Articles published on my business blog

Thoughts about multi-level marketing

May 19, 2012

When I was taken to court in 2005 by a multi-level marketing company (which was annoyed at my mentioning that the Federal Court of Australia had found them to be operating an illegal pyramid scheme) I had to prepare an extensive affidavit in reply. As part of that affidavit I had to put down some thoughts about why I don't like multi-level marketing schemes. This is what I wrote. (I have retained the legalistic style of writing.)

I have always been suspicious of multi-level marketing schemes. In my view they almost never represent real business opportunities for participants at lower levels. There is thus a real need created on the part of participants to advance to the next level and this need can, in my view, almost lead to the same kinds of consequences as an addiction, with people becoming obsessive about the people-recruitment aspects of their "business" and the objective of advancing to a higher level to chase an ever attractive prospect of better returns. These views derive from what I see as the following classic elements of all such arrangements:

1. It is extremely difficult to obtain a viable customer base for direct sales. With sales commissions for direct sales typically in the range of 0.5% to 1% (and even less in some cases or with some product mixes) a very large volume of sales dollars is necessary to make a good living. If customer acquisition techniques such as cold-calling, advertising and the purchase of leads are not allowed then it would seem to be almost impossible to make a good income from direct sales alone. In my business, which is software sales and support, the typical discount from recommended retail price to wholesale price is 20% and there are no restrictions on how customers are acquired, serviced or charged. Even then, quite large sales volumes are required for commercial success.
2. To get around the problem of finding customers, it is suggested that participants recruit others to act as their agents or subcontractors to find more customers. The problem is that this is simply finding competitors for yourself, as the pool of potential customers remains the same. The people at this next level down are in the same situation with regards to customer acquisition so they are in turn encouraged to recruit competitors, and the cycle continues.
3. The mathematical concept of geometric progression has been known for a long time, and it applies a limit to the expansion of any multi-level marketing scheme. I have been told on several occasions that it is trivially easy to recruit five people per month to serve in a downline. Anyone starting out on the first of January in any year who managed to build a network of people who only ever recruited five people each in total themselves (not five each month) and where this recruitment rate was continued down successive levels would have the entire population of Australia working for them by November (they would not reach the full November target because the population would have been exhausted).
4. Participants in these schemes do not have the status of employees in a normal business, and have none of the prospects for promotion, job variety or employee benefits that employees usually enjoy. The only way they can advance is to rise higher in the matrix of "independent business operators".

I would like to emphasise that the problem of financial viability applies to the people brought in at lower levels who are invariably led to believe that they are establishing independent commercial businesses. It does not necessarily apply to the organisations and corporations who construct and manage these schemes. These can be very sound businesses indeed. When Jay Van Andel, one of the founders of Amway, died he was worth $US2.3 billion and was ranked as the 231st richest person in the world.

It is also necessary to point out that, despite what many people seem to think, a multi-level marketing scheme is not necessarily legally a "pyramid" scheme. The laws of various countries (in Australia the Trade Practices Act 1974 and its successor, the Competition and Consumer Act 2010) set out definitions of what constitutes a pyramid scheme and companies generally try to stay just within the boundaries set out in the law. They usually run into difficulties when addressing point "a" above as they attempt to increase the potential income of participants in the lower levels. One way is to increase the commission percentages as people get higher in the matrix (which is contrary to the practice in normal sales operations, where the highest commission goes to the person actually making the sale). Another is to pay bonuses based on the number of participants (either distributors or end customers) brought in through the participant's downline. Both of these approaches increase the problem mentioned in point "b" above and encourage participants to recruit to the scheme rather than find customers for the products. The second is the more dangerous for the sponsoring organisation, because one of the ways that the law defines pyramid selling is to consider the extent to which participants are induced to pay their entry fee on the prospect of recouping it by earning income based not on their own sales of the organisation's product or service but on the sales or recruitment activities of those that they recruit and all who come after them in that branch of the "tree".