MLM v. no-product pyramid schemes v. direct selling
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Comparison of Direct Sales and other Legitimate Distribution Models with No-Product Pyramid Schemes (NPS) and Recruiting MLM's* (Product-based Pyramid Schemes—PPS) By Jon M. Taylor, MBA, Ph.D. What this analysis revealsThe table which follows shows that clear distinctions can be made between classic (1-2-4-8, etc.) no-product pyramid schemes, product-based MLM (multi-level marketing) programs, and all forms of legitimate businesses to which the latter are often compared. MLM programs are often referred to as "network marketing" (also "consumer direct marketing," etc.) and can be separated into two categories: 1. Recruiting MLM's, which use compensation systems that are so heavily weighted towards the top of the hierarchy of participants that it is necessary for participants to recruit aggressively to realize any significant profits. Recruiting MLM's are highly leveraged programs, enriching a few at the top of a pyramid of participants at the expense of the efforts and purchases of a multitude of unwitting downline distributors – whose contributions are "leveraged" for the benefit of those above them. In recruiting MLM's, most of the payout in commissions and bonuses from the MLM company goes to top distributors and very little can be gained from efforts to sell products directly to consumers. Properly understood, such MLM's are illegal pyramid schemes. The vast majority of MLM's today fall into this category.2. Retail MLM's, which pay the bulk of their commissions and bonuses to the person selling the products or services to end use consumers. In a retail MLM, there is sufficient incentive to sell directly to customers that it is not necessary to recruit a large downline to realize significant profits. In today’s regulatory environment, retail MLM's are extremely rare. Out of hundreds of compensation systems studied by the author, the number of retail MLM's could be counted on the fingers of one hand. How these distinctions were derivedFortunately, I was able to draw from an extremely broad business background to make these comparisons, having had direct experience or performed consultation services in almost all forms of business to which MLM's are often compared. In addition, I spent a full year in an intensive one-year test of a leading MLM as a full-fledged distributor, carefully noting everything that went on. I then conducted interviews with hundreds of present and former participants in a variety of MLM's and pyramid schemes before arriving at the conclusion that most MLM's are in fact cleverly disguised pyramid schemes. But I knew enough from my direct experience to know that the major problems with MLM's resulted from the compensation systems, or pay plans, of the various MLM companies. Decades ago, psychologists learned that "you get the behavior you reward." Nowhere is this more evident than in multi-level marketing. Combining the study and experience of myself and others, I carefully itemized what about MLM and no-product pyramid schemes that are unique to them and clearly differentiated them from other types of business activity. Then I broke these down into those which were implicit within the compensation and marketing system – which seemed to cause most of the problems – and those that could be considered merely effects growing out of the reward system. Other useful findingsWhat I found was strikingly clear. Five characteristics clearly defined the recruiting MLM’s, or product-based pyramid schemes from the rest. These factors were both defining and causal – defining the differences, as well as identifying the causes of the problems. No-product pyramid schemes have always been more easily recognized, both by law enforcement and by consumers. What this analysis shows is that traits can be singled out to identify the worst programs. These same five "red flags" could have legal significance in court cases. In most jurisdictions, a key element is considered in defining pyramid schemes – the payment of money by the company in return for the right to recruit other participants into the scheme. If the primary emphasis is compensation from recruiting, rather than from the sale of products to end users, it is considered a pyramid scheme. How such primary emphasis is to be determined has until now been a formidable challenge for investigators. Hopefully, this challenge will be met with this analysis and my more complete analysis entitled THE 5 RED FLAGS: Five Causal and Defining Characteristics of Product-Based Pyramid Schemes, or Recruiting MlLMs* In the spring of 1999, I mailed my conclusions to the presidents of 60 of the most prominent MLM companies and gave them a form to provide data to "prove me wrong." At least five of them attempted to do so, but none were able or willing to do so. So I was left with the necessity of validating my conclusions using other resources. With the help of associates, careful research into public documents, and a lot of communications with key informants, I was finally able to locate the average incomes and percentages of "distributors’ at various payout levels at six "recruiting MLM" companies. What I found was startling – far worse than expected. After eliminating typical deceptions in their reporting, the loss rate for the six recruiting MLM's was approximately 99.9%. That means that at best, one in 1,000 participants earns a profit. No-product pyramid schemes, which are illegal because of the guarantee that the majority left on the bottom layers will lose money, have far better odds than that! The data is showing that product-based pyramid schemes are far worse than no-product schemes. I attempted (unsuccessfully) to identify a few examples of "retail MLM's." I presumed that these would be extremely rare because, while some distributors might realize profits, few would get obscenely rich. So aggressive recruiters would tend to avoid these programs. The chart that follows is color-coded to help the reader see the differences between characteristics of the various business models. Defining and causal characteristics of no-product pyramid schemes are marked in blue, recruiting MLM's are red, and retail MLM's (if such existed) are purple. Significant effects that are not causal are marked in green, with the most important listed first (nos. 7-10).
