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Candid Camera —

August 21, 2012

Trigger warning: This post is all about NutriSystem and its weight loss philosophy.

If you’ve been reading Fierce, Freethinking Fatties awhile, I would assume you’ve come to accept that long-term weight loss programs don’t work for the vast majority of people. Some refer to it as the 95% Rule, which is a rough estimation of the failure rate at five years for every single weight loss program known to woman. It’s based largely on Albert Stunkard’s seminal work from the 1950s*.

It makes you wonder how The Big Three (Weight Watchers, Jenny, and NutriSystem) stay afloat, financially, given their consistent, demonstrative failures. It’s obviously driven by advertising, as evidenced by Weight Watchers and its ridiculous Believe campaign, which emphasizes blind faith over evidence in the claim that most clients will see Hudsonian results.

You would think people would have caught on by now. But another commonly accepted fact is that weight loss companies are so profitable because its client base will ultimately regain the weight, blame themselves and eventually return for another go with the same company, or a different one. Weight loss profiteering is the corporate equivalent of the Sampo.

But I don’t think I’ve ever heard anyone from the weight loss industry admit as much.

Until yesterday.

But a little history, and context, is in order.

In 1971, an entrepreneur named Harold Katz opened his first weight loss center, Shape Up, which offered the radical advancement in weight loss science known as “developing weight loss ‘centers’ that looked like medical offices,” according to a corporate profile on Funding Universe. Having witnessed his mother’s battle with weight, Katz intended to develop a permanent solution.

A January 1992 profile of Katz in The Daily Pennsylvanian described his “unique” approach to weight loss:

He credited the success of his program over other weight loss programs to the franchise’s offering medical supervision in combination with more standard aspects of weight loss like exercise and special diet food.

Katz opened a second Shape Up center himself, and he franchised a third. The franchise became the most efficient and profitable aspect of what would ultimately become Nutri/System. Nutri/System followed this profitable advancement by introducing ridiculously overpriced private-label food, which clients, and franchisees, had to buy directly from Nutri-System at least five times per week.

By the end of the 1970s, Nutri/System was one of the 100 fastest growing companies. At its peak in the 1980s, Nutri/System generated over $50 million in sales each year with predictions of staggering growth. Of course, nobody sells your success like you, and Katz’s profile for H. Katz Capital Group boasts of the accomplishments he achieved at the helm:

In 1977, sales tripled when Mr. Katz developed a line of nutritionally-sound, pre-packaged, pre-measured diet foods to be sold exclusively to Nutri/System center clients. In January 1980, Mr. Katz brought the company public, and listed it on the New York Stock Exchange. Mr. Katz sold Nutri/System in 1986. At the time it was the largest medically-supervised weight control company in the world, with over 700 company owned and franchised centers nationwide.

According to Funding Universe, “By late 1982, Katz, who owned 67 percent of Nutri/System’s stock, had parlayed his $40,000 initial investment into a fortune valued at more than $300 million.” As a result of his newfound fortune, Katz undertook a series of investment disasters, which included a small, but similar weight loss company, Gloria Marshall Figure Salons. Franchisees felt threatened and insulted by the purchase, which marked the beginning of the end for Katz.

Then, senior officials sold their Nutri/System stock, including Katz and his vice president, national medical director and brother, Robert Katz (all the same person, mind you). Soon after, Nutri/System announced that its third quarter earnings for 1983 had dropped by $1.8 million, startling stockholders and leading to a class action lawsuit. Simultaneously, 280 of the 550 franchised centers filed an antitrust lawsuit over price gouging for Nutri/System’s food.

The tailspin began, with Nutri/System announcing “a $17.4 million loss in 1984, one year after reaping a $13 million profit.” According to the History of NutriSystem, Katz attempted to reassure franchisees and investors by bringing in new leadership:

In an effort to stem his losses and repair his relationship with franchisees, Katz hired a new chief executive officer, A. Donald McCulloch, in 1985, who brought a wealth of marketing experience from work with companies such as General Foods, Wilson Sporting Goods, and Pizza Hut.

As a way of saying thanks, McCulloch led an ugly leveraged buyout of Katz in 1986 for $70 million (PDF). Katz walked away with nearly $38 million, a fraction of the $300 million he could have walked away had he sold out four years earlier. By 1989, McCulloch had expanded the company further to 1,800 centers and $764 million in revenue.

The success was short-lived, as the ’90s brought public relations disaster for Nutri/System, when 19 women from Florida filed a series of law suits against Nutri/System on March 20, 1990. Thanks to the rapid weight loss encouraged by Nutri/System, clients began developing gallbladder disease, which often required the removal of the gallbladder all together.

