Saturday, September 21, 2013

MLM Mythbusting: When Will DSA Recognize the Danger of Product-Based Pyramid Scheme to the MLM Industry?

DSA, or Direct Selling Association, is the "industry group" of network marketing, direct selling, multi-level marketing... whatever companies. It periodically holds surveys, and has a code of ethics that it requires its members to adhere to, which it claims will protect the consumers and affiliates from unscrupulous companies. DSA thus far has done an admirable job, both in Public Relations, and Industry Watchdog. However, DSA has a severe blindspot: DSA does NOT acknowledge the existence of product-based pyramid schemes and how similar it is to MLM, and that denial may lead to the destruction of itself and the industry it serves.

DSA pretends that "product-based pyramid scheme" doesn't exist, by pushing multiple narratives which are myths, not reality:
  • MYTH: "Internal consumption is legitimate"
    REALITY: Internal consumption is legitimate... only in "reasonable" amounts, else it is indistinguishable from product-based pyramid scheme
  • MYTH: "There is a CLEAR divide between pyramid scheme and MLM"
    REALITY: "Product-based pyramid scheme" is VERY close to MLM and this clear divide no longer exist. It's one huge gray area. 
  • MYTH: "Pyramid schemes rarely involve products. If they do, they aren't worth much."
    REALITY: "Product-based pyramid schemes involve actual 'legitimate' MLM type products."
It recently re-emphasized these blindspots by pushing its article "The difference between legitimate direct selling companies and illegal pyramid schemes" which again emphasized the three myths, which is no surprise as this was penned with the assistance of mlm attorney Jeff Babener, whom I have previously identified as having a bit of blindspot himself 

Let us go over each myth on why each is a myth, and what is the reality.

Legitimacy of Internal Consumption

One prime example of DSA's "blindspot" is its own rebuttal to Ackman's accusation that Herbalife is a pyramid scheme. According to DSA:
All direct selling companies derive a certain percentage of their income from internal consumption, and that's perfectly legitimate.
The problem with this statement is the blanket declaration that "internal consumption... is perfectly legitimate". In fact, this was repeated multiple times in the rebuttal, and logically, it cannot be. Only "reasonable" amount of internal consumption (or self-consumption, as it's sometimes known) should be allowed, or else this is just "fake sales" toward "fake compliance" of the law.

Here's a theoretical example (based on real case).

Let's say, I'm in a MLM selling vitamins. I've been in a while. I have a network of downlines, going down 6 levels. They generate a decent amount of sales that I can earn THOUSANDS of dollars in commission. every month. But only if I keep my "qualification" as "supervisor" by meeting my own sales quotas, or, say, $1000 a month for 2 months.

If I take the vitamins, I sure can sell $100 of vitamins to myself, and figure out how to sell $900 worth of vitamins to several other people. Or I can take the lazy route, and just buy myself $1000 of vitamins every month. I don't expect to take them all. I just need to make the quota to qualify for my commission.

To the company, there is no difference. They get $1000 stuff "sold" either way. I make a bit less as I don't enjoy the "retail profit" from that extra $900 worth of vitamins, but that's minor compared to the THOUSANDS of commission I would have lost that month.

My $1000 purchase is definitely "internal consumption", and it's clearly not "real" consumption, as no way I'm quaffing $1000 bucks of vitamins a month. Thus, it's clearly NOT legitimate.

Now you're saying, this is just my imagination, no real MLM company would work that way. You'd be wrong. In fact, this very real company actually once encouraged its affiliates to keep buying $1000 of stuff every month, and GIVE THEM AWAY just so they qualify for the downline commissions. That company was called "Omnitrition" in the landmark court case "Webster vs. Omnitrition".

And let's face it: the company don't care what I do with $1000 of merchandise: whether I actually retail it or leave in a storage unit to rot. Sales, to them, is sales.

However, this runs counter to the Koscot Test, which determines whether a business is MLM or pyramid scheme. Rather than explaining in excruciating detail on the evolvement of product-based pyramid scheme, I'll just say that product-based pyramid scheme "appears" to be MLM, not pyramid scheme, by Koscot test, but it is indeed a pyramid scheme, due to products getting moved in lieu of direct payments.  And the courts realized this and added some clarification in the Websters vs. Omnitrition case about actual RETAIL to ultimate user is what separates MLM from pyramid scheme.

