What Is A Pyramid Scheme?

Ever had a friend or family member become a little too passionate about a great business they’ve discovered and they’re super excited to tell you about this wonderful business opportunity they can offer you? It’s probably taken over their social media pages and it’s all they really talk about. Chances are they want you to come to a “party” at their house to tell you a little bit about it. If this sounds familiar to you, your friend or family member might be part of something strikingly similar to a pyramid scheme.

I say “strikingly similar” because actual pyramid schemes are illegal because they are built on an extremely unstable business model that will collapse once it gets to a certain level. Like Ponzi schemes, pyramid schemes are built on fake investments. Without going into too much detail, Ponzi schemes involve getting investors to invest money with promises of high returns, after getting money from a few investors you show them the money they’ve made on their initial investment and most of the time they want to invest more at that great rate of return. This is unstable because the growth the investors think they’ve made is fake and when all the investors ask for their money, there’s not enough to give out.

With pyramid schemes, one investor starts at the top and recruits new investors under them, promising a percentage of the investments by their recruits. For example, I would approach you and 5-10 other people asking you to invest $100 and you’ll get $20 out of each person you recruit to invest $100. You decide you want to partake because you can double your money just by presenting this awesome investment opportunity to 10 other people. Once your recruits find more investors, you’ll get a percentage of those too, so the people at the top of the pyramid keep getting a percentage of every new investor’s money. The only problem is after a few iterations of recruits recruiting more people, there won’t be enough people in the world to recruit, leaving the bottom layer of the pyramid with no chance of getting a return on their money.Pyramid_scheme

As you can see in the image above, if every new investor recruited only six more investors under them, this business model could only last for twelve iterations if every person, no matter the age, were interested and became investors. All the money from those 2+ billion investors would bubble up to everyone in the pyramid above them, but they’d have no chance of getting their money back. As of 2016, there are only 324,118,787 people in the US, so without going internationally, you’d only make it through ten iterations before running out of people to recruit. Take out all of the people who are too young, too poor, or uninterested and you wouldn’t even make it that far.

It’s worth pointing out that although the examples I’ve used so far have been purely about investing money to make money on recruits, some pyramid schemes will try to disguise themselves as legitimate businesses by offering a product to sell. Typically, these products are not great, and although you might be able to make a little money when you sell them, most of your income is designed to come from recruiting new “sellers.” Even when products are in the mix, you can tell a pyramid scheme by the reward for recruiting new members.

Multi-level Marketing (MLM)

By now you should understand what a pyramid scheme is and why you should stay away from them… they’re illegal. What you’re more likely to encounter these days is a friend that is super pumped about a multi-level marketing business they’re now a part of. While MLM’s are legal, they still look a lot like pyramid schemes.

So, what is a multi-level marketing business and how is it different from a pyramid scheme? An MLM is a business structure where salespeople sell a product or products offered by the company, while also trying to recruit new salespeople to sell under them in order to earn a percentage of their sales. Without diving too deep, arguably the biggest difference between a pyramid scheme and an MLM (and why one of them is legal and the other is not) is that salespeople in an MLM do not make money when they recruit new members, only when those members sell products.

So, if MLM’s are legal, why should you stay away from them? To start with, as easy as the members might make it seem to prosper selling their products, the only real way to make a decent amount of money is to recruit a ton of members and make money when they sell products. I think it’s a safe assumption that most people aren’t experts at cold-calling to find recruits, so how do they find them? Usually, it involves asking everyone in their social circle, including friends, family, and coworkers. This gives MLM’s a negative stigma because people feel like they’re constantly fending off friends and family trying to get them involved.

Signs You’re Dealing With An MLM

  1. More emphasis on recruiting than selling products. Great companies sell either products or services, watch out for a business opportunity where selling is second to recruiting new members.
  2. Being ‘sold’ the company or business opportunity. Since when do companies try to convince people to work for them? If you feel like these people are using sales tactics to get you to join their team, you might want to take a step back and reevaluate the situation.
  3. No sales training or experience requirements. Do you really think it’s realistic for you to become a rock star salesperson without any training? And why do they tell you you’ll do just fine even though you don’t have any sales experience? If the product is so good that it “practically sells itself,” you should ask yourself why they’re trying to get you to join them instead of keeping the sales for themselves.
  4. Members redirect your questions to charismatic leaders. I’ve personally heard this one multiple times. As soon as you start asking a newer member questions that they don’t know the answers to (because they joined without doing their research and now have to recruit a bunch of members just to break even), they’ll most likely tell you that they’re having a party at their place and you should come because there’ll be people there that have become extremely successful through this business and they can answer all of your questions.

It’s pretty simple, if you’re not an experienced salesperson and a company wants you to join them and sell their products, this should be a red flag and you should consider doing your research before jumping right in. Unless you have no problem bugging everyone around you to join and/or buy your products, stay away from MLM’s. There’s nothing worse than having your friends and family want to avoid you because they know you’re going to try to constantly sell them on something.

Keep this in mind: if they had a really good product or service, they wouldn’t need a million sales people to bug everyone they know to buy it. If you want to be a salesperson, be a salesperson, but work for a company with a solid product or service or heck, create one yourself!

Notes

  1. http://money.howstuffworks.com/pyramid-scheme1.htm
  2. Featured image by Nina-no
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