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. 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.

  2. 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.

    • I love comments that start with (I’ll paraphrase here), “Don’t be insulted, … while I insult you…” This last comment made me chuckle. Neither Robert Kiyosaki nor Donald Trump have made their money as Network Marketers. Being the supplier for an MLM Network is likely to be a good deal, since you sell high margin products to people who use their social capital to promote it and so it’s potentially a profitable business model. As long as you don’t concern yourself with what happens downstream, i.e., where people are all trying to achieve financial independence by promoting the products, you might do very well. So I can see Trump wanting in on the top of that food chain. But Mr. “Rich Dad Poor Dad” Kiyosaki promoting MLM is another case all together. By all accounts, Kiyosaki is a complete and total fraud when it comes to promoting money-making activities. The stories he writes in his books sounds good on the surface, but he doesn’t make his money at plying those principles. As far as anyone has been able to tell, He MAKES HIS STORIES UP and then makes all his money selling books about how well his principles work. Just look at his Wikipedia article. The stories in his books are not based on truth. His inspirational stories cannot be corroborated. Even the hero of the “Rich Dad” character in his popular book never really existed! That is just so sad that someone is hoodwinking his readers into believing he knows what he’s talking about when it comes to making money.

      • 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.

  3. 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.

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