I’ve come across a few suspect pyramid schemes in the course of my reviews recently so I thought it’d be a good idea to put together an article explain what they are and how to spot one.
What Is a Pyramid Scheme?
Pyramid schemes come in many different variations and are becoming increasingly difficult to detect as time goes on. While there may be a fairly clear cut definition, the amount of companies that know exactly how to skirt around the law and continue operating untouched is staggering.
According to the official Federal Trade Commission (FTC) website the vast majority share this 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.”
Also, in a letter sent from the FTC to the president of the Direct Selling Association (DSA) in 2004:
“…a multi-level compensation system funded primarily by payments made for the right to participate in the venture is an illegal pyramid scheme.”
This kind of investment/ marketing fraud damages the economy and everyday people in a very real and sometimes devastating way. The only people making a full time income (or better) are a small percentage at the top of the pyramid.
The 2 main identifying factors of a pyramid scheme are:
- The business opportunity is geared and/ or promoted for the primary purpose of recruiting new affiliates into an affiliates downline
- The company’s overall revenue is being generated primarily by affiliates themselves in order to participate in the scheme as oppose to legitimate product sales to non-affiliates
When these two criteria are met, there’s a very good chance it’s a pyramid scheme. As I said earlier though, it’s not always that simple to identify them.
In their most basic form these schemes are really quite simple, here’s an example of how a very clear cut pyramid scheme works:
- Company establishes the scheme and recruits 5 people directly who each pay $100 to join after being promised a life changing opportunity
- Each of those 5 are told that if they go out and get 5, they’ll make a $20 commission per direct recruit and a little less from the efforts of those under them, several levels deep
- Each of those 25 now go out and get 5 and so on, multiplying out to a very large number of people starting with just 5 who get 5
- Everyone is making money at this point, until recruiting inevitably slows… then it collapses
In that example there have been no sales coming from the sale of genuine products and services. The original affiliates have been paid a portion of the $100 membership fee that their new recruits paid to join the same scheme. In other words, money is only ever being made when new recruits sign up.
Why Do They Collapse?
This is a mathematically unsustainable business model because there are only so many people in the world willing to sign up to the same scheme.
At any one time the vast majority MUST be at the bottom of the scheme to make the small percentage at the top the kind of money they are making. Yes, affiliates can eventually move up as well but there will always be more people replacing them at the bottom to feed their success.
That would be fine IF there was an infinite number of people on the planet, but obviously this is not the case. When the maximum number of people have been recruited and growth slows (absolutely inevitable) the ones at the bottom have no chance at all to move up the pyramid.
When that happens they naturally quit the scheme and thus starts the topple of the great pyramid these con artists have built.
It really is that simple.
Without exaggeration this is a deceptive scheme designed to sell everyday people false hope and get rich off the back of their failure.
The Tricks Being Used To Disguise Them
There are many different ways companies attempt to fool authorities and the general public into believing they are not actually such a scheme. This has made it increasingly difficult to detect and remove them from the marketplace.
According to the FTC:
“Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure.”
“Modem pyramid schemes generally do not blatantly base commissions on the outright payment of fees, but instead try to disguise these payments to appear as if they are based on the sale of goods or services. The most common means employed to achieve this goal is to require a certain level of monthly purchases to qualify for commissions.“
This clearly indicates that just because a company is giving people a product to buy and sell does not mean it’s legitimate and free from being classed as an illegal pyramid scheme.
This kind of work around is extremely common and only serves to act as an elaborate ‘transfer scheme’, masking it’s true identity.
In this scenario the people may be buying a product BUT they are primarily doing so to maintain their position and earn commissions from those under them. Certainly sheds light on the concept of many companies requiring a certain amount of money to ‘stay active’.
This is just a way companies can reward those with guaranteed commissions from recruiting. If commissions were made from sales of products, which they must be according to law, then if there was no monthly purchasing commitment the recruiters would inevitably be making a LOT less money. A lot less people being recruited would be buying product in a lot of these companies because a lot of the time the products are overpriced and hard to sell to the public.
Think about it.
Is Multi Level Marketing An Illegal Pyramid Scheme?
Multi Level Marketing (mlm) in itself does not constitute an illegal pyramid scheme as described above. In a legit mlm you do not have to recruit others to be in business and make money and can sell products to create a decent income. The focus of a legitimate mlm MUST be on the sale of marketable products first and foremost if it is to be sustainable.
However, not all mlm’s are legitimate and some clearly fall into the above category of a pyramid scheme.
Generally speaking, the more product focussed the company is and the more profits are being generated by affiliates selling to the public rather than ‘paying to play’, the more legitimate the company is and less likely it is to be considered a pyramid scheme.
This business model, while not necessarily illegitimate in itself, comes with it’s own set of drawbacks though.
Difference Between Pyramid & Ponzi Schemes
Ponzi schemes are very similar in nature to a pyramid scheme except they are not hierarchical in nature and do not require recruiting.
They typically involve an investment into a somewhat mysterious operation promising higher than average ROI’s. The con artist behind the operation does not invest the capital into the market, but rather use the funds given to them by new investors to pay off old investors when they want to cash out.
Once it becomes difficult or impossible to pay out existing investors the scheme starts to manifest itself, this is where the con artist takes off with whatever they can and leaves his investors high and dry.
Some Thought Provoking Questions
In order to protect yourself and those you care about from falling victim to a potential pyramid scheme here’s some important questions to ask yourself and whoever is trying to recruit you:
- How value adding, competitively priced and overall marketable are the companies products to non-affiliates?
- Are you being encouraged by your up-line and the company itself to focus on recruiting?
- Is the majority of the companies revenue coming from those not affiliated with the company or those trying to ‘stay active’ and grow their organisation?
- Do the claims the company make about their products have unbiased third party research to supporting them?
- Are the majority of people at least a reasonable kind of profit or failing?
- Are you directly benefiting based on the number of people you recruit as oppose to sales volume based on the sales of goods and services to the public?
Never, and I mean never, allow some guru recruiter to convince you not to look for the truth. If they do not want to answer these simple yet important questions, run for the hills.
The ‘rah rah’ Brainwashing
They often convince people that in order to succeed you must not listen to the ‘haters and dream stealers’. The sad part is there always seems to be a small amount of truth in a lot of the statements these schemers tell people which makes their deception much harder to detect.
Yes, as an entrepreneur it is monumentally important to follow your passion and not let those around you drag you into a negative and mundane way of thinking.
When it comes to pyramid schemes they are using this truth to foster their real intention.
Their real intention is to to get people to ‘believe’ in their company so that they don’t learn all the facts. The facts about why it is an unethical, often times illegal and unsustainable scheme that fails the vast majority of people.
I found this video to be very thought provoking and in my opinion paints a very clear picture about how pyramid schemes appear to be legit when that’s simply not the case:
Pyramid schemes are a fraudulent and (in most cases) illegal scheme that only serve to benefit the a small percentage involved at the very top of the pyramid.
Whichever way you look at it, this is not a sustainable or ethical way of doing business and guarantees that the majority of affiliates make little to no profit despite their hard work. The very construct of this scheme guarantees that the majority of people make little-no money and at some point in the future, will collapse completely.
If someone you know is trying to recruit you into one, they may not know the depth of the scheme they are getting involved with themselves and what they are dragging you into. It may very well be up to you to save them and yourself.