Lee's personal website, blog, and FAQ's
• ## The Mathematics of MLMs

Posted on February 10th, 2008

Every once in a while I get solicited by someone promoting a Multi-Level Marketing (MLM) scheme. This has gone on for as long as I can recall. You have probably already heard an MLM pitch where you recruit 5 members, they each recruit 5 members, and so on until you rise to the top of a pyramid structure and become financially independent. It’s sometimes referred to as Network Marketing.

The majority of these schemes often involve buying ‘lotions and potions’, which have near magical properties. Once you sign up, you agree to recruit others to do the same. The products have amazingly high markups compared to other similar products you can buy in a supermarket. They need these high margins because when you work your way through the math, half or more of their proceeds are gobbled up in payments to people at various levels in the pyramid. With an MLM, instead of eliminating the middle man, you’re adding about 4 or 5 levels of middle men.

Unfortunately, none of these MLM companies can deliver the promise of financial independence to more than about .4% of the people who participate in the scheme. In reality, the ratio is likely to be less. I’ve worked through an example below that will show you what’s wrong with this business model.

If you assume that financial independence for you means making 5 times a minimum wage of \$6/hr, then you’d need \$60,000 annually (\$5,000/month) to achieve this. Many MLMs promise incomes much higher than this, but let’s be conservative and use this amount. Let’s see how big an organization you’d need to get to that income level in an MLM structure.

Assuming that your product requires each member in your downline to purchase \$200 worth of product per month and you get an average of 10% of the money that flows up through your organization, you would need about 250 people in your organization for you to earn \$5,000/month. This means that it would be about 5 levels deep and might look like this:

You + 5 + 25 + 125 + 95

For the sake of simplicity in building a 250-person organization, let’s just say your bottom level is still filling in and that’s why the bottom level has 95 people. If you got a 10% commission on all these people’s purchases, your monthly income would be \$5,000/month. That sounds pretty good right? Well, here’s the rub. ALL of the 250 people in your organization are making little or no money, yet ALL of them were recruited so that they can get to where you are, that is, to financial independence. The people in the bottom level of the organization are spending \$200 per month and making nothing. The 125 people in the level above them are spending \$200 per month and are making less than \$8 per month in commissions on average, so they are out \$192 per month. The 25 people in the level above them each have an average of 9 people in their downlines and thus are making \$180 in commissions and so they are losing \$20 per month. The 5 people above them have an average of 49 people in their downlines and are making \$980/month less the \$200 they spend on products so they are clearing \$780 per month. That’s not even equal to a \$6/hr minimum wage job.

So, in order to achieve your financial independence, you’ve got an organization of 250 people and not a single one of them will be making more than the minimum wage. But ALL of them were recruited with the promise that financial independence was achievable. So in order to achieve YOUR financial goals, you have built an organization where fully 99.6% are unable to achieve THEIR financial goals.

You may say that all you need to do is to keep on building the organization and that will lift everyone up, right? That’s all well and good, but the ratio of people who are financially independent to those who are making little or no money DOES NOT CHANGE. There will always 99.6% working for minimum wage or losing money in an MLM. Do you really want to be part of a scheme that only permits 1 in 250 of its members to achieve the financial goals that everyone who has been recruited is expecting to attain?

What usually happens in these organizations is that the majority of people who are unable to meet their financial goals eventually get disillusioned and drop out and so everyone spends their time recruiting replacements. Few ever manage to rise very far, because the top people are already in place and the bottom members are getting replaced on a continual basis.

MLMs are a complete waste of time, money, and social capital. I was hoping that with the arrival of the Internet that these schemes would simply just go away as people were able to educate themselves about the other side of these “too good to be true” stories. It does seem to be helping expose these schemes for what they are. If you’d like to see a great website on the inherent flaws in the MLM business model, go to Jon Taylor’s MLM-TheTruth.com for an in-depth analysis of it as well as links to many other websites with similar supporting information.

