What is a Ponzi or Pyramid Scheme and What is Legitimate Multilevel Marketing?
18 Nov 14 - By Charlene Fellows
If you have ever wondered what multilevel marketing is, and how to stay away from pyramid or Ponzi schemes, then this article is for you!
Ponzi & Pyramid Schemes and Legitimate Multilevel Marketing - Which is Which?
First let me say that I am not an MLM distributor and have nothing to personally gain from this one way or the other.
There have been a few new MLMs that have been going though the public recently that have been stirring up both interest and concern among my friends and acquaintances (I am not going to name the MLMs here). With one of them in particular, one of my friends in California told me that he made $10,000 in a few weeks. Another friend of mine knows a woman in Florida who did the same thing, twice. I have also heard two very passionate responses about this type of activity being a pyramid or Ponzi scheme.
I recently received two emails on the subject; one stating how brilliant one new MLM was and the other decrying it with equal passion as a scam. I decided to research this myself, not on the merits of this particular MLM, but on what really constitutes a genuine MLM by law and what constitutes a pyramid or Ponzi scheme by law. What I found was surprisingly sane, so I thought I would pass it on so that others could evaluate any MLM and decided whether or not that particular one was legitimate.
I have seen a fair share of pyramid schemes and investment scams especially in the 70's and early 80's. I've noticed that these scams crop up more often during bad economic times. It makes sense that when economic suppressors bear down on a society, desperation may create a greater likelihood of throwing caution to the wind and ignoring warning signs of get rich quick scams. This does not mean all ideas to make money fast and break free of the economic trap are scams. So how do you know which is which?
With the current economic situation MLMs are also getting popular again. This isn't a bad thing. If you look "economics" and/or "economy" up in a dictionary it's clear to see that they have everything to do with the manufacture of goods and services and the distribution and consumption of them. Also, wise management of resources and money - amen. That's it.
I'm going on a limb here as I'm not an expert in economics but to me an economy would exist if: products are manufactured that are needed and wanted at prices that consumers can afford, and manufacturers have a method of making their products known and distributing them so that other people keep buying them. When consumers stop buying, manufacturers stop making products in as much quantity. Consequently, jobs dry up and even more people stop buying, and so forth, and the economy understandably spirals downward. The simplicity of the way out is that individuals, and our nation as a whole, need to produce what is needed and wanted at a price the market can bear, and get the product known and distributed so that public can buy it and consume it and then buy it again.
Good MLMs are just a different way to do this which bypasses standard distribution and marketing lines. There are actually many MLM's that have been around for a long time, and have proven track records and sustainability. They all had to start somewhere. How do you know which ones are legitimate - especially if the new ones are promoting huge pay outs at the beginning, and it just kinda feels wrong?
For me personally, before decrying it completely as a fraud, I realized I really needed to do some thorough research. I realized that I lacked fundamental information regarding pyramid and Ponzi schemes, and good guideposts to measure MLMs against, so I started looking up words. The Federal Trade Commission website has some helpful info on this (imagine that). The Federal Trade Commission, or FTC, deals with issues regarding business [trade] on a federal level instead of a state level and it was very sane in its definitions.
This is how the FTC defines a Ponzi scheme (named after a person who scammed investors named Charles Ponzi):
"A Ponzi scheme is closely related to a pyramid because it revolves around continuous recruiting, but in a Ponzi scheme the promoter generally has no product to sell and pays no commission to investors who recruit new 'members.' Instead, the promoter collects payments from a stream of people, promising them all the same high rate of return on a short-term investment. In the typical Ponzi scheme, there is no real investment opportunity, and the promoter just uses the money from new recruits to pay obligations owed to longer-standing members of the program. In English, there is an expression that nicely summarizes this scheme: It's called stealing from Peter to pay Paul."
Okay, so by definition, Ponzi schemes are fraudulent investment rackets.
This is an excerpt from the FTC web site on what defines a Pyramid scheme:
"Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure....the sales occur only between people inside the pyramid structure or to new recruits joining the structure, not to consumers out in the general public."
