Multi-level marketing businesses— also called direct sales, direct marketing, or network marketing — are legitimate enterprises that involve selling products or services to a network of peers (i.e., friends and family) and recruiting more salespeople.
The problem? According to the Federal Trade Commission (FTC), many illegal pyramid schemes disguise themselves as legal multi-level marketing (MLM) companies. Even legal MLMs can be bad news; most people make little or no money with MLMs, and some even lose money.
Read on to learn:
• What’s an MLM?
• What are the differences between MLMs and pyramid schemes?
• How can you avoid multi-level marketing companies?
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What Is a Multi-Level Marketing (MLM) Company?
A multi-level marketing business, or MLM for short, is a legitimate business that sells products and services through independent distributors. These companies rely on such distributors to sell to networks of peers, typically friends and families. The distributors, often called “participants” and “contractors,” must also recruit new distributors for the program.
The companies are found in a variety of categories. They might be selling supplements, personal-care products, kitchen utensils, or any other number of items.
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How Do Multi-Level Marketing Companies Work?
What is an MLM company, and how does it operate? In a multi-level marketing business, distributors must first buy the products wholesale from the company. They then make commissions off the products that they sell at retail prices.
Distributors also earn a commission from their recruits’ sales, which incentivizes distributors to recruit more people into the business. Those at the top of the company, with multiple levels of distributors beneath them, thus earn the most money without even needing to purchase more products to sell.
Multi-Level Marketing vs. Pyramid Schemes: What’s the Difference?
Though sometimes questionable, multi-level marketing programs are legal. Pyramid schemes, however, are illegal types of money scams. Unfortunately, many pyramid schemes disguise themselves as legitimate MLMs. Here are key differences:
• Pyramid schemes are more focused on recruiting than actually selling the products. While MLMs do ask you to recruit more distributors, the focus is on sales.
• Pyramid schemes may also require distributors to buy more products at regular intervals, even if they have not sold all the products they already have. Sometimes, in a pyramid scheme, you have to buy more products just to get paid or earn a bonus. This is a major red flag.
In the end, most people who are swindled into pyramid schemes run out of money, are stuck with products that they can’t sell, and quit — meaning they lose everything they invested in the business.
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Real-Life Examples of Multi-Level Marketing Companies
Some products marketed and sold through network marketing companies are from legitimate MLM businesses — and you can feel comfortable purchasing them. In other cases, recognizable products can emerge from pyramid schemes.
Here are some real-life examples of legal, established MLMs. You may be surprised to learn that what is an MLM can be a familiar and trusted brand:
• Amway
• Avon
• Herbalife
• Vorwerk
• Mary Kay
• Infinitus
• Perfect
• Quanjian
• Natura
• Tupperware
• Nu Skin
• Primerica.
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Why Is Multi-Level Marketing Legal?
Multi-level marketing businesses must adhere to strict FTC guidelines to be considered legal. The FTC regularly goes after suspicious MLM companies that may actually be pyramid schemes.
Though sometimes seemingly predatory, MLM is just a form of direct sales. When adhering to FTC guidelines, these businesses aren’t breaking any laws.
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What Is the 70% Rule?
Though not technically a law, the 70% rule is a common term in MLM discussions. It arose in a 1979 case against Amway.
In analyzing the business structure of Amway, the FTC determined that, because Amway required distributors to sell at least 70% of the products they bought in a given month to earn a bonus, Amway was attempting to operate as a legitimate MLM. Their business model involved profited from sales, not shady recruiting tactics.
Now, the 70% rule is a loose term that means an MLM is focused on sales, rather than requiring distributors to buy more products or recruit more people to earn bonuses. The trouble with this rule is that it is difficult to enforce: MLMs typically trust their distributors to tell the truth about how much product they’ve sold but cannot always verify the numbers.
Are the Products That MLMs Sell Legitimate?
The products and services that MLMs and even pyramid schemes sell can be completely legitimate. Just think of that trusty Tupperware in your kitchen cabinet or your favorite lipstick from Mary Kay.