I post this only for the purpose of helping people to wrap their minds around the mathematics of MLMs. I know that the majority of people recruited into MLMs are decent people who were recruited by other well-intentioned people who just repeated the sales pitch they were taught. But you can see from the math behind MLM pyramid schemes requires that for everyone who achieves financial independence, about 2% in their organization will make less than a minimum wage and the other 98% will lose money. I cannot imagine anyone feeling good about being a member of such an organization, especially if he is the one living off the other 99.6% of the people in his organization.

### 26 responses to “The Mathematics of MLMs”

1. Very nice article. I have met more than one person who has gotten involved with MLMs at one time or another. The most common one is “Arbone”. I had a client who wanted me to organize/rip here Arbone CD collection. The ripping software played the CDs you were ripping weather you liked it or not, and so I got a chance to listen to some of the CDs while they ripped.

The content of the CDs was classic propaganda, and were pretty downright disturbing. Titles included “the power of you”, “yes”, and others to the like.

Vector Marketing is another one. They hire almost exclusively collage students to sell Cutco knifes.

I don’t have anything against Cutco, in that their knifes are close to the best you can get, but I do not see why they continue to use Vector Marketing.

I had a VM employee come to my house to place a few orders for new knifes, and sharpen existing ones, and I couldn’t help but feel sorry for he poor guy.

2. Hi Chris,

Arbonne is evidently an MLM because it depends on recruiting other sales people whose sales volume get credited to their upline recruiters. The CDs/audio programs that are available through MLMs are often used as a way for making extra income by selling ‘pep talks’ and other promotional materials called ‘tools’ to one’s downline organization. Sometimes these high margin tools are pushed so heavily and frequently that they provide more income than the commissions on the products that are sold.

In the case of Vector Marketing, they do not appear to be an MLM organization. They are a direct sales organization that recruits college students to give in home demonstrations. The students make money on selling cutlery to end users. They do not recruit other sales people so it’s not really an MLM.

Door-to-door sales is a tough way to make a living. I’ve often felt that if you have to disturb someone at their home by arriving unannounced, then you are probably pushing a product or service that the homeowner doesn’t really need or could probably purchase more economically at a retailer.

3. Hi Lee,

You have to actully make an appointment with Vector M before they come to your house, it’s not like they just show up unannounced. I really hate the kind of sales people who do that though. We live far back I our subdivision (last house to be built actully) so we don’t get many of them, but we have gotten a few. I just tell them get to off my property politely, and if they are persistent I tell them to get off my property before I call the police.

4. [...] I may not follow you if the website linked to your profile doesn’t appear to have a real person or real company behind it. If I detect the slightest hint of MLM or network marketing or other pyramid ripoff schemes on your profile, I will most certainly not follow you. Here’s why. [...]

5. [...] I like to expose scammers. Seeing the unscrupulous abuse the goodwill and trust of others is just one of those behaviors that I can’t sit by and idly watch. Several of my most popular blog articles are related to exposing scams like the Amish Heat Surge miracle heater, the Arctic Cool Surge (yes, same company), and exposing the unworkable mathematics of all MLM schemes. [...]

6. I came across this post and thought this was relevent:

“So, in order to achieve your financial independence, you’ve got an organization of 250 people and not a single one of them will be making more than the minimum wage. But ALL of them were recruited with the promise that financial independence was achievable. So in order to achieve YOUR financial goals, you have built an organization where fully 99.6% are unable to achieve THEIR financial goals.”

True. I have been there. It is the ones that get in first that make the most money, as they have a number of people under them working their tails off.

7. Lee, I stumbled across this post and I have to admit, this has to be one of the worst article representing MLM. You can make this argument with every industry on the planet.

This is a more accurate description of the truth.

Your advice is like me going to a financial planner who has never made any money on is own investments and asking him/her to help me with mine.

8. Hi DeMarr, I spent 10 minutes watching the video you linked, and have to wonder why the person featured had such a successful MLM business, yet today he spends his time providing ‘educational’ materials to the MLM industry. If he already had made it as a successful MLM business owner (generating nearly \$2M in annual income from a downline of 56,000 people, no less!), why does he need this extra career of selling MLM training? At one time, there was a problem where people in a well-known MLM company had members who made much more money selling ‘training’ to their downline than they did on commissions from product sales.

