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Multi-level marketing: A pyramid scheme by

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Article January 2007

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Michael R Hyman
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 Business Outlook
November 2007

Multi-level Marketing:
A Pyramid Scheme by Design
Dr. Michael R. Hyman, NMSU

Multi-level marketing (MLM), also called network marketing, is a

way of distributing products or services in which the distributors
earn income from their own retail sales and from retail sales made
by their direct and indirect recruits (Vander Nat and Keep 2002,
p.140). Examples of MLM companies include Amway, Avon,
Herbalife, Mary Kay, and Tupperware. Many marketing
practitioners, a few marketing scholars, and even the Federal Trade
Commission, contend that MLM is not a de facto pyramid scheme
(Federal Trade Commission 2000; Harden 1987; Koehn 2001;
Muncy 2004; Vander Nat and Keep 2002). Are they correct? The
answer is no, and the reason for that answer is economics reduces
all MLM schemes to pyramid schemes.

Pyramid schemes ask people to make an investment and, in

return, grant them a license to recruit others who, in turn, recruit still
others into the scheme. In essence, the investor pays for the
opportunity to receive compensation when his or her recruit brings
others into the scheme. The opportunity to recruit is the product
(Koehn 2001, p.153). Pyramid schemes are illegal because (1)
profits are derived primarily from recruiting people rather than from
selling non-harmful products and services, (2) recruits often pay
large up-front fees for enrollment and sales kits, and (3) recruits are
pressured into stockpiling large quantities of non-returnable
inventory (Koehn 2001; Muncy 2004; Vander Nat and Keep 2002).

In contrast, MLM schemes merely are unethical, according to many

scholars and practitioners, because they encourage sales
associates (1) to hard sell family members and friends, (2) to abuse
professional-client relationships (e.g., dentists who trade on their
medical credibility to push products on patients (Koehn 2001; Rice
1997), and (3) to recruit new sales associates in socially and
psychologically unacceptable ways (e.g., propagating myths that
anyone can be a good salesperson and MLM is the road to riches)
(Block 1996; Brodsky 1998; FitzPatrick 2005).

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Also, under MLM schemes (1) sales associates are recruited by
exploiting their materialism, greed, and religious zealotry, and (2)
unproven, bogus, low quality, and unneeded goods often are sold
at inflated prices (Barrett 2001; Koehn 2001; Muncy 2004).

If page count reflects importance, then Rubinos The 7 Step System

to Building a $1,000,000 Network Marketing Dynasty: How to
Achieve Financial Independence Through Network Marketing
(2005)a typical mass market book in the personal wealth-building
genreindicates a network marketers success firmly depends on
recruiting aggressive sales associates who will in turn recruit other
aggressive sales associates. Other than a psychobabble-laden
chapter on formally envisioning financial success and a paragraph
advocating increased product knowledge by using the companys
productsafter all, it is easier to sell what one knows wellRubinos
(2005) book exclusively focuses on ways to prospect for sales
associates.

Rubino (2005) shows that a five-level network with four persons at

one level reporting to one person in the next highest level creates a
network of 1300 people (i.e., 4 + 16 + 64 + 256 + 1024). If each of
those 1300 people sells $100 of product per month, and the
commission on their sales paid to the person at the top level is 10%,
then that top person receives $13,000 in commissions per month.
Unfortunately for gullible readers of his book, Rubinos illustration
of geometric progressions is incomplete because he ignores the
impossibility of recruiting new sales associates indefinitely (i.e., the
inherent fallibility of pyramid schemes). This failure causes the low
reported success rates for MLM participantsmodestly defined as
realizing a profit after all expensesof roughly 0.1% (FitzPatrick
2005).

One marketing maxim is every required marketing function must be

performed by at least one member of the distribution channel from
producer to end consumer. This maxim implies that viable members
of the channel must perform an economically valuable function.
MLM sales associates promote, order, stock, and deliver products
to their customers. Traditionally, these functions are performed by
producers, wholesalers, and retailers, who are compensated for
their efforts. Commissions for MLM sales associates must derive
from their recovery of this added value. They are not conjured from
a bottomless money pit; rather, they are funded by transferring
required marketing efforts from traditional performers to MLM sales
associates.

If recovered sales cost (RSC) creates the sole economic surplus

inherent to MLM, then the equitable distribution of this surplus

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among sales associates is a critical ethical issue. For the seven
MLM companies listed in the Table, the mean annual payout to the
top 0.22% of sales associates is $236,216, which comprises 44.0%
of total payouts; in contrast, the mean annual payout to the bottom
99 percent of sales associates is $380. Seemingly, payouts are
skewed heavily and unfairly toward only a few people.

