How Network marketing actually works – a 101 explanation

The industry

If you were to hear the phrase “network marketing,” would you have any idea what they were talking about? If not, this crash course in network marketing will introduce you to the concept. It takes you through, what network marketing is, how it works and also what makes network marketing different from a pyramid scheme.

What is Network Marketing – in a nutshell?

Network marketing is a type of business model that depends on a group of distributors and customers to build the company, according to Entrepreneur. Some network marketing companies are also multi-level marketing companies, but many others are single or two-tier programs.

Usually, a network marketing program involves three components, according to the Balance. Those three elements are:

  • Generating leads

  • Recruiting customers (or partners)

  • Managing and building the business

Often, network marketing appeals to people who are looking for part-time employment or who need to earn income but also want to work on a flexible schedule.

The Different Types of Network Marketing

Network marketing is a child to the widely used “direct sales” model. Generally speaking, there are three major types of direct sales, network marketing being one of them.

Single-tier programs involve selling a product from a company directly to a customer. You don’t need to recruit others to sell and only earn money from product sales. A famous example of a single tier marketing program is how Avon used to work, before they became an mlm company. A single tier marketing program is usually also referred to as a “direct sales company”, since the focus lies on selling.

Affiliate marketing programs are actually another example of single-tier network marketing. If you have a website and are an affiliate of a company, such as Amazon, you earn a commission based on the amount of traffic you send to the company’s website.

In some cases, you make money based on the number of people who click through, known as a pay-per-click model. In other cases, you only earn money if someone buys a product after clicking.

If you are part of a two-tier network marketing program, you have two opportunities to earn money. In the first tier, you earn a commission by making sales or by sending traffic to a website.

The second tier of the marketing program is anyone you’re referred to it. If those people sell products or direct traffic to a site, you receive a portion of their commission as well.

Finally, a multi-level marketing/network marketing program involves at least two, but usually more, tiers. If you are a part of an MLM, you earn money on sales you make, plus a commission on sales any person you recruit makes, plus a commission on the sales any other people brought on by your recruits.

If you were recruited to an MLM by someone, that person earns a commission whenever you make a sale, plus whenever your own recruits make a sale.

How Does Network Marketing Work?

The specific way network marketing works depends in large part on the program you are in.

Let’s look at an example of a direct sales program.

You start by signing up to be a consultant or sales rep with the company.

To do that, you purchase a starter kit, which includes a variety of the brand’s products for a discounted rate, plus materials to help you promote your business and make sales. If you’re part of a party-based network marketing program, you convince a friend to hold a party and invite people to it.

At the party, you demonstrate the products and people are thrilled about them. Five of the attendees order $100 worth of stuff and the remaining two order $50 worth of stuff each. You’ve sold $600 worth of product, and since you get a 20 percent profit, have earned $120.

If your company consists of a single tier program, this would be the major part of your business and would therefore end here.

If, on the other hand it is a multi tier program, the example might continue something like this:

Meanwhile, one of the attendees is so jazzed about your products that she wants to sell, too. You sign her up to be a consultant. Now, whenever she sells items to customers, you earn 5 percent of her sales.

If she signs up a friend or two, you’ll earn an additional commission on the sales they make.

Although in-person parties are one way to sell products through a network marketing program, they aren’t the only option. In the 21st century, many programs have gone online. You might sell your products through a website or over social media.

Another option is to meet with potential customers one on one to sell your products. You can try going door to door to make sales. A more reliable way to get leads and new clients is to ask current customers to refer friends or relatives to you.

What are Compensation Plans?

Network marketing programs often offer a variety of different payment plans. How consultants get money depends on the type of program they participate in. Here’s a look at the four most common types of compensation plans:

Unilevel Plan

Under a unilevel compensation plan, you earn a commission on sales you make, plus a commission on sales your recruits make. If they recruit people, you get a cut of those sales as well.

The person who recruited you also gets a part of your sales, plus a chunk of the sales your recruits make. The person who hired your recruiter gets a commission on that person’s sales, plus your sales, plus the sales of everyone below you.

The plan is called a unilevel because there’s no way for you to break away or advance under it. You’ll always be below your recruiter and above the people you brought into the program.

Binary Plan

A binary plan is a bit more complicated than a unilevel plan. Under this arrangement, you recruit two people to the program to sell products, creating two legs. Your compensation is based on the volume sold by each one of your downlines (the people you recruited).

The person who recruited you earns a commission from one of your “legs” under a binary plan. You receive commission from the other leg.

Matrix Plan

Under a matrix plan, you are essentially responsible for putting together a team of salespeople. The plan limits the number of reps on each level. For example, you can usually have three people in your front line (direct recruits). Each of those people can recruit three more people.

But they can’t recruit a fourth, and you’re not able to recruit a fourth. This type of compensation plan isn’t too popular and is usually associated with programs that don’t offer a solid product for sale.

Breakaway Stairstep Plan

According to Make Money Expert, the breakaway compensation plan is the oldest one out there. Under this plan, you earn commissions from your sales, plus the sales of your recruits. Your recruiter also gets a cut of your sales.