[ Those who do want to read the details can check my other blog post: What is a Product-Based Pyramid Scheme, and is Herbalife a product based pyramid scheme? ]

Going back to the case above, I did not sell $1000 worth of stuff. I sold $100 (to myself). Thus, the remaining $900 "sales" is fake sales. Basically, I paid $900 so I can receive payments from my downlines. I paid, so I can take my downline's money, and my downline paid so he can take his downline's money. It could just be one huge pyramid scheme, with some real sales mixed in there.

Maybe it did not START as a pyramid scheme, but it is EFFECTIVELY a pyramid scheme, even though a lot of products were "sold" by the company.

Divide Between MLM and Pyramid Scheme

As the example above shows, there really is no divide between a MLM and product-based pyramid scheme except for the difference between actual sales vs. "fake sales" as explained above, and the only difference is retail to "ultimate users". The more "internal consumption" is allowed, the worse the gray area between the two.

DSA basically *assumed* that nobody would have a motive to hoard inventory when they can simply return them. The reality is people will hoard inventory (i.e. buy more stuff than they can retail) if it involves getting paid large sums of money such as commissions. As long as they pay small amounts (buy stuff to qualify) to get large amounts (get paid downline commission) they will do it.  DSA ethics says company shall not encourage affiliates to buy up inventory beyond what can reasonably be sold. It does not say anything about prohibiting compensation plans rewards such behavior.

Or to view the problem from a different perspective, internal consumption ADDS to the gray area by giving affiliates conflicting motives. In a pure direct sales scenario, the only reason any affiliate would purchase a product is for retailing. When you involve multi-level commissions, things start to get rather confusing. Is the product purchase actually for retailing, or merely to "qualify" oneself for commission payout? As "internal consumption" is NOT retailing (except a "reasonable amount") it must be for "qualify" oneself, and thus, that would indicate suspicion of pyramid scheme.

Thus, it is confusing why DSA would push the agenda to legitimize all internal consumption when it could arguably be a sign that there really is NO divide between MLM and pyramid scheme.

Value of Product as Legitimacy Criteria

Again, DSA's narrative, "pyramid schemes rarely involve products, and even if they do, they are of usually no significant value", is not really based on reality. ANY product, with real intrinsic value or not, can be used in product-based pyramid scheme. The criteria is not the product's intrinsic value, but rather WHY the affiliate bought them. If it's for retail, good. If it's to qualify for commission (see previous part), bad!

One recent example was Burnlounge, the online music retailer that used the term "concentric retailing" but it's just a different name for MLM, and it was shut down by FTC as pyramid scheme. Its primary product sold was its 3 levels of membership, which includes special venue seating, music history documentaries, special access music news subscriptions, and more. Nobody doubted that those products are real, and may even be worth what Burnlounge claimed they are worth, but the problem is one of affiliate motivation: did the affiliates buy the membership because they actually wanted the products / benefits, or did they just buy the membership so they can qualify for bigger paycheck and such? FTC was able to prove that Burnlounge affiliates bought membership for qualification toward payout, NOT for the benefits, making the value of the products/membership irrelevant.

The value of the product / service has no bearing on whether the "biz" is a pyramid scheme or not. You can have product of almost any value in a product-based pyramid scheme. The "worthless products" just makes a pyramid scheme that much more OBVIOUS as there is little if any intrinsic value, thus it must be to qualify for multi-level matrix payout. There are cases where it's far less obvious.

Current Trend and Worst Case Scenario

DSA is perpetuating the current trend by continuing to ignore Ackman's warning, 9 MONTHS after Ackman's initial challenge. Instead of rising up to help Ackman clean up the industry with more transparency and enforcement of existing rules, such as the "Amway Safeguard rules" that had required sales ("10 retail customers rule"), requiring its members to audit affiliates for such retail sales and pay them commission on retail sales, not wholesale sales, and such measures which was ALREADY on the books, DSA has instead assisted Herbalife in mounting a lobbyist defense, through denial that there is even a problem.

It is also interesting to note that Wall Street, seeing the profitability of MLMs, has lined up behind various MLMs, with what seem to be NO recognition of the real issues at stake: the survival of entire MLM industry.

