Has someone you know tried to recruit you into a “business opportunity?”
It may sound exciting, but since you’re reading this, you may also be concerned it’s a scam or a pyramid scheme. If so, this is your inner skeptic talking, and it can be very useful. Because, while some of these businesses are legitimate, many aren’t.
In this post, I’ll show you what a pyramid scheme is, how they work, and show you what you need to know to protect yourself from these scams.
What Is a Pyramid Scheme?
Pyramid schemes come in different forms and are becoming increasingly difficult to detect as time goes on. This is because dubious companies skirt around the law and avoid prosecution for some time.
However, it’s easy to spot a pyramid scheme when you learn the facts.
According to the official Federal Trade Commission (FTC), the vast majority of pyramid schemes share the following 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.”
The FTC sent a letter to the president of the Direct Selling Association (DSA) in 2004 which sheds more light on what defines a pyramid scheme:
“…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.
Families have been destroyed, financial lives ruined. The only people making amazing money with such schemes are a small percentage at the very top of the pyramid.
The two main identifying factors of a pyramid scheme are as follows:
- The business opportunity is geared and promoted for the primary purpose of recruiting
- The company’s total revenue comes primarily from affiliates themselves
When these two criteria are met, there’s a good chance you’re looking at a pyramid scheme. As I said earlier though, it’s not always simple to identify one.
How Do Pyramid Schemes Work?
The easiest way to explain how a pyramid scheme works is with an example:
- Company establishes the scheme and recruits 5 people who each pay $100 to join
- Each of those 5 people are told to get 5 people, and earn a $20 commission for doing so
- Each of those 25 recruits get 5 recruits and so on, multiplying into a large number of recruits
- Everyone is making money at this point, until recruiting inevitably slows and the scheme collapses
In the above example, no money was made from the sale of genuine products and services.
This is simply one giant recruiting game where people are paying for the privilege of recruiting others. But these schemes must collapse…
Why Do Pyramid Schemes Fail?
Pyramid schemes are a mathematically unsustainable business model because there are only so many people in the world willing to sign up for the same scheme.
This can be a difficult point to get across to a zealous pyramid scheme participant, especially if they have no idea that they are involved in a pyramid scheme to begin with.
But it’s the truth.
At any one time, the vast majority of participants MUST be at the bottom of the scheme to make the small percentage at the top the kind of money they are making.
Affiliates can eventually move up as well but there must be more people to replace them at the bottom in order to feed their success. So by design, there are ALWAYS more participants at the bottom of the pyramid than there are at the top.
This would be fine if there was an infinite number of people on the planet, but obviously, this is not the case (lol).
So, when the maximum number of people have been recruited and growth slows (which is inevitable) those at the bottom have no chance at all to move up the pyramid.
And when that happens they naturally quit the scheme and this triggers the topple of the great pyramid the con artists behind the scheme have built.
It’s really that simple when you boil it down.
Without exaggeration, this is a deceptive scheme designed to sell everyday people false hope and get rich off the back of their failure.
The Sneaky Tricks Used To Disguise These Scams
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 website:
“Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure. Modern 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 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 workaround is extremely common and only serves to act as an elaborate ‘transfer scheme’, masking the pyramid scheme’s true identity.
In this scenario, the people may be buying a product. However, they are primarily doing so to maintain their position and earn commissions from those under them.
So, the products are essentially there to facilitate the scheme, not sell otherwise marketable products to the public.
And this is why multi-level marketing (MLM) companies that require affiliates to purchase products just to “stay active” (very common) are, in my opinion, borderline scams.
Because this is often just a way these companies can reward affiliates with “guaranteed commissions” for recruiting since referrals must buy products to participate in the compensation plan. In many cases, if there was no monthly purchasing commitment, the most successful recruiters would make a LOT less money. Especially since the products some MLM companies sell are overpriced and hard to sell to the public.
Is Multi-Level Marketing a Pyramid Scheme?
No. Multi-level marketing is not an illegal pyramid scheme. And while many come close to being a pyramid scheme, there are some legitimate MLM companies.
In a legitimate 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 companies are legitimate and some clearly fall into the above category of being a pyramid scheme.
Generally speaking, the more product focussed the company is the better. Look for companies where a large portion of the profits are being generated from the sale of genuine products and services to retail customers.