At the heart of the lawsuits, former clients claimed that Nutri/System did not provide adequate medical supervision, the supposed advantage of its approach to weight loss.

Law firms began receiving hundreds of phone calls from dieters who complained of gallbladder problems after losing weight on Nutri/System. As word spread of the problem, the Congressional Committee on Small Business announced a series of hearings on the issue. Unfortunately, the results were predictably tepid:

At the May 7 hearing in the nation’s capitol, subcommittee leaders concluded that the $33 billion-a-year diet industry needs to police itself and that federal agencies must enforce existing rules while developing additional guidelines to aid customers.

But in the face of continual bad press, Nutri/System went into damage control:

“There’s been many studies to show that overweight people have a higher incidence of gallbladder problems,” said Nutri-System spokesman James Kemper Millard at the company’s Willow Grove, Pa., headquarters. “We just want the facts out. We don’t want this to be another `Martians have landed’ story.'”

Millard said Nutri-System encourages about a two-pounds-a-week weight loss.

But it was too late. The Martians had indeed landed, and the lawsuits began pouring in. As a result, the medical community distanced itself from from Nutri/System, according to a May 10, 1990 article:

The American Medical Association said it has asked Nutri-System Inc. to stop using the AMA’s name in advertising for the weight loss program, a recent target of lawsuits by people claiming health problems.

The company has said the lawsuits are without merit, suggesting that the gallstones in the plaintiffs occurred coincidentally and that the risk of gallbladder disease among the obese can be reduced by prudent dieting.

And with the announcement of each new lawsuit, Nutri/System consistently shifted the blame to the fatties:

  • May 18, 1990 —”A Bethlehem [Pennsylvania] woman has sued one of the nation’s diet industry leaders for alleged negligence, claiming among other things that her gall bladder had to be removed less than five months after she started the Nutri-System diet… The suit is one of 33 the company is defending nationwide, but the only one to be filed in Pennsylvania, according to Nutri-System spokesman Tim Hermeling… ‘Obesity can cause gall bladder disease,’ Hermeling said yesterday. ‘We believe (similar suits) are without merit.'”
  • July 1, 1990 —”An Orange County woman… Cynthia S. Hamilton alleges she suffered from gallstones, abdominal pains and other digestive problems after losing 41 pounds on the Nutri/System diet plan in 1988, said her lawyer, Neil G. Paulson. ‘She had good health before… but after the weight loss occurred, she began waking up in the middle of the night with sharp pains on her right side,’ Paulson said. ‘They became unbearable in the next six weeks.’… A spokeswoman for Nutri/System said Tuesday that the company’s diet is safe. Nutri/System ‘has not lost a lawsuit. There have been 14 tried to conclusion and we have won all 14,” said Delphine Carroll, a spokeswoman for the Blue Bell, Pa., company… Carroll said the bulk of Nutri/System’s lawsuits have been settled out of court, including 189 cases that were filed jointly against the company in South Florida.”
  • September 5, 1990 — “A 38-year-old Ventura woman has filed a class-action suit against Nutri-System Inc., claiming that her gall bladder had to be removed after she lost 34 pounds in 18 weeks on the company’s diet program… Citing a CBS News report last month, [attorney Louis M. Marlin] said more than 200 people nationwide have sued Nutri-System… Marlin said Kirkham began using Nutri-System in December to try to trim her weight from 216 to 155… By early April, Kirkham had slimmed down to 182 pounds, losing an average of 2 1/2 to 3 pounds per week, Marlin said.”
  • October 18, 1990 —Two Montgomery County women have joined 19 South Florida woman in suing the Willow Grove-based Nutri/System, alleging that its rapid weight-loss plan caused gallbladder damage… Mossop, 33, contracted with the company to lose 135 pounds and was directed to eat only Nutri/System foods supplemented with fresh fruits and vegetables and diet drinks, according to the suit. Within four months she had lost 50 pounds and began having violent gallstone attacks, the suit said, and the gallstone attacks continued for a month until her gallbladder was surgically removed. Barone, 21, lost 23 pounds in two months and then lost her gallbladder after she, too, began having gallstone attacks, her suit contends… ‘Overweight people, especially those who are obese . . . suffer the highest incidence of gallbladder disease,’ said Dr. Stuart H. Shapiro, Nutri/ Sytem’s national medical director. Obese people are three to four time more likely to develop gallstones than people of ideal weight and obese woman have six times greater risk, he said.”
  • November 4, 1990 — “Early last year, Kimberly Burl-Marine wanted to slim down by 25 pounds, so she went to a Nutri/System Weight Loss Center in Parkville. In just a month, the Bel Air woman shed 20 pounds under the program. But soon, the 34-year-old assistant principal in the Baltimore County school system began having severe abdominal pains that eventually landed her in the emergency room at St. Joseph Hospital. A short time later, she entered University of Maryland Medical Center to have her gall bladder removed. ‘In each of the cases, the people had extreme trouble,’ [attorney Paul D. Bekman] said. ‘There was no physician monitoring, no medical evaluation of any kind. You have lay people saying, ‘How much weight you want to lose? You want to lose 49 pounds in 40 days? OK.’ ‘…  ‘Studies, including one in 1989 involving 88,000 women, show that obesity is a major cause of gall bladder disease,’ [‘Kathleen A. Maylath, manager of media relations for Nutri/System Inc.] said in a prepared statement. ‘No reliable scientific or medical evidence has demonstrated that a Nutri/System weight-loss program causes gall bladder disease.'”