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DEFINING AND CAUSAL CHARACTERISTICS in the compensation system that identify harmful pyramid schemes. The features on this page both define a pyramid scheme and cause the harm (extreme loss rate). |
Franchises |
Distributor- ship sales |
Insurance agency sales |
Recruiting business |
Direct sales |
NPS (& chain letters) |
PPS- or recruiting MLM (most MLM's)* |
Retail MLM |
COMMENTS � and PROBLEMS resulting from these characteristics when applied to pyramid schemes (NPS and PPS) |
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1. RECRUITING OF PARTICIPANTS IS UNLIMITED IN AN ENDLESS CHAIN OF EMPOWERED AND MOTIVATED RECRUITERS RECRUITING RECRUITERS. Is unlimited recruiting allowed, and are those who are recruited empowered and spurred on by incentives (overrides, advancement, etc.) to recruit additional recruiters, who are also empowered and motivated to recruit still more recruiters, etc. � so that the effect is an endless chain of recruiters recruiting recruiters? |
NO |
NO |
NO |
NO |
NO |
YES
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YES |
YES |
Income is dependent on downline recruiting, with the assumption of an unlimited market. Perceived or de facto saturation results in diminishing opportunity and guaranteed losses for participants at bottom levels. If all pyramid schemes were defined as illegal (and the laws were enforced) based on this one characteristic, we would not have the proliferation of schemes we see today. |
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2. ADVANCEMENT IN A HIERARCHY OF MULTIPLE LEVELS OF "DISTRIBUTORS" IS ACHIEVED BY RECRUITMENT, RATHER THAN BY APPOINTMENT. Does a participant advance in position (and potential income) in a hierarchy of multiple levels of "distributors," by recruiting other distributors under him/her, who in turn advance by recruiting other distributors under them, etc.? |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
YES |
If a participant must recruit to advance to more profitable payout levels in the scheme, and if a program�s emphasis is on building a downline, it as a de facto pyramid scheme, whether or not it has been declared illegal by authorities. Also, for PPS�s, quality of products often becomes questionable when advancement and monetary incentives are tied to recruitment. |
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3. "PAY TO PLAY" REQUIREMENTS ARE SATISFIED BY ONGOING "INCENTIVIZED PURCHASES**." Are new "distributors" given "pay to play" options? That is, are they encouraged to make sizable investments in "incentivized purchases" (purchases tied to qualification for commissions or advancement in the scheme**) in order to take advantage of the "business opportunity," and later to continue qualifying for advancement and payments from the company? |
NO � only initial invest-ment |
NO |
NO |
NO |
NO |
YES |
YES |
YES |
Such cost of participation assures huge gains for top-level participants, but guarantees losses for those who fail to ascend to higher levels in the hierarchy of participants. The amount of initial investment for PPS�s ma be small, but total purchases over time can be very significant for those seeking promised rewards, such as advancement to higher "pin levels" or bonus categories. |
