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Multi-level marketing schemes (MLM), also often referred to as Direct Sales or Network Marketing, are presented as “business opportunities” targeted primarily at women—especially those struggling with traditional employment; military spouses, mothers with young children, and low-income communities. Throughout the last century, cosmetics and kitchenware companies like Tupperware, Mary Kay, and Avon birthed an industry of social selling to housewives in their living rooms. Saleswomen demonstrated products in a “party” while the host provided light refreshments to guests. Success as a direct seller is difficult with a high turnover rate. MLM companies shift the burden of recruiting and training new sellers onto the existing salesforce through adding a “level” of compensation for the product sales of their recruits, creating the possibility of compensation derived from the endless chain of recruitment.

The reality from the FTC is that over 99% of MLM participants lose money, some even acquiring large amounts of credit card debt to participate, compounding the financial and familial hardships that pressed them to seek income in the first place. Even the MLM industry lobby; the Direct Selling Association, has called participation in MLMs an “activity” rather than a job.

MLM companies rely heavily on personal relationships to make sales and products tend to be lower quality than competing brands, so participants primarily sell to friends, family, coworkers, and neighbors. However, two decades of online shopping has replaced in person purchases and the home party model has shifted to social media, with sellers organizing online events that facilitate ordering from the company website to have items shipped directly to the customers.

Presentation of the business opportunity has also moved to social media pitches that promise financial freedom by selling vitamins, shampoo, or skincare and recruiting others to do the same. New participants pay a small startup fee to the MLM company for access to a personalized website and sales aids to “run their own business” as an independent contractor. For example, Mary Kay Cosmetics exclusively sells its products at “wholesale” to its independent contractors who are then advised to sell at 100% markup. This markup is fictious, because a retail customer purchasing just $100 in cosmetics is better served by paying the $35 fee to become a consultant themselves and access wholesale pricing. Further driving down the retail price is a reliable secondary market, consultants who have overpurchased inventory often price their stock below wholesale on various resale websites.

Critically described as “product-based pyramid schemes,” MLM organizations transfer capital to the top members of the pyramid through commissions derived from the wholesale purchases of the lower members. The driver of these wholesale purchases is the participant’s anticipation of future retail sales. Commissions incentivize the recruiters to provide training and motivation to persuade the recruit that sales are imminent, even as inventory stacks up in basements and garages.

 An incentive to self-consume rather than try to sell the product is built into the design of the MLM compensation plan, which is an almost unintelligible system of levels and titles. All MLM companies use a variation of non-linear incentives to induce effort from members. These incentives are used in non-MLM sales to drastically increase productivity, but they also encourage individual sellers to game the system when they are close to a reward or bonus, which could potentially harm the overall company’s long-term profits. However, in MLM compensation plans, the design guides sellers to game the system by purchasing the products from themselves when they are close to a new reward. Additionally, because MLMs use independent contractors, the companies terminate the contracts of participants that respond too strongly to the incentives and make false claims, unethically pressure sales, or sell too low.

The figure that determines the compensation level paid to any particular participant is based on the sum of two components: personal wholesale volume (which is any wholesale order whether for personal use or ultimately used by a retail customer) and group volume (the personal volume of all the participant’s recruits) Both the intervals between levels and the rate increase are non-linear, which allows participants to alter their selling strategies close to the next level. Because personal volume does not functionally distinguish between retail customer purchases and participant purchases, participants are incentivized at the bonus threshold to close the gap or maintain their level with their own product purchases, sign up friends or relatives without their knowledge, or increase recruiting pressure and siphon commissions before the new recruit becomes disillusioned and exits the company.

Social media has increased the visibility of the desperation to recruit and sell products. Participants plead for sales while citing their personal goals, fundraise for dubious charities, and make improbable product claims. However, participants must attract new recruits by gloating about how the business has changed their life by supplying instant friendship (sisterhood and celebration) enabled them to stay at home with their children, afford extra holiday gifts and financial freedom. Participants have typically been persuaded against their objections to join by family and friends. Recruiting incentives have created a spin-off industry that offers coaching and training programs teaching the art of “overcoming objections” when potential contacts explain they do not have the money, time, or interest in participating. Early websites attempting to expose the predatory practices and provide context to the culture have evolved into an anti-MLM movement that has taken on a culture of its own.

Anti-MLM groups advocate for updating the Business Opportunity Rule to include MLMs. This rule requires that business opportunity sellers provide specific information to assist the buyer in accurately evaluating the opportunity. However, the available income disclosure statements (calculated deceptively and favorably as possible towards the MLM) display bleak figures, yet they are not persuasive enough to prevent an individual from signing up.

There are strong emotional incentives to remain in an MLM despite losing investments into it. MLMs are often compared to cults led by a charismatic CEO, blurring the lines of religion and prosperity with trainings in annual celebrations recognizing top sellers. Members are taught to  positive thinking and blocking out all negative thoughts early on so that they discount their own instincts and follow the teachings that keep them involved in the scheme. Members police each other and encourage continued participation even in the face of financial loss, they are reminded of the successful members at the top, and the only way to fail is to quit.

MLM companies depend on leveraging social capital to obtain members and then incentivize self-consumption of the products for the purpose of creating more transactions from which commissions can travel to the higher levels of the structure. Because MLMs pay commissions calculated from wholesale purchases, self-consumption is not distinguishable from genuine sales to retail customers outside the organization. Legislation to reduce the risk of MLM could focus on requiring these companies to track sales to customers outside the organization. However, the DSA recognizes that one-third of all products purchased were bought by participants for use in their own households. Given this number is self-reported and does not capture excessive inventory not intended for personal use, the true number of self-sales is likely much higher. It is possible that regulations requiring separate accounting of sales to self within the company and sales to retail customers outside the company would reveal there are not enough sales to genuine customers to keep the company solvent. Incentivizing self-consumption of products to transfer commissions upwards has the same financial effect as an illegal pyramid scheme.

 

Suggested Citation: Bridget Moore, More Informed Consumers are Still at Risk of Bad Business Opportunities, Cornell J.L. & Pub. Pol’y, The Issue Spotter (November 20, 2023), http://jlpp.org/blogzine/more-informed-consumers-are-still-at-risk-of-bad-business-opportunities/.