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Multi-level marketing (MLM), also called pyramid selling, network marketing, and referral marketing, is a controversial, pyramid-shaped marketing strategy where profit is theoretically derived from two revenue streams: from direct sales to customers and from commission based on the sales of recruited team members, also known as down line distributors. MLM salespeople are expected to sell products directly to consumers by means of relationship referrals and word of mouth marketing. They are also incentivized to recruit others to join the company as distributors.
MLMs have been made illegal in some jurisdictions as a type of pyramid scheme, including in mainland China. In jurisdictions where MLMs have not yet been made illegal, many illegal pyramid schemes attempt to present themselves as MLM businesses. Some sources define all MLMs as pyramid schemes, even if they have not been made illegal through legislative statutes. According to the U.S. Federal Trade Commission (FTC), some MLM companies already constitute illegal pyramid schemes even by the narrower existing legislation, exploiting members of the organization. There have been calls in various countries to broaden existing anti-pyramid scheme legislation, or enact specific legislation, to make all MLMs illegal, as has already been done in some jurisdictions.
Jurisdictions that retain a legal distinction between MLM businesses and illegal pyramid schemes, even if the distinction is deemed a legal fiction, retain said distinction on a key distinguishing feature, namely that MLMs rely on the sales of actual products, even though significant profit cannot realistically be made by such sales. Instead, profit (after the recoupment of losses) can only be reasonably achieved by the recruitment of other salespeople to cumulatively supplement the salesperson's profits by the addition of sales generated by the salesperson's new recruited salespeople. In this way, a salesperson's first cycle of recruits is augmented by a second cycle of recruits (recruited by the first cycle of recruits), and so on.
MLM salespeople are not employees of the MLM business, so they do not derive a salary/wage nor reimbursement from the MLM business for their invested labor and expenses, with their income from the MLM business derived only from the profits that are able to be generated in the MLM structure. As non-employees they are not protected by legal rights of employment law provisions. Instead, salespeople are typically presented by the MLM business as "independent contractors" or "business owners"; however, salespeople do not possess a business in the traditional legal sense, as they do not hold any tangible business assets or intangible business goodwill which could be sold or purchased in the sale or acquisition of a business.
Companies that use MLM models for compensation have been a frequent subject of criticism and lawsuits. Criticism has focused on their similarity to illegal pyramid schemes, price fixing of products, high initial entry costs (for marketing kit and first products), emphasis on recruitment of others over actual sales, encouraging if not requiring members to purchase and use the company's products, exploitation of personal relationships as both sales and recruiting targets, complex and exaggerated compensation schemes, the company and/or leading distributors making major money off training events and materials, and cult-like techniques which some groups use to enhance their members' enthusiasm and devotion.
Direct selling and network marketing
Network marketing and multi-level marketing have been described by author Dominique Xardel as being synonymous, and as methods of direct selling. Other terms that are sometimes used to describe multi-level marketing include "word-of-mouth marketing", "interactive distribution", and "relationship marketing". Critics have argued that the use of different terms and "buzzwords" is an effort to distinguish multi-level marketing from illegal Ponzi schemes, chain letters, and consumer fraud scams. Some sources classify multi-level marketing as a form of direct selling rather than being direct selling.
The Direct Selling Association (DSA), a lobbying group for the multi-level marketing industry, reported that in 1990 twenty-five percent of members used MLM, growing to 77.3 percent in 1999. By 2009, 94.2% of DSA members were using MLM, accounting for 99.6% of sellers, and 97.1% of sales. Companies such as Avon, Electrolux, Tupperware, and Kirby all originally used single level marketing to sell their goods and later introduced multi-level compensation plans. The DSA has approximately 200 members while it is estimated there are over 1,000 firms using multi-level marketing in the United States alone.
The origin of multi-level marketing is often disputed; but multi-level marketing style businesses existed in the 1920s, 1930s California Vitamin Company, (later named Nutrilite) or California Perfume Company (renamed as "Avon Products").
Independent non-salaried participants, referred to as distributors (variously called "associates", "independent business owners", "independent agents", etc.), are authorized to distribute the company's products or services. They are awarded their own immediate retail profit from customers plus commission from the company, not downlines, through a multi-level marketing compensation plan, which is based upon the volume of products sold through their own sales efforts as well as that of their downline organization.
Independent distributors develop their organizations by either building an active consumer network, who buy direct from the company, or by recruiting a downline of independent distributors who also build a consumer network base, thereby expanding the overall organization.
The combined number of recruits from these cycles are the sales force which is referred to as the salesperson's "downline". This "downline" is the pyramid in MLM's multiple level structure of compensation.