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4. COMPANY PAYS COMMISSIONS AND/OR BONUSES TO MORE THAN FIVE LEVELS OF "DISTRIBUTORS." Does the company pay commissions and bonuses to distributors in a hierarchy of more levels than are functionally justified; i.e., more than five levels?" Even in major corporations with extensive sales organizations, the entire world marketplace can be covered in five levels of sales management � branch, district, regional, national, and international sales managers. |
NO |
NO |
NO |
NO |
NO |
NO � not usually
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YES |
Sometimes � but 5-level limit best |
More than 5 levels in an MLM means huge payouts to top level participants, which come from overrides on purchases of a large downline of participants. This more than compensates for the small payout per sale � vs. NPS�s, where the top person gets it all. Paying bonuses on more than five levels in an MLM primarily enriches those at the top at the expense of those at the bottom. |
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5. THE COMPANY PAYOUT PER SALE FOR EACH UPLINE PARTICIPANT EQUALS OR EXCEEDS THAT FOR THE PERSON SELLING THE PRODUCT, CREATING INADEQUATE INCENTIVE TO RETAIL AND EXCESSIVE INCENTIVE TO RECRUIT � AND AN EXTREME CONCENTRATION OF INCOME AT THE TOP. Would a "distributor" purchasing products "for resale" receive about the same total payout (in commissions, bonuses, etc.) from the MLM company as participants several levels above who had nothing to do with the sale? Those at the top of the hierarchy then profit hugely. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
This results in extreme inequality in payout to distributors and a high loss rate (99.9% for MLMs with characteristics 1-5). Only a few participants at the top of the pyramid get enough payment in commissions and bonuses from sales to a large downline to achieve a significant income. Conversely, those on lower levels seldom get enough payment from the MLM company to cover their expenses, including purchases from the company. As a result, the emphasis is on recruiting, not retailing or direct selling. If distributors on the front line get the bulk (over half) of an MLM company�s payout, it would be a retail MLM � and could be legitimate. |
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6. ALL THE MONEY GOES TO THE TOP (applies to NPS only). Would participants who recruit other participants into the scheme receive little or nothing until advancing to the top level in the hierarchy? |
NO |
NO |
NO |
NO |
NO |
YES |
NO |
NO |
With NPS�s, only participants at the top of the pyramid get paid. Those at the bottom levels will always be waiting to advance to the highest level to get paid. Usually, 93.3% end up losers when the pyramid collapses or is shut down. |
* a.k.a. multi-level marketing, network marketing, consumer direct marketing, etc. Recruiting MLMs can be distinguished from retail MLMs, in which the company pays generously for retailing products without recruiting large downlines. For retailing MLMs, #5 (and preferably #4 as well) would be answered with a "NO." ** "Incentivized purchases" are purchases of goods and services from the MLM company that are tied to qualification to participate in commissions or to advance through ascending levels in the distributor hierarchy. If they constitute a required cost of participating in the "business opportunity," then whether they are used, sold, given away, or stored is irrelevant � they should be considered a cost of doing business.
