What is a Pyramid Scheme?
Pyramid schemes, also referred to as “chain referral”, “binary compensation” or “matrix marketing” schemes, are marketing and investment frauds which reward participants for inducing other people to join the program. Ponzi schemes, by contrast, operate strictly by paying earlier investors with money deposited by later investors without the emphasis on recruitment or awareness of participation structure.
Pyramid schemes focus on the exchange of money and recruitment. At the heart of each pyramid scheme there is typically a representation that new participants can recoup their original investments by inducing two or more prospects to make the same investment.
For each person you bring in you are promised future monetary rewards or bonuses based on your advancement up the structure. Over time, the hierarchy of participants resembles a pyramid as newer, larger layers of participants join the established structure at the bottom.
They say you will have to do “little or no work because the people below you will”. You should be aware that the actual business of sales and supervision is hard work. So if everyone is doing little or no work, how successful can a venture be?
The marketing of a product or service, if done at all, is only of secondary importance in an attempt to evade prosecution or to provide a corporate substance. Often there is not even an established market for the products so the “sale” of such merchandise, newsletters or services is used as a front for transactions which occur only among and between the operation’s distributors.
Therefore, your earning potential depends primarily on how many people you sign up, not how much merchandise is sold.
Pyramid schemes are not the same as Ponzi schemes which operate under false pretences about how your money is being invested and normally benefit only a central company or person along with possibly a few early participants who become unwitting shills. Pyramid schemes involve a hierarchy of investors who participate in the growth of the structure with profits distributed according to one’s position within the promotional hierarchy based on active recruitment of additional participants.
How are Pyramid Schemes Disguised?
These illegal money-making ventures are modified and adapted to suit the victims. They may be disguised as games, chain letters, buying clubs, motivational companies, mail order operations, or investment organizations.
Because of the similarity in structure to legitimate multi-level marketing plans, which survive by making money off product sales to actual customers, not new recruits, pyramid schemes may occur when you are offered a distributorship or franchise to market a particular product. Your investment contract will also authorize you to sell additional franchises.
For each person you bring into such a company, you receive, or are promised, future monetary rewards or bonuses based on the number of people below you (commonly referred to as a “downline”) which ( and this is the key factor in pyramid schemes ) are unrelated to the sale of the product to consumers. The real profit is earned, not by the sale of the product, but by the sale of new distributorships.
Promoters of pyramid schemes stress the selling of additional franchises for a quicker return on your investment. Investors, therefore, expend their energies selling franchises rather than the product. At some point, the supply of potential investors is exhausted, leading to the inevitable collapse of the pyramid. The sale of the actual product often fails because it is overpriced or no real market exists for it.
Once the number of actual product buyers diminishes new recruits will focus primarily on recruiting others into the system without any realistic expectation that they can profit from retailing alone.
This lack of actual retail sales may be hard to determine as many pyramid schemes will claim that their product is selling like hot cakes. However, on closer examination, the sales occur only between people inside the pyramid structure or to new recruits joining the structure, not to consumers out in the general public.
Inventory loading occurs when a company’s incentive program forces recruits to buy more products than they could ever sell, often at inflated prices. Legitimate multilevel marketing plans actually sell their product to members of the general public, without requiring these consumers to pay anything extra or to join the MLM system. MLM’s may pay commissions to a long string of distributors, but these commission are paid for real retail sales, not for new recruits.
Such incentive purchases, which are tied to a higher distributorship level position in the “business opportunity “, lead participants to stockpile or give away unneeded product purchases, all the while chasing the elusive rainbow of imminent success. Often the costs of even long term participation far exceed the payments received.
One indication of a pyramid structure is one which pays override commissions on more than five levels of participation. Even the largest corporations can not stretch the markups on products beyond the hierarchy of sales person, branch manager, district manager, regional manager and national manager without becoming uncompetitive with standard retail outlets.
According to Jon M. Taylor of www.pyramidschemealert.org the suggested retail prices for MLM products are almost always too high to be competitive because huge margins have to be built in to allow for commissions to be paid to down-line distributors for item sales without compromising the company’s overly generous profits.
This need to avoid retail competition is achieved by the marketing of unique or miraculous new products which are unavailable elsewhere or presented as cutting edge technology accessible only to those with the vision to appreciate its benefits to humanity or the American Way.
Many pyramid schemes will also advertise that they are in the “pre-launch” stage, yet they never can and never do launch.
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