MLM is NOT your ticket to fast cash!

Pyramid Schemes & MLM: The one way Ticket to Loss?

TL;DR: it’s impossible for all participants of MLM schemes to make money. The vast majority are a 21st century pyramid scheme. Learn to challenge and critique, as this will be the most important business and personal skill you’ll ever learn!

Last year, I found myself in discussions around MLM marketing and Pyramid Schemes. The industry is worth a couple of hundred billion dollars across the globe and exponents allege it makes more millionaires than any other industry.

There are so many things missing from the headline figures, that those statements border on misleading. Indeed, parallels have been drawn between MLM and Pyramid Schemes, with many governments around the world, including the USA, considering them one in the same where there is no end client with a separate product. But why?

Well, first of all, it’s worth recapping the concept of a pyramid scheme (click the link for a 6 minute video — it’s an important baseline for what I’ll cover next). It’s an old term and due to it not being in the public eye a lot, many younger folk may never have heard of such scams let alone how they operate. So I’ll present a light hearted, but somewhat obvious look at three of the problems and how you’re on to a loser.

Pyramids: Wider at the Bottom than at the Top

When growing pyramid schemes, the scheme is sold to people at the bottom level. Their membership investment, which may be hundreds or thousands of pounds, flows up the ‘back-line’ (each distributors line — due to their being a subtree, there may be more than one), to which each distributor above them keeps a percentage, say 20% of the value they receive. So the membership is £400. The person who sold them the membership keeps £80, sending £320 up the line, so the next person keeps 20% of that (£64), the remaining £256 goes up the line, all the way to the top. Upper levels get a percentage of the commission of all the levels below them.

simple pyramid scheme structure

Now, crucially, you’ll note that everyone at the bottom (shown in red above) has paid £400 pounds in our example network. Just count the number of people in red versus people in grey. There are 6 ‘victims’ and 5 people above them. Here’s a universal truth for pyramid schemes. It is impossible to get a growing pyramid scheme where there are more people in all the layers above the bottom layer than there are people in the bottom layer alone. Given everyone has to continue to recruit to make their investment back, if they’re making an investment of £400, they have to recruit 5 folk given the 20% commission structure (or their folk below that level have to recruit more folk so they get the slightly lower 16%, but potentially more prevalent, commission). So it always grows exponentially. If you’re not mathematically minded, this sounds crazy, but just try it by doubling the number of people under each level.

1 person

2 people (add up above here, it’s 1)

4 people (add up above here, it’s 3)

8 people (add up above here, it’s 7)

See? You might argue that you could get a ‘house’ shape. True, but that firstly then isn’t a pyramid but crucially the next piece of the puzzle is…

Money Flow: Commission Along the Line

Membership money is paid up front. Hence, all the money that is raised has commission paid on it at the point of sale. If a house structure suggested above is employed, it doesn’t matter. Until someone makes enough sales to cover their original investment, they are effectively still at the bottom (i.e. in the red). So if we now modify the previous image to add the number of people in the black, given the number of memberships at the time, a £400 membership fee and a 20% commission rate, it now looks like:

So you can see, despite the amount of membership, only the first level makes any real money and although there is a second level benefactor, in reality, if you take into account their time trying to sell the membership, which remember is not paid by anything but the commission made (even zero hour contracts at least pay a base salary when the person works), and they’re often trying to sell a valueless product for an over-inflated prices, which is hard to sell, the true profit is zero. After all, you have to earn less than the minimum wage for anything to be financially worth giving up working for. Money comes from nowhere except the sale of the product or membership. Hence, anyone at the bottom has sold no memberships, but and the products are so hard to sell, they make no money from them. So they stay at the bottom.

This is why combined with point 1, the vast majority of people cannot ever make money as a cohort. As soon as you sell membership to move off the bottom, there is just a new bottom. It’s mathematically impossible.

Initially, whilst it’s a zero sum game, the commission is swallowed up in the flow. Hence why the amount of funds in the black is less than the amount of funds in the red!

Market Saturation & Collapse Points

For many new entrepreneurs, especially those who are caught by these schemes, this one is probably the most invisible of the three. Note from the video, the psychological profile of those caught up is pretty much the same (More on this later). Every market has a limit to the number of products it can (or is willing to) consume. As a result, once the market has become saturated, either with the product or that of the competition, there is no more appetite for the consumption of the product. So prices drop massively or the industry dies (VHS rental anyone?).

The products in such schemes are hard to sell in the first place. So the receptive market is very very small. In addition, due to the need of the pyramid (i.e. the people within it) to keep growing exponentially to make at least their investment money back, it very quickly gets to the point in its life that it surpasses any possible way of making money from the products it sells and indeed, the memberships it can obtain. As a result, it collapses in on itself, leaving anyone with a loss, at a loss! They can’t claim their money back from anywhere. At the end of the day, the control limit is the point where the money coming from completely independent end clients (those not involved in the network and never signed up before a product is shipped) matches the amount of money flowing inside from membership. If it exceeds it, the network lives on, otherwise, it’ll be catastrophic when it finally collapses.