But even if a product is good, the distributor requirements of a legitimate MLM or shady pyramid scheme can still cause the seller to lose money.
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Can You Create Financial Freedom by Joining an MLM?
Multi-level marketing companies require a lot of entrepreneurial hustle from distributors to make money. As contracted sellers, distributors don’t earn a salary but instead make commissions.
While someone with a true sales spirit may make some money in an MLM, most do not make enough money to achieve any kind of financial freedom without another source of income. In fact, the FTC says some people even lose money from legitimate MLMs.
Pyramid schemes are worse, having left some people in economic ruin.
Tips for Recognizing Predatory MLMs and Pyramid Schemes
While MLMs are legitimate, they may not be worth the effort and could also cause you to lose money. Illegal pyramid schemes, however, are usually designed to hurt the low-level distributor.
So how can you spot a predatory MLM or pyramid scheme? Here are a few warning signs:
• Hyperbolic claims of excess income: If a brand promoter is promising outlandish amounts of income — even saying you can quit your day job and retire early — that’s typically a red flag.
• “Act fast” pressure: You should be able to think about any financial decision and be given the time to talk it over with friends and family. Brand promoters of pyramid schemes and predatory MLMs may use high-pressure tactics, like telling you that you must act now or you’ll lose out on the opportunity.
• An emphasis on recruiting: In a true MLM where you at least have the potential to earn money, the emphasis should be on sales. If during initial conversations with a promoter, the emphasis is on recruiting other members, this is likely an indicator of a pyramid scheme.
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Tips for Avoiding Predatory MLMs and Pyramid Schemes
The first step to avoiding a shady MLM or full-on pyramid scheme and protecting your finances is recognizing them when you see them.
Here’s what you can distinguish what are MLMs from pyramid schemes and avoid the latter:
• Researching the company: Take the time to conduct research online. The FTC recommends googling the name of the company with terms like “scam” or “complaint” and then analyzing the results. The FTC even suggests reaching out to your state attorney general to inquire about complaints for a specific company. Uncovering evidence of lawsuits during your research is often a tell-tale sign.
• Analyzing the products: Legitimate MLMs can sell good products. Pyramid schemes might even have products that you recognize. But if any company has poor-quality products that they expect you to sell, there’s a good chance it’s a pyramid scheme. Watch for products that are priced too high, claim to have “miracle” ingredients, or “guarantee” results.
• Asking good questions: If the promoter is unwilling to answer very basic questions, like how refunds work or what happens if you can’t sell the product, they are likely hiding something.
• Not making decisions in a vacuum: It’s a good idea to discuss all major financial and business decisions with a trusted friend or family member. If you have paperwork for an MLM that you’re unsure about, you can even have a personal accountant or lawyer review it before you sign.
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The Takeaway
Multi-level marketing companies are legitimate and legal direct-sales businesses, but they rarely enable a distributor to make good money; some distributors may even lose money. Pyramid schemes are typically disguised as MLMs and can lead to financial ruin. Such schemes are illegal. In general, it’s a good idea to avoid any kind of MLM company if you are unsure of their trustworthiness.
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FAQ
Is it legal to join an MLM?
Yes, it is legal to join an MLM. However, very few people earn enough money from multi-level marketing companies to make them worth the effort. In fact, some people lose money in MLMs.
What makes an MLM illegal?
MLMs are legal, but pyramid schemes are not. Pyramid schemes often disguise themselves as legitimate MLMs. However, with pyramid schemes, the emphasis is on recruiting new members and forcing distributors to buy more products, rather than focusing on empowering distributors to successfully sell to customers.
Are MLMs the same as pyramid schemes?
No, MLMs are not the same as pyramid schemes, but pyramid schemes often disguise themselves as MLMs. Multi-level marketing companies are legitimate businesses that require distributors to buy products and earn commissions by selling them to a network of peers. Pyramid schemes are more focused on recruiting new distributors and forcing them to buy products than empowering distributors to sell the products.
Photo credit: iStock/Makhbubakhon Ismatova
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