 6, 2007 issue of BusinessWorld

'Pyramiding' fallout still taking its toll on multilevel marketing firms

Jennee Grace U. Rubrico with Felipe F. Salvosa II

First of two parts
Two years after network marketing companies came under intense scrutiny for promising quick money but allegedly leaving investors shortchanged, direct sellers and multilevel marketers are still trying to shake off the negative impressions the controversy left in its wake.

While bigger companies have managed to emerge relatively unscathed, others are still weighed down by questions of legitimacy and sustainability.

In 2005, the Trade department announced a probe of multilevel marketing firms suspected of pyramiding. In its 2004 annual report, the department said 37 companies were "invited" to a business or marketing plan presentation "to assist the department in determining the nature of their plans as well as their operations."

Pyramiding is defined by Republic Act 7394 or the Consumer Act as "sales devices whereby a person, upon condition that he makes an investment, is granted by the manufacturer or his representative a right to recruit for profit one or more additional persons who will be granted such right to recruit upon making similar investments."

The Direct Selling Association of the Philippines (DSAP), the industry group, defines pyramiding as a scheme where people are convinced to pay money for a chance to profit from the payments of others who join later.

In 2005, two high-profile multilevel marketing firms with strong political connections - First Quadrant Philippines Inc. and JC Martin Corp. - were investigated and monitored on charges that investors were earning not from the sale of products such as leather goods and clothing, but from recruiting more people to join their sales networks.

Also monitored for possible violations of the Consumer Act that year were Primanila Plans, Inc., M7D (Dollar Diamond), CPY Loan and Credit Corp., InosPhil Corp., Kabuhi International Marketing, Sophie Martin Philippines, Inc., Ugnayan Philippines Marketing System, Net-Taipan Philippines Inc., Philippine Rich International Marketing Co., XP3 World Corp., and DXN International Private Ltd.

The next year, however, the Trade department zeroed in on only two firms. In its 2005 annual report, the department said it had formally filed charges against First Quadrant and JC Martin. No mention was made of the other firms named in the 2004 report.

On March 14, 2005, the cases against JC Martin and First Quadrant were amicably settled, and the two firms were required to strike off pyramiding activities and incentives from their business plans. They were required to post a P150,000 bond to "assure" compliance with the Consumer Act.
The Trade department and the Securities and Exchange Commission (SEC) had been monitoring, as early as 2002, companies allegedly engaged in pyramiding and the sale of unregistered investment contracts.

"Pyramiding schemes and unregistered investment contracts erode consumers' and investors' confidence in the country," a 2002 agreement signed by the two agencies states.

The agreement provides that suspected pyramiding cases involving products be referred to the Trade department, while cases that do not involve the sale of products but require an investment of money in a common enterprise fall under the SEC's jurisdiction.

Jose Faustino, an Asian Institute of Management marketing professor, said the 2005 crackdown on JC Martin and First Quadrant eventually affected other network marketing firms because Filipino investors are "quite informed."

"He or she - usually a she - will hear about these fly-by-night organizations asking them to put down thousands of pesos for initial investments only to find out later that the basic product was deficient to begin with. Those stories proliferate not only through printed media but more so from AM radio, and they pick it up as soon as they hear it," he said.

The impact of the controversy seems to have been felt on two fronts - in the network marketing firms' bottom lines, as well as in their ability to recruit more investors.

In its heyday, Forever Living Products Philippines, Inc., sold almost P1.5 billion worth of health, beauty, and other products. This was in 2001, when the Philippine branch of the Scottsdale, Arizona manufacturer of aloe vera products, formed by Paranaque Rep. Roilo T. Golez, broke into the country's top 400 companies.

In 2005, Forever Living sales dwindled to P227.2 million, down from P351.8 million in 2004. The company's net loss for that year narrowed to P3.4 million from P3.8 million the prior year. Last year Forever Living's revenues continued to decline, at P157.95 million. Its net loss widened to P4.567 million.

