Business Outlook. Multi-level Marketing: A Pyramid Scheme by Design

Transcription

1 Business Outlook November 2007 Multi-level Marketing: A Pyramid Scheme by Design Dr. Michael R. Hyman, NMSU Multi-level marketing (MLM), also called network marketing, is a way of distributing products or services in which the distributors earn income from their own retail sales and from retail sales made by their direct and indirect recruits (Vander Nat and Keep 2002, p.140). Examples of MLM companies include Amway, Avon, Herbalife, Mary Kay, and Tupperware. Many marketing practitioners, a few marketing scholars, and even the Federal Trade Commission, contend that MLM is not a de facto pyramid scheme (Federal Trade Commission 2000; Harden 1987; Koehn 2001; Muncy 2004; Vander Nat and Keep 2002). Are they correct? The answer is no, and the reason for that answer is economics reduces all MLM schemes to pyramid schemes. Pyramid schemes ask people to make an investment and, in return, grant them a license to recruit others who, in turn, recruit still others into the scheme. In essence, the investor pays for the opportunity to receive compensation when his or her recruit brings others into the scheme. The opportunity to recruit is the product (Koehn 2001, p.153). Pyramid schemes are illegal because (1) profits are derived primarily from recruiting people rather than from selling non-harmful products and services, (2) recruits often pay large up-front fees for enrollment and sales kits, and (3) recruits are pressured into stockpiling large quantities of non-returnable inventory (Koehn 2001; Muncy 2004; Vander Nat and Keep 2002). In contrast, MLM schemes merely are unethical, according to many scholars and practitioners, because they encourage sales associates (1) to hard sell family members and friends, (2) to abuse professional-client relationships (e.g., dentists who trade on their medical credibility to push products on patients (Koehn 2001; Rice 1997), and (3) to recruit new sales associates in socially and psychologically unacceptable ways (e.g., propagating myths that anyone can be a good salesperson and MLM is the road to riches) (Block 1996; Brodsky 1998; FitzPatrick 2005). Page 1

2 Also, under MLM schemes (1) sales associates are recruited by exploiting their materialism, greed, and religious zealotry, and (2) unproven, bogus, low quality, and unneeded goods often are sold at inflated prices (Barrett 2001; Koehn 2001; Muncy 2004). If page count reflects importance, then Rubino s The 7 Step System to Building a $1,000,000 Network Marketing Dynasty: How to Achieve Financial Independence Through Network Marketing (2005) a typical mass market book in the personal wealth-building genre indicates a network marketer s success firmly depends on recruiting aggressive sales associates who will in turn recruit other aggressive sales associates. Other than a psychobabble-laden chapter on formally envisioning financial success and a paragraph advocating increased product knowledge by using the company s products after all, it is easier to sell what one knows well Rubino s (2005) book exclusively focuses on ways to prospect for sales associates. Rubino (2005) shows that a five-level network with four persons at one level reporting to one person in the next highest level creates a network of 1300 people (i.e., ). If each of those 1300 people sells $100 of product per month, and the commission on their sales paid to the person at the top level is 10%, then that top person receives $13,000 in commissions per month. Unfortunately for gullible readers of his book, Rubino s illustration of geometric progressions is incomplete because he ignores the impossibility of recruiting new sales associates indefinitely (i.e., the inherent fallibility of pyramid schemes). This failure causes the low reported success rates for MLM participants modestly defined as realizing a profit after all expenses of roughly 0.1% (FitzPatrick 2005). One marketing maxim is every required marketing function must be performed by at least one member of the distribution channel from producer to end consumer. This maxim implies that viable members of the channel must perform an economically valuable function. MLM sales associates promote, order, stock, and deliver products to their customers. Traditionally, these functions are performed by producers, wholesalers, and retailers, who are compensated for their efforts. Commissions for MLM sales associates must derive from their recovery of this added value. They are not conjured from a bottomless money pit; rather, they are funded by transferring required marketing efforts from traditional performers to MLM sales associates. If recovered sales cost (RSC) creates the sole economic surplus inherent to MLM, then the equitable distribution of this surplus Page 2

