Pyramid Schemes Often Come Disguised as Financial Freedom

Lots of opportunities will claim to be ways to make a lot of money, reach financial freedom, be successful, or even just bring in some extra cash to reduce financial stress. But these opportunities aren’t always trustworthy. Financial fraud often claims the same thing. And even smart people can get drawn in. Though they’re similar, there are key differences between pyramid schemes, Ponzi schemes, and multi-level marketing (MLM). It’s important to know the differences and what questions you should ask before you invest your time or money into an opportunity.

See The Recruitment Trap with Stacie Bosley for a complete transcript of the Easy Prey podcast episode.

Stacie Bosley has a PhD in applied economics, which is an area of economics specifically focusing on using empirical data to understand what happens economically. She is a professor at Hamline University, and her research area is MLMs, pyramid schemes, Ponzi schemes, and similar forms of financial fraud. Her research has also led her to serve as an expert witness for the FTC and SEC in court cases around these kinds of fraud.

Stacie’s initial interest in economics was the choices people made in labor markets and the consequences of those choices. Growing up in rural Wisconsin, there weren’t a lot of shopping opportunities. Everyone she knew bought makeup from their local MLM representative because there was no other option. As the internet became common, more people got involved in MLMs, and Stacie saw people in her community trying more of these kinds of things. Some spent their life savings on things that didn’t work out. Stacie realized this area of people looking for ways to invest their time and energy had lots of room for research, and has been fascinated ever since.

MLMs, Pyramid Schemes, and Ponzi Schemes

The terms “multi-level marketing,” “pyramid scheme,” and “Ponzi scheme” are often used interchangeably. But there are some differences. Pyramid schemes specifically can show up in a variety of ways. And some people think all MLMs are inherently pyramid schemes. So it can be helpful to take a step back and look at the details.

Pyramid schemes have a pay-and-recruit structure. You pay into the system in some way – often when you join, but sometimes on a reoccurring basis. The way you make money out of it is to recruit people underneath you who also pay. Recruiting new people is directly tied to recouping your investment or profiting. But this structure runs into math issues. Eventually, there won’t be any more new people to recruit. And the vast majority of people end up with losses.

This structure can show up in a lot of different ways. The simplest is the old-fashioned chain letter that tells you to mail some money to multiple other people and eventually you’ll get letters with money back. The modern versions of these are called “blessing looms” or “gifting schemes,” but the principle is the same. You pay money, and eventually you’ll be the one getting the money. But that doesn’t happen unless more people pay in. Even though some do profit, the vast majority never get that return.

The Differences Between MLMs and Pyramid Schemes

The best way to understand MLMs is to contrast them with door-to-door salespeople. In the past, people selling products would go door-to-door trying to make sales. They were independent contractors and would make a commission on each sale. That’s single-level sales. There was no incentive for them to recruit more salespeople.

Multi-level adds that extra layer of recruitment. You can make money from selling a product or service, and you can also make money from recruiting. The recruitment element is where it can overlap with pyramid schemes. MLMs aren’t inherently pyramid schemes, but it’s easy to hide a pyramid scheme underneath an MLM. The difference is where the real profit is.

An MLM that’s really a pyramid scheme will still have a product. Instead of paying to buy into the scheme, you might be paying for cases of an energy drink. You will make some money selling that energy drink. But the only way you’re going to really recoup your spending and make a profit is to recruit more people to buy in.

Some people say that if you have a product or service, then it can’t be a pyramid scheme. But if the structure is the same as a chain letter and the whole business is ultimately about recruiting more people, it’s a pyramid scheme. You have to dig in and figure out what the business is really about. Is it about selling energy drinks, or is it about recruiting more people to sell energy drinks? If it’s about recruiting, then it’s a pyramid scheme playing at being an MLM.

You can have a product or a service, but if the bones of it remain the same as the chain letter … [and] it’s really about pay and recruit, then it’s a pyramid scheme.

Stacie Bosley

Ponzi Schemes Don’t Need You to Recruit

Ponzi schemes are similar to pyramid schemes in that the way you profit is because more people buy in. But a big difference is that you don’t need to recruit people to get paid. Often, the early people who see a lot of profit are called “songbirds,” because they sing the scheme’s praises because they had a good experience. But they’re not required to bring people in. And they’re not told that the way they make the most money is by bringing more people in.

