Multi-Level Marketing Businesses vs. Pyramid Schemes

Multi-level marketing (MLM), network marketing, or direct marketing businesses involve selling products to family and friends and recruiting others to do the same. There are some MLMs that are illegal pyramid schemes. Here are a few things to know before joining an MLM program.

What Are MLMs and How Do They Work?

Sometimes known as network companies, MLM companies can be thought of as a poor person’s franchise. Multilevel marketing is designed to replace the retail store as a conduit for selling certain products. 

For those weary of traditional jobs, the appeal is obvious: Work part-time from home, with no employees and no experience necessary, and make big bucks. We’ve heard claims that you can make tens of thousands of dollars per month for just a few hours per week.

As a representative for an MLM company, you’re treated as an independent contractor, and your job is to solicit new customers as well as recruit new representatives. 

These new reps are known in the industry as your downline. The big selling point is that you make money not only off your own customers but also off the business that your downline recruits bring in.

Advocates of the MLM business model maintain that, when given identical products, the one sold face to face (without the cost of maintaining a storefront and hiring employees and paying insurance) is less expensive than the same product sold in a store. 

Additionally, MLM advocates believe that buying a product from someone you know and trust makes more sense than buying from a clerk behind a retail counter.

What’s a Pyramid Scheme, and How Do You Spot One?

Pyramid schemes are frauds. These business opportunities are often remarkably similar to legitimate MLM opportunities and sell actual products, perhaps even products you’ve heard of. You, your family, and friends can lose a lot of time and money if you become a distributor for a pyramid scheme.

In a pyramid scheme, you may be pitched about how much money you’ll earn. By selling the company’s products, they may say you can change your life – quit your job and even become rich. That’s not true. The majority of your income would come from recruiting others rather than selling products. In pyramid schemes, everyone is encouraged to keep recruiting new distributors to keep the money flowing into the business.

Pyramid schemes typically encourage or even require you to purchase a certain amount of merchandise at regular intervals, even if you already have more inventory than you can use or sell.

Before you can be paid or get certain bonuses, you might have to buy products. Additionally, you may have to pay repeated fees for other services, such as marketing materials or training sessions. 

A company may also promise you lavish rewards, such as prizes, bonuses, exotic vacations, and luxury cars. It often turns out that you have to accomplish certain goals to qualify for the rewards, and only a few distributors qualify for the rewards.

Most distributors eventually discover that regardless of how hard they work, they cannot sell enough inventory or recruit enough people to make a profit. Also, they cannot afford the required fees or the inventory purchases needed to qualify for rewards, and they cannot earn enough to cover their expenses. It usually ends with people running out of money, giving up, and losing all of their investments.

A pyramid scheme has the following warning signs:

  • It is common for marketers to make extravagant claims about your earning potential. Be careful. These claims are false.
  • To make money, distributor recruiters stress the importance of building a distribution network. Avoid them. In a reputable MLM program, you should be able to make money just by selling the product.
  • Recruiters pressure you by telling you that if you do not act now, you will lose the opportunity and discourage you from studying the company. Get out as soon as possible. Do not join a company that pressures you to become a member.
  • To stay active in the company or qualify for bonuses and rewards, distributors buy more products than they intend to use or resell. If this happens to you, keep your money.

Is MLM a Pyramid Scheme?

MLM is not a pyramid scheme. 

The number one trait of MLM that leads to its all-too-frequent excesses is that everyone can get in for little money upfront; thus, everyone does get in. And we do mean everyone — hence, MLM’s often shaky reputation.

The problem is that the worst of the MLM companies are the equivalent of pyramid schemes. They offer no legitimate or proven service or product and exist solely to “sign up” as many reps as they can before someone realizes that the castle has been built on a cloud — at which point they take the money and run.

MLMs have been known to offer the pitch that you can make tens of thousands of dollars monthly while sitting on your duff and letting someone else do the work. All you have to do is sign up a few friends and relatives to sell the company’s widgets. 

Then, before you can shout the words easy money, the big bucks come rolling in. We know many people who have been taken for thousands of dollars in MLM schemes; all they found was a quick way to lose money and to alienate friends and relatives.

Is an MLM Right for You?

Those who are interested in becoming an MLM investor should remember that any network marketing arrangement is really just another job. A company, MLM or otherwise, cannot pay you while you watch soap operas. 

If you want to build a business that will support you, you will need time – three to five years, in most cases – and a lot of hard work. In MLM, everyone would get rich if it were as simple as some would have you believe.

