Today this entry is about the differences between “Direct sales” and illegal pyramid scheme in China.
Qualifications for Direct Selling
Under the Regulation on Direct Selling Administration (i.e. Order of the State Council No.443), which was adopted at the 101st executive meeting of the State Council on August 10, 2005, and which come into force as of December 1st, 2005, a company must obtain an approval from the government before it is allowed to engage in any direct selling or even establish a local company that intends to engage in such activities. Qualifying groups will be given a permit that will allow them to prepare to establish direct sales operations and organize a local company. Once the company is established, a separate Direct Selling Certificate may be issued by the government.
The Ministry of Commerce (Foreign Direct Investment Section) is to handle the entry qualification process for all interested companies, while the State Administration of Industry and Commerce (Anti-Pyramid Sector of Fair Trade Bureau) is in charge of the enforcement of legitimate direct selling.
In fact two Regulations, the above mentioned Direct Sales Regulation (Order of the State Council No.443), and the Anti chuanxiao (Pyramid Selling) Regulation (Order of the State Council No.444), govern the direct sales industry in China.
It should be clear that certain fundamental differences exist between legitimate direct sales and the fraudulent Pyramid scheme. For example, the requirement that sales personnel make upfront investments in inventory, the absence of a return-and-refund policy, and compensation based on number of people recruited are the marks of fraudulent scheme, or chuanxiao. Legitimate direct sales do not permit such practices, and have adequate consumer safeguards in their operations (reference must be done to the content of the first mentioned Regulation).
Before the Ministry will issue a permit or certificate to engage in direct sales activities, the company must meet the following requirements:
1. The investor shall have sound business credit, and has no records of serious illegal operation during the past five years before filing the application; a foreign investor shall also have undertaken direct selling business for at least three years outside China;
2. The paid-in registered capital is no less than RMB 80 million Yuan;
3. The deposit has been paid in full amount in the designated bank according to the provisions of the present Regulation; and
In this sense, Article 7 of the Regulation on Direct Selling Administration.
The Regulation requires foreign-invested direct sales companies to have at least three years of direct sales experience in other markets before applying for a license in China.
Permissible Product Categories
The Direct Sales Regulation limits the products direct sales companies can sell to just five product categories: 1) cosmetics, 2) dietary supplements, 3) cleaning products, 4) health and exercise equipment, and 5) small kitchen appliances. Limiting product categories, and the approval process associated with such restrictions, are burdensome to both the government and the industry. Allowing the competitive marketplace to determine what products companies sell would be more efficient and effective.
International practices only set restrictions within the following categories: restricted goods (e.g., firearms, prescription drugs), perishable goods (e.g., foods, fresh produce), goods whose value cannot be easily determined by the average consumer (e.g., gemstones, investment packages), and bulk commodities (e.g., metals, crops). Other than in these specific categories, product approval for direct sales should be consistent with current regulatory requirements for all products across all retail industries.
Sale of the products
The Regulation define a direct selling company as any company that, in addition to selling products through stores, uses contracted salespersons to sell those manufactured products directly to end consumers. In other words, all product sales must ultimately happen in connection with retail stores—fixed establishments meeting certain requirements. Products cannot be sold out of an individual’s home or other similar location. The Regulation recommends that the direct selling company own the retail stores directly. If a direct selling company owns more than 10 stores in any Chinese province, the company can submit application to establish a provincial level branch company to help support its expanding operations.
In particular Article 3 states that “the direct selling, as mentioned in the present Regulation, is a type of business model, in which direct selling companies recruit sales promoters to sell products directly to end consumers (hereinafter referred to as consumers)outside the companies’ fixed outlets.
The direct selling companies, as mentioned in the present Regulation, shall refer to the companies which sell products by way of direct selling upon approval according to the provisions of the present Regulation.
The sales promoters, as mentioned in the present Regulation, shall refer to any personnel who sell products directly to consumers outside the fixed outlets.
A direct sales company is allowed to establish franchise stores, but franchised stores will be forbidden from using contracted salespersons to sell products to the ultimate consumers and may only be traditional retail locations.
All products sold through contracted salespersons must be made in China. A direct selling company cannot import foreign made products and sell them through its direct selling channels.