But there comes a time when you’ve built up enough of a downline that you’re able to “break away” from your recruiter. That means he or she no longer gets a portion of your sales. Under this type of compensation plan, there is a sense of some upward mobility.

What’s the History of Network Marketing?

Although there’s a lot of debate about the origin of network marketing, many people point to Carl Rehnborg, the founder of what would become Amway, as the first person to create a network marketing program. Back then it was known as Nutrilite and was started in 1939.

It was in the 1940s that Nutrilite partnered with Mytinger & Casselberry to create the first network marketing program. Mytinger and Casselberry put together a compensation plan that is very similar to the plans around today.

Distributors of Nutrilite earned a commission on each product they sold. Bonuses were available for hitting certain milestones. After a distributor sold a certain amount of product, he or she could begin to recruit others to the program, earning a cut of their sales.

All Business disputes the claim that Amway was first. It points to Watchers, a sea weed supplement company, as the first network marketing company. Watchers began in 1932, seven years before Nutrilite.

Avon cosmetics is another company thought to be one of the first network marketing programs. According to Avon’s history, the brand and its concept, having women sell cosmetics to women, came about by accident.

David H. McConnell, the founder of Avon, was originally a door-to-door bookseller. He began creating perfume samples to offer customers, making them more likely to open their doors and let him in.

The fragrances ended up being more popular than the books, and McConnell soon saw that many of the housewives he interacted with would make great salespeople. The first woman he hired was Mrs. P.F.E. Albee, back in the 1800s.

By the turn of the 20th century, the brand, then known as California Perfume Company, had 10,000 women selling its products. It would ultimately change its name to Avon in 1937.

Is Network Marketing a Scam or a Pyramid Scheme?

People occasionally confuse pyramid schemes with network marketing. One reason for the confusion could be because the structure of networking marketing and pyramid schemes are often similar. Although there are some similarities between the two, it’s important to understand that there are also major differences.

According to the Better Business Bureau, the focus of a pyramid scheme is often recruiting other people to the system. In contrast, the focus of a real functioning network marketing company, is on selling a product or service.

A pyramid scheme gets its name because the structure of the company or plan is like a pyramid. The person at the start of the company recruits a few people and takes their investments. Those people then each recruit a few more people and take their money and so on.

Since there is a finite number of people in the world, pyramid schemes can’t last forever, according to Investopedia. Although the people in the top tiers often do earn a considerable amount from recruits, those in the bottom lines are more likely to lose money.

There are a few definite ways to tell if a program is a scam or pyramid scheme or to see if it is legitimate and will help you earn an income. The biggest red flag, according to the Federal Trade Commission, is that your income is based on how many people you recruit to the company.

Two more red flags include vague promises that you’ll earn a substantial amount of money, but little details on what you’ll do to get that money, and stories of wealth and fortune that have little substance to them.

Another sign of a pyramid scheme is having to spend a considerable amount of money to join the program. Many network marketing programs have some start-up costs, but these are usually relatively low.

Some unscrupulous people try to mask pyramid schemes as multi-level or network marketing programs, which is why it is so important to do your homework on a company or program before you sign on.

One recent example of a pyramid scheme that scammed thousands of people out of their hard-earned money was the Fortune Hi-Tech Marketing program. In 2013, the FTC charged the company with deceiving customers (around 350,000).

In 2014, the company settled with the FTC and agreed to surrender assets worth $7.75 million, which would be distributed to people deceived by the company. The FTC also barred the company from ever operating as a multi-level marketing program again.

If you’re interested in seeing more examples of, then check out our list of pyramid schemes

What are Some of the Biggest Network Marketing Companies?

You’ve probably heard of some of the largest networking marketing programs. Many of them are household names. In some cases, you might not have been aware that these companies used a networking marketing model.

Mary Kay

Back in 1963, Mary Kay Ash started her cosmetics company with a $5,000 investment, according to the brand’s archives. Today, the company has 3.5 million beauty consultants, selling products in 35 countries. Revenue for the brand was $4 billion in 2015, according to Forbes. It was also named to the magazine’s lists for Best Employers and Best Mid-Size Employers in 2016.

Amway

We already discussed how Amway/Nutrilite was one of the earliest networking marketing companies. Would it surprise you that it’s still one of the biggest? It had revenue of $9.5 billion in 2015, earning it a spot on Forbes‘ largest private companies list.

Avon

Avon’s another old company that’s still a biggie, although it has had some troubles in recent years, as Marketwatch reported. Despite that, the brand had $9.98 billion in sales in 2016 and earned a spot on Forbes‘ Best Mid-Sized Employers list.

Pampered Chef

Pampered Chef got started in 1980, selling kitchen gadgets and gear to women at home parties. 22 years later, Warren Buffett bought the company. At the time its revenue was $700 million and it had 67,000 consultants, according to Fortune.

Where do I go from here?

If you’re interested in reading more about network marketing and the industry it has created, we’ve compiled a list of a few useful articles below.

By Direct Selling Star