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The Buddy System

While multilevel marketing may make you think of scam, many Inc. 500 companies find this approach indispensable.
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MULTILEVEL MARKETING often conjures images of scam artistsselling only dreams. So how come you may soon find its techniquesindispensable?

In some ways Bill Gouldd, the founder of this year's number onecompany, Equinox International, is like many founders on our list:he's in his early forties; he's never studied business; and hisattempts to work for others were often frustrating. And like many ofhis Inc. 500 peers, Gouldd put everything he owned on the lineto start his company.

Few Inc. 500 founders, however, begin their ventures with akitty of more than $800,000 and assets of more than $1 million. Andfewer still find themselves the subject of a 20/20investigative report, as Gouldd did last June. Equinox, in Las Vegas,markets itself as an environmentally conscious "direct-selling"company. The 20/20 report was not so kind: it questionedwhether Equinox was a pyramid scheme.

Equinox is a multilevel marketer, and Gouldd a seasonedmultilevel pro. He cut his teeth at a half dozen othermultilevel-marketing outfits, where he made and lost a small fortune.But Gouldd says he's out to professionalize the industry. He wants toshred the chain-letter-scam image and get people to think ofmultilevel marketing as a smart model of mass marketing. Says Gouldd,"We're taking word-of-mouth advertising and maximizing it."

Equinox is not the only Inc. 500 company to capitalize onthat reputation-challenged distribution channel. In fact, from thetop of the list to the bottom are product and service companies thathave adapted multilevel marketing--practitioners prefer the terms direct selling and network marketing--to controloverhead, create means of distribution, and build a national salesforce on a budget. All of those companies have tapped into a growingcontingent of displaced workers, professionals worried about theirfuture, at-home moms and couples--all looking to get into businessfor themselves.

And growth through network marketing is not new to the Inc.500. Ten years ago the list included two very differentcompanies--Herbalife International, which survived lawsuits andgovernment investigations in the United States before expandingoverseas, and Discovery Toys Inc. (see page 94)--both of which reliedon direct selling to grow. In more recent years we've seen thePampered Chef, in Addison, Ill., which sells kitchen supplies throughTupperware-style parties; Country Peddlers, a two-time winner fromTinley Park, Ill., which direct-sells handcrafted collectibles; andArtistic Impressions, in Lombard, Ill., which markets paintings hometo home.

Granted it might be easy to write off Bill Gouldd as asmooth-talking con artist. And he doesn't do much to challenge thatconclusion: he paid the state of California a $75,000 fine foralleged multilevel-marketing abuses committed while he was involvedin a previous venture, and later he changed the spelling of his name(adding the second d at the urging, he says, of a spiritualadviser who told him he was "out of balance"). While some of theself-improvement courses he personally conducts are free, otherscarry a price tag of up to $2,500. "If you want someone's attention,you'll find it in their wallet," Gouldd says.

But you'd be foolish to dismiss multilevel marketing out of hand.Con-sider that Excel Communications (#80), the largest company (interms of sales) on this year's list, reached almost $507 million inrevenues in 1995 direct-selling long-distance service. Excel makesfamous Inc. 500 alumnus Microsoft Corp. look sluggish bycomparison. Microsoft took 15 years to hit the $1-billion mark; Excelfigures on doing it in 8. In just the first half of 1996, the Dallascompany had surpassed $600 million in sales. Its network ofindependent sales reps now numbers 700,000--second only, the companymaintains, to Amway, which distributes some 400 products through morethan 2.5 million reps around the world.

Wait a minute. Long-distance service sold like Tupperwareor--gasp--NuSkin cosmetics? What's going on here? Is it true, asmultilevel-marketing advocates argue, that in an age of marketingclutter and consumer distrust, there's no more effective way to movegoods than person to person (better yet, friend to friend)--thecornerstone transaction in the multilevel-marketing model?"Multilevel marketing is the future," Excel Com- munications chiefexecutive Kenny Troutt says without hesitation.

What if he's right?

troutt might be doing more than anyone else to change theindustry's image by doing away with some of its more onerous baggage.Take "front loading," for example, the practice of pressuring salesreps (also called distributors) to purchase more inventorythan they can hope to resell. Excel Communications' reps couldn't buyup blocks of long-distance service even if they wanted to.

That difference appealed to Bill Contreras, a longtime real estatebroker in the La Jolla, Calif., area, who joined the Excel networkafter a professional basketball coach told him about the company."I've had many network-marketing opportunities come across my deskover the years, but I never wanted to sell a product," saysContreras. "But when I saw the Excel marketing plan, I said, 'This isgreat, a savings on long-distance service.' The plan said noinventory, no delivery, no collection, no employees, no quotas, andno paperwork. I thought, here's a business I can own, at home,part-time, with serious income potential."