The point of my blog post was to use math to show that only the top 1% (or fewer) in a typical MLM structure make what would be considered a reasonable wage. At a company like Walmart and McDonalds, 100% of the workers make at least the minimum wage. Using my example, in a typical MLM organization, only one person in the organization of 250 people would make above the minimum wage. So that is the difference, and it’s not a subtle difference, between conventional businesses and MLMs. Sure, all companies are shaped like pyramids, but in conventional companies, even the bottom layer makes a minimum wage. In an MLM, 99% of the members are supporting the top 1% and receiving little or no compensation for it. And that’s why the MLM industry needs so much internal marketing to keep the downline from giving up. The guys who got in early and are now at the top would like to keep it that way, and to do that, they need to keep selling the story to keep recruiting the other 99% of the people who are there to sustain the income of those at the top.

9. Lee, you are comparing apples with oranges. You are talking about going into business for yourself -vs- hourly wages. Your talking about just showing up -vs- getting paid for what you produce.

Like I said in my post, there are many, many industries that a small percentage rise to the top. Take the insurance industry…Do you know how many people take the insurance test, get their license and are gone after the first 2 years? Real Estate, Mortgages, anything where your check is solely based on performance you will see the same types of numbers as you do in MLM. Any kind of sales related work you will find this.

Sales, in general, has a high fatality rate. I have lead sales teams in both traditional business and MLM and the failure rate are not much different no matter how you want to spread the math around.

If you took those same 250 you mention and they got excited about selling widgets door to door the ratios would be the same, even if I did had the best training in the world on how to market those widgets.

As far as only the people in the beginning make the money. I would think about doing a little more research. You will find there are plenty of people that come in late and make their dreams come true.

10. Hi DeMarr, I think that you’ve described a major problem with the MLM industry. Most people don’t have the ability to sell, whether it be houses, insurance, or high-margin products. If MLMers were honest, they’d say, “Look, this business is all about sales, but we know that 99% of the people we are likely to recruit can’t sell, yet we need to keep them buying a boatload of these high margin products every month indefinitely, because we need that 99% to hang around and not get discouraged so we can support our star sales people.” Now, I know that wouldn’t be a good selling strategy, especially for the 99% of the organization that is not making money, so you have to give each and every recruit the belief that they can be successful if they only put in the effort.

Here’s another thing that bugs me about the MLM industry. Sometimes I don’t hear from a friend for a long time, and then I get a call out of the blue telling me that they’ve missed me and want to get together for lunch or dinner. Then, as we’re catching up on old times, I find they have been recruited into some MLM company and the only reason I got the call was because they wanted to ‘present me with a business opportunity’, i.e., recruit me into their downline. How does that make me feel? Not very good. You’d have to be a sociopath not to understand how that offends people. The next time you tell a potential recruit, “Make a list of everyone you ever met….”, please keep in mind that the people on the list getting that call will not be pleased when they find that the only reason they got the call was to be recruited into an MLM company.

11. Lee,
In no way do I want you to interpret this comment as a defense of MLM (I actually found your site doing research to write a post about what is wrong with MLMs), but I’m fuzzy on your math here.
I also want to say that I really have no direct experience in any MLM, so maybe my criticism is unwarranted (I hope it is not).

Your example only takes into account the revenue stream from the minimum order amount and assumes that the bottom distributor makes no money at all on the material good for sale. This leaves the false impression that the people at the bottom of an MLM buy a product with absolutely no value or consume it themselves, that all participants only take the minimum order, and that the end user is always the bottom rung contractor.

If this product, let’s call it the Magic Widget, requires each person to purchase \$200 of product, I assume that this item has a retail value of let us say \$230. If the person at the bottom sells his inventory, does he not then make \$30? That is not much, but it is better than a loss. What if one of the bottom 5 buys \$800 of product and sells it for \$920? Has he not generated \$120 in income (albeit for a month of labor)? Feasibly then, this means that there is the potential that some of the distributors at the bottom are making a modest profit, and if one could create an ideal network, everyone would be profitable, though not comfortable.

