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Pyramid Schemes

Pyramid Schemes or "money games," can look like, and even be represented as, Direct Selling companies. It can seem difficult to tell the difference since both pyramid schemes and legitimate direct selling companies offer "income opportunities" and both usually "sell" products or services.

There is however, one very big difference between them, and with a little scrutiny, it's not hard to tell which is which.

Here's the most important difference:

Pyramid schemes mainly distribute money.

Direct Selling companies mainly distribute products to consumers.

Some of the criteria by which regulators determine whether a company is a legitimate direct selling organization or a pyramid scheme include:

  1. The 70% Rule - The "70% Rule" provides that in order to be eligible to receive downline compensation, at least 70% of a distributor's personal sales volume must be sold to "end consumers." "End consumers" are defined as purchasers of the company's products who are not also members or participating in the company's financial compensation plan.


  2. The Five Customer Rule - Like the 70% Rule, the Five Customer Rule is also sales-based. It states that in order to be eligible to receive downline compensation, distributors must develop or maintain a minimum of five personally-enrolled active customers.

Distributors must meet the requirements of both rules in order for a company to be legitimate. Regulators have shut down countless companies because they do not satisfy these criteria. Here are some of the reasons:

  1. The company offers a legitimate product or service but it is over-priced. That is to say, it is a poor value. Regular consumers (non-distributors) are not interested in buying it for this reason. Distributors don't mind paying extra because they are "paid" to buy (or at least they think they are).

    In any direct sales model, there are only two potential sources of revenue. They are: (a) activities related primarily to the introduction of additional participants (called "headhunting" or "recruiting"); or (b) activities related primarily to product sales and customer (non-distributor) acquisition, which is direct selling. "Headhunting" is a classic example of pyramiding. Direct selling is a classic example of a legitimate and legal distribution model. If a product is a poor value, then revenues will not and cannot flow from "activities related to product sales or customer acquisition." Accordingly, the only other possible source is "activities related primarily to the introduction of additional participants" or "headhunting."

    The bottom line is that when the products are a poor value for consumers, it is virtually impossible for a direct sales program not to be a pyramid.

  2. The company offers a legitimate product or service that is priced competitively, but nobody bothers to sell it to non-participating consumers because the compensation plan rewards people for headhunting far more than it rewards people for selling the product or service. People would rather recruit than retail.

  3. The company practices "inventory loading." In an inventory loading pyramid, legitimate products may be sold, but they are sold in unreasonable amounts. When a new distributor is recruited, he or she is pressured into buying hundreds of thousands of dollars of products and then taught to repeat the recruiting/inventory loading process.

  4. The company offers a product or service that is only of value to distributors. This includes things such as: websites used for selling the product or opportunity, voice mail services, business-status software, training etc. A regular consumer would never purchase these because they are of no value to a regular consumer. Only participants find them valuable, and only participants buy them.

There are two things that companies typically offer: (a) products (or services) and (b) sales aids. A "sales aid" is anything that is designed or intended to facilitate the sales of the company's products or services, or the building of its business. Examples of sales aids include catalogs, brochures, promotional web sites, training programs, etc. These things are perfectly legitimate items to support a direct sales business. However, no compensation should flow from their sales because they are not products that could be sold to consumers.

Because only distributors buy sales aids, the payment of multilevel compensation related to sales aids is almost always a disguised headhunting fee-making the program a pyramid.

In a legitimate direct sales program, the products or services that the company offers would sell on their own merits, even if the compensation plan did not exist. Legitimate direct sales and multilevel marketing companies provide compensation for the sales of products, not sales aids.

Each of these scenarios creates a situation where participants buy whatever the company sells, recruit others who do the same, and so on - creating a large consumer chain where very little is sold outside the network. These are all considered pyramid schemes according to current legal guidelines!

Pyramid Schemes are often very exciting because some people make a lot of money. Unfortunately that money comes right out of the pockets of other people. Without the legitimate sale of products, the system is simply not sustainable. When all or most of the revenue is from new people joining, a business literally collapses when recruitment slows or stops.

With this in mind, there are three questions you should always ask when looking at a company that claims to offer you an income opportunity through a combination of selling and recruiting others:

  1. Does the company pay commissions on sign up fees (or on a compulsory first purchase) or count each person who joins as a unit for compensation? If so, it is a pyramid.

  2. Where does most of the revenue come from? Even if the company offers products or services on the surface, if the majority of income earned by distributors is the result of recruiting rather than retailing, it is a pyramid.

  3. What would happen if recruiting stopped? Would there be any income flowing to the company or its distributors? In legitimate companies, even if recruiting stops or slows, revenue continues because customers keep buying the products or services from existing representatives. If revenue stops when recruiting stops, it is a pyramid scheme.



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