MLM Vs. Pyramid Scheme – Everything You Need to KNow

What is an MLM?

Many people are looking for their own ‘side hustle’ – something they can do on the side to make some money. Maybe you don’t want to quit your job or are a student, or just want to make money with your weekends. Whatever the reason, when looking for a flexible business opportunity, you will almost certainly eventually come across a multi-level marketing (MLM) company.

So, what is multi-level marketing? MLMs are traditional companies in that they sell products to customers, but non-traditional because they only sell products through their network of ‘distributors’. Distributors are people who buy products in bulk directly from the company, and then sell to individual customers. MLMs have grown significantly in the last few years with the growth of social media, which has enabled distributors to sell not only to friends and family but to anyone in the world.

Another key feature of MLMs is that new distributors are brought into the company by existing distributors. The new distributor is called the ‘downline’ to their recruiter, and the recruiter is known as the ‘upline’. There are many levels of recruitment, as anyone recruited by someone in your ‘downline’ also is considered your downline. These multiple levels of recruiting and connection are where the name ‘multi-level marketing’ comes from.

It is important to realize that people who really make money in MLMs are not great sellers – they are great recruiters. This is because all distributors get a percentage of sales from everyone in their downline. This means that having a few dozen people in your downline could mean thousands of dollars a year in income for you.

But now we have to get to the main issue with MLMs: doesn’t this structure sound a lot like a pyramid scheme?

MLM Diagram-MLM Vs Pyramid Scheme

What is a Pyramid Scheme?

Pyramid Scheme-MLM Vs Pyramid Scheme

Before we discuss this issue, let’s quickly review what is a pyramid scheme. A pyramid scheme is where a company claims to sell products to customers through distributors (just like an MLM), but no or very little product ever gets sold. Instead, the company pushes its distributors to buy more and more products to increase the company’s revenue, without caring if the distributors are able to resell the products to outside customers. If this happens, money does not go from customers to the company in exchange for products – instead, money is just taken from lower-level distributors to people higher up in the company’s recruiting structure.

Pyramid schemes usually entice people to join by talking about how much money can be made and how easy it will be to sell the products. Of course, the only people really making money are the people at the very top of the company. Pyramid schemes have been around probably for hundreds of years in some form or other, and today many of them disguise themselves as MLM companies. 

What’s the Difference Between an MLM and a Pyramid Scheme?

The fundamental difference between an MLM and a pyramid scheme is whether or not the company makes its money from actually selling products to outside customers. If this is the case, then it’s not a pyramid scheme.

It is important to remember, however, that even in a completely legitimate MLM most people are not going to make all that much money through selling products. There are just too many distributors and too much competition from other sellers in the age of online shopping and Amazon. So, people in a legitimate MLM might still not be selling much product to outside customers. This means it can be hard to differentiate between an MLM and a pyramid scheme from the outside even if you do your research.

Case Study: Herbalife

Herbalife-MLM Vs Pyramid Scheme

Probably the most famous MLM lately is Herbalife. Founded in 1980, Herbalife sells a variety of nutritional supplements. While the company has been around for decades, it really took off under its former CEO Michael Johnson. While he was with the company, it went public and its shares rose from under $5/share to now trading at over $45/share. The company has also significantly expanded its global reach, and now has a major presence in countries like India and Mexico.

However, the company has been plagued by scandal for years. It started in 2012 when famous hedge fund manager Bill Ackman publicly announced a multi-billion-dollar bet against the company. While we won’t go into the details here, if you want to know more you should watch the documentary Betting on Zero. In summary, this public announcement by Ackman led to the Federal Trade Commission (FTC) officially investigating Herbalife and whether or not it was a pyramid scheme. After a lengthy investigation, in the end, the FTC did not call Herbalife a pyramid scheme…but also did not explicitly say it was not a pyramid scheme either. Basically, the report said Herbalife was operating in a ‘gray zone’ and should improve its business model. The report even said that the company “…will need to prove that its business model is legitimate going forward.” Not exactly a glowing report.

Herbalife is a good example of the gray area in which many MLMs operate – they are not recognized as pyramid schemes by the government, but there are definitely some questions about their business practices. This is a good example of why you should be careful before starting to work for any MLM company. At the same time, you should not assume that all MLMs are frauds and avoid them altogether.

How can you avoid pyramid schemes?

The main question you need to answer before you start working for an MLM is: how do they make money? If they only make money from distributors buying products from the company, that is a red flag. But if the company makes most of its money from final sales to outside customers, it is more likely a legitimate MLM. When researching various companies, look into their financial reports and see if they record this data. If no data can be found on this, you should proceed with caution.

You should also find people who work for the company as distributors and ask them about their experience. How much money do they make, and does it come mainly from selling themselves or from their downline? Also, ask them how long they have been working as a distributor. MLMs with long-term distributors are less likely to be a pyramid scheme since people leave once they realize what it is, and that usually doesn’t take long. You should be wary of MLMs with extremely high turnover rates among distributors.

Conclusion

In general, go with your gut on MLMs. Before you start: ask yourself if you think it’s the right fit for you. If it doesn’t feel right, or if it seems too good to be true, it probably is. However, if you think the company is legit and you genuinely think you would enjoy selling their products – then give it a try.

If you are already involved in an MLM, make sure that you don’t give more than you get. Don’t spend thousands of dollars on inventory until you start seeing a profit on the first, smaller, investment you made. Once you get a business going, and maybe have recruited a few people under you, and are feeling more confident in the MLM, then you can invest more to grow your company and income. 

Sources

  1. “Multi-Level Marketing Businesses and Pyramid Schemes.” FTC.gov, Federal Trade Commission, Oct. 2019, www.consumer.ftc.gov/articles/0065-multi-level-marketing-businesses-and-pyramid-schemes.
  2. “Herbalife Financials.” Yahoo Finance, Yahoo Finance, 17 January 2020, https://finance.yahoo.com/quote/HLF/financials?p=HLF.
  3. Parloff, Roger. “Why Herbalife CEO’s Departure Is a Body Blow to the Company.” Fortune, Fortune, 3 Nov. 2016, fortune.com/2016/11/03/herbalife-michael-johnson-ceo/.
  4. “Bill Ackman Ends 5-Year Battle Against Herbalife.” Forbes, Forbes, 28 Feb. 2018, www.forbes.com/sites/gurufocus/2018/02/28/bill-ackman-ends-5-year-battle-against-herbalife/#277fa8a91983.
  5. Cullen, Terri. “Herbalife Soars after Dodging Pyramid Scheme Tag in FTC Settlement.” CNBC, CNBC, 15 July 2016, www.cnbc.com/2016/07/15/ftc-determines-herbalife-is-not-a-pyramid-scheme-dj.html.