Network Marketing, Pyramid Schemes, and Business, Part 2

In my last article, I wrote about conventional business – using a pyramid structure (again, lowercase ‘p’) in its construction – and Ponzi schemes.

 

As a quick recap, businesses typically build in a pyramid structure, with higher levels in the structure carrying more responsibility in the company, and typically receiving better remuneration.  This is usually done in branches, and if you place them all together on paper, it ends up looking like a pyramid.  As a general rule, businesses would collapse if they were not run this way, and so the structure remains.

 

Ponzi schemes generally rely on a single “investor” or “investment firm” of some kind promising large returns to any who will invest with them, and pay the original investors with money from the new investors, with the core “investor” taking a small cut each time.  This can go on until they are being required to pay out more than the new investors are paying in, at which point the whole scheme collapses.

 

Now, with that out of the way, let’s move on to Pyramid (capital ‘P’) structures.  What makes this different from a business with a pyramid structure or Ponzi scheme?

 

Contrary to a Ponzi scheme where a single party acts as the hub for the whole thing, a Pyramid scheme relies on “investors” signing new people up below them in the structure, being told that their return will come from this.  The way this form perpetuates is that the initial “investor” will recruit other people to “invest” with them, charging a fee for this privilege.  Each new “investor” is now invited to repeat the process with more people, while sharing a portion of their profits with the level above them, all the way to the top.  These new invitees are then are invited to find more people who… well, you get the idea.  No product or service is genuinely produced, and this is the key issue.  As nothing is produced, this can only perpetuate as long as new people are found, after which point profits dry up, and the perpetuator(s) either disappear or are arrested.

 

This usually has a shorter lifespan than a Ponzi scheme as it requires an exponentially growing base of members, while a Ponzi scheme more often will rely on repeat investors, keeping the required number of victims at a relative minimum.

 

Another way that a Pyramid scheme can operate is by “selling” a product or service with extremely little or no monetary value (examples include mailing lists, or some kind of report), typically only to members of the structure (i.e. it is nearly or completely impossible to charge money for these products or services outside the Pyramid organization as few people – or none – would pay for them).  This version closely resembles the operational approach of MLMs, often including similar approaches to how money is distributed (“those that do the work get the pay”, or you only get a percentage of the group volume below you by some calculation or other, etc.), except that again the vast majority of the money comes from new sign-ups, and very little or no money comes from outside the structure, as the product or service is essentially bereft of monetary value.  This last part is the primary, most important difference between a Pyramid scheme and an MLM.

 

Finally, MLMs.  Many have called MLMs Pyramid schemes… and in some cases, they’re right (see the above paragraph).  One of the key differences an MLM carries is that it’s possible to earn a reasonable income through product sales outside the structure.  Essentially, being a salesman of whatever goods or services the MLM offers, which therefor must have some monetary value to the target market (examples include various health products, makeup, hygiene products, leadership training, and so on).  Typically, the profits will be a mix between sales profits (either through markup of products sold to individuals or companies that are not members of the MLM or from commission from such sales, or both) and a profit sharing structure that often gives people the impression that they are being suckered into a Pyramid scheme (e.g. once one “team” reaches a certain size, you begin gaining a certain percentage of the total profits or revenue from it).

 

If it is properly set up, however, an MLM can be completely legitimate, and many such do exist.  One difficulty with them, however, is that to see it fully, one must stop thinking in terms of employment (as a great many of us think) because there is no employment occurring.  Joining an MLM is not employment, at least not in the same way that getting hired as a salesman is; it is a form of business ownership, and thus carries some of the same risks as starting any business does, only usually the start-up cost and operating cost are orders of magnitude smaller than a conventional business, and the business model is presented to you instead of created by you.  This is another part of why many consider these to be scams, yet would not consider a 100% commission job as one.

 

Regardless of which of these led you here, look well into the opportunity presented to you.  On the one hand, it may look like “one of those things”, a Pyramid scheme that will disappear with hundreds or thousands of your dollars, or it may be completely legitimate, and you could be missing out on something massive by refusing it!