Your example seems to assume a worst-case scenario- one where the final user is required to purchase the end product at absolutely no benefit to them. I’d like to, with your permission, use a variation on this example in my post.
I think that MLMs are still a scam, but your example seems to suffer from being unrealistic and as such easily dismissed.

12. Hi George, You are correct, I did not take into account the actual value of the products and cost avoidance. I guess I felt that the margins on the products are often so high that trying to account for the amount that might have been spent on alternative products were not worth counting. For example, if you can purchase a month’s worth of vitamins for \$6 at Walmart, and the equivalent amount of vitamins from an MLM would cost \$90, then I should have given credit for the \$6 of expense that could have been avoided by purchasing \$90 of vitamins from an MLM. This range of costs and savings is not a hypothetical example, but one that I have evaluated personally.

As for people selling MLM products at the MSRP and making some money from it, that would be amazing and , yes, one should count the markup as income. I don’t think that happens very often. One of the things that Jon Taylor’s book mentioned is the IRS officials have found that nearly all people involved in MLMs don’t pay taxes on their MLM income because they operate at a loss. That is, they write off MLM expenses against wages they earn from another profession. Fortunately, the MLM companies make plenty of money and they contribute to politicians who have helped to protect them and their business model.

13. I think, and don’t take this as insulting, that you are happy to factor credulity into the equation at the recruiting level and completely disregard it at the consumer level.
Many of these MLMs do a better than average job marketing their product as a designer product or as a product that holds untold advantages over generic alternatives.
In my own research over the last week into a MLM fruit juice, I have encountered many very well written and well thought out marketing tools that make the \$50-110 MLM product out to be far superior to both the mass market versions that can be found at health stores and competing alternatives. It took me several hours to gather and dissect evidence to the contrary. If I were listening to a good salesperson (and less generally skeptical by nature) I would be happy to accept that their product has a premium value.

Where this whole objection of mine falls apart is when the rubber meets the road. I bet that most contractors are more concerned with their downline than with their consumer sales, and would certainly capitalize on the customer’s credulity and pull them into the fold. I’m willing to wager that for most MLM structures, this doesn’t make financial sense- since I am assuming that a POS commission is likely higher than a downline commission. That fact is likely outweighed by the “get rich quick” mentality of the contractor- who sees an opportunity for advancement as the point more than the immediate benefit to their income stream.

My point is better proven with the only MLM I can think of who sells a large cross-section of products at competitive market prices. My better judgement prevents me from advertizing their name here- I’m sure you know of who I speak. Someone starting out with a solid business plan in this MLM (ex. building POS business that gives a respectable income stream combined with downline recruitment to selected individuals who do not impact your POS clientele) would read your article and assume they had beaten the system or that you were dead wrong- when in fact they are destined to collect little income from their endeavor.
So I like the spirit of your example, but I think that it doesn’t hold true for all MLM contractors- and as such suffers from easy handwaving.

14. No offense…but you are clueless. You obviously did not do our research on Network Marketing. Ever heard of Donald Trump or Robert Kiyosaki? Why don’t you read his book “The Business Of The 21st Century” it perfectly explains the business model of network marketing. Robert Kiyosaki also admits in the beginning he was close minded about Network Marketing but now after RESEARCHING and talking to people who are in the industry he has a new outlook on the matter.
Isn’t it odd that the entire business world operates under the principle of getting in early and making money off the people who come in later, yet the network marketing industry is often shunned for it! Yet, network marketing can point to thousands of people who make more money than the people who brought them into the business.
Network marketing…when done right and ethically is the fairest business on the planet.

16. Lee

Your article was true and accurate!. I have been an advocate against MLM for yrs. If anyone can understand marketing design, they should be able to see right away that it is flawed and sooner or later, will callapse under its on weight.

17. Mr Devlin

Thanks for your heads-up. I was around MLM for a short period, and having 33 yrs of marketing experience, I found out in a hurry that MLM by design is doomed to fail, and, as you say nothing but a mathematical “hoax”.

