Len Clements Commentary

August 5th, 2008
California Attorney General Jerry Brown filed a lawsuit against YTB Travel (YTBLA.OB) yesterday seeking $25 million in fines and restitution, calling it a "gigantic pyramid scheme". The suit was filed against YourTravelBiz.com, a subsidiary of YTB International. The AG's press release states the lawsuit seeks to, "shut down the company's unlawful operation before more people are exploited by the scam." The basis for this position, according to the release, is that, "Once enrolled, members who join the pyramid scheme earn compensation for each new person they enlist, regardless of whether they sell any travel." The Attorney General has charged the company and it's senior management with unfair business practices and false advertising.

The timing of the AG's action seems opportunistic and deliberate. The YTB national convention in St. Louis starts tomorrow.

To read the entire press release see:

http://caag.state.ca.us/newsalerts/release.php?id=1596

YTB Travel also announced on July 14th that they are considering adopting a franchise operating system by 2009, where their distributors, which they refer to as "referring travel agents" (RTA's) can convert to franchisees.

In the company's press release they state: "Details regarding price, product offerings and the conversion plan are all under consideration, but the Company anticipates that its existing RTA base would be treated favorably under its forthcoming proposal." The company claims the franchising model "would facilitate the Company's expansion into additional markets by providing more comprehensive training and a new proprietary e-commerce platform."

YTB Travel has already hired iFranchise of Chicago to "consult in the planning and development of the franchise model".

To review the company announcement see:

http://biz.yahoo.com/prnews/080715/nytu134.html?.v=101

Commentary:

As I have stated in past Alerts (#84, #86 and the end of #97), I have always considered YTB Travel's business model to be legally vulnerable. Based on much legal precedent we know that state and federal regulators do not like to see commissions being paid on things only a distributor (participant in the income opportunity) would ever purchase. They also don't like to see the company itself make any significant income from the sale of products or services that only a rep would purchase. A perfect example is a distributor kit, or sales aids, such as brochures, promotional and training CDs, and - a distributor's website. Since only a distributor would ever purchase these things this creates a direct connection between recruiting and earning income.

Examples of cases where a company was declared an illegal pyramid for paying multilevel commissions on the business website are BigSmart and Km.net, which sold websites, or "online malls" that offered a variety of goods and services, including travel. But the affiliate commissions paid by the vendor to the company for purchases made through the cybermalls was very small - usually 5-15%. Then this amount had to be split between the company and the pay plan, and then split again down each level of the plan, so there was no significant income potential from the sale of the actual goods sold via the site. To compensate they charged a large upfront fee for the "cybermall" (website) itself (BigSmart $300, and Km.net $400). Since this resulted in a de facto recruiting bonus (since only new recruits would ever purchase the website), and the sales of the websites far exceeded the sales of actual products through the sites, both companies were found to be operating pyramid schemes and closed down.

Sales of actual travel via these sites, and the payment of commissions on these sales, is perfectly fine. But isn't the site itself simply a sales aid? Who else would purchase the travel booking website other than a participant in the business opportunity? In fact, it appears to me that a substantial income could be earned from nothing more than enrolling other YTB agents even if not a single penny's worth of travel is ever booked.

In the first quarter of 2008 YTB had revenue of $33,959,388 from the sale of the agent business package, which is primarily the booking website (up front purchase and monthly recurring fees). YTB paid out $3,852,416 in actual travel commissions through their pay plan. However, bonuses from the sale of the websites this travel was booked through totaled $25,068,543! Six-and-a-half times as much was paid out on the website (what is essentially a sales aid) than was paid on travel - the service RTAs are supposed to actually be in the business of selling.

Similar statistics were specifically cited in the California AG's press release and lawsuit. The lawsuit contained these statements:

"While Defendants purport to be in the business of selling travel, their real business is the operation of a pyramid scheme that relies on the sale of essentially worthless websites they refer to as 'online travel agencies'."

"Of the more than 200,000 consumers who purchased or maintained Defendants' websites during 2007, 62% failed to earn a single travel commission -- not even on their own personal travel."

"While the vast majority of consumers made nothing selling travel, Defendants generated 73% of their net revenue of over $141 million dollars from the sale of websites and monthly fees."

