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Differences Between a Pyramid Scheme and a Multi-Level-Marketing Business

Mariaines is interested in the operation of home-based small business as a way to grow financially at her own pace and circumstances.

Characteristics of a Pyramid or Ponzi Scheme

Many people are skeptical of any business that relies on networks for earning money. The reason is that legitimate multilevel marketing (MLM) shares some characteristics with unsustainable pyramid schemes. However, there are ways to tell one from the other.

Mary Christensen defines pyramid schemes, in her book Be A Network Marketing Superstar, as any plan that primarily rewards people for recruiting, rather than for selling real goods and real services.

In pyramid or Ponzi schemes:

  • There is no product or service in exchange for your money
  • The initial investment is too high (i.e, large sums of money are demanded up front, gambling with your financial security)
  • No work is said to be required to obtain the profits and benefits. It sounds like easy money.

Bernie Madoff is a notorious stockbroker who exploited wealthy people, including many celebrities, in a Ponzi scheme. His victims consistently said that he was so believable, and the returns he offered were so far beyond other investment strategies, that they were willing to risk their assets. As Yarnell et al. say in their book (see below), the victims were risk takers who, in many instances, invested their entire retirement capital.

  • Bernard Madoff - Wikipedia
    Bernard Madoff is the admitted operator of a Ponzi scheme that is considered the largest financial fraud in U.S. history.

What Is Multi-Level Marketing?

Investopedia defines multi-level marketing as a strategy that some direct sales companies use to encourage their existing distributors to recruit new distributors by paying the existing distributors a percentage of their recruits' sales. The recruits are known as a distributor's "downline."

Characteristics of a Multi-Level Marketing Business

I started reading about Multi Level Marketing Business because I enrolled in one. The first thing I learned is that the money does not come easy. You need to work as hard as you would to earn a salary, at least at the beginning, while you assemble your team.

Both Christensen and Yarnell et al., recommend investigating a business you are considering. A reliable business should:

  • Be registered as a member of the Direct Selling Association
  • Have a real product or service
  • Have a reputation plus several years in the market
  • Have a global presence
  • Have support from an organization
  • Have support for the client
  • Have a return policy
  • Show commitment in the long term
  • Explain clearly the compensation plan

For example, the company I enrolled in manages unilevel and dual-team (binary) compensation plans. The company's website says that 80% of their members earn a maximum of USD 600 a year. It sounds feasible, not like a pie-in-the-sky unrealistic goal.

On the other hand, Ranelli (2018) tells us about some characteristics that differenciate MLMs from Ponzi schemes:

  • The company rewards the distributors for selling of goods/services and not merely for recruiting other distributors.
  • The cost for the entry of new distributors is low
  • Distributors achieve success over time as opposed to other get rich quickly and easily activities
  • The company provides refunds for resalable inventory
  • The company discourages inventory loading
  • The company requires that distributors sell to a certain number of customers each month

MLM or Network Marketing is about cultivating relationships and earning loyalty.

MLM or Network Marketing is about cultivating relationships and earning loyalty.

Compensation Plans

Christensen explains the way these strategies work.

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  • The unilevel plan pays commissions on the products your team sells as a whole. It also pays commissions on the personal and breakaway groups (people who do better than the person who recruits them).
  • The binary plan allows you to have two people as your team, and the commissions will be paid based on the sales of the weaker performer.

She explains other two plans that are common in this business: stairstep plans and forced-matrix plans.

  • Stairstep plans do not limit the number of people you can have on your team. Your first level is made of people you recruit directly, your second level will be made of people that they recruit, and all of them are part of your team; the commission is based on the performance of the whole team. Under this schema when a representative exceeds the sales of his upline, he will move up the rank. (Spina, 2016)
  • Forced-matrix plans limit the number of people you can recruit per level and the levels can also be capped. Stairstep or breakaway plans pay for breakaways, while forced-matrix plans do not.

Beware of Scams

Scammers are always very active trying to use legal channels to steal. Ranelli (2018) notes that indeed some MLM have been found in court to be a pyramid scheme. However, we should remember fraudsters are everywhere. For example. some websites suplant legit online shops and steal information and money from victims. Others buy expensive items only to receive counterfeit products, ficticious online banks offer loans at incredible low rates just to make you pay some money upfront to cover some admin fees and then dissapear.

Another point, to keep in mind, is that the core of a MLM is having a real product or service to sell. Some dubious companies might have a product, but not one that delivers to its promises. It is not that these products can´t appear in other marketing scenarios, but unfortunately, MLMs allow these kind of entrepeneurs to sell products using a word-of-mounth tactic within a community, without being noticed by authorities.

So, use caution and research before you join any MLM business.

My Final Remarks on MLM

MLM is a valid distribution model to sell the products of a company. It is also a job in sales, in which you are paid by commissions for retailing and marketing their products. I know few people that actually make a profit in this way. It is hard work, so if you choose to earn money this way you probably need to enjoy networking, selling, and using the product as well. In fact, the first step for success in this business model is to be convinced that the product delivers on its promises, as you become an effective sales force leading by example.

Binary Strategy Model. The consultant has two groups (left and right) and will earn commissions based on the the group that makes less sales of the product.

Binary Strategy Model. The consultant has two groups (left and right) and will earn commissions based on the the group that makes less sales of the product.

Reference List

Christensen, M. Christensen, W. (2007). Be a Network Marketing Superstar. New York. AMACON Publishers.

Ranelli, W (2018) Strategies for Building and Retaining a Productive Multilevel Marketing Downline. Doctoral thesis Walden University. Online University

Spina, E (2016) The Everything Guide to Network Marketing. Adams Media, Avon Massachusetts

Yarnell, M. Bates, V. Hall, D. Hall, S. (2012). How to Become Filthy, Stinking, Rich Through Network Marketing. New Jersey. John Wiley & Sons, Inc.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2017 MariaInes


MariaInes (author) from Bogota on February 06, 2017:

Thank you MsDora.

Dora Weithers from The Caribbean on February 06, 2017:

Every generation is introduce to new pyramids and MLMs. So articles like this are always relevant. Thanks for the information.

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