The same FTC web site has this to say about MLMs:
"Some people confuse pyramid and Ponzi schemes with legitimate multilevel marketing. Multilevel marketing programs are known as MLM's, and unlike pyramid or Ponzi schemes, MLM's have a real product to sell. More importantly, MLM's actually sell their product to members of the general public, without requiring these consumers to pay anything extra or to join the MLM system. MLM's may pay commissions to a long string of distributors, but these commission are paid for real retail sales, not for new recruits."
I reread that a couple of times as it really contains key data which differentiate pyramid schemes and MLMs and is elaborated on in the articles.
The FTC site also makes it clear that if a person is promoting the activity that they are responsible for those they recruit and the claims that are made even if the data was gotten from brochures, etc.:
"If you decide to become a distributor, remember that you're legally responsible for the claims you make about the company, its product and the business opportunities it offers. That applies even if you're simply repeating claims you read in a company brochure or advertising flyer."
So, again, it was brought home that some due diligence is in order if you are going to represent a company.
It is best to read all three articles (links below) in context to get the full picture.
Here are the links:
My take on what I read on the FTC site: If there are real products or services that are actively being sold to public people outside of the distributors of the MLM, then it is a legitimate MLM. However, if there is just a "show" of products or services being sold, and all, or a majority, of the money for commissions is earned from signing up new distributors and/or earned in selling the products and services mainly to other distributors then it is probably not legitimate.
The theory of what makes a pyramid scheme is this: When commissions are earned based mainly on the necessity for continual expansion in recruitment of new distributors (i.e., you have to recruit three and then they have to recruit three and then they have to recruit three and so on) it eventually becomes so broad that it can't support itself with new distributors and collapses. That's the pyramid. When you sell products/services and recruit new distributors who sell products/services, who then recruit other distributors to do the same selling, you are duplicating your efforts to sell products/services and getting paid for it. Products and services are consumable items. You can get repeat business with the same people and you don't have to continually recruit. You can't keep signing up the same distributors so the other model is unsustainable.
That is my understanding. Yours may be different which is why I gave the links to the articles. Once I read the criteria on the FTC site, I felt well-informed on how to better evaluate any MLM for myself.
The Real Purpose of Multilevel Marketing
Amongst all of the hoopla and excitement, the real purpose of MLMs sometimes gets lost in the selling of the idea of financial independence.
MLMs are supposed to be an alternative way to market, distribute and sell goods and services. That's it. It gives the distributor the opportunity to make his own distribution network and get paid for it, instead of just being a salesman. In other words you are supposed to get paid for selling goods and services (like water machines or vitamins) and also for setting up a good distribution network so that they in turn sell those goods and services. You set it up so that your efforts are duplicated by others and you can walk away once in a while and the rest of the network keeps on producing.
A company normally spends massive amounts of money on continually promoting their products on TV, radio and print ads; then on finding, getting and maintaining good distribution channels, all the way down to getting good shelf placement in stores. That takes a lot of money. It is also a known fact that word-of-mouth is very effective advertising. For example, I saw lots of infomercials on the Michael Thurmond diet but when my friend told me she lost 20 lbs the first month on the diet, I bought the product within 24 hours.
In MLM the majority of the money that would have been spent on advertising, etc., is redirected to the down line who actively promote, distribute and sell the products. The person who builds a better distribution system and whose network of distributors move more product and/or service would get a bigger reward. A true MLM has good products or services at competitive prices that people want to buy and reorder. The bottom line is that the products and services have to be sold to the public for it to be a legitimate MLM.
The FTC site is clear on the fact that in most states paying commissions on signing up distributors is not allowed. The FTC article also mentioned that if a distributor is stockpiling product in the garage (in order to get their commissions) instead of moving the products, this can be another sign that the MLM is a guise for a pyramid scheme.
With a hot product that you can sell easily and repeatedly, you can theoretically make money fast. Whether it is done quickly or slowly, you legitimately make money by selling products and services and attracting new distributors who will do the same. If it doesn't meet this criteria, or there is a so-so or flimsy product that won't be consumed and bought repeatedly, it probably isn't a good thing to get involved in.
Hopefully this information will help you evaluate the validity of any MLM. It definitely helped me.
©2011 Charlene Fellows. All Rights Reserved.