Table
Payout Skewedness

Company Top Pct. of Mean Pct. of Mean

Sales Annual Total Annual
Associates Payout to Payments Payout to
Top Pct. of to Top Bottom 99
Sales Sales Pct. of
Associates Associates Sales
Associates
Arbonne 0.20% $126,675 57.0% $87.36
International

Cyberwize 0.28% $91,841 43.3% $291.72

Free Life 0.17% $549,662 27.0% $861.79

International

Melalueca 0.30% $126,322 35.2% $502.32

Nikken 0.25% $121,252 46.0% $276.64

Nu Skin 0.16% $480,403 52.5% $386.36

Reliv 0.21% $158,129 47.0% $154.44

Mean 0.22% $236,326 44.0% $379.95

Based on FitzPatrick (2005)

Ironically, MLM recruiters and their promotional materials must

present this pyramid-driven distribution of RSC in a positive way.
Highly skewed rewards allow fables of richesembodied in the
opulent lifestyles of a few peoplethat lure the sales associates
needed to fund these rewards (Van Druff undated). As practically
all these later-recruited sales associates will earn little if any money,
it is unethical to imply otherwise.

Conclusion

Despite claims to the contrary, most MLM schemes are deceptive

because the promotional materials used to recruit sales associates
reflect impossible outcomes for almost all targets of those materials.
Although top sales associates probably recognize that their
lucrative rewards result from a hugely skewed distribution of
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recovered selling costs, these promotional materials obscure the
limited money-making potential of lower-level sales associates.

Fortunately, MLM need not be deceptive. Rather than tempt

potential participants with dreams of great riches, promotional
materials merely could reinforce that recovered selling costs make
great products available at good prices. Promotional efforts that
stress product quality, good prices, an opportunity for socializing
(Bhattacharya and Mehta 2000), and a way to earn a few dollars,
would be non-deceptive if true. (Note: MLM companies that provide
lists with full and discounted prices are fooling customersmostly
sales associatesinto believing they are buying goods at bargain
prices.)

References

Barrett, Stephen (2001), "The Mirage of Multilevel Marketing,"

(August 17), http://www.quackwatch.com/01QuackeryRelated
Topics/mlm.html.

Bhattacharya, Patralekha and Krishna Kumar Mehta (2000),

Socialization in Network Marketing Organizations: Is it Cult
Behavior? Journal of Socio-Economics, 29 (4), 361-374.

Block, Brian (1996), Multilevel Marketing: Whats the Catch?

Journal of Consumer Marketing, 13 (4), 18-26.

Brodsky, Norm (1998), Multilevel Mischief, Inc., 20 (8), 41-42.

Federal Trade Commission (2000), FTC Consumer Alert: The

Bottom Line about Multilevel Marketing Plans, (October),
http://www.ftc.gov/ bcp/conline/pubs/alerts/pyrdalrt.shtm.

FitzPatrick, Robert L. (2005), "The Myth of 'Income Opportunity' in

Multi-Level Marketing," http://www.falseprofits.com/MythofMLM
Income.doc.pdf.

Harden, Michael P. (1987), The Handbook of Multilevel Marketing:

Understand Multilevel Sales Programs, Direct Selling, and
Pyramids. Carrollton, TX: Promontory Publishing, Inc.

Koehn, Daryl (2001), Ethical Issues Connected with Multi-Level

Marketing Schemes, Journal of Business Ethics, 29, 153-160.

Muncy, James A. (2004), Ethical Issues in Multilevel Marketing: Is

It a Legitimate Business or Just another Pyramid Scheme?
Marketing Education Review, 3 (3), 47-53.

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Rice, Berkeley (1997), Whats a Doctor Doing Selling Amway?
Medical Economics, 74 (13), 79-85.

Rubino, Joe (2005), The 7 Step System to Building a $1,000,000

Network Marketing Dynasty: How to Achieve financial
Independence Through Network Marketing. Hoboken, NJ: John
Wiley & Sons, Inc.

Van Druff, Dean (undated), Whats Wrong with Multilevel

Marketing? http://www.vandruff.com/mlm.html.

Vander Nat, Peter J. and William W. Keep (2002), Marketing

Fraud: An Approach for Differentiating Multilevel marketing from
Pyramid Schemes, Journal of Public Policy & Marketing, 21 (1),
139-151.

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