Nutri/System’s response remained firm: there was no evidence of a relationship between Nutri/System and gallbladder disease, plus Nutri/System had won the relatively few suits it had followed through to judgement. Meanwhile, behind the scenes, Nutri/System began settling hundreds of cases out of an estimated 700 similar lawsuits filed nationwide. In fact, Nutri/System settled 199 lawsuits in South Florida alone, according to a November 7, 1991 article in the Sun Sentinel. though the results remain confidential.

The lawsuits devastated Nutri/System, and on April 29, 1993, it filed for Chapter 11 bankruptcy and all non-franchise operated centers were shut down as seven banks seized the firm’s assets. Weeks later, operations were handed over to Heico Acquisitions, led by principal Michael Heisley. The takeover promised potential windfalls for the company, which specializes in turning around troubled companies:

Nutri/System is attractive because it posted profit of $126 million as recently as 1990, Heisley said. Franchise revenue is about $30 million a month, said David Skulnick, who owns franchises in New Jersey and Illinois franchises.

By August 4, 1993, Nutri/System announced it would emerge from bankruptcy in mid-September as an acquisition of Heico. Heisley outlined the company’s future path for success:

Heisley said that under his ownership, the core business of Nutri/System would continue to be weight-loss programs built on company-supplied foods. However, he said the company would broaden its focus to include more emphasis on exercise and long-term weight maintenance.

Although a brief bidding war broke out when two Ohio diet companies jointly offered $15 million in cash for the ailing company, Heico managed to hang onto the property and announced the end of its bankruptcy on December 29, 1993, just in time for the all important New Year’s resolution season.

Nutri/System cast off the shadows of bankruptcy and began growing immediately, as it began to offer an exciting new pharmaceutical arm to its plan: Nutri/System Rx. In September 1995, Nutri/System launched four Rx centers that specifically offered the wildly popular weight loss pharmaceutical cocktail of fenfluramine and phentermine, or fen-phen.

But even the patronizingly supportive article in the 1995 Fortune hinted at trouble on the horizon:

For a couple of reasons, however, fen-phen is not the ideal and ultimate diet drug combination. First, there is some debate over safety. Most fen-phen researchers say the drugs pose minor health risks compared with amphetamines. For most patients the short-term side effects are offsetting — phentermine heightens alertness while persuading the body to burn more calories, and fenfluramine, thought to cut cravings for starches and sweets, can induce drowsiness. But some users experience a racing heartbeat and, although rarely, high blood pressure.

The “debate over saftey” ended in September 1997, when reports of cardiac damage from fen-phen (PDF) were made public.

Two months ago the Mayo Clinic reported 24 cases of heart valve damage by users of fen-phen. A week ago, the Food and Drug Administration reported 58 more cases and ordered new warning labels. The F.D.A. stopped short of recommending that patients not use the pills, but it urged doctors to be cautious.

Another round of costly lawsuits forced Nutri/System to restructure itself yet again, abandoning its brick and mortar stores in 1999 and offering an online-only service. It also renamed itself In December 2002, sold itself again to HJM Holdings LLC, led by entrepreneur Mike Hagan. According to a 2005 profile on Hagan for Business Week, “Hagan heard Heisley was looking to get out and swooped in with an investor group that bought a 58% stake for $10 million in 2002.”

Hagan took the reigns of NutriSystem’s stripped-down business model and, with a fresh start, Hagan began rebuilding the company once again:

The signless building houses 28 marketers who design and monitor ads, a handful of food-quality managers, a few accountants and Michael Hagan, the chief executive. You won’t find a doctor or anyone in a lab coat. The only science practiced at NutriSystem is a carefully engineered form of selling. [emphasis mine]

Six years later, NutriSystem launched an aggressive comeback, spending $35 million on television and radio advertising, bucking the trend of online ads. As well as a new concentration on male dieters. The strategy worked and NutriSystem increased its annual revenue from $38 million in 2004 to $212.51 million in 2005.