Two of the company's top sales performers, spouses Jurgen and Mary Ann Gonzales, recalled the good old days when top-tier distributors were rewarded with hundreds of thousands, if not millions of pesos, in bonuses. But other networking firms such as First Quadrant emerged and promised even quicker money, poaching sales staff from Forever Living, they said.

Unlike First Quadrant, however, Forever Living has stayed on in the network sales sector, albeit with a smaller business and a leaner marketing force. Mr. Mendoza attributes this to the popularity of the company's aloe vera products.

"People are starting to come back," he told BusinessWorld.

The more established brands remain formidable. In its 2005 financial statement, Avon Cosmetics Inc., the biggest multilevel marketing firm in the country (accounting for 50% of total industry revenues), reported net sales of P8.628 billion, slightly down from P8.69 billion in the previous year. Net income was higher at P837.22 million from P781.93 million in 2004, as the company was buoyed by other income and cost cuts.

Sara Lee Direct Selling Philippines, Inc., (now Fuller Life Philippines, Inc.), posted net sales of P597.6 million and profits of P54.7 million for its fiscal year ending June 30, 2005. In the 2006 fiscal year, it posted stronger sales of P2.4 billion, and a higher net income of P155.5 million.

Two companies which went under the government probe saw their businesses shrink. First Quadrant reported sales of P401 million in 2005, down from P539.2 million in 2004. Profit fell to just P172,873 for the period, from P12.112 million in 2004. JC Martin, meanwhile, posted gross receipts of a mere P14.8 million in 2005 from P25.4 million in the previous year. At the height of the network marketing wars in 2005, JC Martin lost P3.3 million.

First Quadrant and JC Martin did not respond to requests for interviews.

Officials of the DSAP said the sluggish sales cannot be blamed solely on the negative publicity regarding multilevel marketing firms.

"Speaking of profitability, that's affected by many reasons. It could be internal - poor management, mismanagement, or wrong cost structure where you don't have a relevant product for the relevant market. Or you don't have a good understanding of the Philippine market. Invariably you will have a host of reasons why these companies are losing some of its key distributors to a competitor. Obviously these things have an impact on profitability," DSAP director Enrico Garcia said.

While some firms are having a hard time, the industry has been "growing" in terms of combined revenues, said Bernard Mercado, DSAP president and general manager of Mary Kay Cosmetics, Inc. "Overall, when you look at the industry, sales turnover is growing, but it's not as big as it should be. Our best estimate is 12% to 13%. But in terms of players, dumami rin (they are also increasing)," he said.

"My best guess there is we're sharing in a pie which is growing but not as fast as it should be," he added.

DSAP officials, however, admitted that following the JC Martin and First Quadrant probe, networking companies found it more difficult to recruit distributors. First Quadrant and JC Martin are not members of the industry group.

"The impact was felt most in the ability to recruit people into the business of network marketing. Insofar as that is concerned, yes, it's harder because you have an extra obstacle to hurdle," Mr. Garcia said.

"When you tell them this is network marketing, they're not going to have a big smile and embrace it because they must have heard something from somebody or they have had their own experience ... But sadly, a lot of people don't know what they're saying no to," Mr. Garcia, who is also the managing director of Nikken Philippines, Inc., added.

Forever Living's Mr. Mendoza agreed, saying "You need to do a lot of explanation (sic) nowadays."
But recruitment is becoming less of a concern, at least among the 26 DSAP member-firms.
"Generally, in the association, the companies have increased recruitment. This is a significant thing. We would not be able to recruit more now if we are still saddled by that negative perception," Nice Cruz, DSAP treasurer, said.

It has helped, DSAP officials said, that measures have been put in place to make it easier to catch scammers hiding behind the multilevel marketing strategy. "The association has done a lot of work. There's existing literature on how to help consumers do their due diligence on network marketing companies they want to affiliate themselves with," Mr. Mercado said.

"I just want to say that it really is the same principle as caveat emptor - buyer beware. You are looking into a business, it is your responsibility to do the due diligence. Access to information that helps you make that decision is where I feel the direct selling association has done its part."