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Other significant characteristics. These are NOT part of the compensation system, but are EFFECTS that are neither causal nor defining. The most important are in green. |
Franchises |
Distributor- ship sales |
Insurance agency sales |
Recruiting business |
Direct sales |
NPS (& chain letters) |
PPS- or recruiting MLM |
Retail MLM |
Problem resulting from these characteristics when applied to pyramid schemes (NPS and PPS) |
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7. Emphasis is on payments for the rights to recruit as the primary source of income, rather than the sale of products and services |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
This EFFECT results from the system of rewards in the compensation system. Though not a CAUSE of the harm done by pyramid schemes, it is a key criterion in federal and state laws against pyramid schemes. |
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8. Loss rate is so dismal enough to disqualify them as legitimate businesses. It is rare for participants to report a net profit to the IRS. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
Loss rates for recent NPS�s have ranged from 87.5% to 93.3%. For PPS�s or recruiting MLM's the loss rates are about 99.9%. One can do better with a single roll of the dice in a game of craps in Las Vegas. |
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9. Misrepresentation and deceptive sales practices are commonplace, as they are essential for any pyramid scheme to survive and grow. If the truth were told about the abysmal odds of "success," few would join the program, and it would soon collapse. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
Misrepresentation causes harm to consumers who invest on the basis of incorrect information. To be successful in a PPS or NPS, one must first be deceived, then maintain a high degree of self-deception, and finally go about deceiving others. |
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10. New pyramidal organizations are set up in other areas (or with new product divisions for PPS�s) to maintain downline networks until the pyramid collapses or the scheme is stopped by legal action. By having to recruit new participants to repay earlier investors, NPS�s and PPS�s evolve into Ponzi schemes. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
The more durable MLM companies avoid collapse by initiating new pyramids, which they label "growth oppor-tunities." They then evolve into Ponzi schemes, moving to new areas or starting new divisions to get new recruits to buy products so that earlier investors can profit. |
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11. The distinction between buyer and seller becomes blurred. With multi-level schemes, the seller, buyer, and recruiter (and his/her immediate family) may be the same entity. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
This creates confusion and a low level of trust in the minds of consumers � and contaminates the marketplace for legitimate enterprises. |
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12. The program displays a pattern of rapid growth, then a leveling off in sales, followed by a precipitous decline in volume, unless aggressive re-pyramiding occurs. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
This pattern is common to all pyramid schemes due to empowerment and incentives given to each recruit to recruit other recruiters, as in #1 (above) |
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13. Duplication of one�s efforts and investment is encouraged in order to build one�s downline. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
YES |
Recruits are taught that this process can lead to great leverage for one�s time and investment � but not that they are only fattening the checks of their upline. |
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14. Continuous replacement of "losers" is supplied by continual recruiting of new participants. |
NO |
NO |
Some-times |
NO |
Some-times |
YES |
YES |
NO |
Replacement also helps to maintain a pyramid scheme by creating a "body shop" of new victims to replace an inordinate percentage of dropouts. |
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15. Demand for the products is distributor-driven, not market-driven. |
NO |
NO |
NO |
Some-times |
Some-times |
NO |
NO |
YES |
The need for and quality of products becomes secondary to participation in the scheme. "Pay to play" purchases become disguised (or laundered) pyramid investments. Some MLM's are notorious for hyper-consumption of products, filling garages, etc.. |
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16. Promises are made of quick return on investment, huge residual ("permanent") income, time freedom, and other easy money appeals. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
Pyramidal income appeals induce distributor investments, which ultimately become losses for the vast majority of participants�especially for PPS�s. |
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17. Pyramid addiction can be seen in many programs. |
NO |
NO |
NO |
NO |
NO |
YES |
YES |
NO |
"MLM junkies" have been observed cycling through one MLM after another, losing money each time. It is likely that these same people would fall for NPS�s. |
For more information, e-mail to Dr. Jon Taylor: jonmtaylor@juno.com.
See also – www.pyramidschemealert.org © 2003, 2005 Jon M. Taylor
PLEASE HELP! I believe this site presents information about MLM/network marketing that is as close to the truth as can be found. It can save you much time, money, and grief, as it has done for many others. And since law enforcement has essentially looked the other way on this type of consumer abuse, it is left to informed consumers to inform and warn their friends and relatives about the potential losses they could suffer from participation in a “recruiting MLM.” So please print and distribute at least 5 copies of the answer cards to those you care about – and ask each of them to share answer cards with 5 people, and each of them with 5 more, etc., etc. . . . In this way, you can influence many people for good – through an endless chain of truth-telling. Check out these handy answer cards that you can print and distribute now – as well as carry with you for those awkward moments when you are recruited by a well-meaning friend or relative. For more information, click on the appropriate links above.