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.
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.
http://www.youtube.com/watch?v=-LEjX1GfDEI&feature=related
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.
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.
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.
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.
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.
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.