One major difference between Ponzis and pyramids is that there’s no structure connection between your compensation and your recruitment of new people.

Stacie Bosley

Another big difference is how they’re presented. While MLMs often focus on entrepreneurship and building a business, Ponzi schemes usually claim to be investment opportunities. They use investment language and often claim to have expert investors or have found a “trick” to beating the market. Just invest your money with us, they say, and we’ll get you a huge return! Sometimes they even make grandiose claims about how much money you’ll make, like telling you you’ll be able to live off the residual earnings for the rest of your life.

This presentation is usually the biggest way to differentiate a Ponzi scheme from a pyramid scheme or MLM. Building a business or becoming an entrepreneur tend to have similar language, and both tend to emphasize the financial freedom you could get. But Ponzi schemes are a passive investment, while pyramid schemes and MLMs usually want you to be more active.

Who These Schemes Target

With MLMs especially, there are a lot of different types. Almost any kind of person could find an MLM that targets them in some way. A lot of the more well-known ones selling fashion and beauty products target stay-at-home moms who want to make extra money from home with a flexible schedule. But there are also products like financial education claiming to teach you how to invest in crypto. Those tend to target young men. MLMs are overall female-dominated, but there are different targets depending on the type of product.

Pyramid schemes and Ponzi schemes can also be arranged around affinity groups. One of the early MLMs that was secretly a pyramid scheme was created by pastors. They used the language of their religion and the scheme spread through evangelical churches. When recruitment is a big part, having an affinity group involved can be part of the pitch, because those interpersonal connections are how it spreads. That’s one of the things that Stacie finds so fascinating about these schemes. People aren’t just passive participants. They’re actively recruiting and propagating it across their social network.

The people who tend to be attracted to these types of fraud are people who are very responsive to rewards, want to show off signifiers of their success, and often have a need that they are trying to get met within the constraints of their current life. For women who are out of the workforce, the unpaid labor of parenting and housekeeping that women tend to do doesn’t often offer recognition. People are also looking for ways to form or maintain relationships, build skills, and demonstrate their own abilities. All of these are things that MLMs and pyramid schemes seem to offer.

How to Be Less of a Target

It’s useful to think about your own responses to things. If you are responsive to rewards, want to show off that you’re successful, and feel like you have a need you haven’t been able to meet in your current life, you may be more vulnerable. But Stacie thinks this also gets to the broader idea of assessing whether or not an opportunity is worth it. You need to be able to identify what you’re aiming for and assess whether or not a given opportunity is going to be worth it.

Even if you ignore the possibility of it really being a pyramid scheme, you still need to assess the prospects of a business. You might have looked into it and determined that it is a genuine retail opportunity with a genuine product that there is a demand for. But you need to know what you want to get out of it and whether or not you’re likely to achieve those goals. If you’re a reward-responsive person, it’s also important to ask yourself if you want to get involved because you think it will actually help you achieve your goals, or if you want to for the possibility of reaching a high rank, getting a status symbol, or ending up on stage. And if it’s the latter, what are your chances of actually getting there?

Most people who get involved in MLMs say they do it because they want to make money. Multiple surveys have found that they’re just bad as income opportunities. You’re highly unlikely to make the kind of money you want. So if that’s your goal, you need to know going in what your income prospects look like and determine your chances of meeting your goal.

What the Pitch Leaves Out

If you’re going to start a restaurant, you have to have a lot of investment up front to buy or build a building with the appropriate kitchen, stock it, and hire staff. If you don’t have the spare money to fund that yourself, you’d have to draw up a business plan that explains how you’re going to be profitable and hope it makes a strong enough case that a bank will give you a loan. Part of the pitch for MLMs, though, is that you don’t have to do all that. They’re what some call a “turnkey business.” They’re giving you a metaphorical box with a complete business inside, all you have to do is open the box and you’re running your own business. In many cases, they’ll claim that if you just follow the steps they give you, you’re guaranteed to get what you want.