18. No matter what business you talk about, money has to be spent in order to make money. You need customers.
You say the product is more expensive, that can only be if you can buy the same product elsewhere.
Even if you could, than the comparison should be done with the business using a coventional method and how there products flow and who earns from that and how. I think you will find more of those customers to be in the minimum wage area.
Thats just the business world.
Mlm has been using a compansation plan like reward points. Beleive it or not, people like us pay for that but humans are easly influenced. Hence why the majority says negative things about it.
Think about. These are my thoughts.

19. Everywhere I go on the net I see MLM getting a good “bashing”. While I concede that the criticisms are well warranted as there is a lot of “smoke and mirrors” surrounding the whole MLM Industry.
I myself am a successful MLMer, I make good money but not huge money and yes it grows every year.
What annoys me about the criticisms is the sheer volume of ignorance and naievity.
Before considering joining a MLM company or even commenting on MLM it is absolutely essential to understand the numbers. Then once you understand the numbers, you make be honest enough with yourself to evaluate whether or not you can deal with task….the numbers are very daunting to look at.
I am with SFI as it gives all affiliates a decent shot at making some money, even if it is just to list and sell products on the tripleclicks e-commerce site (totally FREE to join).
To help you all begin to grasp the numbers involved with MLM here is an excerpt from a newsletter I send to my new team members before they get too committed:

The Power of Network Marketing

Mark Yarnell was a minister in a small town in Texas. Unfortunately, he was headed for bankruptcy and was just about to lose his car and home. He was looking for a way out and discovered network marketing. Luckily, he had a wise sponsor.

His sponsor gave Mark what he called “THE PRICE OF PROMISE”: “This business can set you free financially in one to three years.” The price is: “To succeed, you will have to face and conquer 4 major enemies.”

Mark said, “It’s a deal.” Mark began by inviting 200 friends over to his house to watch a video. 80 said “No, not interested.”

Mark had encountered ENEMY #1: Rejection. He thought, “No problem. My sponsor warned me about that. But I still have 120 people that are confirmed to come over.” Guess what? Only 70 showed up.

Mark had just encountered ENEMY #2: Deception. Mark thought, “No problem. My sponsor warned me about that. At least those 70 people watched the video!” Guess what? 57 said “Not Interested.”

Mark had just encountered ENEMY #3: Apathy. Undaunted, Mark thought, “No problem — 13 people DID sign up!” Guess what? 12 of them dropped out of the business shortly thereafter.

Mark had just encountered ENEMY #4: Attrition. Attrition had left Mark with just one serious associate. Guess what? To this day, that single distributor earns Mark over \$50,000 per month.

Mark Yarnell’s story is NOT Unique! You may have heard of Bill Britt, one of the most successful distributors in Amway. Some years ago, 20/20 did a feature story on Amway. The story spent 19 minutes interviewing whiners and complainers — distributors who had failed. They showed garages full of products they couldn’t sell. During the last minute of the show, Mr. Britt was interviewed in front of his palatial home. He was asked, “Mr. Britt, this business has obviously worked for you. What’s your secret?”

He replied, “There is no secret. I simply showed the plan to 1200 people. 900 said, ‘No’ and only 300 signed up. Out of those 300, only 85 did anything at all. Out of those 85 only 35 were serious, and out of those 35, 11 made me a millionaire.”

Like Mark Yarnell, Bill worked through the numbers. Jason Boreyko, co-founder of New Vision, told this story. When he was a distributor in Matol, he signed up 50 people. He heard a lot of “Nos” on the way to those 50. Jason took one man, who he knew would be terrific in the business, to lunch and told him about the business. The man said “No.” Jason took the man to lunch again the next month and gave him some updates. Once again the man said, “No.” Jason sent him some more information and took him to lunch again the next month. Again the man said, “No.” That went on for six months. The seventh month, something had changed for the man, and he said, “Yes.” That man made Jason over one million dollars. Jason also worked through his numbers.

While starting Amway, America’s eleventh richest entity,Rich DeVos and Jay Van Andel, recruited 500 people. 495 dropped out. The five that didn’t quit, built Amway. All \$7 billion of Amway’s business was built under those 5 people. Jay and Rich had to work through the numbers.

