A pyramid scheme is a business model that recruits members by promising payments or services in exchange for enrolling others in the scheme instead of providing investments or selling products. As the number of members increases, recruiting becomes increasingly complex, and most members are unable to profit; as a result, pyramid schemes are unsustainable and frequently illegal. But did you know why these kinds of businesses are deemed illegal?
Market saturation is a significant reason why Pyramid Schemes are illegal. If you started a pyramid scheme with five people and each person recruited five more people, you would have outnumbered the entire population of the Earth by the 15th tier.
The Difference Between Multi-Level Marketing and Pyramid Scheme
The term multi-level or network marketing refers to a type of business in which independent representatives sell products or services to family, friends, and acquaintances. A representative is paid commissions on retail sales and sales made by others they recruit. Amway and Mary Kay Cosmetics are two well-known multi-level marketing companies.
Some businesses call themselves multi-level marketing when they are pyramid schemes that violate Michigan’s Pyramid Promotion Act. Even if a multi-level plan does not violate Michigan’s Pyramid Promotion Act, the plan’s marketing may violate Michigan’s Consumer Protection Act if the acts, methods, or practices are unfair, unethical, or deceptive.
Consumers frequently struggle to distinguish between an illegal pyramid scheme and a legitimate multi-level marketing opportunity. Government regulators and the industry are still debating where the legal lines should be drawn. Multi-level marketing is a legal and legitimate business method that sells consumer products through a network of independent representatives. Compensation must be based primarily on selling goods and services to the final consumer.
Pyramid schemes present themselves as multi-level marketing companies claiming to sell products to consumers. However, there is little or no effort made to market the product. Instead, money is made in the traditional pyramid fashion…by recruiting others to market the program. When new “distributors” sign up, they are sometimes persuaded to buy inventory or overpriced products/services.
Pyramid schemes make almost all their money by signing up recruits and frequently try to disguise entry fees as the cost of mandatory training, computer services, or product inventory purchases.
Pyramid schemes are illegal and a waste of time and money. Because pyramid schemes rely on recruiting new members to generate revenue, they frequently fail when the pool of potential recruits runs dry due to market saturation. When the plan fails, most people lose their money, except for the few at the top of the pyramid. (Source: Michigan Government – Consumer Protection)
The Chain Letters
The chain letter is the most basic type of pyramid scheme, in which the recipient pays $1.00 or more to each of five names on a list, copies the letter, and then sends it out to new people with the recipient’s name added to the list. Because they offer a product, many chain letters claim to be legitimate. Close inspection reveals that the product is merely a ruse. The newsletter often describes additional get-rich-quick schemes and may be the only item new members purchase.
Alternatively, the newsletter could be made accessible to any new paying member. If the scheme pays distributors to recruit new members rather than selling an actual product to the general public, it is simply a pyramid scheme. Pyramid schemes have become more sophisticated recently, and many have surfaced on the internet. (Source: Michigan Government – Consumer Protection)
Image from Investopedia