Inventory loading: when does a company cross the line?

NASCAR and the Need for Speed

In NASCAR, drivers are taught to push themselves and their vehicles to the limits and work on that fine line that separates losers from road kill. In their quest for speed, the best drivers are always driving on the brink of disaster. And drivers that can endure this “danger zone” longer than their opponents usually come out ahead. In the MLM industry, the “danger zone” can be defined as a company’s challenge to generate as much product volume as possible from its sales force without crossing the line of “inventory loading.”

What is “Inventory Loading?”

There’s been a few definitions of “inventory loading” over the past few years. In FTC vs. Amway in 1979, the FTC defined inventory loading as a practice which “[requires] a person seeking to become a distributor to pay a large sum of money, …, for the purchase of a large amount of nonreturnable inventory.” Under the 1979 definition, a company could easily avoid inventory loading allegations by simply having a good return policy.

In Webster vs. Omnitrition, the Ninth Circuit court of appeals seemed to reject the definition from the Amway decision and defined inventory loading as “Occurring when distributors make the minimum required purchases to receive recruitment based bonuses without reselling the products to consumers.” With this definition, the responsibility is passed on to the distributors and goes to their intent behind the purchases. If they’re purchasing the minimum amount necessary to stay qualified for bonuses, it would be perceived that they’re only buying the products to stay eligible for their bonuses, which is problematic.

In the DSA’s code of ethics, they prohibit inventory loading when they say, ” A member company shall not require or encourage an independent salesperson to purchase inventory in an amount which unreasonably exceeds that which can be expected to be resold and/or consumed within a reasonable period of time.” In my view, the DSA’s definition falls short because they fail to recognize the behavior that leads to pyramid allegations in the first place: opportunity driven demand. When a compensation plan is involved, distributors can purchase and use the items with the expectations of recruiting additional participants to do the same.

As a tie breaker, the FTC issued an advisory opinion and said the following about forced inventory requirements:

“The Commissions recent cases, however, demonstrate that the sale of goods and services alone does not necessarily render a multi-level system legitimate. . . The most common means employed to achieve this goal is to require a certain level of monthly purchases to qualify for commissions. While the sale of goods and services nominally generates all commissions in a system primarily funded by such purchases, in fact, those commissions are funded by purchases made to obtain the right to participate in the scheme.”
Staff Advisory Opinion—Pyramid Scheme Analysis, Op. F.T.C. (2004).

Based on the statement above, the FTC is not a large fan of forcing inventory onto distributors. Still, based on their history, the practice of requiring inventory purchases is usually not by itself clear proof of a pyramid. It’s usually one of a few factors that goes into the pyramid equation.

MLMs and the Need for Profit

MLM Companies have the difficult task of finding the sweet spot where they’re extracting as much revenue as possible from their sales force without crossing the line into “inventory load” land. The most aggressive companies, and usually the largest, will require a certain amount of inventory each month from distributors in order for them to remain eligible for bonuses. These companies are usually smart enough to avoid the outrageous inventory requirements i.e. $1,000+ a month. The requirement will usually at least be over $100 a month in purchases, which places a little pressure on the sales force to maintain their monthly orders to enable themselves to tap into the compensation plan. In my opinion, this sort of behavior flirts with an inventory loading allegation but if it’s a company’s only problem, the car will probably not explode.

So when exactly does a company cross the line?

This is one of my least favoriate answers, but I’m afraid it’s the right one: it depends. The issue always boils down to the motivation behind the purchases. If there’s an inventory requirement and the company is creating a history of transactions where the vast majority of orders land exactly on the required level, the FTC might argue that the purchases are made for the purpose of staying qualified and treat the inventory requirement as a form of inventory loading.

If a company has inventory requirements, it’s imperative that they get the rest of their house in order because if there’s another crack in the dam i.e. a sales culture that makes terrible product claims, a lack of income disclosures, distributors enrolling in multiple positions, etc, it would be easy for a regulator to exploit the weaknesses.

Free Advice

If a company wanted an inventory loading requirement and at the same time wanted to hedge its bet, it would be wise to have some type of a retail sales rule. With a retail sales rule, the distributors would be incapable of earning commissions on downline volume unless they made some sales to nonparticipants. With an enforced retail sales rule, it would at least demonstrate to regulators and class action attorneys that the products are marketable and that there’s a small limitation on the practice of endless recruitment.

What do you think? Can you think of any examples where in your mind, a company crossed the line into inventory loading? Oh, and don’t forget to click the button below and subscribe to this site. It’s new, so I wanted to remind you.