And Contreras wasn't the only guy with a desk job to jump at thechance. He says that his local Excel group includes "a half dozendoctors, law-yers, and CPAs."

In the two and a half years he's been with Excel Communications,Contreras has moved into its highest ranks. By bringing in more than50 long-distance customers, he's become an executive director. Thecompany pays him a percentage of his customers' long-distance billseach month. (Contreras must maintain 20 customers to keep his statusas a senior representative.) Contreras has also sponsored 27 reps,each of whom has gathered at least 3 customers and sponsored morereps, and so on down the line. In total Contreras estimates that hehas about 2,000 reps in his "downline." The commission he earns onthose reps and their sales helps him bring in about $15,000 a month."In a year or so, I'll probably do this full-time," he says.

For many would-be entrepreneurs looking for a shortcut to companyownership, the choice comes down to network marketing or franchising.But buying a franchise requires an investment of anywhere from$10,000 to $1 million. "Everything I do is aimed at Joe and MaryLunchbucket," says John Cummuta, CEO of Financial IndependenceNetwork (#295), a publisher and marketer of personal-financeinformation products in Boscobel, Wis. "And I mean thataffectionately. This is their first venture into entrepreneurism.Network marketing is so cheap to get into that some call it the'people's franchise."

"That's what's so exciting," echoes Troutt. He makes no bonesabout the fact that many of his reps are just earning spending moneyby signing up friends and family. "You take my Mama Nadine. She wantsto make an extra $100 a month to play bingo." But the company saysit's attracting more professionals like Contreras every day,including a few state senators and a former attorney general. Excel'smost recent rep survey re-vealed a 60-40 split of men to women, aratio nearly unheard of in a field that attracts many women who'vebeen shut out of traditional sales.

personal transformation is a powerful theme in network marketing.Gouldd brags about the schoolteacher who's become an ace sales rep onthe side. Equinox's start-up story is the story of Gouldd's ownrecovery from what he describes as a "toxic overload ofpollutants"--the inspiration for his line of environmentally correctcleaning and body-care products. Cummuta points to the folks he'shelped get solvent. He says, "I'm an evangelist for no debt." His ownhistory of living high off the hog provides a moving testimonial.

For his part, Troutt likes to point to the beautician who was ableto buy a house after working as a rep for Excel part-time for a year."A lot of people live paycheck to paycheck," he says. "This is aboutchanging people's lives." Multilevel marketing has certainly changedTroutt's life. After Excel went public, last May, Troutt became abillionaire, at least on paper.

But Troutt was once as skeptical as anyone about the channel.Before he started Excel he'd founded an oil and gas company and aconstruction business. He had no experience with network marketing.Troutt was nearly convinced that to succeed as an unknown reseller oflong-distance service, he'd have to do what the big companies did:hire a conventional sales force or a fleet of telemarketers, andadvertise like crazy. That was in 1988, a few years after theAT&T breakup. The challenge was not so much how to compete in acommodity market--AT&T's rates at the time left plenty of roomfor rivals. It was how to acquire customers as quickly as possible sothat Ex-cel's volume would enable it to buy cheaply and establishitself as a player before the dust settled on all the upstarts bornof the divestiture.

Troutt took his ambitious sales projections and studied hismarketing options. He was introduced to Steve Smith, who for threeyears had been trying to set up a direct-selling plan at a regionallong-distance service in Houston. "That company didn't see the powerof network marketing, and I don't think Kenny was real im-pressedwith it either," says Smith. "It's a different thing." It took aboutsix months to win over Troutt, who says now, "I saw how easy it wasto sign up long-distance service. Anyone could do it, a collegestudent or a retiree."

The concept wasn't entirely new in telecommunications. It's alittle-known fact, for example, that Amway has been distributing MCIservices since 1983. But by its own account, Excel was the firstlong-distance provider to take network marketing in-house. Thatstrategy allowed the company to stay competitive with MCI andAT&T while sparing it combat with cheaper regional players. Excelnow has 4 million long-distance customers, and it got them allwithout spending a dime on consumer advertising.

Recently, in the wake of deregulation in the energy industry,Smith (Excel's executive vice-president of marketing) has beenapproached by companies that want to tap Excel's 700,000 reps to sellutilities in the home. "I think you'll see more consumer servicesbeing sold this way," says Smith. Thomas Wotruba, professor ofmarketing at San Diego State University, agrees: "Network marketingis part of a broader trend, which includes direct marketing and TVmarketing, toward offering convenience to the consumer. We're goingaway from in-store retailing toward having stores come to thecustomer."

Still, there's no denying that the direct-selling industry remainsplagued by serious problems of ethics and image. The classic blindads promising overnight wealth haven't gone away, and it's hard topolice revenue claims made by far-flung reps. Excel's "businesspresentation" meetings for recruits are one-hour professional affairsheld at swank hotels and restaurants. But many multilevel marketers'initiation meetings still have the creepy feel of Invasion of theBody Snatchers. The relentless recruiting of new reps is aneconomic imperative--many reps drop out or don't sell much--but it'salso a big reason the industry remains dogged by allegations ofpyramid schemes.

