Have you ever been curious about the difference between a multilevel marketing (MLM) company and a pyramid scheme?
It’s really important to know that MLMs are legitimate and respected businesses that use network marketing, while pyramid schemes are dishonest scams designed to take money from people who aren’t aware.
In this article, we’ll look into the key differences between MLMs and pyramid schemes to help you understand them better.
Table of Contents
What is an MLM and How Does It Work?
Multilevel marketing, or MLM, is a unique business model where a company sells its products through a network of independent sales representatives. Each representative essentially runs their own mini-business within the larger company.
Here’s how it works in a more straightforward way:
Individual Sales: MLM reps buy products at a discounted rate from the company and then sell them to their customers at a profit. Some reps make a decent income just from selling these products.
Recruitment: However, the main twist in MLM is the recruitment aspect. Reps are encouraged to recruit others to become representatives as well. When they successfully bring in new recruits, they earn a commission from the sales made by those recruits.
Building Levels: As these new recruits bring in more people, a multi-level structure is formed. Each level represents a layer of recruits. This is why it’s called “multilevel” marketing.
Commission Cascades: As you rise through the ranks and recruit more people, you earn commissions not only from your direct recruits but also from their recruits and so on, creating a cascading effect.
In essence, MLM relies heavily on recruitment, and the more levels deep you go, the more potential income you can earn. However, it’s important to note that MLMs have faced criticism and controversy because not everyone at the lower levels makes substantial money, and some people may end up losing money.
Read more: What Is an MLM?
What is a Pyramid Scheme and How Does It Work?
A pyramid scheme is a deceptive scheme where a supposed marketing company promises you substantial profits if you bring in new people to join the scheme.
Pyramid schemes often pretend to be real companies selling stuff. They might even have products or services to show.
But here’s the catch – they’re obsessed with getting more people to join, not with selling things. New recruits are called various names like investors, salespeople, agents, or distributors.
In a real business or MLM, you earn money by selling products or services. In a pyramid scheme, you make money by recruiting more and more folks, not by selling actual stuff.
Usually, if you get involved in a pyramid scheme, you’ll have to pay fees and buy lots of their products each month, whether you want them or not. They don’t care much about selling these products.
It all starts with a few people convincing others to join their “business.” These newcomers have to invest money, pay fees, or buy stuff from the scheme each month.
The people at the top – the ones who started it all – make loads of money. How? They collect fees and commissions from all the folks they recruited. And those folks recruit more people below them, and it keeps going like that.
The name “pyramid” comes from the shape of this scheme. Picture it like a pyramid where a few at the top make the most money by getting lots of people below them to join. Meanwhile, those at the bottom end up losing money because it’s nearly impossible for everyone to recruit enough people to make a profit.
So, pyramid schemes are all about recruiting, not real business, and they’re not only unethical but also often illegal.
Read more: What is a Pyramid Scheme?
MLM vs. Pyramid Scheme
Even though MLM and pyramid schemes might seem similar at first glance, they’re actually quite different. Let’s break down these differences to help you make smarter choices.
- Legality: The biggest difference is whether they’re legal or not. MLM is legal in Canada and most of the United States, while pyramid schemes are against the law. Taking part in a pyramid scheme can get you in trouble in Canada, and you might end up in jail for up to five years.
- Focus: MLM and pyramid schemes have very different goals. MLM is all about selling products to both regular customers and other people involved in the MLM. If you’re working as an MLM consultant or distributor, you make money by selling products to customers, including those who are a part of your MLM group. The main idea behind MLM is to sell products, and the bigger your network of distributors, the more products can be sold.
In addition to making money from your own sales, you can also earn a part of the money made by the distributors you’ve brought into the program – this is called your “downline.” MLM companies often give out bonuses based on specific sales goals or recruiting new members, and these bonuses can include things like cars, trips, and cash rewards.
