The 3 Things Dragging Avon Down

The 3 Things Dragging Avon Down

Avon Products was down nearly 17% at the end of last week following a third-quarter report that featured warnings about bribery charges and metrics showing that sellers -- and customers -- have headed for the hills.

CEO Sheri McCoy came aboard last year and is still trying to guide the company across the rough waters. But Avon's is carrying three large burdens that threaten to sink it.

1. That bribery charge
Avon had offered $12 million to settle bribery charges from the U.S. Securities and Exchange Commission. But the company admitted in this earnings report that the SEC is likely to come back with a much higher number. And the Department of Justice will present its own settlement figure.

Avon self-reported the potential bribery of Chinese officials a few years ago. The company fired some executives as a result of the controversy and has tried to strike a more favorable deal with the authorities. Avon will have to sit back, pay up, and learn not to do it again.

2. Fleeing representatives
North American revenue was down 19% year over year due in part to a 16% drop in active representatives. Avon does allow customers to shop for products online, but too much of the business still relies on ordering through the neighborhood Avon representative. But that's hard to do if fewer people are around to sell.

What's behind the exodus? To quote Avon's conference call, "our recruiting engine fell apart."

Avon tried to make too many large changes too quickly. This started back in 2011 when the One Simple Sales Model was launched in the United States. One Simple Sales was supposed to streamline the distribution model while cutting costs. But it mostly alienated existing representatives. And the loss of those representatives meant losing an employee and any potential for recruiting more representatives through that employee.

In the third quarter, Avon's attempt to redo the Canadian system also backfired and helped drag down revenue. Avon at least seems to have learned its lesson and stressed the importance of repairing relationships damaged by the changes while promising to make future changes at a slower pace. Time will tell if the company can pull that off.

3. Multi-level marketing model
Avon does have a nice website where customers can shop either directly through the main company or through the local Avon representative. But the fact that Avon is still using the representative model could keep its skies gray.

Companies using the multi-level marketing model can only thrive if representatives stay and recruit more representatives. Sure, it can work. Herbalife last week posted a record third quarter -- even while prominent investors such as Bill Ackman call it a pyramid scheme deserving a federal investigation. And that was because Herbalife's number of active sales leaders was up 13% year over year worldwide -- and up 9% in North America alone.

The good times for MLM companies can only last as long as the base of sellers continues to grow. That's too difficult of a prediction to make.

Foolish final thoughts
Avon has more to worry about than the potentially lofty bribery settlements. The drop in active representatives due to renovation attempts point to the cracks in the MLM model. Avon would need to woo back even more representatives than have left to really have a chance at a turnaround. But that seems increasingly unlikely.

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Fool contributor Brandy Betz has no position in any stocks mentioned. The Motley Fool has the following options: long January 2015 $50 calls on Herbalife. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published