Assuming the blue individual recruits five, and those five recruit their own five, and so on, the maximum theoretical cycles of recruits possible in the "downline" of the blue individual is 14 cycles (514 = 6.1 billion people), after which point the total human population is exceeded.
Distributors can also earn a profit by retailing products they purchased from the company at wholesale price.
MLMs often argue that all businesses are pyramidal in structure, with a CEO at the top, management levels beneath, and successive levels of increasingly numerous employees undearneath them.
That pyramid organizational structure of a business is then argued by MLMs to show that MLMs are no more pyramids than other business structures, and that it is unfair to paint MLMs as a type of pyramid scheme rather than a legitimate business structure.
The pyramid shape in MLMs, however, does not refer to "pyramid organizational structure," but rather, it refers to the pyramid structure of MLM's incoming revenue sources, which itself stems from its unpaid participants (i.e. its unpaid participating non-employees). This is the reason MLMs are grouped with other ordinary pyramid schemes, even where they might not be classified as such by existing law.
In ordinary businesses, though, the pyramid shape does not refer to a pyramid structure of revenue of the business, but refers to the "pyramid organizational structure" of the business' human resources (i.e. its paid employees). Revenue and income of ordinary businesses then comes from independent customers (i.e. not from participants of the business).
Several sources have commented on the income level of specific MLMs or MLMs in general:
- The Times: "The Government investigation claims to have revealed that just 10% of Amway's agents in Britain make any profit, with less than one in ten selling a single item of the group's products."
- Eric Scheibeler, a high level "Emerald" Amway member: "UK Justice Norris found in 2008 that out of an IBO [Independent Business Owners] population of 33,000, 'only about 90 made sufficient incomes to cover the costs of actively building their business.' That's a 99.7 percent loss rate for investors."
- Newsweek: based on Mona Vie's own 2007 income disclosure statement "fewer than 1 percent qualified for commissions and of those, only 10 percent made more than $100 a week."
- Business Students Focus on Ethics: "In the USA, the average annual income from MLM for 90% MLM members is no more than US $5,000, which is far from being a sufficient means of making a living (San Lian Life Weekly 1998)"
- USA Today has had several articles:
- "While earning potential varies by company and sales ability, DSA says the median annual income for those in direct sales is $2,400."
- In an October 15, 2010 article, it was stated that documents of a MLM called Fortune reveal that 30 percent of its representatives make no money and that 54 percent of the remaining 70 percent only make $93 a month. The article also states Fortune is under investigation by the Attorneys General of Texas, Kentucky, North Dakota, and North Carolina with Missouri, South Carolina, Illinois, and Florida following up complaints against the company.
- A February 10, 2011 article stated "It can be very difficult, if not impossible, for most individuals to make a lot of money through the direct sale of products to consumers. And big money is what recruiters often allude to in their pitches."
- "Roland Whitsell, a former business professor who spent 40 years researching and teaching the pitfalls of multilevel marketing": "You'd be hard-pressed to find anyone making over $1.50 an hour, (t)he primary product is opportunity. The strongest, most powerful motivational force today is false hope."
Legality and legitimacy
MLM businesses operate in all 50 U.S. states. Businesses may use terms such as "affiliate marketing" or "home-based business franchising". Many pyramid schemes attempt to present themselves as legitimate MLM businesses. Some sources say that all MLMs are essentially pyramid schemes, even if they are legal.
The U.S. Federal Trade Commission (FTC) states: "Steer clear of multilevel marketing plans that pay commissions for recruiting new distributors. They're actually illegal pyramid schemes. Why is pyramiding dangerous? Because plans that pay commissions for recruiting new distributors inevitably collapse when no new distributors can be recruited. And when a plan collapses, most people—except perhaps those at the very top of the pyramid—end up empty-handed."
In a 2004 Staff Advisory letter to the Direct Selling Association, the FTC states:
Much has been made of the personal, or internal, consumption issue in recent years. In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme. The critical question for the FTC is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture.
The Federal Trade Commission warns "Not all multilevel marketing plans are legitimate. Some are pyramid schemes. It's best not to get involved in plans where the money you make is based primarily on the number of distributors you recruit and your sales to them, rather than on your sales to people outside the plan who intend to use the products."
The Federal Trade Commission issued a decision, In re Amway Corp., in 1979 in which it indicated that multi-level marketing was not illegal per se in the United States. However, Amway was found guilty of price fixing (by effectively requiring "independent" distributors to sell at the same fixed price) and making exaggerated income claims.
The FTC advises that multi-level marketing organizations with greater incentives for recruitment than product sales are to be viewed skeptically. The FTC also warns that the practice of getting commissions from recruiting new members is outlawed in most states as "pyramiding".
