Pyramid Scheme VS. MLM

Has one of your friends started pushing beauty products on Facebook?  Were you invited to a casual party and then shown a bunch of candles that the host hoped you would buy?

Scenes like this are frequently becoming more and more commonplace as thousands of people who are looking to start a side hustle are signing themselves up to become sales representatives for something called an MLM distributor.  

The idea is simple: Show the products to their friends and family, get them to buy the items, and then the MLM company will pay you a cut.  Easy as that, right?

You might be thinking: Wait! I’ve heard about businesses like this before.  Aren’t they all a scam?

The reality is that it depends on who you ask.  For many people, including the companies who run them, the lines between what’s legitimate and what’s not can be a bit blurred. There are tons of MLM companies out there, such as OPTAVIA, Young Living, and Mary Kay, and the list goes on and on. With such a vast amount of MLM companies, how do you know which ones are legit and which are a pyramid scheme?

In this post, we’ll explore the differences between MLM companies and pyramid schemes, and show you how you can safely spot one from the other.  

pyramid scheme

What Is An MLM?

Multi-level marketing or MLM is a type of business where the company (or distributor) will use independent representatives to sell their products direct to consumers.  Each sale will result in the representative being paid a commission.  Therefore, the more sales they make, the more money they’ll earn.

It’s very common for people, particularly young women such as stay at home moms, to get involved with MLMs.  According to a study by the AARP: Roughly 1 in 13 Americans have participated in an MLM organization at some point during their lifetimes.

Recruiting

One of the most questionable elements of MLMs is the practice of recruiting.  

Typically, recruiting works when an existing representative will convince another person to also become a representative.  When they do this, the existing representative will then receive a percentage of the new representative’s commissions.  The new representative will then also try to recruit other new representatives in hopes of getting some of their commissions, and so on.

Some MLMs with sketchy recruiting practices have even been accused of creating high-pressure situations to recruit new representatives.  The existing representatives will often try to persuade potential new recruits not to “miss out on an opportunity of a lifetime” and will paint a picture of how easy it is for them to make a ton of money.  However, their motivation is not for the well-being of the new recruit; they simply just want to increase their earning potential by bringing in as many recruits as possible.

What Is A Pyramid Scheme?

On the surface, a pyramid scheme has a lot of similarities to an MLM.  Their business model is also to sell a variety of products and use representatives to market them directly to consumers.

However, the major differences are in how they handle inventory and recruitment.  In a pyramid scheme, existing representatives are highly incentivized to recruit new members.  This is because oftentimes the distributor will require that their representatives buy the inventory from them before making any sales to consumers.  That means the distributor makes a profit up-front and puts all the burden on the back of the representative who is left with one of two choices: Either sell the products or recruit some new representatives whom you can offload your inventory upon.  

What Is A Pyramid Scheme

As you might guess, that’s totally a scam since each time one representative offloads their inventory onto a new representative, the margin for potential profit becomes slimmer.  Eventually, those people toward the end of the cycle will find it too difficult to make any money at all, and they will end up losing the money they paid for the inventory.

Note that even some legitimate MLMs might require you to buy their inventory up-front.  However, they are supposed to have a clearly defined buy-back policy in place if you are not able to sell the products.

Are MLM’s And Pyramid Schemes The Same Thing?

Here’s the major difference between MLMs and pyramid schemes:

  • MLMs are legal
  • Pyramid schemes are not

In most instances, the line will be in how they handle their recruitment process.  At their extremes, a good MLM will focus on promoting quality products and only use recruitment incentives to supplement your commissions.  On the other hand, a pyramid scheme will generally offer low-quality products (or sometimes no product at all), try to get your money up-front, and then encourage you to make your money back by recruiting other people (so that you can take their money instead).

If that sounds a little confusing, then you’re not alone.  There is a lot of grey area in-between these two extremes, and as a result many MLM companies have been publicly accused of illegal practices.  

Perhaps one of the most recent and notable companies to be accused of being a pyramid scheme was the supplement business Herbalife back in 2011.  When the FTC got involved, they found that many of the representatives were only making a startling $5 per month.  In 2016, the company settled the case for $200 million.

Pyramid Scheme Lawsuit

Are MLMs Legitimate?

When done responsibly, an MLM venture should be just like any other sales business. The representatives do all the legwork of directly selling the products, and then earn commissions for their sales.  In truth, that’s really no different than the arrangement of millions of people who work in sales earning commissions as a full-time career.  

The reality, unfortunately, is that the grand majority of people who participate in MLMs never end up making any money at all.  According to the FTC (Federal Trade Commission), a sobering 99% of those people who get recruited end up losing money. 

mlm scheme 03

How To Spot A Pyramid Scheme

Is someone trying to get you involved with an MLM?  Here are several tall tale signs that it might actually be a pyramid scheme in disguise: 

  • Have you never heard of the product or can’t find out any information about it?  Is there not actually any market demand for it?  
  • Do you have to buy your own inventory and are stuck with it if you don’t make any sales?  
  • Are you being charged a fee to become a distributor?
  • Do the recruitment practices seem very high-pressure?  Are you being told you’ll make unbelievable amounts of money?  Does a large part of that money depend on you finding other recruits?

If the answer to any of these questions is even a hint of “yes”, then beware.  You might be being preyed upon by a pyramid scheme.  

Before signing up with any MLM, always investigate them first with the Better Business Bureau.  Also, check around for reviews of the products that the company offers.  If they’ve got generally poor ratings, then that should be a red flag.

Also, never let them convince you that you are “missing out” on an opportunity.  When someone is doing this, they need you more than you need them.

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<span style="font-size:12px;font-weight:500">Author</span><br><a href="https://wealthpursuits.com/author/kevin/" target="_self">Kevin</a>

Author
Kevin

Kevin is an ambitious entrepreneur that is obsessed with all things related to finance. From a young age, Kevin has always been involved with side hustles ranging from online selling to freelance work. Over the years, Kevin graduated from side hustles and started launching multiple online and offline businesses. Kevin is a serial entrepreneur who loves starting new businesses and exploring all things related to business and finance. He is constantly looking for new ways to save money, invest money, and create income streams.

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