A lot of business models have been starting here and there. For some time the multi-level marketing had been quite a buzz. Because of that, pyramid schemes are making their way into the business world disguised as multi-level marketing models in order to exploit prospective business startups.
Without an in depth look, it would be hard to see the difference between a legitimate multi-level marketing model and a fraudulent pyramid scheme. This is because both of them are built on multiple level recruits and distributors. With a similarity of the business models, one could confuse a pyramid scheme as a multi-level marketing.
This business endeavor is not all dangerous. It could be fun and profitable, even satisfying. It’s just that some purported legitimate business models are actually cons that are crafted to bulk up some peoples’ wallets while flattening those of the naïve. It doesn’t just flatten your wallet, but also the dream of running a sustainable income-generating business.
No one would want to waste their financial resources in a fraudulent investment. Especially if these funds are needed for essential purposes like making ends meet. Hence, in this article I’ll discuss the difference between a multi-level marketing model and a pyramid scheme. I’ll also discuss ways to avoid falling into the trap of the fraudulent schemes.
Multi-level Marketing (MLM)
What really is a multi-level marketing? This is an appealing business proposition for startups because it allows for a chance to be involved in an established system of distributing goods to consumers. In MLM you do not start from scratch. An MLM member benefits from the support of a direct selling company which supplies the products and trainings needed.
The MLM strategy is constructed to promote a product through distributors. This is done through multiple levels of compensation. It promotes through many distributors their products which exponentially increases its team members. The distributors, as members are called, gain commissions on a product sale as wells as a percentage from the sales of their personal recruits. It is structured in a way that a commission is paid to distributors at multiple levels when a sale is made. The commission would then depend on the overall volume of the generated sales.
More on MLM Compensation Plans
Different MLMs offer different compensation plans. The difference lies on how the commission in divided between the distributors. It could either be a Unilevel Plan, Stairstep Breakaway Plan, Matrix Plan, Binary Plan or Hybrid Plan.
The simplest compensation plan is the Unilevel model. The plan is that an individual can recruit as many frontline distributors as he wants for the products. These frontline distributors are fostered to recruit more distributors. The commissions are paid up to seven levels of recruits.
The Stairstep Breakaway model fosters individual and group sales. With this model, multiple recruits will work under a group leader. The aim is to reach a specific volume within a set time. When that it achieved, the distributors on that group go up to a higher commission level. The pattern goes on until it reaches the company’s set limit. After that, the distributor breaks away and commission pattern stops. From that point on, incentives and commissions are afforded to the representative.
The third compensation plan is the Matrix model. This is somewhat similar to the Unilevel model. However, in this model, a specific number of distributors can be sponsored at any level. When the specified number is reached, a different matrix can begin.
A fourth compensation plan is called the Binary model. This model allows for just two distributors to be at the frontline. This means that at any level, two distributors would be needed to complete a compensation plan. The compensation will then have to be balanced among the two distributors no matter which level they are. In this model, the sales volume must not exceed a certain percentage of the total sales of the distributor.
The last compensation plan is the Hybrid model. As the name puts forward, it is a combination of the earlier mentioned compensation plans.
In a nutshell, MLMs goal is to move products. MLM works on the theory that the larger the distribution network is, the more productive sales will be made.
What is a pyramid scheme? It is a sham business opportunity disguised as an MLM. A pyramid scheme is illegal while an MLM is not. There is no real product sold in pyramid schemes. The commission is based on the number of recruits made in the scheme.
An exorbitant fee is charged for a simple enrollment. Only those who are involved in founding the scheme make large amounts of money. When no new recruits are made, the scheme falls into failure and most that joined in lose their money.
Pyramid Scheme Compensation Models
The two models in the pyramid scheme are called the 8-ball model and the matrix model.
The 8-ball model requires two people to be recruited into the system. The two people recruited will have to pay a certain amount of sum to enter the “gift sum”. The person at the top receives the “gift sum” from up to 8 people before leaving the scheme. The remainder of the people move up the scheme and the pattern goes on until no more recruits will be made.
The matrix model is also used by a legit MLM. However, in a pyramid scheme, those who will join will be required to pay for a product ahead and will have to wait in order to enter the scheme. When a recruit is able to bring in his own recruits, he will be given a product which is worth much less that the money paid. He then leaves the scheme. Like the 8-ball model, this scheme collapses when no more recruits would be made who will join and pay the entry fee.