Finally, the price of all products sold to consumers must be published. The regulation will permit a retail price and salesperson price, but the price is not permitted to deviate greatly from the market average price of similar products of same category in same location during the same period of time.
The success of a direct selling company in China under the Regulations depend on the company’s ability to hire qualified contracted salespersons. The Regulations state that the direct selling company will be held jointly liable for the activities of its salespeople. A salesperson must meet the following requirements:
- The salesperson for a direct selling company must have a salesperson certificate. To obtain the certificate, the salesperson must take and pass a national test prepared and administered by the government.
- The salesperson must sign a formal contract with the direct selling company. The contract must set out clearly the responsibilities and rights of both parties. Moreover, the contract must be pre-approved by the government.
- The salesperson must be from mainland China. The Regulations specify that foreigners who are non-company personnel are prohibited from engaging in any sales activities.
- The salesperson must be assigned to a company owned store or provincial level branch company.
- The salesperson must not sell product outside his or her assigned territory, or cross-boarder.
The current Regulation stipulates that direct sales agents can only be compensated based on personal sales and only up to 30 percent of personal sales volume (inclusive of commission, bonuses and all other economic benefits). Such restrictions seems to put direct sales companies in China at a disadvantage relative to businesses not categorized as direct sales, as the latter are free to use any incentives to stimulate sales and motivate employees.
Customer Recruiting and Training
The Regulations also discuss what training and recruiting activities are permitted. Generally, the only training that is permitted relates to product training. However, in a separate area of the Regulations, it permits training that relates to selling skills, bonus plans, and so forth. It appears there as several levels of training contemplated, which at this point are not clearly defined. It is difficult to understand the exact intent of the Ministry on this provision. It appears the Ministry is concerned about training meetings that relate to improper schemes used to promote the products rather than the products themselves.
The Regulations limit how many individuals are permitted to attend a training meeting at any one time. A company may have a maximum 600 attendees at any training meeting, a provincial level branch office can have up to 400 attendees, and stores can have 100 attendees. All meetings over 100 people must be reported and approved by the government in advance of the meeting.
In order to better define the limits of the legality of Direct Sales in China, the REGULATION ON PROHIBITION OF PYRAMID SELLING (i.e., Order of the State Council of the People’s Republic of China , No. 444) was also introduced in 2005 (in effect as of November 2005).
Article 2 of this second Regulation states that:
The term “pyramid selling” as mentioned in this Regulation refers to such an act whereby an organizer or operator seeks for unlawful interests, disturbs the economic order and affects the social stability by recruiting persons, calculating and paying remunerations to recruiters on the basis of the number of persons a recruiter has directly or indirectly recruited or the sales performance, or asking the recruiters to pay a certain fee for obtaining the qualification for participation.
Under China’s Regulations on Forbidding Pyramid Selling, parties who introduce, lure or force others to join in multi-level marketing shall have the relevant assets and illegal income confiscated and fined up to CNY500,000 and serious violators shall be punished by law.
Though Direct Sales is formally considered a legal activity in China, multi-level marketing in the form contemplated in the Regulation on PROHIBITION OF PYRAMID SELLING is prohibited because it is considered as an illegal activity.
To be more precise, multi-level marketing is considered an illegal activity when: ‘organizers or operators take in new members, calculate and pay salaries one member according to the number of new members who join in the multi-level marketing, introduced by one member directly or indirectly, or the sales performances. Or, the organizer asks new members to hand in a sum of money as a precondition to join in. Or, by means of developing new members, the organizer or the operator ask members to invite more people join in, forming a multi-level relationship. The salaries of members at certain level are based on the sales of members at a lower level. By this way, the organizer and the member at top level obtain interests illegally, disturbing normal economic order, and affecting social stability. The great difference between direct selling and multi-level marketing according to the rules of China relies in: all direct sellers are normally trained by the
direct selling companies and any direct seller is not allowed to develop new followers or form multiple levels; the direct selling companies pay direct sellers salaries according to their sales; the total salary (includes wages, rewards, bonuses, or other economic benefits) of one direct seller should not exceed 30% of his sales.)
This should serve as basis to understand Direct Sales and the differences with the illegal “pyramid scheme”.
- Cristiano Rizzi