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Avon splits with trade group, citing risk of pyramid schemes

Before we start talking about fraud and pyramid schemes, let's just take a moment to admire this woman's nails. (Ron Antonelli/Bloomberg)

Avon Products is leaving the trade association it helped to found more than a century ago, writing in a letter to other member companies last week that the group's bylaws might not adequately protect consumers from fraud.

"We felt like it was a good moment to get some clarity around our business model and the things that Avon believes in," said senior vice president Cheryl Heinonen, who previously represented Avon on the board of the group, the Direct Selling Association.

The association represents firms like Avon that rely on a network of consumers who double as salespeople and recruiters, soliciting friends, family and neighbors. The business model is called direct sales, or multilevel marketing in its modern version. Many multilevel-marketing companies have been accused of operating pyramid schemes over the past few decades, including Herbalife, a member of the association that sells nutritional products and herbal supplements.

Avon's departure suggests the historically lucrative and powerful firm is concerned about the public perception of its business and the possibility of broader regulatory action on multilevel marketing.

Two years ago, the investor Bill Ackman called Herbalife a fraud and said his hedge fund had bet $1 billion that the company's share price would fall. The company disclosed that it is under investigation by the Federal Trade Commission earlier this year.

The accusations have been the subject of media attention and heated public debate on Wall Street. Herbalife's stock reached its lowest point in the past year following the news last week that it would settle a class-action lawsuit brought by former salespeople.

The letter from Avon also criticized the trade association's agenda for being "overly focused on the issues of a few specific brands rather than industry-wide challenges." Asked whether this phrase meant Herbalife in particular, Heinonen said that it referred to opportunities and innovations in multilevel marketing generally. "It's really an exciting place to be right now, and I think that as an industry, I think that's where many of us would like to be focused," she said.

Joe Mariano, the association's president, said in a statement that he was "disappointed" in Avon's decision.

"Our association is far better equipped to address the challenges and opportunities of our industry when all of our member companies stand together," the statement read.

Avon's letter did not take a position on one of the most frequently debated issues in multilevel marketing: whether a company must demonstrate its products are popular with consumers who are not also salespeople, or whether a company's primary customers can be part of the sales force. (Herbalife has previously said that only about 39 percent of its products are consumed by people outside its network.)

"When I think it's problematic is when you sell inventory -- bulk product -- that the person who is acquiring it can't use themselves and sometimes may not know how to sell," Heinonen said. She added that the language in the trade association's code of ethics on this point and other aspects of consumer protection need to be firmer.

Herbalife has said it complies with the law, and a spokesman provided a statement noting that Herbalife's policies, not the Direct Selling Association's bylaws, are what protect the company's salespeople.

"Herbalife’s consumer and distributor practices, which we believe to be industry leading, are developed, executed and monitored independent of the Direct Selling Association," the statement read.

Established in 1886, Avon was among the companies that pioneered the old-fashioned direct-sales or door-to-door model. It was the most profitable U.S. company by 1967, said Bill Keep, the dean of the business school at The College of New Jersey and an expert on multilevel marketing.

Yet as women entered the workforce and later as the Internet automated shopping at home, customers with time for sales pitches became harder to find.

Avon reported nearly $10 billion in worldwide revenue last year, 88 percent of which came from overseas, but business has slowed for the cosmetics supplier. Chief financial officer Kimberly Ross resigned last week amid continued efforts at restructuring at the company, which has laid off roughly 1,250 employees since December.

Multilevel marketing, an innovation on the traditional direct-sales model that encouraged salespeople to recruit new members as well as to make sales, has kept Avon's competitors profitable, but Avon has resisted change, Keep said.

In dropping out of the Direct Selling Association, Avon joins Tupperware, another iconic direct-sales brand that has become leery of the "direct sales" label. "We didn't leave direct selling," Tupperware chief executive officer Rick Goings told The Wall Street Journal last year. "Direct selling left us, because the industry became dominated by buying clubs and what looked like pyramid schemes."

Meanwhile, regulatory scrutiny of multilevel marketing is "causing friction inside the industry," Keep said.

"Avon’s decision is one that suggests they do want to distance themselves," he said. "This represents a direct selling company that is concerned with its association with other direct selling companies, and I think it should be concerned."

Avon has had regulatory problems of its own. The federal government accused it of corrupt practices in China and extracted $135 million and a guilty plea from the company earlier this year.