A Word of Caution
Even with MLM’s legal status, it is still noteworthy to remember that a number of people have still lost money in the business. Some MLMs major profits come from the recruitment of other members rather than from selling the products. Hence, when this is the case, a distributor’s investment will collapse.
Although this doesn’t go for all MLMs, but the success rate of some is so remote that no commission will be received from the company. One MLM company wasn’t able to give out the commission for its distributors for a given month.
Hence, before entering a specific MLM company, do a background check. Meet former and current members and learn from their experiences and stories. You could even check for stories regarding a specific MLM company online. Support groups also exist where people warn the others of possible dangers.
How to Detect a Pyramid Scheme
Here are some ways to detect pyramid schemes. Some pyramid schemes, offer products too, so learn the difference here of a legit MLM from a fraudulent pyramid scheme.
- Fraudulent pyramid schemes, offer large amounts of incentive from just recruiting people. These are usually dubbed as a commission from a starter kit sale or as a recruitment bonus.
- Pyramid schemes will not focus on selling a product, but mostly on recruiting additional distributors.
- Exorbitant startup costs are required for joining which includes a mandatory training with a fee and a non-refundable membership fee.
- Pyramid schemes collect commission on a single sale for up to five or more levels deep.
- Pyramid schemes’ products have no real value and no competitive price. They do not distribute reputable brands and its manufacturers may have been involved in lawsuits.
- Fraudulent schemes only offer lists of sales leads to just people inside the company. The information is mostly outdated.
- Fraudulent schemes come in conjunction with high-pressure motivational events. These events usually don’t let you have time to think about registering.
- Many pyramid schemes flaunt their personal wealth.
Consider These Questions
- Are you obligated to invest a huge amount up front in order to become a member? Legit MLMs would not require exorbitant startup costs.
- Will you be required to pay for inventory?
- Is the company offering to buy back unsold inventory? Legit MLMs would propose to buyback up to around 80% of what is originally paid.
- Does the company have an interest in consumer demand? When there is no attention paid to marketing product or service that serves as a warning signal. Legit MLMs are always interested in consumer demand for products and services they offer.
- Do they offer fast profits from recruiting people? Capitalizing on recruits is a clear sign of a pyramid scheme. When emphasis is put on recruitment than on products or services, it’s time to back away.
Do not be easily enticed with earning large commissions. Protect yourself. Do your research. Investing in information is a key to put your monetary investment in a good place. Gather as much information as possible regarding a company’s products, services and operations.
When available, read copies of the company’s sales publications, business and marketing plans.
As mentioned earlier, it will be wise to talk with people who have a reasonable amount of experience with MLMs. Talk about how things went about for them and if the products offered are of high quality that are competent in the market. Check for any complaints and verify if these are legit complaints or are just stories to taint the company’s reputation.
Be attentive at recruitment meetings and don’t get over excited by claims of amazing amounts of income you could make. As the saying goes, if it is too good to be true, then it probably is.
If you are someone who wants to get free from the 9-5 job and want to start your own business, I would not recommend you MLM at all. Even with legit MLMs the chances of making some good profit aren’t good if you are down in the line.
It is much easier to start making money online by building your own online business and making money as an affiliate marketer. You don’t need to have your own product, you don’t need to recruit anybody.
But you must be serious about your online business and put some time and effort into building it. Fortunately, you can start for free by joining the best affiliate marketing community online – Wealthy Affiliate.
Scott Hinkle says
Thank you for this great comparison between Pyramid Schemes and Multi-Level Marketing. The differences can be subtle but those subtleties really do distinguish legitimate from illegal.
That said, due to the inherently complex requirements and payment setups most MLM’s have, I tend to steer clear of them. It’s just a bit too convoluted for me. Still, there are one or two that catch my eye every now and then and I do consider joining them (especially now in the cannabis industry.
Thanks for the list of questions to consider to help evaluate potential opportunities.
Thank you for the comment.
Great post here and very nice warning. I am not a part of any MLM programmes right now but i was once in that game and i lost my money after a while thinking i could still go on. For me, i define an MLM as a pyramid scheme with a product to sell because this is what i see it as. Only except people make it with MLM only just a few. Great article.
Thank you for sharing your experience.