Pyramid Schemes vs Ponzi Schemes
Many people get confused about the difference between a pyramid scheme and a Ponzi scheme, and this is likely because the two schemes are very similar.
But there is a clear difference: Ponzi schemes are not hierarchical in nature and do not require recruiting. They can, and often do have a recruiting element, but this isn’t essential for the scam to operate as it is with a pyramid scheme.
A typical Ponzi scheme involves an investment into a somewhat mysterious operation promising higher than average ROIs. The con artists behind these operations do not invest the capital into the market. Rather, they use the funds from new investors to pay off existing investors when they want to cash out.
This can work for a while. But once it becomes difficult or impossible for the scammers to pay out existing investors the scheme starts to fall apart. And this is often when the people behind it take off with whatever money they can and leave investors penniless.
How To Detect a Pyramid Scheme
In order to avoid a pyramid scheme, the first step is to figure out what one is, which this post is designed to help you with. And once you know what to look for, the best defense is to ask the right questions if someone is trying to recruit you.
For example, ask the recruiter (and yourself) the following questions:
- How marketable are the company’s products to non-affiliates? In particular, consider the (actual) quality of the product and the price.
- Are you being encouraged by your sponsor to focus heavily on recruiting? A common red flag is someone asking you to recruit people you know.
- Does the majority of the companies revenue come from affiliates trying to ‘stay active’ and grow their downline? This can be hard to know, but worth considering.
- Can the claims the company makes about its products be supported with third-party research? There’s often lots of hype surrounding MLM companies and pyramid schemes, so it pays to do your research to figure out if the products are genuine.
- Are you directly benefiting from the number of people you recruit, rather than selling tangible products? Consider how much you could potentially make if you never recruited anyone into the business, but instead focused on selling the product. In a pyramid scheme, it’s often very difficult to make money without recruiting.
These questions should help you get to the bottom of whether or not an MLM company is genuine or a pyramid scheme. And if the person recruiting you doesn’t want to answer these simple, yet important questions, that could be a red flag.
The ‘Rah Rah’ Brainwashing
Many pyramid schemers convince people that, in order to succeed, you must not listen to the “haters and dream stealers.”
The tricky part is that there is SOME truth in this. As an entrepreneur, it is important to follow your dream and not let those around you drag you into a negative and mundane way of thinking. Otherwise, it can be difficult to achieve your goals.
However… when it comes to pyramid schemes, they are using this truth to hide their real intention and stop you from seeking the truth. In my experience of having joined an MLM company, which I suspect might’ve been a pyramid scheme, it’s almost like being in a cult.
They want you to “believe” in their company without questioning anything so that you don’t learn all the facts. The facts about why the scheme is unethical, oftentimes illegal, and unsustainable. Not to mention, that it fails the vast majority of people.
I found this video to be very thought provoking. It paints a very clear picture of how pyramid schemes can appear legitimate when the reality might be very different.
Pyramid schemes are fraudulent and often illegal schemes that only benefit the small percentage of participants 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, at some point in the future, it will collapse.
What’s a better alternative?
There are many legitimate business models but the best alternative to multi-level marketing or pyramid schemes is affiliate marketing.
In short, affiliate marketing is where you earn commissions selling other company’s products. So, in that way, it’s similar to MLM. However, the difference is that with affiliate marketing, you can promote ANY product you want and you never have to recruit anyone.
For example, you can join the Amazon affiliate program for free (it’s called Amazon Associates) and promote any of their millions of products. And when someone buys a product through your affiliate link, you earn a commission.
That’s just one example, there are many companies you can work with as an affiliate. And the best part is, you don’t have to recruit anyone. With affiliate marketing, you only get paid a commission on the products you promote, not on “multiple levels” of people you recruit.
It’s a much better, more ethical business model. And in my experience, it can be far more profitable because you can market competitively priced products online instead of pitching overpriced health products (for example) to family and friends.
I’ve put together a complete beginner’s guide to affiliate marketing that you may find helpful if you want to learn more. In it, I walk you through how the entire process works and how I’ve used this business model to eke out a living online.
I’ve also published a detailed comparison between affiliate marketing and MLM. So if you’re interested in learning more about the differences, I recommend checking that out.
Anyway, thanks for reading; I hope you found this helpful.