And CEOs squeamish about profiting off the entrepreneurial dreamsof others need not apply. Network marketers always make money ontheir sales reps regardless of what the reps themselves make--it'spart of the business model. All the network marketers on this year's Inc. 500 list, for example, sell a start-up kit that ranges inprice from $30 to $195. Reps aren't required to buy a kit, butnaturally many do, just as they attend product and sales trainingclasses that start off free but jump in price as reps climb theladder.

Yet, despite the real and perceived problems, network marketingactually may make sense...and not just for suppliers of consumerproducts. Borges Lamont Co. (#491), in Orem, Utah, is best known as adesigner of premium and incentive programs. CEO Frank Lamont Davissaw the appeal of using independent reps to call on small companies.But there was no sales association or rep group he could just call upto jump-start sales. "And I didn't want manufacturers' reps becausethey're so territory-specific." What Davis wanted was his ownnational sales force, only he knew that wasn't cost-effective.Besides the expense of base salaries, travel, computers, and otherperks, it costs more than $5,000 on average to train each new salesrep, according to Dartnell Corp., in Chicago, which tracks theselling expenses of small and large employers. Companies spendthousands more each year recruiting, interviewing, and relocatingsalespeople. For owners of small companies, it's a high-stakesgamble.

Davis shuns the term network marketing but admits that the"home-business opportunity" he created works in a similar way. His300 reps pay their own sales expenses, including a $60 monthlyadministrative fee to Borges Lamont, and call their own shots. Theyreceive an ongoing commission on clients' yearly contracts. Davissays he does much of the up-front work. "We'll even do salesproposals for reps," he says. "What I needed was the legs." He got300 pairs of legs by hiring marketing firms to make "start-upopportunity" presentations at hotels around the country.

"There's a home-based-business explosion, and I tapped into that.We're more of a shirt-and-tie opportunity," Davis says. But he'sdiscovered the limits of dispatching a sales force with little salesexperience. Too many reps call it quits after a few rejections. "Theygive up and complain about the whole program." So Davis tried a newtack: recruiting health-insurance reps. "If you can sell insurance,you can sell anything," he notes.

In another twist, Davis has stumbled across what may be his mostsuccessful experiment in door-to-door selling yet: he has 6,000independent reps who resell consumer goods that he buys at closeoutprices. The arrangement is not as strange as it sounds becausethere's a tie-in to the employee-incentive business: the goods(watches, camcorders, and the like) are the same type Davis suppliesas prizes to his corporate clients' workers. Only in this case the6,000 reps sell to their neighbors, at prices the reps set. "It'slike a collective-buying organization, but I also do the buying andwarehousing," Davis explains.

At least three companies on our list turned to network marketingto circumvent the start-up costs and inefficiencies of conventionaldistribution channels.

John Cummuta of Financial In-dependence Network didn't want to seethe self-help book he wrote, Debt-FREE and ProsperousLiving, languish on store shelves, only to be returned in boxloads at the end of the season--the accepted practice in bookretailing. "From a businessperson's perspective, a bookstore is theworst place in the world to sell a book," quips Cum-muta. As it was,his book wasn't exactly an easy sell--few bingers freely admit tobeing over their head in credit-card debt. After launching hiscompany with direct mail, Cummuta began building hisnetwork-marketing sales force. It started, he says, with a fewcustomers asking if they could send the book to friends. Over fiveyears the network has grown to a core group of 55,000"financial-independence consultants," as well as 1,260 "certifiedfinancial-independence consultants" who offer Cummuta's book,newsletter, and tapes at investment seminars around the country.

Recent statistics appear to vindicate Cummuta's rejection ofpublishing's traditional sales channel. Mainstream publishers areseeing return rates grow, cutting deeply into their profits.Ac-cording to a report in the New York Times, the AmericanAssociation of Publishers found that from 1990 to 1995, losses forreturned hardcovers rose 60%--while gross sales grew just 47%. Inabout the same period, Cum-muta's sales grew some 900%, and profitsclimbed. "It started slowly, but last year network marketingaccounted for half my sales; this year it'll be 75%."

Meanwhile, Cummuta gets the conventional 1% to 2% response on hisdirect-mail pitch. What's more, he says, "when I do a mailing, 60% ofmy overall costs go to mailing. In network marketing, 60% goes to thepeople who put together the sales organization." He adds that hisseven-level compensation plan is not unlike the commission structurein place at insurance companies and other large organizations wheremanagers collect a percentage of all the sales made "below" them.