Mary Kay and Tupperware, for example, are legitimate, successful MLM companies. However, they are the exception rather than the rule, especially among the types of MLMs you’re likely to have heard others pitch to you aggressively.

These tips can help you protect yourself from bad MLM experiences.

1. Ask yourself these questions

Would you like to be a salesperson? When you join an MLM, you will be a salesperson. It will be your job to sell the company’s product and, in many cases, convince other people to invest in the company, join it, and sell the company’s products. It is not a good idea to join an MLM if you hate selling or do not like asking people you know for money or time.

What is your sales plan? Consider whether your friends and family will buy this product from you again and again. Consider how you can attract and retain new customers. Are you able to sell a similar product elsewhere at a lower price?

What is your income goal? By working hard, you might think that MLM can provide you with a substantial income. MLMs make little or no money for most people, and some people lose money when they join.

Are you willing to risk the money and time? All business is risky. Multilevel marketing is no exception. Despite the low start-up costs, the additional expenses can add up quickly. There can be training and travel costs, website fees, promotional materials, party hosting costs, and product purchase costs. If you borrow money or use your credit card to pay for your expenses, you may face high interest charges. Also, consider how much time the business will take, such as training, recruiting new distributors, managing paperwork, taking inventory and delivering products.

2. Do your homework

Check out the company. Find online reviews, scams, and complaints about the company by searching for the company’s name and words like “review,” “scam,” or “complaint.” You can also read articles in newspapers, magazines and online about the company. Is the company known for its customer satisfaction? Find out if any complaints have been filed with your state’s attorney general’s office. There is no guarantee that a company is reputable if there are no complaints, but complaints can indicate potential problems.

Find out what distributors are saying. Distributors often promote MLM online by posting their own training videos. Look for them online. It’s a red flag when training courses make profit claims, promise that you’ll make money by “recruiting, recruiting, recruiting,” or tell you that you need to “find two people who find two people” to build a downline. Claims like these are a hallmark of a pyramid scheme.

Take a look at the products. There may be quality products at reasonable prices from MLM companies. However, some offer overpriced, questionable or even dangerous products. For example, watch out for health products that are advertised with “miracle” ingredients or success guarantees. Usually, these claims are false or unproven, and the products may even be dangerous.

Know the costs. MLMs often require that you purchase training materials or marketing materials to build your business. Hotel and meal expenses are common with MLMs. Make sure you know what you will have to pay for and what the cost will be in the long run. You should ask the company if you will lose your right to bonuses or rewards if you forgo some of these things, such as regular product purchases or training.

Find out if a refund is available. Many MLMs require you to buy the products from the company before you can sell them. Ask the company how they handle refunds. Be sure to get information about returning unused products, including restrictions and penalties. Consider whether you’ll get a full or partial refund – and how long that may take.

Review the paperwork with a friend or advisor. Read the company’s sales documents, business plan, disclosure documents, and any contracts you are required to sign. Consider asking an attorney, accountant or other person you trust – who is not affiliated with the company – to review the MLM’s records. Ask them to take a look at your earning potential and whether the company can back up its claims. Get their honest opinion on whether they think the MLM is reputable and whether it is right for you.

The Bottom Line

Quality MLM companies make sense for people who really believe in and want to sell a particular product or service and don’t want to or can’t tie up a lot of money by buying a franchise or other business. 

Just remember to check out the MLM company and realize that you won’t get rich in a hurry, or possibly ever. Capitalism has taught us over the years that whatever looks too good to be true usually is. Be sure to check the references of the MLM company that you’re considering.

Remember that due diligence requires digging for facts and talking to people who don’t have a bias or reason to sell to you. 

Legitimate MLMs put as much emphasis, if not more, on the products or services they offer as they do on recruiting new reps, and they don’t claim that you’ll make a killing without working hard to find new customers. 

Although not shy about advertising the big earnings its successful salespeople make, Mary Kay doesn’t hype the income potential. Local sales directors typically earn $50,000 to $100,000 per year, but this income comes after years, not weeks or months, of hard work. Mary Kay rewards its top sellers with gifts, such as the coveted pink Cadillac.

If you do decide to buy into an MLM company that seems reputable, think twice before signing up relatives, friends, and coworkers in your MLM venture — at least until you’re satisfied that the concept is a viable one. The particular danger in doing business with people you care about, and who care about you, is that, in addition to your reputation and integrity, your friendships and family relations are on the line.

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