Saturday, 24 September 2011

The mathematics: why MLM pyramid schemes cannot work!

The Pyramid Structure of Multi-Level Marketing - Why it IS a Scam

MLM's are described as having an inherent basis in a pyramid structure since, for most MLMs, the product is really a just window-dressing to divert attention from the real profit-making dynamic: joining fees selling product internally and distributorships. Now, the product or service may well be good, and, as we discussed in the previous page, it might oversaturate the market at some point, but  the product is not the incentive to join an MLM. If the product were really the focus it would ALSO be sold by other methods, including the traditional stores and online retailers.  In reality, the product is the excuse to create an appearance of legitimate business.
MLM-Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic:
They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure.
There are two tell-tale signs that a product is simply being used to disguise a pyramid scheme: inventory loading and a lack of retail sales. Inventory loading occurs when a company's incentive program forces recruits to buy more products than they could ever sell, often at inflated prices. If this occurs throughout the company's distribution system, the people at the top of the pyramid reap substantial profits, even though little or no product moves to market. The people at the bottom make excessive payments for inventory that simply accumulates in their basements.
A lack of retail sales is also a red flag that a pyramid exists. Many pyramid schemes will claim that their product is selling like hot cakes. However, on closer examination, the sales occur only between people inside the pyramid structure or to new recruits joining the structure, not to consumers out in the general public.
Remember, in order to avoid being classified as an illegal pyramid scam, the MLM MUST try to sell SOME product (or service).  By law, they must derive at least 51% of their income from product or service sales, rather than fees and distributorships in order to avoid being legally classified as a pyramid scam.  That's why each distributor must buy sales kits, trial kits, and sometimes, a certain amount of "product" each month themselves. All to prop up the illusion that the product is the real focus of the company, which is is not.
So in their presentations, they will tell you that there are two career paths: as a seller and as a distributor (or manager). The seller path is just a cover. Notice in their presentations how little time is given to the products, and  how often you hear, "If you can convince eight people to become a distributor and they can convince eight people, and so on, that's how you make the real money."
Of course, the fact that that few people needs this product or service and few people are presently buying similar products available in the market even at lower prices is ignored.  The uphill climb is two-fold.  You'd have to convince 8 people to become distributors, and in order to keep the scheme from being declared an illegal pyramid, everyone would have to sell overpriced product to people who probably aren't even buying much of the lower priced product that is already available in Wal-Mart.

The mathematics: why MLM pyramid schemes cannot work!

In the classic "pyramid" scheme, participants attempt to make money solely by recruiting new participants into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same.
The fraudsters behind a pyramid scheme may go to great lengths to make the program look like a legitimate version of a multi-level marketing program. But despite their claims to have legitimate products or services to sell, these fraudsters simply use money coming in from new recruits to pay off early stage investors. But eventually the pyramid will collapse. At some point the schemes get too big, the promoter cannot raise enough money from new investors to pay earlier investors, and many people lose their money. The chart below shows how pyramid schemes can become impossible to sustain:
This table shows how many new paying members must be recruited at each level for programs (schemes) that require each new member to recruit 4, 5, 6, 7, or 8 new members.
LevelNumber of new members each level must recruit to be profitable. (columns indicate the numbers for requirements of recruiting 4, 5, 6, 7, or 8 new members)
You will notice that the reddish colored cells signify levels that are unachievable because there aren't that many people on earth (approximately 6 billion people)! The orange colored cells signify levels that are practically unachievable: there are no existing companies on earth with this many employees or members.  The yellow colored cellsindicate levels that are mathematically possible, but would mean that the company would be huge by most standards (7,000 to 1 million employees) and this is VERY unlikely. The uncolored cells are levels that are possible and maybe even practically achievable - by really good con men! This does NOT mean that we are recommending  them!!!!
You can see that for most "programs", you'd better have no more than 3 levels of members "distributors", etc.) above you!
For the sake of this example, let's assume that the scheme depends on each participant recruiting 6 new members into the scheme. The figure below shows how many people will need to have joined the scheme at each level, in order for those above to be paid. Since the current total population of the world is approximately 6 billion people, after only 13 levels there are not enough people on the planet to keep the scheme going!  this means if there are 11 or 12 levels of "distributors" or "representatives" (or whatever they call the participants) above you, you can not possibly make a profit!
If a plan offers to pay commissions for recruiting new distributors, watch out! Most states outlaw this practice, which is known as "pyramiding." State laws against pyramiding say that a multilevel marketing plan should only pay commissions for retail sales of goods or services, not for recruiting new distributors.
Why is pyramiding prohibited? Because plans that pay commissions for recruiting new distributors inevitably collapse when no new distributors can be recruited. And when a plan collapses, most people -- except perhaps those at the very top of the pyramid -- lose their money. For information about anti-pyramid laws, see this page.
Nothing irritates a die-hard MLM'er more than the preceding argument. If you point out the absurdity, for example, that if "the pitch" at an Amway meeting were even moderately accurate, in something like 18 months Amway's income would be larger than the Gross National Product of the entire United States.  If you point this out, they will shift their premise and say  "Well, that is absurd, of course. Not everyone will succeed, and so the market will never saturate."
Well, which is it? Are we recruiting "winners" to build a real business, or planning by design to profit off of "losers" who buy into our "confidence"?
During the initial pitch, they will emphasize that anyone can make it work, even if you have no previous experience selling.  "The product sells itself!  Just give them the trial kit!" (oh yes, you must purchase the trial kits, by the way!).  "It's the opportunity of a lifetime.", they'll tell you.

Slowed market expansion

Some modern incarnations of MLMs attempt to address this particular problem by limiting the number of people you can sponsor, say, to four. But the same geometric expansion problems exist; the failure mechanism has just been slowed down a bit. And now there is the added problem of even more unnecessary layers in the organization.
The claim that an MLM is merely a "common man" implementation of a normal real-world distribution channel becomes even more absurd in this case. Imagine buying a product or service in the real world and having to pay overrides and royalties to five or ten unneeded and uninvolved "distributor" layers. Would this be efficient? What value do these layers of "distributors" provide to the consumer? Is this rational? Would such a company exist long in a competitive environment?
The only people who make money in an MLM are the first 2 or 3 levels of the organization, and they do so at the expense of all of those who follow them into the company!

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