Like Cummuta, Greg Martin, CEO of ShapeRite (#44), a supplier andmanufacturer of dietary supplements and personal-care products,didn't have the means to make a dent in retail. Admitting that salesand marketing weren't his strengths, Martin outsourced them. He has150,000 distributors, 50,000 actively selling for the Salt Lake Citycompany. "People come in, but we need to help keep them in. Our goalis to get everyone to at least $300 a month in sales," says Martin."Done right, this is a viable distribution channel. Part of ourmission is to improve the image of the industry." His recent "MissionPossible" sales campaign is something of a throwback--the grand prizeis a Jaguar--but he's also slated name sales trainers Tom Hopkins andLes Brown to speak at the company's national convention.

Jewelway (U.S.) (#29), in Tucson, was started by a CPA, BruceCaruth. Caruth had seen too many small companies fail, crushed bytheir overhead. So when he left his job as chief financial officer ofa Tucson real estate development company to start his own business,he chose one with the lowest possible start-up costs: selling jewelrythrough multilevel marketing. Caruth knew the field; he'd moonlightedas an independent rep when he was still a CFO. Although themultilevel marketer he toiled for eventually went bankrupt, Caruthhad "learned the power of this marketing: the loyalty of the reps andthe reps' friends and family." He knew that some people might haveconsidered buying a franchise, but that would have involved taking ondebt. "And I hate debt." Besides, he knew that franchising limitsentrepreneurs to a certain territory. Caruth's network of more than100,000 reps has allowed him to expand into Canada, Australia, andthe United Kingdom.

Caruth, too, is out to professionalize multilevel marketing. Hiscontribution to the field: he shuns sales quotas. "I wanted to be oneof the first network marketers to have no sales quotas. That meansreps who don't sell for eight months don't lose their downline." Hesleeps easier knowing that his $60 million in U.S. sales are nearlyall retail because "there's no motivation" for reps to overbuy.

Think what you will about equi-nox, but multilevel marketing ishelping the company solve its competitive problems. Bill Gouldd isbuilding a worldwide brand on the cheap. In-stead of spendingmillions on newspaper circulars and supermarket slotting fees, he'smaking millions while his disciples preach the word. "You have toreach the people who eat at Burger King one-on-one," says Gouldd."You don't get a personal experience from a catalog or a storeshelf." Gouldd says he's spending heavily on developing new productswith outside manufacturers, even taking a minority stake in some. Hislong-term goal is no less than to replace the store for hiscustomers. The Equinox product line has burgeoned to 315 items.

Excel also sees an unlimited upside. The company is planning aline of pagers and home security devices, satellite TV, and evenlocal phone service for its long-distance customers. "For this kindof product line, multilevel marketing is far superior to selling witha traditional sales force. We don't want salespeople talkingtechnology," says Troutt, adding, "Our independent reps will alwaysbe our sole channel of distribution."

But for every gung ho sales rep like Bill Contreras, there's aLayne Golan. Golan, an anesthesiologist by day and formerly an Excelrep by night, grew weary of attending meetings, "which is what youhave to do" to succeed, he says. But it was more than that. He caughtsome people lying about their sales, and that made him nervous. "Whatif I fake it 'til I make it for a few years, and I never make it?"

That's a question some financial analysts have put publicly toExcel. They want to know whether the company's cash flow is driven bymoney made on the sales of long-distance service or on the recruitingand training of reps. Troutt and his CFO Jack McLaine insistit's a 75-25 split between long-distance and rep-building revenues.Still the company was expecting 10,000 of the faithful in Dallas thisSeptember for its annual Excelebration sales meeting. The admissionprice: $165.

Somehow the idea of asking Joe and Mary Lunchbucket to pay $165for a few days of festivities--or $595 for Equinox's MillionaireWorkshop--seems, well, not quite copacetic. And that's just onereason multilevel marketing continues to be controversial. The DirectSelling Association estimates that last year the industry generatednearly $18 billion in sales at retail. What no one knows is how muchwas made at the game of transforming more than 7 million people intoentrepreneurs. The advantage lies with those network marketers whocan achieve an equitable balance between what they make recruitingreps and what they make selling their wares. *

Research assistance for this article was provided by MelodyNelson


Pros & Cons:
When Friends Sell to Friends

Why multilevel marketing is the distribution channel in yourcompany's future...

* It eliminates the need for slick advertising, which consumersobject to anyway.

* In a world of marketing noise, friends are the only salespeoplecustomers listen to and trust.

* It reduces the cost of acquiring customers.

* It reduces cash-flow risks because merchandise has to sellbefore reps get paid.

* It enables a company to build a large sales force very cheaply.

* It capitalizes on the exploding supply of soloists andhome-based "entrepreneurs."

...and why it isn't...

* It means going into the sales training business.

* There's the constant threat of consumer complaints, lawsuits,and government investigations.

* There's image angst--friends may bolt when they see you coming,for example.

Last updated: Oct 15, 1996




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