Proponents of Herbalife are betting that FTC will do nothing, and that is less and less likely, with more and more Latino lawmakers wondering what is going on in their community. Latinos comprised of 17% of US population, according to 2010 US census, yet Herbalife figures show 60% of its sales are through Latino affiliates (which suggests they are all to Latino customers... with or without "internal consumption")  Given that Herbalife thus far,  has NOT proven itself as MLM or PBPS... (cannot, or will not?) is it any wonder that the Latino lawmakers are worried?

The worst case scenario is, of course, destruction of Herbalife, and by extension, the entire MLM industry.

However, even some order to reform will SEVERELY affect the entire industry, much like the original FTC vs. Amway decision defined the entire industry.


DSA, instead of leading the effort to "help" the industry be legal and separate PBPS from MLM by adopting additional code of ethics for both company AND affiliates, is basically pretending that pyramid scheme will never evolve into a more advanced form by adopting products as a disguise. Given that MLM itself had evolved from pyramid scheme, that is a VERY DANGEROUS attitude to have, and the results can be devastating to the entire industry.

Ponzi schemes have evolved from pure money ponzi into product-based Ponzi such as Pigeon King International. Even regular Ponzis such as Zeek Rewards have adopted virtual goods ("bids", with some value in certain circumstances) as disguise.  DSA is in denial, and denial is a very dangerous phase to be in, esp. if one is also in a fight for its life.

So where does that leave the average Joe affiliate? Ask yourself this very simple question... How much direct selling did you really do? If you don't sell enough to make a living, how long will it take you to do so? If you do sell stuff and are happy and comfortable, then there's nothing you can do or should worry about.

However, if you do generate "fake sales" as described above, just so you can get that MLM commission, and you likely learned that method from your upline, and you probably taught the same attitude to your downlines... are you *sure* you're not in a product-based pyramid scheme?
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  1. Imagine a product based direct sales organization that has millions of lower level people making minimum wage while the guys who have been around longer make decent money. A handful at the top of the pyramid are making tens of millions a year. The worst ones are: Walmart, KMart, McDonalds, Wendys, Giant Eagle, Food Lion, Pizza Hut, Circut City, LA Fitness, etc. Get a grip people. MLMs are NO different than any other business. The only exception is that if you are a go getter you can make what the CEO makes without having to marry his ugly sister to get a good paying career.

    1. Have you looked at how much MLM CEOs are making lately? vs. highest earners?

      Herbalife CEO Johnson made 10.7 million in 2013 and 6.4 million in 2014.

      How much did top Herbalife top sales guy (or gal) make in 2014? Id on't have that number, but I have 2011 numbers. According to their own income disclosure... 194 people made average of $724,030 for the group making 250K or more a year.

      The top sales guy is unlikely to be making more than 1.5 million, nowhere CLOSE to what CEO makes.

      So your idea "you can make what CEO makes" is, frankly, wishful thinking and not based in reality.

      Did I mention that this "250K and over club" is 0.2% of all "commissioned" distributors, which is only 12% of ALL distributors? (Herbalife itself admits that 88% of distributors earned NO commission so there's nothing for Herbalife to track)

      Your chances of making a million bucks in MLM is about as good as getting elected Senator or winning 2nd or 3rd prize in lottery.

    2. Whenever I see someone make a an argument based on what percentage of people make what amount I just roll my eyes -- because the comment lacks any sense. Exactly how many people do you think ever have the opportunity to become CEO of a company? And if we outlawed companies where those "at the top" make more, then pretty mush all companies would be illegal. The idea is brainless. Further, this argument is based on the idea that one should be guaranteed to make a certain amount or the business then is illegal. It's moronic. Last -- in response to the article -- no one make any MLM distributor buy some massive to qualify for anything; that is the distributor's choice. And that choice typically is made if the distributor has not built a strong enough downline to satisfy whatever is the sales requirement. But I say, so what -- no one is making them do that, and the behavior can be discouraged if its so bad. The real question is why does anyone make the assumption it's bad for this to be practiced? That is the unsupported assumption made by the author. Maybe ALL business should be examined so that the biz-starter has no risk of loss, because that essentially is what this author really is promoting.