MLM vs. Pyramid Schemes
If you’ve ever heard of multilevel marketing (MLM), you know that it has a bad rap—typically because people associate MLM companies with their sinister twin, pyramid schemes.
WHAT’S THE DIFFERENCE BETWEEN AN MLM AND A PYRAMID SCHEME?
In this article, I’ll explain to you what a multilevel marketing company is, what a pyramid scheme is, where they overlap, and how they’re different. Let’s kick off with a quick overview of why it’s reasonable that many people are confused about the difference between the two concepts.
WHY DO PEOPLE BUNCH MLM COMPANIES AND PYRAMID SCHEMES TOGETHER?
MLM companies and pyramid schemes are more than superficially similar.
Most authoritative sources admit that there’s a lot of overlap between MLM and pyramid schemes. Confusing the issue even further, the Skeptic’s Dictionary describes MLM as “a legal pyramid scheme.”
At the end of the day, MLM are bunched with pyramid schemes because many companies which allege to be MLM are in fact merely pyramid schemes. Likewise, even legitimate MLM companies may be subject to litigation asserting that they’re a pyramid scheme.
Importantly, an accusation doesn’t guarantee guilt in the US legal system, and accusations of running a pyramid scheme are no different. Many MLM companies weather lawsuits on a regular basis which claim that they are pyramid schemes, though repeated successful defenses imply otherwise.
WHAT SHARED FEATURES DO MLM COMPANIES AND PYRAMID SCHEMES HAVE?
The overlap between MLM and pyramid schemes is perhaps a matter of terminology, as the Encyclopedia of White-Collar and Corporate Crime characterizes MLM as “a form of pyramid scheme, not necessarily fraudulent.”
MLM and pyramid schemes both:
- Don’t retain the marketers as employees
- Use marketer recruitment of other marketers
- Sell products
- Distribute products from the top down
- Distribute commissions from the bottom up
- Enrich the people at the top
- Often leave the people at the bottom with less money than they started with
- Are often plagued by legal trouble
- Have a veneer of respectability
- Require the associate to pay for access to the product
It’s unfair to say that all MLM companies are inherently pyramid schemes, though—there are some legitimate differences that real MLMs have with pyramid schemes. Let’s dive into more detail on MLM companies so that we can flesh out exactly how they’re different from pyramid schemes when operated benevolently.
WHAT’S AN MLM COMPANY?
The FTC describes MLM companies as companies in which contractors sell products to members of the public and recruit other contractors who then render them commissions when they, in turn, sell to the public.
Though it’s not mentioned in the FTC’s description, the key point here is that MLM companies sell a product which isn’t entirely useless or ephemeral. Participants in MLM companies may be paid for their recruitment of other marketers, but their primary pay comes from selling products.
That doesn’t mean that MLM companies sell products that are good, or that MLM companies don’t often engage in deceptive advertising to sell their products—many do. The barest guarantee is that those products aren’t 100% spurious.
MLM companies don’t necessarily have strong or weak products, but they do tend to have weaker products.
Typically, MLM products aren’t retail- able, or else the manufacturers would arrange for their retail distribution on their own. Weak products are easier to produce and move and offer greater freedom to discount wholesale for downstream marketers to purchase.
Weak products make for tough sells, which makes it tough to turn a profit under the best of conditions. Even legitimate MLM companies can result in marketers spending more money than they earn, according to an article in USA Today.
Once again, this isn’t necessarily always the case; it’s just true on average.
HOW DOES THE LAW DEFINE MLM COMPANIES?
In US Legal’s summary, the law describes MLM as “systems in which companies contract with individuals to sell a set of products door to door or office to office. It is called multilevel because a contractor can also invite others to work and earn money for their performance.
The sales representative thus has incentives to enlarge the sales force and to earn added commissions on the sales of his or her recruits.”
The law on MLM companies varies from country to country. MLM companies are banned altogether in some countries, like in China.
WHAT’S AN EXAMPLE OF AN MLM COMPANY?
Amway is one of the largest MLM companies in the world and is representative of what you can expect when examining one. Direct Selling News marks Amway as the number one MLM company. Amway offers a bevy of healthcare products for its associates to sell and employs many thousands.