There are many similar stories. Jeff, the top money earner in Mannatech, signed up 27 people his first month. One might think that he is especially talented at sponsoring. Actually, Jeff will be the first to tell you that he is not talented at all. In fact, he feels that he did very poorly. To recruit those 27, Jeff talked to 2000 people that first month. And of the 27, the only one who did anything significant with the business was Ray Gebauer, who has more than half of Mannatech in his downline. Jeff’s word to you is this: “The numbers never lie. Pick your goal and then get into massive action. If you talk to enough people, you will make it!”

Here’s the lesson: Your success is directly related to the degree to which you are willing to work to find others like yourself who are committed to succeed.

Mark Yarnell’s odds were 1 in 50. Jeff’s were really 1 in 2000. Would you be willing to go through 200 people to find the 1 who will make you \$50,000 a month? Or go through 200 people to become a millionaire? Or hear “No” uncounted times to sign up 50 people and find that million dollar person? I hope you will. It’s easier when you know the odds up front.

But here’s the catch: You have your own set of odds — and you won’t know what they are until AFTER YOU’VE SUCCEEDED.

So if you’ve gone through 50 or 100 people and you haven’t found one serious person yet, you can either give up and assume the business doesn’t work, or recognize that you are working through your own numbers.

Are you willing to find out what your own set of odds is? This means that you must pay the price for freedom. Remember that the numbers never fail you. Despite where your skill level is, your success is assured if you talk to enough people. And as your skill improves, so will your odds.

Winning big is a matter of being willing to pay the price. Are you willing? Your future is in your hands! The choices which you make today will determine the course of your future.
—————————-

Hope you find this informative and educational.
Regardless: if you can’t deal with the numbers, steer clear of MLM.

Kudos to all my fellow MLMers out there who take on the numbers and emerge in profit….I know you earn them!

Best Regards to all readers of this post.

mike

20. Mike, it’s a moral issue. There is only a certain number of people on earth (around 7 billion). To prove the OP’s point if we extrapolated out from the business’ founder until every person on earth was also an MLM business member, then who will the people on bottom recruit or sell to?
It’s very simple logic, don’t try and add any complications to it, when all is said and done the fact remains that money ( or wealth, however money is not wealth) flows upstream, and those on the bottom will lose. And those on top win.
(I say wealth because wealth is created in an economy when people produce more in less time at equal or better quality)
The reader may be wondering how this is any different from any other business model, well let me explain; in a normal business there is an incentive to produce a good or service as efficiently as possible to drive the price of labor down to make it more affordable to CUSTOMERS who are willing to trade their time and work (represented today with money) for that business’ product: and thus wealth increases. The distinction is that in an MLM no one produces anything, no economic wealth is generated. Not only that but a super majority of the products sold by the MLM and purchased by its members. The wealth transfers upstream and none comes down. Oh the money you “get back” is a commission from your purchase and that of everyone downstream of you.

21. A super majority of the products sold by MLM’s are* purchased by its members.
Winning IS a matter of being willing to pay the price. And the price my dear friends is not money or time, it’s reaping what everyone downstream of you has sown. Are you selfish enough to pay that price, are you willing to pay that price?

22. Mike

Your post proves how difficult it is to succeed in MLM. They fit in with what the experts say, and that is the failure rate with MLM is about 98%. That is a conservative number. 1/2 of 1% would be more realistic based on what the experts have found. 1/50= 0.02 (98% failure), 1/2000= 0.0005. Way less than 1/2 of 1%. I can’t even count that low. Why would someone want to waste the time and resources to most likely fail. Maybe that’s why about 90% of distributors quit after about 1-2 years. These people, in my opinion, are the lucky ones. I’d take my chances in Vegas where I understand the odds are better. At least I would have a good time being separated from my money.

23. Very nice article. I just remind the Amway owners became billionaires with a MLM. Mr. Richard M. DeVos, one of the owners has US\$ 5.1 billion selling overpriced soaps through his MLM associates. Just saying…

24. Mackenzie Brunson