Has one of your friends started pushing beauty products on Facebook? Were you invited to a casual party only to discover the host was hoping you’d buy a bunch of candles?
These scenarios are becoming increasingly common as thousands of people seeking side hustles sign up as sales representatives for MLM distributors.
MLM stands for multi-level marketing—a form of network marketing that enables people to earn commissions from product sales.
The concept seems straightforward: share products with friends and family, get them to purchase items, and the MLM company pays you a cut. Sounds easy, doesn’t it?
You might wonder: Hold on! I’ve heard about businesses like this before. Aren’t they all scams?
The answer depends on who you ask. For many people—including the companies operating them—the boundaries between legitimate and illegitimate can become blurred. Countless multi-level marketing companies exist, including OPTAVIA, Young Living, and Mary Kay, with the list continuing to grow. Given this vast landscape of MLM companies, how can you distinguish legitimate operations from pyramid schemes?
In this post, we’ll examine the differences between MLM companies and pyramid schemes while showing you how to safely identify one from the other.
What Is An MLM?
Multi-level marketing or MLM represents a business model where companies (or distributors) employ independent representatives to sell products directly to consumers. Representatives earn commissions on each sale, meaning higher sales volumes translate to greater earnings.
For instance, if you partner with an MLM company selling makeup products, you might receive a 10% commission on every sale. A $100 sale would net you $10 in earnings.
People—particularly young women like stay-at-home moms—commonly join MLMs. A study by the AARP reveals that roughly 1 in 13 Americans have participated in an MLM organization at some point in their lives.
Recruiting
The recruiting aspect of MLMs raises the most questions.
Recruiting occurs when existing representatives convince others to join as representatives. The original representative then receives a percentage of the new recruit’s commissions. New representatives attempt to recruit additional members, hoping to earn portions of their commissions, creating an ongoing cycle.
Using our earlier example: you sold $100 worth of product and earned a $10 commission (10%). If you refer someone new to the program, you might also receive 1% of their sales. This means you’d earn a 10% commission on your own sales ($10 on a $100 order) plus 1% on your referral’s sales ($1 on a $100 order).
This explains why MLM participants actively recruit new members. As an MLM distributor, you can generate income from:
- Selling products
- Recruiting new distributors who sell products
MLMs with questionable recruiting practices often create high-pressure environments to recruit new representatives. Existing representatives frequently urge potential recruits not to “miss out on the opportunity of a lifetime” while painting unrealistic pictures of easy money-making potential. However, their motivation isn’t the new recruit’s well-being—they simply want to maximize their earning potential by bringing in as many recruits as possible.
Now that we understand how MLM businesses operate, let’s examine pyramid schemes.
What Is A Pyramid Scheme?
Superficially, pyramid schemes share many similarities with MLMs. Both feature hierarchical structures resembling a (you guessed it) pyramid.
In pyramid schemes, the entire structure revolves around recruiting new members (building the pyramid). Without continuous recruitment, the pyramid scheme collapses.
Pyramid schemes aren’t legitimate businesses. Even when a business component exists, it takes a backseat to the scheme itself.
These schemes operate with different tiers, where people at the top reap the greatest benefits.
Consider this hypothetical example.
John recruits you for his cleverly disguised pyramid scheme. You pay him $100 for recruitment privileges. As a recruit, you can recruit others. Each person you recruit pays you $100—you keep $95 while John receives $5. If you recruit 10 people, here’s the breakdown:
- John Makes $150 – Your initial $100 + $50 from your recruits( $5 x 10)
- You Make $850 – $950 from your 10 recruits minus the $100 you paid John
While these numbers may appear attractive initially, two major problems exist:
- The numbers are completely manufactured – This isn’t legitimate business. No valuable exchange occurs. It’s an unethical scheme.
- You’re unlikely to recruit 10 people – In the example above, you profited because you recruited 10 people. In reality, you probably won’t recruit anyone, meaning you’d lose your initial $100.
How does this relate to MLMs? Let’s examine this connection more closely.
Are MLM’s And Pyramid Schemes The Same Thing?
MLMs and pyramid schemes share similarities, but one critical difference exists:
- MLMs are legal
- Pyramid schemes are not
Typically, the distinction lies in recruitment practices. At their best, legitimate MLMs focus on promoting quality products while using recruitment incentives merely to supplement commissions. Conversely, pyramid schemes generally offer low-quality products (or sometimes no products at all), demand upfront payments, then encourage participants to recover their investment by recruiting others (essentially taking their money instead).
If that seems confusing, you’re not alone. Considerable gray area exists between these extremes, resulting in numerous MLM companies facing public accusations of illegal practices.
One of the most recent and notable companies accused of being a pyramid scheme was supplement business Herbalife in 2011. When the FTC investigated, they discovered many representatives earned merely $5 per month. The company settled the case for $200 million in 2016.
The distinction between pyramid schemes and MLM companies often centers on the underlying business model. Let’s explore this further.
Are MLMs Legitimate?
When operated responsibly, MLM ventures should function like any other sales business. Representatives handle the direct selling of products and earn commissions on sales. This arrangement mirrors that of millions of people working in commission-based sales careers.
While pyramid structures might raise red flags, many completely legitimate businesses operate with similar frameworks. For instance, by the time you purchase a product in stores, multiple parties have profited from it. The manufacturer sells to a wholesaler who sells to a retailer who sells to you. That’s standard business practice.
The issue with MLMs lies in their tendency to operate under questionable principles.
Unfortunately, the vast majority of MLM participants never earn any money. According to the FTC (Federal Trade Commission), a sobering 99% of recruits end up losing money.
Here are key tests to distinguish between legitimate business opportunities and fraudulent schemes.
Does The Business Make More Money From Selling Products or From Recruiting?
We mentioned that MLM participants can earn money two ways:
- Selling product
- Recruiting new MLM participants
The first represents legitimate business practice, while the second can indicate an MLM scheme or pyramid scheme.
Ask yourself: “Are people purchasing this product because they want the product or because they want to join the MLM business?“
If people only buy products to join the MLM, it’s probably not a legitimate MLM company (and could be an illegal pyramid scheme).
Are the Recruitment Methods Ethical?
Legitimate businesses employ ethical recruitment practices. While they may highlight business perks, they keep claims grounded in reality.
For example, when you enroll in business school, legitimate institutions won’t lure you with fantasies of becoming a millionaire.
When you land a new job, recruiters are unlikely to make false claims about “making bank” and early retirement.
Many MLM recruiters make bold promises and attempt to trigger emotional responses. Their pitches can be compelling, explaining how you can earn thousands monthly by simply recruiting a few new participants.
If it sounds too good to be true, it probably is.
How To Spot A Pyramid Scheme
Is someone trying to involve you in an MLM? Here are several telltale signs it might actually be a disguised pyramid scheme:
- Have you never heard of the product or can’t find information about it? Is there genuine market demand for it?
- Must you purchase your own inventory and remain stuck with it if sales don’t materialize?
- Are you being charged fees to become a distributor?
- Do recruitment practices seem highly pressurized? Are you being promised unbelievable profits? Does a significant portion of that income depend on finding other recruits?
If you answer even tentatively “yes” to any of these questions, proceed with caution. You might be targeted by a pyramid scheme.
Before joining any MLM, always investigate them through the Better Business Bureau. You should also check for outstanding cases with the Federal Trade Commission. Look for reviews of the company’s products. Consistently poor ratings should raise red flags.
Also, never let them convince you that you’re “missing out” on an opportunity. When someone employs this tactic, they need you more than you need them.