Amway is also beset by a parade of civil and criminal investigations according to the Hindustan Times, much like many MLM companies.
WHAT’S A PYRAMID SCHEME?
Now that you’ve got an idea about what makes up an MLM company let’s examine what constitutes a pyramid scheme.
First and foremost, pyramid schemes are scams which enrich those at the top to the detriment of those at the bottom, who have no chance to rise in the ranks. An Australian government website detailing scams offers the following account of what makes a pyramid scheme:
- You pay to join
- You must convince other people to pay you to also join to make your money back
- The product that the scheme purports to sell is worthless
- The promoter claims that the business arrangement isn’t a pyramid scheme
- The venture’s primary mechanism of making money is via recruitment and the associated costs
There are a few callouts here right off the bat, starting with the worthless product. Many pyramid schemes that involve selling goods attempt to sell extremely cheap goods that claim to be miracle cures or otherwise fantastical products.
Pyramid schemes frequently come hand in hand with false advertising and a strategy of exploiting consumers’—and marketers’—hopes. On some level, there is no pyramid scheme without misrepresentation of the product, because the scheme can’t be profitable for those at the top on product sales alone.
Aside from the quality of the product, pyramid schemes typically reward participants for recruiting other members rather than selling products. If an organization seems to promote recruiting overselling, it’s probably a pyramid scheme according to Investopedia.
HOW DOES THE LAW DEFINE A PYRAMID SCHEME?
According to the FTC, Pyramid schemes “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.”
The law tends to enforce pyramid scheme laws as they become aware of violations, as many MLM companies may be outside the confines of legality as a matter of course—making them pyramid schemes.
WHAT’S AN EXAMPLE OF A PYRAMID SCHEME?
The law offices of Girard Gibbs provide us with a few examples of pyramid schemes in recent times, kicking off with Wealth Pools International. Wealth Pools International purportedly sold sets of DVDs to its associates, who then made money by recruiting more people who would have to then buy sets of DVDs in turn.
The Wealth Pools International pyramid scheme got popped by the SEC in 2007, much like all other exposed scams along the same lines.
HOW DOES STRUCTURE DIFFERENTIATE BETWEEN THE TWO?
As Pyramidschemealert.org puts it, pyramid schemes—but not legitimate MLM—will have a “profit margin [that] is inadequate for covering sales costs and achieving a net profit.”
Furthermore, MLM companies may offer a difficult—though realistically possible—pathway for associates to “climb the pyramid” and rise in the ranks of the organization to the point of being in a management position.
Importantly, such an ascension wouldn’t throw a legitimate MLM company off the rails because its fundamentals are based on product sales, not expanding membership.
Pyramid schemes offer no such possibility. By their nature, pyramid schemes rely on the cabal at the top to operate and fall apart as soon as there is a shakeup in the upper ranks.
Thus pyramid schemes cannot survive the migration of those at the bottom to the top because it would require recruiting far too many people.
HERE’S A LIST COMPARING MLM COMPANIES WITH PYRAMID SCHEMES
The primary points of difference between a multilevel marketing company and a pyramid scheme are:
- The usefulness of the product
- The distribution of the controlling shares of the company
- Whether the venture’s primary moneymaking comes via selling products or via recruiting new members
- The ability to rise from the bottom ranks into a controlling rank
- The quality of the product
- The advertising claims of the product
- The ability to successfully defend against litigation
It’s important to remember that there are legitimate MLM companies out there. It’s equally important to realize that legitimate MLM companies can easily slip and fall into the purview of pyramid schemes if they’re not careful.
Stay vigilant, ask questions, and assess each organization periodically. Remember, a pyramid scheme can’t ever be profitable on the merits of its product, only a real MLM company can.
- Sales of actual product or services to consumers, MLM offers products whereas Pyramid schemes do not
- Commissions are paid on sale of products and not on enrolments; MLM has a hierarchical commission set up on the sales of products, whereas pyramid schemes are based solely on new enrolments.
- Company buys back inventory from participants at the time of termination, pyramid schemes do not have any inventory.