MLM Vs. Pyramid Scheme – Everything You Need To Know
If you are looking for an amazing opportunity consider MLM and pyramid schemes. MLM is a multilevel marketing scheme that involves direct sales. Most people consider multi-level marketing companies more legitimate than pyramid schemes.
In this article, we discuss all you need to know about a multi-level marketing company, what to do to not lose money to illegal pyramid schemes, and other deceptive business practices. Let’s begin by explaining a multi-level marketing program.
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 want to make money with your weekends. 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 (direct-selling). MLMs have grown significantly in the last few years with the growth of social media, which has enabled distributors to deal not only with friends and family but with anyone in the world.
Another critical feature of a lawful MLM program is that existing distributors bring new distributors into the company. The new distributor is called the ‘downline’ to their recruiter. The recruiter is known as the ‘upline,’ and there are many levels of recruitment, as anyone recruited by someone in your ‘downline’ is also considered your downline. These multiple levels of recruiting and connection are where the name ‘multi-level marketing’ comes from.
It is essential to realize that people who 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. Having a few dozen people in your downline could mean thousands of dollars a year in income for you.
Also, the multi-level marketing practices such that commission gets paid to old and new members at different levels after a successful sale. The total number of sales and the sales force determines what each member gets.
But now we have to get to the main issue with MLMs: doesn’t this structure sound like a pyramid scheme?
What Is a Pyramid Scheme?
Before we discuss this issue, let’s quickly review what a pyramid scheme is. A pyramid scheme is where a company claims to sell products to customers through distributors (like an MLM), but no or very few products get sold.
Instead, the company pushes its distributors to buy more and more products to increase the company’s revenue, without caring if the distributors can resell the products to outside customers. Pyramid schemes employ high-pressure sales tactics and ask you to pay money upfront, which is why losing money is quite common in this business.
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. But, of course, the only people making money are the people at the very top of the company. This is why it is not a legitimate business opportunity.
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 the sales generated from marketing products to outside customers. If this is the case, then it’s not a pyramid scheme.
However, it is essential to remember 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 other 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 an illegal pyramid scheme from the outside, even if you do your research.
Also, pyramid schemes are fraudulent schemes without any real product. The vast majority of participants only make money from new recruits. Unlike the MLM strategy with a valid compensation plan, Pyramid schemes promise high returns in a short period without making your own sales.
These extravagant promises are why several people have fallen victim to a pyramid scheme and lost money. Sometimes, family members spend money on these schemes only to lose it all. Thankfully, there are warning signs or red flags to watch for to avoid becoming a victim. We’ll get to them shortly.
Case Study: Herbalife
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 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 significant 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, you should watch the documentary Betting on Zero if you want to know more.
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.
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 an excellent example of the gray area in which many MLMs operate – they are not recognized as pyramid schemes by the government. Still, there are some questions about their business practices. This is an excellent example of why you should be careful before working 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 cash 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 about their experience. For example, 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, which usually doesn’t take long. However, you should be wary of MLMs with extremely high turnover rates among distributors.
In summary, you can verify the legitimacy of an MLM or pyramid scheme by:
- Finding out how long the company has been exiting and the company’s products and market saturation. You can request the company brochure.
- Getting a comprehensive list of their distributors or independent contractors and the qualities they require distributors to have. Also, request a copy of the company’s purchase inventory.
- Requesting the company’s income disclosure statement, to verify their earnings claims.
- Checking to see if the company has faced a lawsuit for fraudulent business practices.
- Verifying if the company is a member of the Direct Selling Association
In general, go with your gut on MLMs. Before you start: ask yourself if you think it’s the right fit. It probably is if it doesn’t feel right or seems too good to be true. However, if you believe the company is legit and genuinely think you would enjoy selling their products, 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, more minor, the investment you made. Then, once you get a business going, have recruited a few people under you, and feel more confident in the MLM, you can get more inventory to grow your company and make more money.
- “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.
- “Herbalife Financials.” Yahoo Finance, Yahoo Finance, 17 January 2020, https://finance.yahoo.com/quote/HLF/financials?p=HLF.
- 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/.
- “Bill Ackman Ends 5-Year Battle Against Herbalife.” Forbes, Forbes, 28 February 2018, www.forbes.com/sites/gurufocus/2018/02/28/bill-Ackman-ends-5-year-battle-against-herbalife/#277fa8a91983.
- 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.