Often the term multi-level marketing and pyramid scheme are used as synonyms. Invariably, it is assumed that any MLM initiative is a pyramid scheme as well. But in reality, the question is, are these two really the same or is it more like one is an extension of another?
While multi-level marketing is more a format that is used by new players in the business as a means of reaching more clients within a reasonably low budget and greater impact, the pyramid scheme may or may not be part of that plan. Almost always, the pyramid scheme is all about big plans, huge cash promises and a lot of money for the minimum effort.
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Multi-level Marketing vs Pyramid Scheme
The most important difference of the legal MLM programs and illegal Pyramid Schemes is that the first one has a real and tangible product to promote and sell through a multi-level marketing system, but the second one usually has no products and members of the higher levels make money only through the membership fees the new members pay to join the scheme, exactly like the Ponzi schemes that the old members get paid with the money that the new investors pay to join the scheme.
How to Distinguish MLM & Pyramid Scheme?
When you are trying to discriminate between legal multi-level marketing and illegal pyramid schemes, there are many points to identify the problem areas.
You have to understand that the fundamental idea driving the multi-level marketing initiative is primarily to promote the product. They use a wide spectrum of the re-sellers for this purpose, and the added incentive is you get a commission on the total sales. The compensation plan is so designed that it can promote sales exponentially. The benefit in MLM is that the distributor gets compensation for both selling the product and recruiting fresh sales representatives or distributors. Therefore, an individual earns commission at multiple levels, and hence you get the name multi-level marketing. A single sale is, therefore, instrumental in generating multiple incomes at multiple levels.
In contrast, when you look at pyramid schemes, money gets in the system only when people enroll into the scheme, and there is no real product that is being sold in the process. Another interesting part is that only a selected group of people who are associated with the initial process of creating the pyramid. When the scheme finally reaches its saturation point, it collapses. Understandably no one, apart from the promoters, makes money and almost everyone who invests in this type of scheme ends up losing money.
With the MLM programs, you can make money through promoting the products as well as recruiting new affiliates, whereas with the pyramid schemes, you won’t make any money if you don’t recruit anybody.
This is the next most important point of consideration in the comparison between multi-level marketing vs pyramid scheme. According to the guidelines put forth by the US Federal Trade Commission, there are many differences between the two in this regard. These include
- The MLM offers actual products for sale to the customers, and the sales revenue forms an important part of the overall compensation plan. In the case of a pyramid, there is no real product on offer.
- Commissions in the case of multi-level marketing are generally paid by the product volume that is being sold and not primarily on enrollments. In general, the FTC outlines that MLM has a more or less hierarchical commission arrangement based entirely on the basis of product sales. The pyramid scheme is pretty different in this context where the income generated is solely on the basis of fresh enrollments.
- In the case of MLM, when the scheme is ended, the company returns the value of the shares that the participants had bought. The pyramid schemes, on the contrary, does not have any supporting inventory.
3) Compensation Plan:
The compensation plan also throws up interesting differences if you compare multi-level marketing vs pyramid scheme. Essentially the commission in case of MLM is based on the way it is paid to the re-sellers and marketers.
The Unilevel model is the simplest. In this model, members are allowed to refer and recruit and unlimited number of new members and the new members can do the same as well. It means there is no limit for any of the members to recruit new re-sellers and affiliates. The commission can be paid from the first two levels up to several more levels depend on the decision and intention of the managers.
In the SB or Stairstep Breakaway model, the design is such that both individuals and also the groups can join the program. In the case of a group sale, there is a leader assigned, and that person becomes responsible for multiple recruits whom he manages. The overall target for the group, in general, is to generate a certain amount of sales volume within a specified period by the group as a whole. This pattern, however, is not limitless. It continues for a set period of time and then breaks away from the overall core. At this point, the commission too ceases. Other kinds and types of commissions are initiated at this point, and representative also gets access to a fresh set of incentives.
The next model that we can consider is the Matrix model. This is quite so close to Unilevel one except the fact that the number of members who can be sponsored at any given time is limited. A new matrix needs to be started the moment the existing one reaches this number.
The next MLM compensation model that we would consider is no doubt the Binary model which allows only 2 members to be sponsored at any point of time. In case, there are more than two uplines, they spill to the next hierarchical level. Additionally, in this compensation plan all the sales have to be divided between the two members and re-sellers in a way that the sales volume doesn’t go above a pre-decided number of the members’s total sales.
Hybrid model, as it is clear from its name, is the mixture of the multi-level marketing compensation plans that I described above.
Compensation Model for Pyramid Scheme
8-ball model which is also known as Matrix scheme, is the compensation model for a pyramid scheme.
In a case of the 8-ball model, each person has to recruit about two people in the scheme and these two have to pay a basic minimum sum called the ‘gift sum’ to enter the pyramid scheme. The person who is on top of the pyramid invariably receives the biggest gift sum, and it keeps reducing in the same margin.
In the case of the Matrix scheme, people make advance payment for a product and wait for their turn to sign up for the program. When this new recruit manages to rope in the required number of new entrants they receive a gift in kinds like TV or camcorder or the like. This kind of scheme, as you can understand, collapses the moment there are no new players interested in joining the scheme.
In the comparison between multi-level marketing vs pyramid scheme, it can be easily concluded that authenticity of the product, the legitimacy of the operation and the depth of the compensation scheme is what acts as the key deciders. The MLM is invariably one that uses this multi-level marketing format to promote the product. The pyramid scheme uses it more as a guide to help the promoters make money at the expense of the ones at the lower level of the pyramid.