Broken Secrets

The Difference Between Pyramid Schemes and MLM

Multilevel Marketing (MLM) Organizations are not Pyramid Schemes. I’m not trying to defend MLM companies, because I think those are terrible businesses for most people, but I wish more people knew what a real pyramid scheme was because they’re so fascinating!

So try to forget everything you know about MLM and pyramid schemes, unless of course you already know that a pyramid scheme is very different from Multilevel Marketing.

For those of you who are unfamiliar with multilevel marketing companies, these are the companies where your success depends heavily on how many other people you can recruit into the company (because you get a bonus for selling them in and/or a cut of their sales). They also involve direct selling of products. Some of the largest and most recognizable MLMs are:

• Avon Cosmetics
• Amway (Household Goods)
• Mary Kay (Cosmetics)
• Herbalife (Vitamins/Supplements)
• Primerica (Financial/Investment Products)
• Tupperware (Home Storage)
• Pampered Chef (Kitchen Tools)

You probably recognize most of the companies listed above and they’re not small companies. Pampered Chef is the smallest one in that list and it’s a $500 million publicly traded company on the New York Stock Exchange! Avon is the largest at over $10 billion in revenue with more than 6 million sales people.

$10 billion in revenue and 6 million sales reps is impressive, but it also cuts at the heart of why I don’t like MLMs and why many people try to steer clear of them. If we do some quick math to understand those numbers, $10.3 billion in revenue leaves each of the 6.2 million sales reps and 42,000 employees with about $1650 each.

Of course, we can assume the 42,000 employees are being paid a reasonable salary or they’d probably go work somewhere else. So that leaves a sales rep with even less than $1650 as an average. We see the best sales reps driving around in pink Cadillacs, so we can also assume the best sales reps are making much more than $1650. In other words, some sales reps are doing very well and others don’t make enough to survive.

That’s not a problem per se, any sales rep is responsible for their own success of course. But a lot of people are sucked into these ventures with the promise of (potential) wealth. I’m not speaking about Avon specifically, but I have been invited to meetings for other MLMs and that was always the pitch. When the results don’t match the pitch, people start to feel like they’ve been scammed, especially when they’ve paid money to join or buy product inventory to get started selling. While they’re not exactly trying to scam people, they are giving a hard sell and I have been to pitch meetings where people were misled about typical results.

Multilevel marketing companies are legal, assuming they’re actually selling a real product (and the product is legal). Again, they might not be good business opportunities but they are technically legal. Like I said, they’re on the New York Stock Exchange! In fact, there are plenty of legal and lousy business opportunities out there, go to any franchise trade show and see some for yourself — MLMs do not have a monopoly on lousy (high failure rate) business opportunities.

On the other hand Pyramid Schemes are illegal. They are fly by night operations (sometimes literally since they may only operate at night). They are not traded on stock exchanges. In fact, these are some pretty big indicators that a business is not a pyramid scheme: it is legal and the company is on a stock exchange.

Because a lot of people dislike MLM organizations and think they’re a scam, they often refer to them as “Pyramid Schemes” either out of confusion or as an insult or exaggeration. There’s also that funny scene in The Office where Michael Scott draws the Organization Chart of an MLM and then Jim draws a pyramid shape around it to demonstrate that it’s a Pyramid Scheme:

It’s a really funny scene, but as we know: MLMs are not Pyramid Schemes.

So, let’s get to the really interesting part:

What is a Pyramid Scheme?

The key indication that you’re dealing with a Pyramid Scheme is that the people involved actually describe it as a pyramid scheme. They may have clever code names for the organization, but nobody is denying the fact that it’s a pyramid scheme because it’s important for everyone to understand how that works and it’s important for everyone to know it’s illegal so they can tread carefully. On the other hand, people in MLMs never refer to their organizations as Pyramid Schemes, because they probably don’t know what a real pyramid scheme is, and they do know they’re not in one because their business is actually legal — lousy perhaps, but still legal.

So let me get back to the beginning, if there’s no product involved then how does anyone make money? That’s the evil genius of some pyramid schemes: they just pass around money!

The Eightball Model

This type of Pyramid Scheme is called the eight ball model because there are exactly 8 people at the bottom of the pyramid. There are exactly 4 people above these 8 (one person for every two below). There are exactly 2 people above the 4 (again, one person for every two below). Then there is 1 person above the 2 (again, one person for every two below). If you haven’t figured it out, this structure makes something that resembles an actual pyramid shape:

This is another key difference between Pyramids and MLMs — Pyramids actually look like Pyramids. MLMs can have any number of people on each level and therefore the never actually look like pyramids.

So how does a Pyramid Scheme keep its pyramid shape when new people join? The person at the top of the pyramid gets kicked out (blue) and the pyramid divides in two new pyramids with the 2 people on the second level (red) now as the top person in each of their own pyramids.

Now there are two pyramids and the people in each pyramid will try to recruit people to join the bottom of their pyramid which will then force these 2 pyramids to become 4 pyramids (and so on). This is illegal because there are only so many people who can join the pyramid so eventually there will be many pyramids that are waiting for people to join and not enough people in existence to join them, thus everyone already “invested” in the pyramid will lose their money.

So again, MLMs are not Pyramid Schemes. But, to make things more complicated, some scams pretend to be MLMs. This further confuses people into thinking MLMs are scams and scams are Pyramid Schemes. One method of making a Pyramid Scheme sound like Multilevel Marketing is called a:

Matrix Scheme

In a matrix scheme, victims typically pay a fee (or buy a fake or worthless product) to join a queue to receive a luxury item (iPad, Cellphone, etc). These businesses are sometimes made to seem like MLMs because the people are told they will receive their item quicker if they get their friends to sign up.

The person running the scheme waits until income equals double (or more) of the cost of the item and then they send out the first item to the first person on the list. When income doubles the cost of the item a second time, they send the item to the second person on the list. This is a ponzi scheme to some degree, but it also suffers from the same problem as the 8 Ball Pyramid Scheme: exponential growth is required to pay each new person who joins, which eventually becomes impossible to sustain.

At the end of the day, the Federal Trade Commision does have some specific criteria to tell the difference between MLMs and Pyramid Schemes. MLMs:

1. Have a real product to sell
2. Sell the product without requiring the customer to join the MLM
3. Pay commission for real sales, not recruiting

Regardless of the differences, you should be wary of both Pyramid Schemes and MLMs since it’s quite possible that you’ll lose your money in both.

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Sources: FTC, College of New Jersey

May 2, 2016 at 3:00 am Chad Upton 1 comment