How to Tell if That Home Business Opportunity Is Really a Pyramid Scheme

By Holly Johnson on 3 March 2017 0 comments

Work from home! Get out of debt! Make a full-time income selling products you love! Such are the promises of companies and their agents looking to recruit people to be distributors or "consultants" for them.

These types of "job opportunities" are called multilevel marketing (MLM), and most people who sign up never realize the benefits. If you're considering becoming a distributor for an MLM company, beware of the many warning signs that you could end up making little to no money, or worse, adding to your debt. (See also: Multi-Level Marketing: The Future or Folly?)

Tupperware, Avon, and Mary Kay are some of the best known MLM firms, though they sometimes shun that term in an attempt to distance themselves from controversy-laden companies such as Herbalife and Amway. Both of those companies have been accused of making inflated earnings claims and of being pyramid schemes. The main difference between MLM companies and true pyramid schemes is that the primary purpose of a pyramid scheme is recruiting other distributors, rather than making direct sales. Pyramid schemes are illegal. (See also: 8 Terrible Work-From-Home "Jobs" You Should Avoid)

What Are MLM Companies?

MLM companies, also called network marketing or direct selling companies, incorporate a business model in which representatives make money in two ways. The first is direct sales to consumers — often friends and acquaintances — through parties, social networks, and other web sales. The second income source is commissions from sales made by team members you recruit, also known as "down line" distributors.

IBISWorld estimates the direct selling industry makes $41 billion in revenue and employs about 800,000 people. Intense competition from mass merchandisers has kept growth to a modest 0.6%.

MLM Promises Are Tempting

The sales pitches of MLM companies can be alluring, especially for stay-at-home moms, students, and the unemployed. Just imagine, they exclaim, a work day that includes jumping on social media, talking up strangers at the grocery store, or networking with friends. By selling products you love and believe in, you could earn extra money while enriching others' lives. And if you could convince a few friends to become distributors beneath you, you could have your own business — becoming the "boss" for the first time in your life. The promise is this: If you pour your heart into your business, get people to sign up beneath you, and never give up, you can (and will) become successful — no matter what.

And when it comes to recruiting new distributors, some MLM companies pull out the big guns. It Works! — a company that sells body wraps, supplements, and personal care products — advertises huge cash payouts for new distributors who meet specific sales goals. How huge? The company frequently advertises bonuses of $15,000 or more for their top tier sellers, although it's hard to find concrete data on how many sales you need to make to earn these bonuses, or how they are paid out. (See also: 17 Part-Time Jobs to Do While Your Kids Are at School)

The Problem With Multi-Level Marketing Operations

While people can and do earn huge sums of money with MLM companies, there are myriad pitfalls to avoid. First, it can take a ton of sales to get anywhere near the mind-blowing income levels posted on corporate websites. And to reach the highest ranks of earners with any MLM, you may need to recruit dozens of people to work beneath you (with them recruiting people to work beneath them as well).

Secondly, as we mentioned before, the line between MLM firms and pyramid schemes is fuzzy. In a pyramid scheme, the price of the products sold is inflated, making them hard to sell and causing the vast majority of participants to lose money. The Federal Trade Commission (FTC) warns of the similarities, noting:

Not all multilevel marketing plans are legitimate. If the money you make is based on your sales to the public, it may be a legitimate multilevel marketing plan. If the money you make is based on the number of people you recruit and your sales to them, it's probably not. It could be a pyramid scheme. Pyramid schemes are illegal, and the vast majority of participants lose money.

Even if the company is legitimate, most MLM companies require a "buy in." You'll need to pay a certain amount of cash upfront to sell their products. While these "starter kits" normally cost a nominal amount (a few hundred dollars), they will certainly start your business in the red. If you're trying to make money to pay off debt, that's the last thing you need. (See also: 11 Signs the Job Is Too Good to Be True)

How Much Do MLM Distributors Really Make?

If you make money right out of the gate, then a nominal investment could be money well spent. Unfortunately, most distributors for MLM companies barely eek out a profit, let alone earn a full-time income from home. You can find proof directly on their websites.

Let's go back to It Works!, the body wraps and personal care products company. According to its 2015 annual income disclosure statement, 82% of its representatives had been with the company for an average of one month and were still on the first rung of the payment hierarchy — distributor status. Their monthly earnings ranged from a low of $1 to a high of $3,847, with a monthly average of $54.

Income grows incrementally up the ranks, and tends to coincide with longer time spent growing the business. But income growth is slow, and the percentage of distributors who stick around more than a month drops dramatically. Only 7.8% of It Works! sales people are at the Executive level. They've been there an average of three months and earn an average of $231 a month. About 0.6% of reps are at Double Diamond level, making an average of $4,741 a month after 13 months of effort.

Of course, some huge, mythical incomes do exist. According to the disclosure, the top tier income earner (. 02% of all distributors) — Ambassador Diamond — pulls in around $37,583 per month.