3 among sales associates is a critical ethical issue. For the seven MLM companies listed in the Table, the mean annual payout to the top 0.22% of sales associates is $236,216, which comprises 44.0% of total payouts; in contrast, the mean annual payout to the bottom 99 percent of sales associates is $380. Seemingly, payouts are skewed heavily and unfairly toward only a few people. Table Payout Skewedness Company Arbonne International Top Pct. of Mean Annual Payout to Top Pct. of Pct. of Total Payments to Top Mean Annual Payout to Bottom 99 Pct. of 0.20% $126, % $87.36 Cyberwize 0.28% $91, % $ Free Life International 0.17% $549, % $ Melalueca 0.30% $126, % $ Nikken 0.25% $121, % $ Nu Skin 0.16% $480, % $ Reliv 0.21% $158, % $ Mean 0.22% $236, % $ Based on FitzPatrick (2005) Ironically, MLM recruiters and their promotional materials must present this pyramid-driven distribution of RSC in a positive way. Highly skewed rewards allow fables of riches embodied in the opulent lifestyles of a few people that lure the sales associates needed to fund these rewards (Van Druff undated). As practically all these later-recruited sales associates will earn little if any money, it is unethical to imply otherwise. Conclusion Despite claims to the contrary, most MLM schemes are deceptive because the promotional materials used to recruit sales associates reflect impossible outcomes for almost all targets of those materials. Although top sales associates probably recognize that their lucrative rewards result from a hugely skewed distribution of Page 3

4 recovered selling costs, these promotional materials obscure the limited money-making potential of lower-level sales associates. Fortunately, MLM need not be deceptive. Rather than tempt potential participants with dreams of great riches, promotional materials merely could reinforce that recovered selling costs make great products available at good prices. Promotional efforts that stress product quality, good prices, an opportunity for socializing (Bhattacharya and Mehta 2000), and a way to earn a few dollars, would be non-deceptive if true. (Note: MLM companies that provide lists with full and discounted prices are fooling customers mostly sales associates into believing they are buying goods at bargain prices.) References Barrett, Stephen (2001), "The Mirage of Multilevel Marketing," (August 17), Topics/mlm.html. Bhattacharya, Patralekha and Krishna Kumar Mehta (2000), Socialization in Network Marketing Organizations: Is it Cult Behavior? Journal of Socio-Economics, 29 (4), Block, Brian (1996), Multilevel Marketing: What s the Catch? Journal of Consumer Marketing, 13 (4), Brodsky, Norm (1998), Multilevel Mischief, Inc., 20 (8), Federal Trade Commission (2000), FTC Consumer Alert: The Bottom Line about Multilevel Marketing Plans, (October), bcp/conline/pubs/alerts/pyrdalrt.shtm. FitzPatrick, Robert L. (2005), "The Myth of 'Income Opportunity' in Multi-Level Marketing," Income.doc.pdf. Harden, Michael P. (1987), The Handbook of Multilevel Marketing: Understand Multilevel Programs, Direct Selling, and Pyramids. Carrollton, TX: Promontory Publishing, Inc. Koehn, Daryl (2001), Ethical Issues Connected with Multi-Level Marketing Schemes, Journal of Business Ethics, 29, Muncy, James A. (2004), Ethical Issues in Multilevel Marketing: Is It a Legitimate Business or Just another Pyramid Scheme? Marketing Education Review, 3 (3), Page 4

5 Rice, Berkeley (1997), What s a Doctor Doing Selling Amway? Medical Economics, 74 (13), Rubino, Joe (2005), The 7 Step System to Building a $1,000,000 Network Marketing Dynasty: How to Achieve financial Independence Through Network Marketing. Hoboken, NJ: John Wiley & Sons, Inc. Van Druff, Dean (undated), What s Wrong with Multilevel Marketing? Vander Nat, Peter J. and William W. Keep (2002), Marketing Fraud: An Approach for Differentiating Multilevel marketing from Pyramid Schemes, Journal of Public Policy & Marketing, 21 (1), Page 5