Medifast, Part Two: Weight-Loss Miracle or Pyramid Scheme?

(Note: See my previous post evaluating Medifast’s claims of a “clinically proven” weight-loss method.)

Chief executive officer Michael McDevitt claims the sales growth at Medifast is due to the successful execution of the company’s diverse multi-channel distribution strategy, through which Medifast brand’s value proposition “continues to be successfully communicated and accepted by its customers.” Detractors allege, however, the company’s growth is attributable to nothing more than a twist of the notorious Ponzi postage stamp con of 1921 — a modern day, multilevel pyramid scheme. Is the company getting a bum rap?

Competitors in the commercial weight loss sector are blaming lower consumer spending and a falloff in new customer traffic on a dearth of discretionary income, a result of the global economic slowdown. Weight Watchers International, which derives more than 60 percent of its revenue from members paying service fees to attend more than 50,000 weekly support meetings worldwide, reported a nine percent drop in comparable sales to $763.1 million in the first six months of 2009. Nutrisystem, a leading provider of dietary food products sold directly to consumers through its e-commerce website, witnessed a 28 percent year-on-year decline to $294.5 million.

The state of the economy, however, has not prevented Medifast customers from attending to their expanding waistlines. For the six months ended June 30, Medifast reported revenue of $74.4 million, an increase of 41 percent from the prior year period, according to the company’s earnings release.

Just what is Medifast’s value proposition? Customer testimonials, (20,000 plus) alleged medical endorsements, websites (owned, third-party, or something in-between )-all make noise promulgating that the Medifast Program “is a lifestyle change, not just a short-term weight loss solution.” Medifast ads tout that the company “won’t abandon you the way fad diets have in the past,” and promise Medifast’s Transition, Maintenance, and Exercise Plans “pick up where the “clinically proven” weight loss meal replacement meal plans end -teaching you how to sustain your weight-loss results long term.” See my previous post for a review of Medifast’s clinical studies.

So, in a crowded, dietary hippodrome filled with a plethora of options, from commercial meal replacement plans to medicinal appetite suppressants and self-help books, what are the distribution platforms used by Medifast to successfully communicate its branded message to prospective customers?

1. Medifast Direct — In the direct to consumer channel, customers order Medifast product directly through the Company’s website, www.choosemedifast.com, or an in-house call center.
2. Take Shape for Life — The channel offers the personal support of a health coach that is often a person who h as achieved success on the Medifast program and has turned their success into a business opportunity generating incremental revenue for the company through relationship marketing.
3. Private Physicians — Health practitioners carry inventories of Medifast products and resell them to their patients.
4. Medifast Weight Control Centers — A medically supervised and structured model for customers who prefer more accountability and personalized counseling on the program.

The Take Shape for Life unit is the fastest growing sales channel, accounting for 58 percent of total revenue for the first half of 2009, up from 33 percent in 2007. Sales increased 96 percent year-on-year to $42.9 million in the first six months, driven by increased customer product sales from the growing ranks of health coaches, according to the 10Q regulatory filing:

The number of active health coaches during the second quarter increased to approximately 4,650 compared with 2,800 during the period a year ago, an increase of 66% and up from 4,000 at the close of the first quarter of 2009. We continue to see the benefits of a physician-lead network of coaches that are able to support their clients in their weight-loss efforts. In today’s environment where trust and personal recommendations are becoming a more important component in consumer purchasing decisions, the Take Shape for Life model of one-on-one communication continues to excel. Take Shape for Life customers who have utilized the Medifast products and programs and successfully have addressed their body weight and health issues are increasingly choosing to become active health coaches.

In contrast, the direct marketing sales channel, which is fueled primarily by consumer advertising, witnessed an eight percent year-over-year decline in revenue, as compared to the first six months of 2008. This distribution model now accounts for only 31 percent of sales, down from 56 percent in 2007.

The Take Shape For Life (TFSL) website boasts that becoming a health coach is a business opportunity that has a low cost of start-up, requiring no holding of inventory as all orders are shipped to the end consumer. In addition, the site promotes an image where you start making money right away, with no limit to your earnings potential-as compensation is in the20form of a commission compensation on product sales made to your clients.

A closer examination of company documents and regulatory filings, however, suggests a troubling lack of transparency at Medifast:

• Signing onboard as a new heath coach will immediately set you back $200 for the New Health Coach Career Kit-add a few hundred dollars more, too, if your recruiter convinces you that your ultimate success is predicated on the additional purchase of marketing materials and TSFL business accessories, such as a Business Builder’s Bag and personalized apparel;
• Mike McDevitt admitted on the year-end 2007 earnings call that it is rare for a new coach to start making many right away, commenting that there was roughly a three month education period from the time and individual becomes a health coach until they begin to produce noticeable revenues; and,
• Medifast does not disclose actual incomes, costs incurred, attrition rates, or even a breakdown of the total number of sales representatives who are active or inactive. In fact, one could infer from available data found in the compensation plan table that the only way a health coach can earn significant income is through recruiting to advance to higher payout levels-the classic recruitment con of a multilevel pyramid scheme.

In June 2009, the Fraud Discovery Institute published a detailed, 30-page report by Robert FitzPatrick of Pyramid Scheme Alert, a consumer information website dedicated to identifying and differentiating legitimate from shady business opportunities. In the report, FitzPatrick examines and offers his opinion on why the Take Shape For Life division of Medifast is nothing more than an “Endless Chain Pyramid Scheme.” In addition to the aforementioned inconsistencies, FitzPatrick asks the reader to question Medifast’s logic-defying claim that its customers have become more “health and appearance” conscious during a recession, leading them to buy its meal replacement products.

Indeed, Medifast’s financial performance is not supported by the contrary evidence put forth by its peers, and is contradicted by historical experience that actually links recessions with declines in discretionary consumer spending and poorer health and nutrition of waste-conscious consumers.

Nonetheless, opinions of its critics aside, if Medifast’s success going forward is measured by recruiting rates of the TSFL segment, then the company is in a healthy position to witness continued strong revenue growth in the second half of 2009 and fiscal 2010. The TSFL National Convention 2009 , held at The Phoenician in Scottsdale, Arizona back in July, recorded record attendance of almost 1,300 TSFL Health Coaches, representing a 73 percent increase from the 750 in attendance in 2008.