Thursday, January 17, 2013

So how *do* you recognize a pyramid scheme? Fitzpatrick shared some tips

Robert Fitzpatrick, who runs Pyramid Scheme Alert, has been warning people about pyramid schemes (and its very close cousin, MLM) for decades. He just penned an article on Seeking Alpha. Here's a quick summary (any bad interpretation is mine)

Recognition is NOT Sign of Legitimacy

Equinox Intl sold water filters and such and was loudly featured on Inc. Magazine as #1 in "Inc 500 fastest growing privately held companies", with 100000 distributors, as of 1996. By 1999, it was shut down as a pyramid scheme by the FTC and various state regulators.

Pyramid Selling Schemes Are Currently Legal in Certain Forms

Pyramid selling schemes are about recruiting people, not about selling. Yet modern MLM companies, even those listed on Wall Street, simply disclose that they may get hit by regulators for being too close to a pyramid scheme (without admitting to be one) but still structure their comp plan to entice people to recruit, not sell. By disclosing that "risk" to the public, they go on operating.

One hit is all it takes

MLM, due to its complexity and volatility, can attract quite a bit of capital and interest. However, MLM's weak foundation means one hit, by ANY regulatory agency, will likely bring down the company. In 2008, then Attorney General Jerry Brown hit YTBI (i.e. Your Travel Biz) with an injunction that it's a chain recruiting business opportunity. While the case resulted in a settlement (the company agreed not to do business in California and paid a fine), that essentially drove the company out of business.

What's Volatile for Wall Street is Even WORSE for Main Street

When hedge fund managers, who analyzes companies for a living, can't agree on what is the legitimacy of a MLM company, what chances do the average Joe have? Millions of people already have stakes in the company... as independent affiliates/associates/distributors/IBOs/whatever. They had already put money and effort and time into a company they may not understand!

So What Really Is a Pyramid Scheme?

A better, more "generic" term is "endless chain scheme", a scheme where salespeople recruit more salespeople (by selling the "business"). That's the most basic definition. Anything else that "infers" legitimacy, like endorsements, personal experience, income claims, and such, are irrelevant.

Retailing, or Recruiting?

An endless chain scheme can have products, lots of products, but what role do they actually serve in the company? MLM is supposed to market products, and salespeople are supposed to SELL products (to "ultimate consumers"). If an IBO choose NOT to sell products, but merely to consume the products ("I just joined for the discount") did his upline (sponsor, whatever) achieved retailing, or recruiting?

The Self-Consumption Gray Area

The primary debate between Ackman and Herbalife is same question as above: is it retailing, or recruiting?

According to Herbalife themselves, a "distributor" can be a self-consumer ("I joined for the discount"), a small-time retailer (with no MLM commission, just the 25% markup to SRP), or a big-time reseller with downlines (with increased markup to SRP, plus MLM commission). Herbalife even claimed that "73% of all distributors joined primarily for the discount" based on one of their surveys of 408 former distributors. (why former?)

Ackman disagrees about the idea that people would join a MLM "just for the discount" (25%) at lowest level. These purchases would be so small that their upline would need many of them to get a promotion to upper ranks based on sales volume.

So which is easier: selling products individually at retail... or recruit a bunch of these "I just want the discount" distributors?

As a prospective member who's thinking about joining, are you going to make a little bit by selling retail, or by recruiting a whole bunch of these "I just want discount" people? And what are your chances of "making it" (i.e. making serious income)?
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  1. a video(in Brazilian Portuguese, but English subittles are available) about multilevel marketing