Near the end of 2005, Marketwatch declared NutriSystem the undisputed winner, not just the Big Three, but on all of Wall Street:

The direct marketer of prepackaged diet products has gained an eye-popping 1,500% in value since the beginning of the year, making it the clear leader on the Russell 2000 and the biggest gainer on any major U.S. index.

Investors reaped the rewards, and investors read tea leaves into NutriSystem’s future:

Analysts at research firm Thomas Weisel are also bullish on the stock, rating it outperform on expectations of strong long-term growth, driven by increasing sales to existing and repeat customers, a more differentiated product lineup and a soon-to-be-announced price hike.

But research company Stifel Nicolaus is more cautious, rating the stock a hold on the grounds that its business model could easily be replicated.

Could advertising really impact a company’s bottom line? If so, then NutriSystem was hoping for a dose dependent response when it tripled the advertising budget, spending $26 million during the first quarter of 2006 compared to $8.1 million in the first quarter 2005.

This time, the results were evident and impressive, but  not as dramatic as the previous year. NutriSystem more than doubled its revenue from $212 million to $568 million in 2006. The revenue trajectory rose to a high of $777 million, making it Fortune magazine’s fastest growing company of 2007. In 2008, Hagan handed over the reigns of CEO to Joe Redling.

That’s when NutriSystem’s luck ran out, as the company bottomed out at $400 million in 2011:

As a result, in April 2012, NutriSystem and Redling announced a mutual agreement that he would step down immediately and would not renew his contract in September, while Hagan will return to his role as CEO.

Considering the tumultuous history of NutriSystem and its many near death experiences, one might wonder why investors continue to prop up NutriSystem’s abject failure as a company.

A June 2011 article on Small Cap Network, hints at the justification:

The bottom line: With so many obese people in the USA and developed countries, certainly weight loss and dieting stocks like Weight Watchers International, NutriSystem and Medifast are worth looking at closely as they definitely have room to grow.

But it’s Hagan himself who confirms our suspicions in the Business Week profile:

Dieters on portion-control plans like NutriSystem’s lose 5% of body weight after one year if they stick to it, according to many studies.

But of course, most don’t. The average customer stays on the program just 10 weeks and loses about 2 pounds per week. About one-third come back within a year, many having regained the weight. “It’s a sad thing from the consumer’s standpoint,” Hagan says candidly. “But it makes a very attractive business model.” [emphasis mine]

There you have it. NutriSystem profits from the failure of its dieters and has a history of saying and doing anything to turn a profit off their eternal hopes. Like most weight loss companies, it shamelessly misleads the public in an attempt make them a little thinner in the pocket book.

Even today, NutriSystem continues to mislead customers by trading on its claim to “medical supervision,” despite multiple lawsuits claiming a complete absence of medical supervision. For NutriSystem, “medical supervision” means “strongly recommending” that clients work with their doctors while on the plan.

That doesn’t stop NutriSystem from implying that medical supervision is a part of the program, as evidenced in this February 1, 2012 press release:

“This Company was founded on the belief that there has to be an easier way for people to lose weight,” says Joe Redling, Nutrisystem’s Chairman and CEO. “Nutrisystem’s innovative approach – to combine low-calorie prepared meals based on the science of the Low Glycemic Index (GI) with counseling and medical supervision – has withstood the test of time and is responsible for millions of pounds being lost on the Nutrisystem program.” [emphasis mine]

Even if this weren’t a lie, even if Nutrisystem did still offer medical supervision, we now know that it isn’t the millions of pounds lost that makes NutriSystem so profitable. It’s the millions of pounds regained.

*This New York Times article explains Stunkard’s work, but it also attempts to dispel the “folklore” of the 95% by citing the results of the National Weight Control Registry, a self-selected sample of successful dieters. Stunkard’s work was at least 100 consecutive patients who took part in a weight loss program. There are absolutely no five-year randomized, controlled trials with results comparable to the NWCR studies for obvious reasons. I loathe this article because it then makes it possible for people to dismiss the 95% Rule outright without attempting to understand just how abysmal weight loss failure rates really are.

One Comment leave one →
  1. vesta44 permalink
    August 21, 2012 4:26 pm

    I’ve said all along that’s why the diet companies out there make so much money – not because people lose the weight and keep it off forever, but precisely because they don’t keep whatever weight they’ve lost off forever. That and the fact that diet companies (and society in general) blame the dieter for not being successful at maintaining weight loss when it’s actually the fault of the diet itself.

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