To many, the American Dream might only be a multilevel marketing company away. Take a closer look, though, and multilevel marketing doesn’t seem like a dream many people would want to have.
MLMs are legal, but it’s often difficult to distinguish them from pyramid schemes, a term the Direct Selling Association calls a “scarlet letter” for an industry that rose to $36 billion in retail sales in 2015.
“‘Multilevel marketing’ is not synonymous with ‘pyramid scheme,'” Joseph N. Mariano, the president of the DSA, told The New York Times last year. “The former is an accepted, lawful method of marketing consumer goods and services. The latter is an illegal business operation that should be prosecuted to the fullest extent of the law.”
While that’s true, people pondering buying in to a multilevel marketing business should give it careful consideration, even if they are desperate—or especially if they are desperate. They could end up losing what little money they have.
How Do Multilevel Marketing Businesses Make Money?
Here’s how pyramid schemes work: the company recruits distributors who make more money by recruiting other distributors than they do by selling the products.
Here’s how most MLMs work: see above.
The Federal Trade Commission advises: “Avoid any plan where the reward for recruiting new distributors is more than it is for selling products to the public. That’s a time-tested and traditional tip-off to a pyramid scheme.”
That advice hasn’t stopped the growth of MLMs that operate like pyramid schemes. Here’s a big reason why: The FTC set a standard in 1979 when it ruled that Amway was a legal business—even as they determined that the company was guilty of price fixing.
While that set legal precedent for MLMs, they have been in legal trouble ever since. Most recently, Herbalife paid $200 million dollars in July 2016 to settle charges brought by the FTC, which said in its ruling that Herbalife’s “compensation structure was unfair because it rewards distributors for recruiting others to join and purchase products in order to advance in the marketing program, rather than in response to actual retail demand for the product, causing substantial economic injury to many of its distributors.”
The word pyramid did not appear in the complaint against Herbalife, but when asked about it, FTC Chairwoman Edith Ramirez said the agency wasn’t focusing on the label and added: “They were not determined not to have been a pyramid.”
Anyone who remembers learning about double-negatives in school knows that the teacher would have edited that confusing sentence like this: “They were not determined not to have been a pyramid.”
Who Benefits Most from MLMs?
MLMs seem unlikely to be declared illegal anytime soon, but there’s a famous argument in Latin that supports their cause: caveat emptor. What sets apart MLMs from other businesses, though, is that the buyers who need to beware aren’t the buyers—it’s the distributors. Those are the real customers of these types of MLMs. They often pay startup costs and membership fees, and they purchase the product in bulk. If they can’t sell the product or recruit people into their personal selling web, the MLM has already taken its profit.
MLMs entice distributors with the promise of wealth and the freedom of being their own bosses without needing much money up front, and regardless of education and experience. It’s aspirational.
That’s another clear signal of who the real customer is, especially considering that the products MLMs sell are ubiquitous. Is Amway’s dish soap better than the dish soap you can buy in any grocery store anywhere in America? Why would someone prefer to buy skincare products from Rodan + Fields rather than any of the stores in the mall? How much more energetic are AdvoCare’s energy drinks than the ones in the cooler at every gas station?
In many cases, the products are almost irrelevant. MLMs remain attractive to some people because they are selling more than that.
“They sell hope to people in need,” says Robert FitzPatrick, who wrote a book on multilevel marketing, serves as an expert witness in court cases against MLMs, and is the president of Pyramid Scheme Alert. “For people to make money here, other people have to lose money. It’s a win-lose proposition.”
One of many examples of that win-lose proposition came in 2009, just after the recession, when Ideal Health became the Trump Network.
“Oh, my god, people cried when they heard it was him,” Jenna Knudsen, who had been a high-ranking saleswoman there, told the Washington Post. “They cried and looked at each other and said, ‘We’re going to be millionaires!’”
Membership quadrupled the first year but the company, which sold vitamins and urine tests, turned out to be a lose-lose for almost everyone. Trump’s licensing contract ended in 2011, and the owners filed for bankruptcy. Bioceutica, another MLM, bought the business.
Look around and you’ll find many similar MLM stories. HBO’s John Oliver recently did a takedown of the industry and highlighted many other horror stories, as well as some of the more disturbing business practices that go way beyond caveat emptor. One of Oliver’s main targets was Herbalife, but his report didn’t seem to dent the company. Herbalife’s stock price rose after it aired.
What’s Does the Future Hold for MLMs?
Despite all the bad press, the trajectory of MLMs keeps rising. One reason is that they are effective at marketing hope through their success stories, which are difficult to verify. Rodan + Fields touts the white Lexus they give to each of their stars. Lore Cardella drives one of them. She did not respond to a request to be interviewed for this article, but in 2015 she made her six-figure success seem easy in an interview with Allure. “I went out and introduced the products to about 50 people,” she said, “and they went out and introduced the products, and it grew exponentially.”
Cardella said she became wealthy while still having plenty of time for her family in less than five years. Allure reported that she “has thousands of people on her team, says 95% of her income comes from commissions on their sales and only about 5% from her own.”
But not everyone who goes into MLMs sets their goals as high. Some people just want to make a little extra money on the side with a venture that fits their schedule and family demands. The DSA reported in 2009 that the median annual income in direct sales was $2,400. (The DSA did not respond to a request for more recent information.)
Bottom Line: Tread Carefully
Even with modest goals such as that, it’s worth being cautious. Jon Taylor, who wrote a free e-book called “Multi-Level Marketing Unmasked,” says he has studied MLMs for two decades and analyzed the compensation plans of 600 MLMs. According to his research, 99% of people lose money.
“Losses far exceed those for classic no-product pyramid schemes,” he said.
The FTC says that it’s important for people considering buying into an MLM to get all the details. They advise people to evaluate the products and payment plan, learn as much about the company as possible, and ask tough questions. (For more information, see the FTC’s complete guide for navigating MLMs.)
But FitzPatrick offered what might be the best tip of all….
“MLM has many success stories—for the owners,” he says. “Starting an MLM can make you a billionaire. I don’t know the success rate of those schemes, but to make money, you have to start at the top. There’s no way to lose then.”
Fundera is here to support all entrepreneurial endeavors. If you are considering becoming a distributor for an MLM, we recommend the following:
- Do as much research on the company as possible to ensure they are legitimate.
- Make sure you do not make more money recruiting other distributors than selling the product.
- If there is a large upfront cost, be sure to evaluate this investment carefully. Not all MLMs will require this, but for those that do, you want to make sure and evaluate the pros and cons of investing in this venture versus elsewhere.
- Keep in mind that the success stories you hear didn’t happen overnight. There really is no way to get rich quick. They worked incredibly hard and made many sacrifices along the way—just as all entrepreneurs do!