The Mathematics of MLMsPosted on February 10th, 2008 26 comments
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”
[…] Of course, on a more basic level, you are set to fail anyway because that is how Multi Level Marketing schemes work. More details here. […]
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