Unfortunately, the average income for all It Works! Distributors was only $227 per month in 2015.

And It Works! is far from the exception; their distributors actually make more than those working for many other MLM companies. Check out these annual income figures from other multilevel marketing disclosures for more proof:

  • Thirty-One Gifts: a company that sells organizational totes and monogrammed bags. In 2015, the average consultant (92.1% of distributors) earned $548 per year.
     
  • Scentsy: a company that focuses on candles and wax warmers. In 2014, the average lowest-level rep, called an Ecsential Consultant, earned $81 per year, while the average Certified Consultant (one level up from Ecsential) earned $463 per year.
     
  • Advocare: a company that sells nutritional supplements and diet products. In 2015, the average annual compensation paid by Advocare to active distributors was $1,586.
     
  • BEACHBODY: a company that sells fitness products and nutritional shakes. In 2015, the average BEACHBODY coach earned $502.
     
  • Isagenix International: a company that focuses on nutrition and diet products. In 2015, 87% of Isagenix business builders earned between $702 and $2,101, on average per year.

As you can see, the average "little guy" is not making bank with any of these companies. In fact, your average distributor may be earning $100 per month or less. If they're a hobbyist who signed up for product discounts, then that might be fine by them. But when someone signs up to follow their dreams, the reality of not earning much can burn.

MLM supporters argue that the reason so many people don't earn more is because they aren't really dedicated to building the business. Barriers to entry are very low, so many people sign up, then lose interest and give up in a way they wouldn't if they were building a regular business in which they'd had to invest more.

But there are also real challenges to growing a viable business using the MLM model, even for committed salespeople. For example, many MLMs ask you to focus your sales efforts on family members and friends, which can be awkward and presents a limited pool of customers. Even if you expand your sales network, the products may be overpriced, making them difficult to sell.

Lastly, it's not easy to grow your sales if your MLM is overly saturated with distributors already. And if you happen to recruit a distributor (the key to earning commissions), they then often become your competition.

Tips for Vetting an MLM Company

Just like anything else, it pays to do some research before you sign up for a multilevel marketing company. As the FTC notes, it's smart to not only consider the products, but to learn more about the company itself.

Questions to ask should include:

  • How long has the company been in business?
  • What is its standing with the BBB?
  • Has the company been sued for deceptive business practices?
  • What are the company's annual sales?
  • What percentage of average sales are made to distributors, as opposed to retail consumers?

Beyond those considerations, the FTC suggests making sure you understand compensation structure, terms and conditions, and potential business expenses. Also, get all the company's details, including their refund policy, in writing.

The U.S. Securities and Exchange Commission also offers an array of tips for people vetting a MLM and trying to avoid a pyramid scheme. According to the SEC, you should:

  • Watch out for MLMs that don't appear to offer a product or service. If you can't figure out what a MLM sells, run.
     
  • Be leery of MLMs that promise huge returns in a short amount of time. If it sounds too good to be true, it probably is.
     
  • Be skeptical of companies that offer compensation for little work. Terms like "easy money" and "passive income" should be a red flag.
     
  • Look for proof of retail sales. Ask to see documents that show how the MLM generated revenue from the selling of its products to people outside the program.
     
  • Think long and hard before you "buy in." Question the value of any opportunity that makes you purchase a product to get started.
     
  • Watch out for complex commission structures. If it's hard to understand how you'll get paid or you can't figure out how commissions work, beware.

Lastly, the FTC and SEC both suggest avoiding MLMs that place a heavy emphasis on recruiting members to work beneath you. The hallmark of a pyramid scheme is when you make more money recruiting than you do for product sales.

Check out these FTC and SEC pages for further details on how to vet a multilevel marketing company. While these companies do offer a path to earning extra income, the reality is that most of that income goes to the very top few earners, not to the average distributor like yourself. And if you don't wind up earning much, the costs of buying a "starter kit" and hosting parties could easily leave you in the red.

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Guest's picture
Guest

I've heard it said that you can make money selling a lot of products to a lot of people for a little money, or by selling a few products to a few people for a lot of money. The trouble with trying to make serious money from most MLM companies isn't how they are organized, it is what they sell and to whom they sell it. Avon costmetics may be wonderful, but the per item profit is low. If I am a great customer I spend $30-40/month and most customers aren't great. The local drugstore sells make-up too, and there I get instant gratification and the opportunity to buy all sorts of things other than make-up. With MLM make-up, the labor involved per sale is tremendous.

Guest's picture
Lauren Fitzgerald

I think this article offers good advice. One point that was missed is to research if the company is part of the Direct Selling Association (DSA). The DSA audits its member companies for legal and ethical compliance, it will remove a company for unethical actions. There are good, reputable MLMs out there, and people can make money but they must work at it, just like any other job.