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The China Conundrum

China

What will be the impact of China’s 100-day action on the direct selling channel going forward? Time will tell.

When Direct Selling News released its Global 100 list of the top direct selling companies in the world in June, one country was conspicuously underrepresented. China, the second largest direct selling market, had only one company in the ranking—No. 4 Infinitus—compared to 26 in 2018.

How was that possible? High-profile incidents involving direct selling companies led to public outcry and negative media attacks on the channel, culminating with the Chinese government initiating a 100-day review of the health market. The increased scrutiny resulted in companies wanting to stay under the radar. “Coupled with the public opinion turmoil since the end of last year, many Chinese direct selling companies have suffered from poor performance and chose to act in a low-key manner,” said a Chinese source.

With several U.S. companies looking to China for future growth, what will be the lasting effect of this recent 100-day action? Will it be back to business as usual, or is it just the start of a new framework for the direct selling channel, one in which new guardrails will be imposed on the business model.

How It Started

The public opinion turmoil brewing over the last six months began in December 2018, when Quanjian, a Tianjin-based direct selling company, was investigated for false advertising. They were called out by a popular Chinese health website for using the photo of a child who had died in promotional materials for its cancerfighting products. Social media erupted, with people sharing their experiences with Quanjian products.


“When you talk about consumable categories like nutrition being the primary category that is down, it’s not like you are going to make that up in Q2, Q3 and Q4.” —Bob Bass, Lead Strategic Insights Analyst, Amway

One month later, another direct selling health company, Hualin Suanjianping Biotechnology Co. Ltd., made headlines when authorities investigated it on suspicion of deceiving customers and operating as a pyramid scheme.

Within days of the Hualin incident, 13 Chinese ministries and government agencies, led by the State Administration of Market Regulation, jointly launched a 100-day action to rectify the health market.

Officially begun on January 8, the “Hundred Days of Action” saw 2.741 million law enforcement personnel dispatched throughout the country to supervise and inspect key industries, key areas and key commodities. Forty-nine direct selling products were revoked during the investigation.

On April 18, the 13 departments reported that after 100 days of joint rectification, the “health market chaos was effectively curbed, but the hidden dangers caused by chaos and some deep-seated problems still exist.”

Impact On U.S. Companies

While the focus of the 100-day action was mostly on health companies, other direct sellers from around the world felt its impact, including those here in the U.S. Most analysts believed the government restrictions on holding meetings and the negative media toward health companies would show in net sales for the first quarter. That was true for most of the top U.S. companies.

USANA Health Sciences’ net sales decreased 8.7 percent in Greater China during the first quarter. In USANA’s latest investor call, CEO Kevin Guest attributed part of the decline to the action but is optimistic normal sales activity will resume once the company begins offering promotions. Guest said that while the government reviews are not uncommon in China, the company did not anticipate the significant volume of negative media coverage about health products and direct selling.

“This media coverage slowed the productivity of our Associates, and generated skepticism amongst customers and potential customers, all of which ultimately affected sales in China for the quarter,” Guest said. “Notwithstanding, we are confident that our strategies, plans and promotions for 2019 will drive sales and generate momentum.”

Herbalife Nutrition was down 25 percent in China for the first quarter. Alex Amezquita, the company’s senior vice president of Finance, Strategy and Investor Relations, said the impact on Herbalife’s business stemmed from the inability to hold standard business meetings and “that nutrition club operators faced increased scrutiny that created an overall hesitation in their activities.”

Securities analyst Doug Lane sees trouble looming ahead for Herbalife Nutrition in the second quarter due to very little momentum. “They are having to reboot from a standing start by having more meetings again,” said Lane. “They really rely on meetings for their business, and they were restricted from doing that. So now they have to recapture stalled momentum.”

One of the companies hardest hit by the action was NHT Global. Total revenue of $19.3 million decreased 63 percent compared to $52.4 million in the first quarter of 2018. Chris Sharng, president of parent company Natural Health Trends Corp., said, “While our financial performance was adversely impacted by this initiative during the quarter, we strongly support the actions taken by the Chinese government to root out bad products and deceptive practices in order to protect Chinese consumers. We have great confidence in our ability to navigate the business through uncertain times and to renew growth once the macroclimate improves.”

Nu Skin Enterprises had a stellar first-quarter performance for a company with nutrition making up 40 percent of its business. The company had 12 percent growth in Mainland China, which the company attributed to a focus on personal care products.

What’s Next?

China has always been a volatile direct selling market. In 1998, the government shut down the channel completely, calling it an “economic cult.” Companies like Amway, Avon and Mary Kay Inc. worked hard to bring it back by reforming the framework, only to see other companies come in and corrupt the model. The frequent government reviews are due to scams and pyramid schemes that continue to plague the channel.

 

However, as volatile as it has been, the market has always continued to grow. Analyst predictions that it would one day surpass the U.S. as the largest direct selling market were nearly realized in 2018: recent data suggests China is now tied with the U.S. for the No. 1 spot, although the 100-day action will likely cause it to fall back to No. 2 in 2020.

U.S. companies looking to enter the Chinese market can look to companies like Amway for inspiration. China is now Amway’s largest market, accounting for approximately 30 percent of its worldwide sales according to the company’s president, Doug DeVos. While not as greatly affected by the 100-day action as nutritional companies, net sales in China were down slightly for Q1 2019 according to an Amway source.

Bob Bass, lead strategic insights analyst at Amway, notes what was lost during the recent 100-day action, he believes, will most likely not be made up over the three remaining quarters in 2019.

“When you talk about consumable categories like nutrition being the primary category that is down, it’s not like you are going to make that up in Q2, Q3 and Q4,” said Bass. “It’s not pent-up demand. You lost that opportunity for people to be using your product during that full three-month period. While pent-up may apply to durable products, it should not be applied to consumables like nutrition.”

Governance May Stifle Momentum

While direct selling executives will try to recapture momentum over the coming months, the truth is that it may never be back to business as usual for nutritional companies in the China market for two reasons. One, the events of the past six months likely mean greater regulation in direct selling as a whole and more watchful eyes on health/nutrition companies. The 13 departments intend to build a system of joint governance—where none existed before—to safeguard the rights of Chinese consumers and to ensure a fair and competitive marketplace.

And two, some industry experts believe social media will play a critical role in shaping the channel. The Chinese government is sensitive to citizen unrest. The speed with which the Quanjian incident was widely shared—and the anger it generated—was because of social media. Consumers and those wishing to participate in direct selling as a business opportunity now have the means to quickly vocalize their suspicions and displeasures. The government will want the channel to regulate itself better and do better compliance so as to avoid more Quanjian and Hualin moments. Therefore, it can never again be business as usual. There must be changes if direct selling, which has received intense negative press over the last few months, can positively move forward.

What is encouraging amid all this is that the direct selling channel does have the support of the Chinese government. Dale Sun, CEO of the Global Direct Selling Research Institute based in Hong Kong, says that while the Chinese companies are currently hesitant about bringing any attention to their companies, the 100-day action could be the catalyst for a much better future for them all.

“All I see is positive,” said Sun. “The market is huge and the demand for direct selling exists. The question is, how do companies meet the customers’ need and in what way for the long-term benefit.”

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