The Mathematics of MLMs

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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.

27 thoughts on “The Mathematics of MLMs

  1. 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”.

  2. 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

    • 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.

      • 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?

  3. 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.

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