To head off potential fraudulent marketing schemes, state regulators are investigating several companies' efforts to mass market phone cards.
Companies such as Destiny Telecomm International Inc., Oakland, Calif., and start-up Fox Telcom Inc., Memphis, Tenn., are undergoing the investigations by regulators in such states as
Alabama, North Carolina and Michigan.
Dennis Wright, an associate attorney general in Alabama and chief of the state's consumer affairs unit, is reviewing marketing plans prepared by Destiny for its 6,000 sales representatives in
"We are trying to ensure the [Destiny] program ... is not a pyramid scheme," Wright said. Destiny - whose automated phone system assures callers that the company offers "the greatest business opportunity on the planet right now" - already has 500,000 independent sales representatives nationwide.
Destiny's national sales force is growing by roughly 4,500 representatives per day, putting the company on track to reach $200 million in sales by the end of 1997, said Paul Matson, a company spokesman. The company was formed in July 1994, and now has 500,000 sales representatives and 450 employees, he said.
Pyramid schemes, also called Ponzi schemes, use entry fees paid by new participants to reward existing participants. These schemes can generate large fees for the early participants who are paid off with money put up by later investors. The investment swindle typically collapses because of a lack of investors or is shut down by regulators.
|A SNAPSHOT OF PHONE CARD COMPANIES |
|COMPANY ||LOCATION ||FOUNDED ||SALES REPS ||'96 REVENUE |
|Destiny Telecomm International Inc. ||Oakland, Calif. ||July 1994 ||500,000 ||$100 million |
|Tele-Card Networks Inc. ||Escondido, Calif. ||May 1995 ||360,000 ||Not available |
|Strategic Telecom Systems Inc. ||Knoxville, Tenn. ||March 1994 ||275,000 ||$150 million |
|Fox Telcom Inc. ||Memphis, Tenn. ||Nov. 1996 ||Few reps ||Not available |
Destiny has attracted the attention of state regulators because it is the leading company in the United States selling phone cards via independent sales reps. This marketing arrangement is sometimes called multilevel marketing and can be operated as a pyramid if the companies charge sales reps a fee to join, or if they sell the bulk of their products to the sales force, rather than outside customers, said state officials.
North Carolina began its investigation of Destiny after receiving information that showed the company's 15,000 reps had sold only 17,000 cards, said Kristine Lanning, an associate attorney general for the state. Moreover, many of these 17,000 cards were bought by the representatives, each of whom had to pay about $100 to join Destiny, she said. To satisfy the states' concerns, Destiny drafted marketing plans in cooperation with officials in Oregon and Michigan and is negotiating with officials from Alabama, Florida and Kansas, said William Hill, a lawyer for Destiny. Hill is a partner at Donahue, Gallagher, Woods & Wood, Oakland, Calif.
On Jan. 22, Destiny signed an agreement with North Carolina that requires Destiny's 15,000 North Carolina representatives to sell 70 percent of their phone cards to people who are not part of the network, said Lanning. If Destiny fails to meet the 70 percent target, it must stop selling phone cards to sales representatives and must halt recruitment of new reps, she said. Destiny also paid $100,000 to the state and promised to end a practice that pushed sales representatives to buy multiple sales kits, usually priced at $100, she said.
Because of the agreement with North Carolina, "we're back in business there," said Hill. "We'd have a hard time doing business in the states if we can't convince the attorneys general that we are a legitimate organization," he said.
Under the North Carolina agreement, Destiny will only charge its new sales representatives $25 for the cost of registration paper- work, said Matson. "If one does not have to pay anything for the privilege of selling the product, it is not a pyramid," he said.
Overall, multilevel marketing companies such as Destiny took in roughly 20 percent of the 1996 revenues gained by the fast-growing phone card industry, said Sandy Beshover, publisher of PCM Magazine, a monthly magazine based in Matewan, N.J. Nationwide, the industry's revenues grew from $800 million in 1994 to $1.4 billion in 1996, he estimated. By 2000, the industry's revenues should reach $5 billion, he said.
There are perhaps 30 multilevel networking companies selling phone cards, said Beshover. The industry is led by Destiny, Strategic Telecom Systems Inc., Knoxville, Tenn., and Tele-Card Networks Inc., Escondido, Calif., and includes many small companies such as Fox, he said.
These multilevel marketing companies are spearheading the growth of the phone card business, often by selling low-cost cards, he said. Companies such as Destiny are selling cards for roughly 25 cents per minute of phone time, compared to the price of roughly 40 cents per minute charged by the larger phone companies, he said.
However, "the problem is that the [companies] that grow up overnight looking for a quick buck are hurting the image of the industry," said Beshover.
Companies such as Success Telecom, based in Charlotte, N.C., have gone out of business, leaving tens of millions of dollars in debts to phone companies, sales reps and card purchasers, he said. "Bad news travels a lot faster than good news."
State regulations can suppress fraudulent schemes but can also prevent competition from newcomers, said Beshover. For example, Fox Telcom has delayed marketing until it works out a plan acceptable to Alabama officials, said Priscilla Duncan, a Montgomery, Ala.-based consultant for Fox. "We are trying to devise a plan that would promote sales and keep recruitment [of sales representatives] to a manageable level," she said. Unless sales
grow in step with recruitment, the company will run afoul of state antipyramid rules, she said.
The regulations "require more research and more expenditure of time and capital" before marketing can begin, said Larson Elmore, Fox's product development chief.