The Not-So-Great Pyramid: Why multi-level marketing is always a bad idea

“Honest work is much better than a mansion.”— Count Lev Nikolayevich Tolstoy

“It’s a big job, just getting by”—Merle Haggard, “Working Man’s Blues”

Most everybody works hard, and despite this effort, most everybody has limited resources. It’s disheartening for us to struggle and sacrifice and yet still fear financial catastrophes, such as a major car repair or outsized medical bill, to say nothing of the specter of job loss and the uncertainty of retirement. We were told as children that we were special, at least by Mr. Rogers et al, and so it is especially unsettling to find ourselves living ordinary lives. It doesn’t seem fair.

This feeling of injustice, otherwise known as quiet desperation, creates a problem to be solved, which in turn creates a market with products to be sold. As with other terrors of modern life such as the hopelessness of finding a suitable romantic partner or the failure to lose weight, this void has been filled with a creature both utterly modern and thoroughly timeless: the huckster.

Here, the huckster has taken the form of a “brand ambassador,” who agrees with you in these key areas: You ARE special and you were meant to be wealthy, wealthy in a way that manifests itself in material goods and tropical vacations. You’re meant to be a success, but the problem is, you’ve been doing it wrong (and nobody needs to tell you THAT). Your boss is “buying you at wholesale and selling you at retail,” when fairness dictates that you keep the fruits of your labor for yourself. You need to cut out the middle man. Oh, and you get a Lexus.

To right this injustice, you simply join your new advocate in a business opportunity known as multi-level marketing, also known as direct selling or network marketing, but hereinafter called MLM.

In this post, I’ll define MLM and explain why it’s mostly illegal and always ill-advised. I’ll explain why I advise anyone who will listen to avoid these scams (and let me be clear: they are all scams in one way or another).

What is an MLM?

We’re familiar with MLMs because we can name a few of the largest ones. The products are not sold in stores but are sold by your friends, neighbors, and relatives, sometimes at parties or online. Perhaps someone we know has approached us to sell Amway or Pampered Chef home products, Avon or Mary Kay cosmetics, or Young Living or doTerra essential oils.

MLMs are regulated by state agencies and by the Federal Trade Commission (FTC), which defines an MLM as an organization that

  

distributes products or services through a network of salespeople who are not employees of the company and do not receive a salary or wage. Instead, members of the company’s salesforce usually are treated as independent contractors, who may earn income depending on their own revenues and expenses. Typically, the company does not directly recruit its salesforce, but relies upon its existing salespeople to recruit additional salespeople, which creates multiple levels of “distributors” or “participants” organized in “downlines.” A participant’s “downline” is the network of his or her recruits, and recruits of those recruits, and so on. https://www.ftc.gov/tips-advice/business-center/guidance/business-guidance-concerning-multi-level-marketing

How do legitimate MLMs differ from illegal pyramid schemes?

Chain letters and Ponzi schemes are clearly illegal and ill-advised, and most people know those are sketchy, so it doesn’t make sense to talk about those in depth here.

(A chain letter asks you to send money and a copy of the letter to a certain number of people, with the false hope that you’ll get even more money back. A Ponzi scheme takes money from new investors and gives it to current investors, making them believe that the enterprise is profitable, thereby defrauding them into investing more money.)

In short, organizations that don’t sell products but make their money by recruiting new members who pay joining fees that profit those further up the chain are certainly illegal pyramid schemes.

But MLM promoters often claim that MLMs are NOT pyramid schemes by definition, because MLMs sell real products. This isn’t necessarily true. An MLM can sell products AND function as an illegal pyramid scheme at the same time.

The key difference is: Do participants make money by profiting from the sale of a legitimate product to other people, which is legal, or do participants make money primarily by recruiting other people to join the organization, which is illegal? See In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1181 (1975)

That is, if you buy legitimate products from a wholesaler and make your money by selling the products at retail to other people without making false claims regarding the products’ effectiveness, you’re not breaking the law.

Few MLM participants adhere to this, however, as I’ll explain below. 

Even “legal” MLMs cause the participants to break the law

Many MLMs operate within the bounds of the law (barely). In fact, they’ve wisely hired lawyers who specialize in this area of the law to advise them on how to push the envelope—but not so far that they’ll be sanctioned by the FTC or sued by a state’s attorney general.

Even if the MLM operates legally, its participants usually don’t. They operate as independent contractors and are not closely supervised by company employees, and their claims are hard to regulate because they’re made at parties or on social media and not in widely distributed written materials such as sales brochures.

This loose structure allows MLM participants to break the law in two keys ways. First, they make (or attempt to make) a profit primarily through recruiting new members rather than by selling product. Second, they make false claims about the product.  

