Multi-level Marketing (MLM) is a marketing strategy designed to promote a product or service through distributors. It offers them multiple levels of compensation.Pyramid schemes are, however, fraudulent schemes, disguising themselves as an MLM strategy. They sell no real product. Furthermore, they base commissions only on the number of new individuals one introduces into the pyramid scheme. See more about the uniqueness of multi level marketing below:
The main idea behind the MLM strategy is to promote maximum number of distributors for the product, and to exponentially increase the sales force. The promoters get commission on the sale of the product as well as compensation for the sales that their recruits make. Thus, multi-level marketing pay commission to individuals at multiple levels. The commission depends on the total volume of sales generated. In the case of pyramid schemes, the money charged is simply for enrolling other people into the scheme and not real product sales. Only a few people (those who are involved in starting the scheme) make money. When no new individuals can be recruited, the scheme fails. At this point, most of the promoters, except the top ones lose their money.
The Federal trade Commission (FTC) has set guidelines that help consumers discern legitimate plans from illegal ones. The guidelines below help us deduce the definition of mlm companies and that of pyramid schemes.
Sales of actual product or services to consumers: MLM offers products whereas Pyramid schemes do not.
Commissions paid on sale of products and not on enrolments. In MLM hierarchical commission comes with the sales of products whereas pyramid schemes base solely on new enrolments.
Company buys back inventory from participants at the time of termination. On the other hand, pyramid schemes do not have any inventory.
Pyramid schemes quickly become unsustainable because there are not enough people in the world to support it.
MLM strategy has different compensation plans. These differ slightly based on the commission distribution among promoters. The plans include Unilevel, Stairstep Breakaway, Matrix, Binary and Hybrid plans.
The Unilevel model is the simplest one. The design is such that a person can recruit unlimited “frontline” distributors for the product. The frontline distributors recruit more distributors, and thus the cycle continues. Commissions payments are up to seven levels deep.
The Stairstep Breakaway model is designed to encourage individuals as well as group sales. In this model, a group leader is assigned with multiple recruits under them. The goal is to achieve as set of volume of sales in a set time. Once that is achieved, the distributors move to a higher commission level. This pattern continues up to a certain limit, after which the distributor breaks away and this pattern of commission ceases. From this point onwards, other commissions and incentives are provided to the representative.
Matrix models are similar to the first type. However, in this case, sponsorship of a limited number of distributors occurs at any level. Thereafter we start another matrix for we have already attained a certain preset number.
Binary models allow only two distributor sponsorship in the frontline. If there are more sponsors, they spill over to the next level. Therefore this implies that at any level, only two distributors complete the compensation plan. Also, the compensation balance between the two distributors at any level, such that the volume of sales does not exceed a certain percentage of the distributor’s total sales, is paramount.
Lastly, there are hybrid models. These, as the name suggests, combine any of the above mentioned compensation plans.
The models in the Pyramid Scheme include 8-ball model and Matrix scheme. In The 8-ball model each person has to recruit two people into the scheme. These people have to pay a sum to enter the scheme called a “gift sum”. The captain or the person at the top receives the gift money from 8 people before exiting the scheme. The remaining people move up the scheme, and this pattern continues with more people recruitment into the scheme.
Matrix scheme is also a pyramid scheme except that people are required to pay for a product in advance and wait in a queue in order to enter the scheme. When the recruited person further recruits a certain number of people, he or she receives a product like a camcorder or television that is worth much less than the money paid, and exits the scheme. This scheme collapses when no more people are willing to pay and join.