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Network Marketing, Pyramid Schemes, and Business (Part 1 of 2)

Anyone who has either been in or been invited to a network marketing (or multi-level marketing, if you prefer) company has likely either seen it compared to a Ponzi or Pyramid scheme, or made that comparison themselves.  When the claim is made, no doubt the person making the invitation quickly moved to defend their position, and how their particular model does something differently, making it “not a Pyramid”.

But is it true?

To answer this, first we need to know what a Ponzi scheme is, what a Pyramid scheme is, and how network/multi-level marketing is or claims to be different.  I will do this in two parts as even when giving only the general overview, there is a good bit to say.  Today, I’ll cover “conventional” business and Ponzi schemes, while in a future article, I’ll cover Pyramid schemes (note the capital ‘P’) and Multi-Level Marketing, or MLM; until then, stay tuned, as the conclusion will come at that time!

As a foreword, it is important to note that I am here giving only an overview; there are details being omitted because it would be possible to write [at least] a book on each subject, never mind a comparison of all these!  

First, I need to describe, in general terms, our typical corporate structure as a baseline.  Virtually every corporation today is built with a pyramid (small ‘p’) structure.  A pyramid structure is where for each person in the structure at a given level, there will be a notably smaller number of people above that level.  The higher you go, the more responsibility each person has over the work of those below.  Generally, they will have higher pay for this additional responsibility, and the only way to move up the structure is for someone to vacate a spot above.  In this model, all profits come from – or are supposed to come from – investors paying into the building of the entire structure with a promised return in the future, and payment from customers in exchange for a product, service, or both.

This is what one might call “conventional” business.  It works, make no mistake, and that’s why it’s still around.  When most of the structure is little more than the construct of the mind of the founder, it is a high risk venture, usually because the founder is not an expert at providing the product or service that is planned.  However, if they can make it far enough that they can construct their corporate structure to the point where they are no longer doing any of the work, eventually they can check out from there.  This is a long term process, and quite frankly, it is very fair, as the one or ones who did all the up-front work and took all the up-front risk is/are the one(s) rewarded for it the most.

If someone approaches someone with a “business idea”, this is one of the legitimate things they may be intending.

Ponzi schemes can sometimes be harder to catch early on.  Made famous by Charles Ponzi in 1920, the general idea of a Ponzi scheme is that money entering from new “investors” (members, etc.) is used to pay for those who got in earlier.  There’s no particular structure to this effect, at least not regarding those who are investing into it; it’s simply that those who get in earlier are more likely to get a payout… and invest again.

It’s worth noting that sometimes, the offer is legitimate; this investor knows of an upcoming opportunity but simply lacks the capital to make good use of this opportunity, and turns to the public to raise that capital.  He takes a cut of the profits – indicating that he will from the very beginning – and they keep the rest of the profits from what he invests.  It’s a win-win… if it works.  Sometimes, however, the market is unforgiving, and something happens that the would-be investor did not anticipate, and loses some of the money, or the returns are quite up to par with what he promised.  When his happens, he can either own up to his failure, or he can turn to the Ponzi model.

An example similar to this is Bernard Madoff, who ran a reportedly legitimate investment company until the 1990s, when he simply stopped investing.  At that point, as the company no longer generated profits from the market, the asset management division of the company because one of the largest reported Ponzi schemes ever seen.

Regardless of how the scheme starts, sooner or later it reaches an end when there no longer is enough money coming in from new sources to cover those cashing out.  Sadly, our own governments here in North America technically run such a scheme, only they call it “CPP”, “QPP”, “Social Security”, etc.  The intent of the scheme is not what makes it so, but instead the method through which money is gathered and payouts are made.  If new investors are the only way an “investment” is funded, this is the category it falls under.

Inevitably, the whole structure will fall apart, as every new “generation” of “investors” requires more than the last in order to keep it going.  The larger it is, however, the longer it may perpetuate, especially if the returns are not astronomical, or some condition prevents massive payouts (in the last examples, the relatively small payouts and late date at which these payouts can be gathered may keep them going a long time, but the fact that all over far over budget is indication enough of this issue).

Not all is always at it seems, then.  Investment scams always exist, and it is generally best to make sure you know where the money is going before you ever buy in.  If it is going into legitimate investments, ones you can track, then the only red flag would be promised returns.  As for business, venture at your own risk… and potential profit.