Amway and the 70 percent rule

We’ve established that a “legitimate” MLM is distinguished from an illegal pyramid scheme because the bulk of its profits results from product sales and not downline recruiting, but how much product must be sold to satisfy this requirement?

The decision in the 1979 case In re Amway Corp. (93 F.T.C. 618) answers that question. Here, the judge held that if 70 percent of an MLM’s earnings come from product sales, then the MLM is not an illegal pyramid scheme.

It’s easy for an MLM to reach the 70 percent mark. The MLM requires its new recruits to buy a certain amount of products from it at the outset and perhaps at regular intervals, thus making 70 percent or more of its profits from product sales. This works well for the MLM, but it means that the members must sell all of those products or be stuck with them.

Even in the unlikely event that the member sells that many bottles of lotion to the public, the earnings will not generate enough income to make the effort worthwhile. The member may meet the 70 percent rule but will be making a modest income, which isn’t the member’s goal.

The real money is in adding new recruits to the bottom of the pyramid, which motivates the member to recruit new participants and make promises that violate FTC regulations including the 70 percent rule.

The MLM is in the clear, but you are not. Because you’re an independent contractor who is violating written MLM company policy that you agreed to when you signed up, the MLM won’t defend you if you get into trouble.

False claims

In addition to overstating the potential financial gains, MLM participants are prone to make false or misleading claims about the products themselves. These claims may constitute false advertising or worse—untrue or even dangerous promises about the health benefits and risks of the products.

The biggest problem areas: Dietary aids, supplements, anti-aging potions, and some household products.

When selling a dietary supplement or food product, to suggest that a product is intended to “diagnose, treat, cure or prevent any disease” violates the Dietary Supplement Health and Education Act of 1994. Further, to make such claims violates the Federal Food, Drug, and Cosmetic Act. Taken to the extreme, you could be practicing medicine without a license.

Two recent, egregious examples:

The now-defunct MonaVie (sellers of acai fruit juices) claimed that its juices contained large concentrations of phenolics, which were said to prevent or treat such conditions as hypertension, diabetes, and heart disease. Independent laboratories tested the juice and found that it contained fewer phenolics than Mott’s apple juice and Welch’s grape juice, even though it was priced 40 times higher. The Food and Drug Administration (FDA) issued a warning letter to MonaVie. The MLM toned down the claims, but its members did not and continued to promote the juice as a miracle drug.

Essential oil MLM Young Living encountered a similar problem by stating that using its oils in the home infused the household air with disease-fighting and illness-preventing properties. The FDA sanctioned Young Living, but this has not stopped its members from making these claims, and the FDA has collected screen shots from members’ social media accounts as evidence.

While MLMs frequently violate FTC and FDA regulations, that’s far from the only legal trouble they’ve encountered. They’ve also been sued by celebrities for using their images without permission. Anti-aging skin care MLM Nerium International settled out of court with actor Ray Liotta when it falsely claimed that he was a Nerium customer and featured him in advertisements that used doctored before-and-after pictures of his “results” without his permission. (Speaking of Nerium, it contains oleander, which is toxic in small doses. Users have reported skin rashes and other serious side effects.)

Note that the MLMs have a team of lawyers and millions of dollars to survive these legal actions. Its members do not, and the MLM generally will not aid in your defense.

Both of these behaviors (profiting by recruiting and making false claims) mean that the MLM participants are breaking the law even if the MLM itself is not. And both of these behaviors are rampant in MLM participants.

You’ll lose money

Despite the compelling sales pitch, almost no one makes money by joining an MLM. Indeed, the numbers are bleak.

A study of 350 MLMs conducted by the independent research firm Consumer Awareness Institute found that 99 percent of MLM participants lose money. (Jon M. Taylor, MBA, PhD., “The Case (for and) against MLMs.”) The study further found that the net income for the few who profited was insignificant. For example, acai juice MLM MonaVie’s own financial disclosure report from 2007 showed that less than one percent of members earned a commission at all, while ten percent of that one percent earned a commission greater than $100 for the entire year.

And do not believe the company’s claims that its participants earn money. These reports, even when technically accurate, are written to deceive. For example, the FTC found that Nu Skin’s “2008 Distributor Compensation Summary” listed the income for the handful of people who made significant profits but then falsely projected these earnings onto the other participants to show an astronomically high rate of return for all participants. MLMs frequently do this: Take two or three successful participants and then imply that all participants met with similar success.

One reason it’s hard to make money: Overhead is high. To comply with the 70 percent rule, MLMs require recruits to buy large amounts of product, commonly $5,000 as with Lularoe leggings. It’s hard to sell $5,000 worth of leggings to your friends and family.

The real money in MLMs, then, is made by the people who set up the company. That’s not you.

