Nu Skin China Scandal’s Repercussions for Other Direct Sales Brands

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“The direct-selling market, which helps create jobs and diversify retailing channels, is forecast to achieve double-digit growth in China in the coming years.”

That was the takeaway from an April 18, 2013, giddy and optimistic report from mainland state newspaper China Daily, titled “Nu Skin sees $1b in sales for anti-aging products.” And yet, less than a year later, another state media newspaper report has sent Nu Skin stock plunging, casting the company’s heretofore rosy China future in deep, deep doubt. Investors are jittery as its stock halted trading in the wake of China’s investigation into its selling practices.

What’s more, just as the pharmaceutical scandal that proceeded it, Nu Skin’s China meltdown should serve as a warning to other direct-selling brands operating in China.[more]

As Bloomberg Businessweek noted,

Government scrutiny could easily expand to other so-called direct sellers in China, which has some of the most restrictive laws in the world on how they are allowed to operate. In general, these kinds of companies rely on door-to-door salesmen, as opposed to a chain of stores, and salespeople earn money both for selling products and for enlisting new members into the enterprise.

China is an unusual market, both in terms of its size and its regulations. It banned multilevel marketing in 2005, and direct sellers—eager to find their footing in China—have had to adapt. Even so, there is evidence that companies still rely on marketing structures that depend, more or less, on giving sales agents incentives to recruit as many people as they can underneath them.

If there is any doubt about the pyramid scheme accusations against Nu Skin, the recent People’s Daily report added a helpful graphic explanation complete with a pyramid. Pyramid marketing scenes are illegal in China. Nu Skin share prices took a nosedive following the news.

The Utah-based Nu Skin—which counts Greater China as its largest market for a nearly uncountable number of beauty and betterment products that product revenues from 2013 somewhere in the neighborhood of $2.5 billion—immediately released a statement touting its 11-year history in China and committed itself to cooperation:

“As part of our ongoing commitment to comply with all applicable Chinese regulations, we have initiated our own province-by-province business review and will invite relevant regulators to provide guidance. Given the substantial growth in our China salesforce over the last year, we are also taking additional steps to reinforce our training and education efforts.”

Nu Skin’s statement and PR approach looks like a near carbon copy of the one used six months ago by GlaxoSmithKline after the pharmaceutical giant was accused of bribing Chinese doctors to use its products. Compare Nu Skin’s statement to that of GSK’s CEO:

“We support the efforts of the Chinese government to reform the medical sector, and we are open to looking at all ideas to improve affordability of and access to our medicines, including changes in our own business model in China… We have a long history and a very large footprint in China, and we continue to see the country as a key place for further investment.”

GSK even announced it would conduct an independent internal review of all of its China business, just like Nu Skin.

The only surprise about the investigation is that it came as a surprise at all. “Nu Skin” and “China” had been mentioned in state media reports alongside “pyramid scheme” for months, if not years. In fact, a June 7, 2013 state media Beijing Youth Daily report laid out, in quite a lot of detail, that Nu Skin (“如新”) was operating as an illegal pyramid scheme. An Oct. 2013 report from Citron Research echoed the charges and warned that Nu Skin’s China pyramid scheme plus its level of leverage in the nation left it vulnerable to investors.

It’s no surprise that Herbalife’s stock drop mirrored Nu Skin’s. In fact, Amway, Avon, and Mary Kay investors might all want to fret a bit also; those three brands were all mentioned alongside Nu Skin and Herbalife in that aforementioned glowing April 2013 China Daily article.

Likewise, after GlaxoSmithKline got smacked with charges, its competitors soon followed suit. Eli Lilly, Sanofi SA, Lundbeck, Novartis and a number of Chinese companies also were accused of bribery and illegal business practices.

Given the reach and entrenchment of Nu Skin (and its peers), it’s difficult to see how the business doesn’t rebound after enough swords are be fallen on and examples are made. Going back to the GSK example, the drugmaker swiftly ceded its cooperation and a number of executives were canned.

Meanwhile, on Jan 14—the day before the report on Nu Skin broke—GlaxoSmithKline’s CFO said on the company’s Q413 earnings call with analysts that after quarter when its China revenue free fell 61 percent, the drug maker is again seeing improving sales and “the trend is definitely looking a bit more positive.”

Below, Sinocism China editor Bill Bishop’s remarks on the Nu Skin news on Twitter:

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