But they talk much less about the investment you’re going to have to make. FTC data shows that the share of people who earn more than they put in varies, but it’s not a high percentage. It’s even worse when you take the cost of your time into account. If you’re interested in an MLM, you need to know those numbers in advance. And the company should be willing to give them to you. Even if they are a true MLM and not a pyramid scheme, you still should look at the data.

Companies Don’t Like Giving Numbers

Even when an MLM company does provide income disclosures, they may be misleading. Common tactics are providing an average so a few high earners drag the number upwards, or providing only income without factoring in expenses. MLM companies often claim that because their distributors aren’t employees, they don’t know the expenses. It’s true that there are some expenses that aren’t immediately obvious to the company. But they still have easy access to things like the startup investment and how much the person buys from the company every month.

The FTC recently analyzed MLM participants’ income and found that there is a very small percentage of people making substantial money. The overwhelming majority make less than $1,000 a year. In many cases, people are making nothing – which means that even small expenses can put them into negative territory. Once you calculate in even the expenses that are observable to the company, the majority of people are losing money in MLMs.

Once those observable expenses are deducted, in most cases, the vast majority of people are losing money [in MLMs].

Stacie Bosley

State and federal regulators have said that if a company is going to make claims about income – whether that’s saying you can earn a specific amount or more general things like being able to afford a vacation or to leave your job – it’s their responsibility to provide information so people are left with the appropriate impression. The group Truth In Advertising has found that 98% of MLMs don’t appropriately represent the amount of money most people make. It’s challenging because, especially for the ones that are closer to pyramid schemes, recruitment is a huge part of it, and money claims are great for recruitment.

What You Should Ask Before Starting a New Opportunity

There’s a growing anti-MLM community that has contributed to the perception that “MLM” means the same thing as “pyramid scheme.” So many MLMs are distancing themselves from that term. Phrases like “direct sales” and “network marketing” are common. So if you’re interested in a potential opportunity, your first step should be to figure out what it really is. No matter what it calls itself, if the key to making money is recruiting, it’s a pyramid scheme. If you can earn by both selling a product and by recruiting people, it’s an MLM.

MLMs aren’t necessarily bad. You may determine this opportunity is an MLM and that’s okay with you. At that point, ask questions about how much it costs. What does a typical person pay when they start and what do they spend every year? If they can’t or won’t give you numbers, just say “it varies,” or try to get you to focus on the income potential instead, that’s not enough to help you make an educated decision. Just like with any business opportunity, you want to do your due diligence. In Stacie’s ideal world, they wouldn’t just tell you what’s typical or average. They’d also tell you what the majority of people spend and make.

Attrition and retention rates would also be good to have. If 100 people joined a year ago, how many of them are still there now? How many of those are still profitable? If only 2 out of that 100 are profitable, that’s a high failure rate. Sometimes MLMs compare their failure rates to small business failure rates, which can also be high. But if Stacie went to a store and found out 98% of their employees quit within one year of hire, clearly something is wrong.

The Inherent Flaw in MLMs and Pyramid Schemes

MLMs also dismiss a low retention rate by saying that anyone can do it. Lots of people try it and the ones who don’t really want it leave. But that’s a problem from an economic perspective. When recruitment is a part of your earning structure, you’re being encouraged to set up more competitors. You can even have a product people genuinely want, but eventually there are so many distributors that the bottom falls out of the market. It defies the laws of economics by suggesting there’s unlimited demand that can support an unlimited number of sellers.

You can have a product that people even genuinely want, and you can pair it with an MLM model, and if the recruitment side is dominating, it’s like the market falls out underneath you.

Stacie Bosley

When talking about information people might want to know before joining an MLM, some people suggest that they might want to know how many other distributors are in their area. For any other business, the number of nearby competitors would be useful data. But MLMs and pyramid schemes encourage people to actively create more competition for themselves. In fact, having more distributors for the same company acts almost like social proof that other people think it’s a good idea, too. There are inherently limits to any opportunity when you’re encouraged to recruit your own competitors. Ultimately, whether the operation is a pyramid scheme or a legitimate MLM, you’re going to run into that problem.

Read more of Stacie Bosley’s research on Google Scholar. You can also watch her TED Talk, “How to Spot a Pyramid Scheme,” on ted.com. Stacie also encourages you to check out the Truth in Advertising organization at tina.org. And she is always happy to chat via email at [email protected].