MLM Pyramid Schemes: A Primer

Pershing Square Capital Management

Starting your own successful business has long been an important part of the American dream. Some legitimate companies rely on aspiring entrepreneurs in order to build their businesses. H&R, Block, Burger King, and Midas are a few good examples. Some of the start-your-own-business offers you'll see are legitimate opportunities. But some are designed to take advantage of you. If you get involved with one of these companies, instead of making money, you will likely lose it.

One of the most damaging and pernicious scams out there is known as a pyramid scheme. In order to protect yourself from pyramid schemes, you need learn how to identify them. So what is a pyramid scheme?

Most companies that sell products make money by selling them to consumers. But many MLMs make money by selling overpriced, difficult to sell products to their own distributors who are typically aspiring entrepreneurs hoping to fill the business. To qualify as a distributor, you must buy a minimum amount of product from the company. This can cost you hundreds or even thousands of dollars. Once you purchase enough of the product to qualify for commissions, you will soon realize it is difficult to resell the inventory you purchased and generate retail profits.

At that point, you will learn that recruiting others to become a distributor is the only way to have a chance of recouping the money you invested. You will likely be pushed by the distributor who recruited you to convince others to buy in and become distributors. Under pressure to recruit and faced with the risk of losing what you have already invested, pyramid scheme victims often recruit their own friends and family into the scheme to try to make back what they have lost. This constant emphasis on recruiting new distributors is a telltale sign you're dealing with a pyramid scheme.

In order to survive, pyramid schemes need a constant flow of new aspiring entrepreneurs to buy in at the bottom levels. To do this, distributors work hard to convince you to sign up—often using very convincing yet false and misleading arguments.

In order to get you to part with your hard earned money they will first work to earn your trust. The person recruiting you into a pyramid scheme is likely to be someone you know, a member of your family, a friend, someone from church, work or a sports link or another parent at your child's school. The person recruiting you may not even know the set-up is a pyramid scheme and may be sincere in the attempt to recruit you.

Pyramid schemes have been very successful recruiting from the Latino community, communities of people who are similarly situated with similar life experience, language, religious affiliations and shared aspirations make ideal targets. If you sign up, you will be told that if you work hard anyone can do it. If you stay with it for a while, you might even begin to receive small royalty payments, which encourage you to believe that success is just around the corner.

New distributors often think about these small royalty payments as profits but forget to consider the much larger investment in unsellable inventory and other expenses including the enormous amount of time and energy that they have already invested. You will also be encouraged to invest more money in training sessions, marketing and sales aids, and motivational events called extravaganzas. Pyramid schemes will focus their attention on the very few people at the top who are making a lot of money when in reality the vast majority of the people in pyramid schemes eventually fail. Failing distributor's money is lost and transferred to those individuals at the top of the pyramid who likely came into the scheme in its earliest years.  


Six-minute video: English || Spanish

So how can you protect yourself? Use this checklist to see if your company fits the pyramid profile.

Protect yourself against pyramid schemes by learning to recognize the warning signs. In order to keep your money safe, remain skeptical about money making schemes that rely on recruiting others to succeed. Help your community by spreading the word. If you want to capture your piece of the American dream, don't get caught in the pyramid scheme.


The above message is slightly modified from the brilliant video produced by Pershing Square Capital Management, whose president, Bill Ackman, is urging government regulators to shut down Herbalife. I agree with his analysis, but my advice about MLMs is simpler: Since consumable MLM products tend to be overpriced and the odds of profiting as an MLM distributor are so small, the best course of action is to avoid product-based MLMs altogether. —Stephen Barrett, M.D.

This article was posted on January 15, 2015.

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