"In short, Defendants sell an illegal pyramid scheme that uses the minor, incidental sale of travel as a front for their scheme."

Keep in mind, California isn't one of those states (like ND and MO) that reluctantly allows MLM and doesn't really like any of them. In CA's position statement to consumers on this issue they acknowledge "there are legitimate multi-level or network marketing companies... Multi level marketing can be a lawful business."

The MLM model is perfectly sound, but simply doesn't work well with service based businesses such as travel. There just isn't enough margin on travel to generate a large enough commission to afford a competitive payout. Yes, YTB claims they sold $414 million in travel last year, but again, they earned $5,328,627 in commissions on that travel (1.3%), of which they paid out $3,852,416 (72%) of that to the field. So while $414 million in travel sales sounds impressive, when you consider they only paid 72% of 1.3% of that to their distributors (for those of you keeping score at home, that's a pay out of 0.9% -- most MLM companies pay out 40-50%), it's clearly not competitive as a stand alone MLM opportunity. That's why every MLM travel deal I've ever seen (many over the last 18 years) has based the large majority of their compensation plan on something else besides booking travel.

It is therefore my opinion that it is inevitable that YTB Travel will abandon the MLM model - one way or the other. I believe they will be economically forced to (they had a net loss of $3,517,651 first quarter of '08), or legally compelled to. Which is why it makes perfect sense for them to be "considering" the adoption of a franchise system.

The "Franchise" Announcement

The way in which YTB Management handled the announcement of this proposed new plan was dreadful. First they published a short, cryptic notice saying they were "contemplating the replacement of its referring travel agent ('RTA') business model with the implementation of a franchise operating system" (emphasis mine), then followed up with a notice from YTB CEO Scott Tomer in which he attempted to clear up "misrepresentations and untruths" being spread on the internet regarding YTB's "commitment" to the network marketing business model. The first notice not only made no mention of YTB maintaining their MLM model, they specifically said they were "replacing" it! What's more, the notice stated that the "existing RTA base would be treated favorably under its forthcoming proposal", further implying the MLM aspect was being eliminated. Where YTB had the opportunity to forgo any such misunderstanding, they instead stated, "Details regarding price, product offerings and the conversion plan are all under consideration".

Mr. Tomer began his follow up announcement (three days later) by saying, "I realize that many of you want more information about our July 14th announcement of the potential use of a franchise model". I'll bet they do!

Within hours after the first notice was published high level leaders within YTB were claiming they had been on a call in which management assured them the MLM model was not being abandoned, and the franchise system was only being considered as an "option". This only seemed to increase the confusion. Why would YTB announce publicly the franchise system was "replacing" the MLM system, but only tell a few key leaders it was being considered as an "option" in addition to the MLM model? I called and emailed YTB's Media Relations director and she was quick to send me Mr. Tomer's follow up announcement where he stated, "If RTAs elect not to become franchisees, they will be able to continue with no change to their status with all income opportunities and privileges they currently enjoy... the downline genealogy and network marketing division will remain intact."

YTB's stated reasoning for adopting the franchise model is also confusing. For example, "We believe a franchise model of our existing business will be easier to comprehend and more readily accepted by the general public." That would make sense if you were "replacing" the less accepted MLM model with a franchise model, but not if you're still going to be an MLM company, too. Or, that the franchise model will allow them to provide "additional tools and training for those who choose to actively pursue the travel business". What tools and training can be provided under the franchise model that can't be offered under the current MLM model?

Mr. Tomer also claimed that "many months of due diligence preceded our July 14th announcement". Well, then why confuse and scare the heck out of their reps now, while they're still just "contemplating" it, and when "Details regarding price, product offerings and the conversion plan are all under consideration" and "While there are some things we are unable to comment on"?

Mr. Tomer further acknowledge that "outsiders will question this decision". For the record, I'm still as confused as most YTB reps seem to be about what, exactly, is being proposed. YTB corporate doesn't even seem to be clear on what this is all going to look like when it's done, and what effect it's going to have on those building multilevel incomes. And yes, I've made several attempts to avoid asking these questions rhetorically, but no one from YTB will respond to them.

Personally, I can't question this "decision" until I know what it is! I'm not questioning what they are proposing, I'm questioning when and how they proposed it.

But then, it may all be a moot point now.