What is a Pyramid Scheme? Are Multi-Level Marketing Companies the same as Pyramid Schemes? What is the difference between a pyramid scheme and network marketing?

The truth, on the surface, is that they are the same. It doesn’t mean that all opportunities in the network marketing arena are bad. It’s just that they may work for some people, but not others.

The term “Multi-level Marketing, “MLM” and “Network Marketing” all refer to the same thing. The overall business structure is like a pyramid

One other point that I’ll cover again later, is that even legitimate network marketing opportunities often have slim margins on the products or services offered, such that the only way to make moony of any consequence is by recruiting others to work on your “team” (often called the “downline”).

Pyramid Schemes Broken Down

There are actually two types of pyramid schemes:

  • A “naked” pyramid. This is one in which there is no product or service offered, just an exchange of cash
  • A “product-based” pyramid. Just as it sounds, there is a product or service that is offered via a pyramid-style business model.

In both cases, we often use the term “Multi-Level Marketing” or “MLM” in today’s world. The terms can be used interchangeably.

The Naked Pyramid Scheme

With the Naked Pyramid Scheme, it’s just a matter of recruiting in levels. There is nothing to be had except money – maybe. Here’s an example:

  • Mary recruits ten people to her “big plan”.
  • They each pay Mary $100
  • Now those ten people have to do the same
  • If they are successful, they’ll each have a nice profit of $900

The problem is, those ten people would have to each find ten people, and the 100 people would have to find 1,000 people. Well, you can see that eventually its going to crumble and those at the bottom will lose out on their investment

The Product-Based Pyramid

With a product-based pyramid, you have the same concept. Typically, though, it is offered as a direct sales opportunity. This makes it seem enticing and adds legitimacy.

  • The company hires a distributor who sells starter kits at $100 to 10 people (new sales people)
  • The distributor keeps $10 for each kit sold
  • The distributor also gets 10% of product sales by the 10 recruits, including more starter kits
  • The recruits are trained that the fastest way to make money isn’t by selling products, but by recruiting more people to buy starter kits
  • The people at the top get commissions from everyone in their downline (sometimes called a “team”).

The problem here is that some products don’t always sell very well or have small profit margins. So the best way to make money is by bringing on more recruits.

The market can quickly become saturated when you have too many people trying to sell the same products and there is no one left to recruit, as was evident in this hilarious episode of Schitt’s Creek (this is just the beginning of the episode – look online for the full episode).

In fact, mathematically, pyramid-based businesses won’t work unless someone at the bottom loses. Statistically, 88% of the members on the bottom level will lose their money. [source: Pyramid Scheme Alert]

Multi-Level Marketing vs Pyramid Schemes

Multi-level Marketing, or MLM or network marketing, has been around for well over a hundred years. One of the best known was Tupperware, which started in 1946 with legions of housewives flooding the country selling plasticware at home parties. Truth: We still have some from 50 years ago!

Legitimate MLM’s and Pyramid schemes look the same, in that they are both built using “multiple levels” of distributors and recruits. There are some who claim that even supposedly “legitimate” ones are pyramids in disguise.

The company that lead the way towards legitimacy was Amway when, in 1973, a ruling by the Federal Trade Commission claimed they were not a pyramid scheme. The differences at the time:

  • Amway does not pay “distributors” for simply recruiting new salespeople (or participants in the program)
  • One makes money by selling products or managing a team of sales people. Managers get a percent of the recruits’ sales
  • They do not require the purchase of a starter kit or impose a minimum monthly order amount to remain a member.

Ways To identify Potential Pyramid Schemes

  • Money is offered simply for bringing in new sales people. It could be in the form of a recruiting or signing bonus or commission from a starter kit
  • Emphasis is put on recruiting salespeople rather than on product or service sales
  • There may be a steep start-up cost for joining which could include a membership fee, starter kit or mandatory training
  • This could include any MLM which allows more than 5 levels above to get commissions on a single sale.
  • Are the products sold offered at a competitive price? (naming names – Pampered Chef comes to mind here with their over-priced kitchen ware)
  • Do the products have real value?
  • Has the company been involved in any lawsuits?
  • If someone is trying to sell you on something by flaunting their fancy cars, yachts or big homes, take caution
  • If they say you will receive free sales leads, etc. – it’s likely that the lists are old and out of date
  • Be watchful of signing up at high-pressure events, or on websites that make it seem like the clock is ticking.
  • Do your homework first.

Can it all go completely wrong? How about a cult? Read about NXIVM, an MLM that became a cult.

So, yes, it can be very bad it you don’t do your homework first.


The Bottom Line

I have seen some legitimate networking companies that possess some of the potential pitfalls mentioned above. I want to say that there are plenty of people working with those companies and doing well, so it’s not all bad.

A final note: Anything that sounds too good to be true, probably is. I’ve said it before, there is no way to get rich quick by marketing anything, no matter the method you are using. It takes time, honesty and dedication. Recruiting others into a dead end scheme is no way to make a living that is sustainable.



Related Reading:

Affiliate Marketing vs. Network Marketing