It’s rude

Most of us would sooner pick up a wild-eyed hitchhiker who is brandishing a bloody knife than invite a relative into our home who is making an MLM pitch.

The favorite sales and recruiting tool of the “brand ambassador” is the “party.” Real parties are warm gatherings in which you artlessly spend time with people you like. If you’re selling something, you’re not a host, the attendees are not your guests, and it’s not a party. It’s rude to conceal a business venture in the guise of a social event. Don’t do it.

There’s nothing wrong with selling products or services to someone you know. Indeed, it would be hard to avoid doing this if you own a small business. The difference is: Are you trading on your relationship with this person to manipulate them into doing business with you? If so, it’s unethical.

Even more unpleasant, some MLM recruiters adopt cultish behavior. When I was researching this post, many commenters reported that family and friends had chosen to end relationships when their targets refused to join an MLM. When I left comments on some online posts, MLM participants attacked me with harsh language and fervor usually reserved for defending a political candidate. It was downright disturbing.

To me, this should be enough to dissuade you from joining an MLM.

How to research an MLM

If all of the above hasn’t stopped you from considering an MLM, I hope you’ll at least research the MLM and make an informed decision.

Here’s the best way to do it:

First, don’t bother Googling the name of the company, even if you include “scam” or “fraud” in your search terms. MLMs and their proponents write blog posts with titles such as “I though this company was a SCAM but….” The first three or so pages of your search results will return these phony positive accounts, so it doesn’t help to Google. Further, MLMs tend to bully reviewers by threatening them with lawsuits unless they remove their negative reviews. It’s therefore hard to find any honest accounts of MLMs online.

In general, the Better Business Bureau (BBB) is not helpful—for anything, really. The BBB has been credibly accused of bias toward those businesses that pay membership dues. It’s unlikely that the MLM would have been on the losing side of the BBB’s dispute resolution process, so you’d either find no information at all or an untrustworthy favorable rating. Skip the BBB.

Instead, start with your state’s consumer affairs agency. Their website (and their often helpful staff) will tell you if consumers have filed complaints against the MLM (and they almost always have) and have detailed information on the various scams and frauds that have plagued the state’s consumers. Tennessee’s is the Department of Consumer Affairs at https://www.tn.gov/commerce/consumer-affairs.html, but find yours by visiting your state’s secretary of state’s website and navigating to consumer affairs from there.

While you’re at the state level, ask your state’s attorney general’s office whether the company has been sued by the state. Often, the state’s consumer affairs division is part of the attorney general’s office, but it doesn’t hurt to check both places even if this is so.

Then, go to the federal level. The FTC website has quite a bit of helpful information. In addition to its general information section on scams and fraud and warnings about recent scams (https://www.consumer.ftc.gov/features/scam-alerts), it describes recent and historical complaint cases and their outcomes. Start with https://www.ftc.gov/enforcement/cases-proceedings.

Next, ask yourself (and the recruiter) these questions:

Start with specific questions such as: How long has the company been in business? Who is the CEO? Have there been any complaints? You’re not asking these questions to get the specific information contained in the answers, but you’ll find that the recruiter doesn’t know the answers at all, which is a very bad sign.

Ask for time to consider the written materials. If you’re not allowed to do this, don’t get involved. A legitimate business opportunity is upfront about its numbers and wants you to make a sound decision. It provides its prospective investors with written materials and gives them time to review them. Before you commit, discuss the MLM with a trusted friend or adviser, particularly if the friend or adviser is an accountant or a lawyer.

Think about this: If the product is so effective and therefore profitable, why aren’t the companies that make their profits from selling similar products already selling THESE products? Cosmetic companies, for example, spend millions of dollars per year on research and development, so it isn’t credible that Olay and Neutrogena have failed to develop a certain revolutionary wrinkle cream or bought the rights to sell it, and it doesn’t make sense that stores such as Wal-Mart or Target aren’t making millions from retailing the product.

Because the recruiter is discussing his income with you openly, ask to see his income tax returns from the last year or so. If this sounds odd to you, consider that any other company that would have you be their sales rep would show to you a profit-loss statement, so why not this one? Your recruiter claims to be an entrepreneur and wants you to be one, too, so it’s only fair that you examine relevant financial documents.

If this product is so effective at helping people lose weight or avoid the visible signs of aging, has the recruiter effortlessly maintained a slim figure or an ageless appearance? If not, clearly the product doesn’t work. If you think about it, you may conclude that your cousin or friend appears to be aging at roughly the same rate as the rest of us.

Finally, consider your personality and interests. If you’ve never spent many hours per week successfully selling products, or if you’ve got no experience running a similar business, this may not be the best fit for you.

The truth is, MLMs are profitable for those who own the MLM but not for those who participate in it. The best way to be successful with regard to MLMs is to avoid them entirely.