In April 2006, the FTC proposed a Business Opportunity Rule intended to require all sellers of business opportunities—including MLMs—to provide enough information to enable prospective buyers/participants to make an informed decision about acquiring/joining a business venture with information disclosed about the average likelihood of monetary probability (and the extent of monetary profitability, if any) of acquiring/joining the business venture. In March 2008, however, the FTC removed "Network Marketing" (i.e. MLM) companies from the proposed Business Opportunity Rule, thus leaving MLM participants without the ability to make an informed choice of entring or not entering MLMs based on the disclosed likelihood of success and profitability:
The revised proposal, however, would not reach multi-level marketing companies or certain companies that may have been swept inadvertently into scope of the April 2006 proposal.
Walter J. Carl stated in a 2004 Western Journal of Communication article that "MLM organizations have been described by some as cults (Butterfield, 1985), pyramid schemes (Fitzpatrick & Reynolds, 1997), or organizations rife with misleading, deceptive, and unethical behavior (Carter, 1999), such as the questionable use of evangelical discourse to promote the business (Höpfl & Maddrell, 1996), and the exploitation of personal relationships for financial gain (Fitzpatrick & Reynolds, 1997)". In China, volunteers working to rescue people from the schemes have been physically attacked.
MLMs are also criticized for being unable to fulfill their promises for the majority of participants due to basic conflicts with Western cultural norms. There are even claims that the success rate for breaking even or even making money are far worse than other types of businesses: "The vast majority of MLMs are recruiting MLMs, in which participants must recruit aggressively to profit. Based on available data from the companies themselves, the loss rate for recruiting MLMs is approximately 99.9%; i.e., 99.9% of participants lose money after subtracting all expenses, including purchases from the company." In part, this is because encouraging recruits to further "recruit people to compete with [them]" leads to "market saturation." It has also been claimed "(b)y its very nature, MLM is completely devoid of any scientific foundations."
Because of the encouraging of recruits to further recruit their competitors, some people have even gone so far as to say at best modern MLMs are nothing more than legalized pyramid schemes with one stating "Multi-level marketing companies have become an accepted and legally sanctioned form of pyramid scheme in the United States" while another states "Multi-Level Marketing, a form of Pyramid Scheme, is not necessarily fraudulent."
In October 2010 it was reported that multilevel marketing companies were being investigated by a number of state attorneys general amid allegations that salespeople were primarily paid for recruiting and that more recent recruits cannot earn anything near what early entrants do.
Multi-level marketing (simplified Chinese: 传销; traditional Chinese: 傳銷; pinyin: chuán xiāo) was first introduced to China by American, Taiwanese, and Japanese companies following the Chinese economic reform of 1978. This rise in multi-level marketing's popularity coincided with economic uncertainty and a new shift towards individual consumerism. Multi-level marketing was banned on the mainland by the government in 1998, citing social, economic, and taxation issues. Further regulation "Prohibition of Chuanxiao" (where MLM is a type of Chuanxiao, Chinese name of the regulation is 《禁止传销条例》 ), was enacted in 2005, clause 3 of Chapter 2 of the regulation states having downlines is illegal (original text from the regulation '组织者或者经营者通过发展人员，要求被发展人员发展其他人员加入，形成上下线关系，并以下线的销售业绩为依据计算和给付上线报酬，牟取非法利益的。'). O'Regan wrote 'With this regulation China makes clear that while Direct Sales is permitted in the mainland, Multi-Level Marketing is not'.
MLM companies have been trying to find ways around China's prohibitions, or have been developing other methods, such as direct sales, to take their products to China through retail operations. The Direct Sales Regulations limit direct selling to cosmetics, health food, sanitary products, bodybuilding equipment and kitchen utensils. And the Regulations require Chinese or foreign companies ("FIEs") who intend to engage into direct sale business in mainland China to apply for and obtain direct selling license from the Ministry of Commerce ("MOFCOM"). In 2016, there are 73 companies, including domestic and foreign companies, have obtained the direct selling license. Some multi-level marketing sellers have circumvented this ban by establishing addresses and bank accounts in Hong Kong, where the practice is legal, while selling and recruiting on the mainland.
It was not until August 23, 2005 that the State Council promulgated rules that dealt specifically with direct sale operation- Administration of Direct Sales (entered into effect on 1 December 2005) and the Regulations for the Prohibition of chuanxiao (entered into effect on 1 November 2005). When direct selling is allowed, it will only be permitted under the most stringent requirements, in order to ensure the operations are not pyramid schemes, MLM, or fly-by-night operations.
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