How to Identify a Product-Based
Pyramid Scheme ("Recruiting MLM")
© 2003, John M. Taylor, MBA, PhD.
Multilevel companies that are based on profits from recruiting rather than retailing should be regarded as pyramid schemes or "recruiting MLMs." This article describes five ways to distinguish them from "retail MLMs" in which the company pays generously for retailing products without recruiting a large downline. "Recruiting MLMs" typically display five features:
1. Recruiting of participants is unlimited in an endless chain of recruiters recruiting recruiters.
Ask whether unlimited recruiting is allowed. When a given market is saturated, and the program must move on to another location or introduce new products or divisions to continue, the opportunity for each new person to make money becomes less and less as the programs expands.
2. Advancement in a hierarchy of multiple levels of "distributors" is achieved by recruitment, rather than by appointment.
3."Pay to play" requirements are satisfied by ongoing "incentivized purchases." These are purchases of goods and services that are required to participate in commissions or to ascend in the distributor hierarchy. If they are required to participate 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.
Ask whether prospective "distributors" are encouraged to make sizable investments ("front loading") in "incentivized purchases" in order to take advantage of the "business opportunity" and later to continue qualifying for advancement or higher payout in overrides (commissions and bonuses). This practice, can result in large losses if the products cannot be resold. Also be wary of plans that require minimum periodic purchases ("pay to play") to qualify for commissions or advancement. Do not sign up for continuing product purchases on auto-ship through an automatic bank draft or credit card, rather than making occasional purchases as needed. Such purchase requirements may be disguised investments in a product-based pyramid scheme or a clever attempt to disguise pyramid investments as product purchases.
4. The company offers commissions and/or bonuses to more than five levels of "distributors."
Ask whether the company pay overrides to distributors in a hierarchy of more levels than are functionally justifiable. Even in major corporations, the entire world marketplace can be covered in five levels of sales management - branch, district, regional, national, and international sales managers. Paying commissions and bonuses on more than five levels in an MLM program primarily enriches those at the top at the expense of those at the bottom. You would be wise to avoid any program that pays overrides on more than five levels. Breakaway compensation systems are particularly exploitive, as payments are on a hierarchy of "breakaway" organizations of whole groups of participants, not just individuals —creating an extraordinarily high loss rate, except for those at the top of a "mega-pyramid of pyramids."
5. 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.
Ask whether a "distributor" purchasing products "for resale" would 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. If so, the company's payments to the person retailing the product would be pitifully small, while those at the top of the upline can compound the small commission per sale by the sales of hundreds or even thousands of downline distributors. This is great for the upline leaders but lousy for those attempting retail sales. Avoid any MLM company that pays less than half of all distributor payout to the person actually selling the products to outside customers.
Never accept income projections of retail sales at full retail prices, especially for products that are overpriced and not competitive in the marketplace. Also be wary if you are asked to choose between two options or "tracks"—one for those who want to "retail" the products and another track for those who are serious about "building the business." This sales pitch usually indicates that the incentives are heavily weighted towards recruiting
Where valid data are available, recent research has demonstrated that when all five of these red flags are found in an MLM, the percentage of participants who lose money is 99.9%—even worse than the loss rates for typical no-product pyramid schemes and for games of chance in Las Vegas.
Dr. Taylor is president of the Consumer Awareness Institute. He has taught college classes on entrepreneurship, ethics, and communications and founded more than 40 home businesses, focusing on sales and marketing. His experience in MLM; communications with top MLM executives, law enforcement, and thousands of inquirers; consumer advocacy; and wide-ranging research on MLM/network marketing make him a premier consultant and expert witness on chain-selling and product-based pyramid schemes. His Web site contains a wealth of material about MLM pitfalls and deceptions.
This article was revised on February 12, 2003.