On the flip side, a pyramid scheme’s main goal is to get money from participants and then pressure them into getting others to join. Unlike MLM, pyramid schemes are only about recruiting people, not about selling products. In fact, pyramid schemes might not even have real products or they might offer low-value items just to seem legitimate.
Types of Pyramid Schemes
1. Poorly Designed MLMs Turned Pyramid Schemes
Some multi-level marketing (MLM) schemes, when poorly structured, can transform into pyramid schemes. These schemes rely heavily on recruitment to sustain themselves, often making it impossible for members to profit without continually bringing in new participants.
2. Investment Clubs
While legitimate investment clubs help people pool money for investments, fraudulent ones operate like pyramid schemes. They prioritize recruiting new investors over legitimate investments, promising fast returns. Participants who’ve profited are urged to create their own clubs, inviting friends and family to join, with promises of compensation for recruiting others.
3. Chain Emails
These digital pyramid schemes masquerade as “chain mail” and promise participants quick cash. Participants send money to the first person on a list, remove that name, add their own to the bottom, and forward the email to others, encouraging them to do the same. This illegal version of the traditional pyramid scheme is highly deceptive.
4. Fortune Hi-Tech Marketing
This scheme hired agents to sell products from legitimate companies such as Dish Network and Frontpoint Home Security, as well as health and beauty products. Salespeople earned more from recruitment, while annual fees lined the pockets of higher-ups.
The company settled a lawsuit with the FTC, repaying over $5.5 million to nearly four hundred thousand deceived individuals.
5. BurnLounge Inc.
Founded in 2004, BurnLounge Inc. claimed to make “store owners” wealthy by opening online storefronts. Participants paid subscription fees and were compensated in points redeemable for BurnLounge products.
They also earned bonuses for recruiting new members. However, the FTC eventually shut down this scheme, reimbursing consumers who lost money with checks totaling almost $1.9 million in 2015.
How To Identify and Protect Yourself From a Pyramid Scheme
Pyramid schemes can be tricky, masquerading as legitimate chances for business success. But with a little awareness and the right questions, you can shield yourself from falling into their trap.
1. Review Company Info
Dig into the details of a business opportunity. Look at their brochures, business plan, and marketing strategies. Genuine multi-level marketing (MLM) companies provide clear information about their products, payment plans, and target customers. If something seems vague or misleading, be cautious.
2. Ask Those in the Know
Connect with people who have experience with the MLM company and its products. Chatting with them can help you figure out if the products are actually being sold and if they’re up to the promised standards. Honest advice from those in the loop will help you judge the opportunity’s authenticity.
3. Check the Better Business Bureau (BBB)
Do some research on the company using the Better Business Bureau’s website. You’ll find complaints and ratings based on customer experiences. If there’s a history of unresolved issues or a low rating, think twice or explore other options.
4. Be Alert at Recruitment Meetings
At MLM recruitment sessions, listen carefully to what the representatives are saying. Be cautious of over-the-top promises of huge profits, as these might be signs of a pyramid scheme. Legitimate opportunities focus on steady growth and profitability, not quick schemes for making money.
Questions to Ask Before Joining an MLM
In case you remain uncertain about the authenticity of a business opportunity, ask yourself the following questions:
Do they ask for a big upfront payment to become a distributor?
Real MLM businesses don’t ask for large starting fees disguised as inventory charges. Be careful if they request this.
If you have to buy inventory, can you get a refund for what you don’t sell?
Legitimate MLM companies usually let you return unsold inventory and refund around 80% of what you paid. This helps you avoid financial strain.
Do they talk about the demand for their products or services?
MLM relies on having customers interested in their products. If the company isn’t focused on meeting customer demand, think twice about joining.
Are they more focused on getting new recruits than selling?
MLM and pyramid schemes differ in focus. MLM sells products, while pyramids profit from recruiting. If they’re mainly focused on recruiting, it’s better to stay away.
Are they paying you mainly for getting new members?
Pyramid schemes often do this. Legit MLMs pay based on product sales, not just recruiting.