Imagining the pyramid shown in the detailed diagram above collapses at that point because it ran out of cash flow from any source. Only two people ever made their investment back. 9 people made a loss! That is a failure rate of 82%! 82% of people lost their original investment!

Pyramid Schemes: Why Do People Fall for It?

The problem is that many folk either don’t realise they’re falling for it, realise too late, are unwilling to ditch the bad investment due to the money they’ve lost and think they’ll regain (sunk-cost fallacy. A lighter hearted link can be found here).

The psychological profiles of many of the people who fall into these schemes/scams is pretty much the same. As the video suggests.

We in the UK have one of the worst levels of mathematical literacy in the developed world. This makes it difficult to see the wood for the trees. It also gives rise to businesses and organisations that perhaps shouldn’t need to exist (e.g. Advice) that are there to help people who have been scammed or otherwise got into debt. This is particularly acute before the age of 16, where our education system lags behind almost every other developed nation.

2012 mathematical literacy results for developed nations

Going through the generations we can see it improve as a wider cohort (between 16 and 65), which lends credence to the position that our life experience teaches us a lot, but overall we’re still below average as a nation. If we then add the level of disposable income we have (source: Business Insider), coupled with a citizen’s desire to create your own business (source: Global Entrepreneurship and Development Index 2013- worldwide startup rate. A measure of entrepreneurial thinking) we see the best places for pyramid schemes to target from a position of literacy-income, are the UK and USA. Guess what, when we look at the two major countries where we have low mathematical literacy, high disposable income and a high propensity to entrepreneurship, we see that exactly those countries have been targeted. Only some countries around the world have legislation to cover it, though the numbers are increasing. What’s worse is once a country adds to its legislative arsenal, the schemes move on to other countries.

Marketing Deception

This is used a lot. Such schemes aim to link high net worth individuals with the schemes (even though there are absolutely no links to them whatsoever). In addition, slides are often used to sell the size of the network marketing industry to recruits. Here is one from MastermindEvent.com which shows global sales for the whole industry. What most fail to tell you is these global sales include the membership fee. In addition, the $65 billion the industry ‘gives back’ is often made up of the commission and it of course, not distributed evenly.

To draw a parallel with the UK lottery (Lotto) for example.

The UK national Lottery is played by 32 million in the UK each week at a cost of £2 per set of 6 numbers. The prize fund for last week totalled £15,047,165 and if we averaged that across the 32 million players, some could sell the idea that it’s 47p given back per person. Do you play the lottery and do you get 47p back each week? Even if you did, is that a good investment for your £2 if you wanted to make money from it? No! Put it in the bank or give it to the charity directly. This is the first thinking error.

Second thinking error. The table shows there are 162,820 of the 32 million players that win anything. Those are like the people who make their investment back on a pyramid scheme. That’s a success rate of 0.5% who break even and make any profit this week. But one could present the argument that £15,047,165 split between 162,820 folk means each winner wins £92.42!! Brilliant!

Did you win anything last week? Congratulations if you did! Did you win more than £92.42? I’ll bet most of you didn’t. Indeed, if we look at the table again, only 8,189 people won more than £25 let alone £92. But I’ll be generous. So that’s 5% of winners, but really, only 0.02% of all players! That is 1 in every 5,000 players wins anything at all!

The third thinking error is getting ‘high net worth’ rich from it. From that £15,047,165 matching 6 numbers gives you £7,714,351. As you can see, nobody did this week, but let’s assume one did (“It was you!”). Just to fulfil someone’s fantasy. That’s half of it gone to one [set of] winner[s] straight away! One person in 162,820 winner and 1 person in 32 million gets to be a millionaire. One! This is like the person at the top of the pyramid scheme’s chain.

Here’s the kick that is also the simplest way of understanding how this isn’t going to make you super-rich. If you didn’t set up the pyramid, you can’t be at the top!

There many ways to slice the rest and I’ll leave other ways to represent that data as an exercise for the reader.

Summary

Remember, numbers NEVER lie! People do! What is worse is that it is really easy precisely due to our general lack of mathematical skill, for an adept salesperson to turn an entire cohort against one or two people, or even turning it into a cult mentality. After all, mathematical skill, the only thing that cuts through all of the smoke and mirrors, is a huge outlier in the countries in the previous links (including us here in the UK) and because of the homogeneity of the individuals who find themselves in these schemes, being keen (or desperate) to make a buck, it makes it really easy to turn the entire cohort against the people who are right and trying to help the rest by telling them not to enter into it. Indeed, the abuse happened to me even during that discussion the other day (good job I can give as good as I get ;) and has resulted in some countries seeing physical attacks take place on those helping to rescue people from pyramid schemes.

It’s big business, but so was the mafia! Indeed, I expect I’ll continue to get abuse about this, or more. The crowd isn’t always so wise (I often argue it almost never is — but it’s homogeneous, which is a double edged sword — that homogeneity allows both good and bad to propagate through it). So learn to challenge and critique, as this will be the most important business and personal skill you’ll ever learn!

This article was first published on LinkedIn.