Consumer Behavior

The Case of the Missing $32 Billion

Missin-32billionMultilevel/Pyramid Marketing Schemes Lure Unsuspecting Consumers through FTC Loophole

Don’t look now, but dozens of companies, starting with Amway back in 1979, and more recently Herbalife, the supplements company being challenged as operating a pyramid scheme by activist investor Bill Ackman, have been diverting billions in sales every year away from traditional retailers across the health, beauty and general merchandise industries.

Multilevel marketing, or MLM, is a simple model that enriches those who start it at the expense of those who join later. The premise is simple, and there are few barriers to entry. A multilevel marketer pulls together a line of products, puts a brand name on it, and develops an enticing sales spiel which has, as its primary attraction, the ability, for those who make a bulk investment in these products, to profit from commissions earned when friends, neighbors, and family members become distributors, make a similar bulk investment, and recruit other friends or family members to do the same. They all will get a commission on those and all subsequent purchases that those friends and their recruits make. Everyone back up the line to the original seller gets part of the commission as well. The process creates an exponential geometric growth pattern which, in theory, would eventually encompass all potential prospects and leave later entrants no one to recruit.

Although some participants enter at little cost and do not proceed to the recruiting distributor level, the primary inducement in MLM involves an offering where a prospect is required to make a bulk purchase (or series of bulk purchases) of inventory in return for the right to recruit others to the same distributive level and profit via commissions on their recruits’ bulk purchases. High suggested retail prices reflect the multilevel commissions necessary to perpetuate and fund the plan. Mandatory inventory purchases are the primary source of profit for the MLM Company.

Mega-Billions Scheme

Current industry data puts MLM annual revenues in the US well over $32 billion, all of which reflect wholesale purchases of products or services by participating distributors qualified, via bulk inventory purchase, to buy from the company.

The diagram illustrates how many potential participants such a scheme would yield as levels are added. Before long it’s more than the world population, which, of course, makes it impossible to attain, let alone sustain.

If the diagram looks like a pyramid, then you share the concerns of consumer advocates around the world who filed a petition with the Federal Trade Commission concerning MLM.

Way back when, this type of marketing was uniformly condemned in the same category as a Ponzi scheme. Both resulted in latecomers enriching early entrants and losing when new recruits stopped joining. Both were considered inherently deceptive since they could not truthfully claim that all entrants have a chance to succeed.

However, in 1979, the Federal Trade Commission, having sued Amway as an illegal pyramid, found that its sales plan was not illegal because it had “Rules” which supposedly protected participants from pyramid related losses. Generally, these rules were supposed to eliminate participant risk due to inventory loading, and require:

a. 70% of monthly purchase inventory to be sold at retail or transferred further down the line for retail sale

b. that each distributor sold to at least 10 retail customers every month (a group including spouse, kids, and parents)

c. that a buy-back program protected against consumer loss.

Aside from the critical fact that these claims of investor protections were never factually verified by the FTC judge, or proven to prevent consumer loss, the Amway ruling remains as a primary basis for the perpetuation of these plans even to this day. This has resulted in confusing and indistinct legal standards by the FTC which more or less say follow the Amway rules and keep going unless and until you are sued, if ever.

Level Up

Some of the biggest and most visible of these successful companies (which include Amway and Mary Kay) actually began as MLM companies. Others, like Tupperware, Avon and kitchen knife maker Cutco, began as direct sellers but later adopted the MLM model when the whole “door-to-door” selling opportunity dried up. (And understandably – I mean, who in their right mind would answer the door and invite a stranger in, particularly one carrying a set of sharp knives?) As management realized how much money could be made in multilevel selling, the concept took off. Avon was one of the most recent to adopt MLM, in 2001.

The Direct Selling Association (DSA), a trade group that has these companies and many others as its members (Avon recently and with much fanfare resigned from the group, unhappy that it was being viewed as a pyramid selling operation, as did Tupperware in 2013), claims there are almost 16 million MLM distributors in the US.

Herbalife has been accused of being a pyramid by prominent hedge fund owner William Ackman, and is currently under investigation by the Federal Trade Commission. Amway recently settled private litigation which accused it of being a pyramid. NuSkin has had its pyramid related troubles in China. Mary Kay is the subject of a dedicated web site dealing with the subject. The wife of an Amway distributor also has a supportive blog for victims, with some colorful language. Googling a DSA member along with the word “pyramid” will provide interesting reading, once you get past the pro company sites that have been set up by, you guessed it, the companies themselves.

Social Justice

The topic of retail selling has some personal aspects. My father spent his life in retail establishments, starting as manager of the basement store at Carson, Pirie, Scott & Company in Chicago. I followed in his footsteps with a degree in Marketing at Northwestern (where I met Robin Lewis). I eventually went to law school and wound up as a consumer fraud attorney with the Wisconsin Department of Justice, where my experience in marketing was of considerable value.

This background enabled me to recognize the extensive damage caused by pyramid style offerings. My primary concerns were, and are, with the victims – people who left productive jobs and tapped into their savings to “invest” in MLM product samples, and the legitimate businesses, from small independent retailers to large chains, who lose sales and customers to these operations.

Multilevel marketing has been so poorly defined, at least by the federal government, that most proponents and victims operate under the impression that they are legal. This impression, and the fact that many MLM companies are listed on US stock exchanges, has perpetuated this myth, and has also enabled entry into a large number of other countries – to the extent that, collectively, current annual revenues exceed a whopping $150 billion worldwide – and growing. The US portion of this, in terms of actual retail sales – as estimated by the DSA, is currently around $32 billion. If, as claimed by the DSA, these are bona fide retail sales, the impact on the traditional retail establishment is considerable.

Legitimate retailers have a vested interest in seeking a response from the Federal Trade Commission containing a meaningful definition of a pyramid scheme and/or regulations to prohibit them.

MLM is not going away on its own. In fact, I predict it will get much worse unless the FTC takes a much stronger stance on this important issue.

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