Multi-level marketing

A typical multi-level marketing MLM binary tree structure. The blue individual will receive compensation from the sales of the downline red members.

Independent non-salaried participants, referred to as distributors (variously called "associates", "independent business owners", "independent agents", etc.), are authorized to distribute the company's products or services. They are awarded their own immediate retail profit from customers plus commission from the company, not downlines, through a multi-level marketing compensation plan, which is based upon the volume of products sold through their own sales efforts as well as that of their downline organization.

Independent distributors develop their organizations by either building an active consumer network, who buy direct from the company, or by recruiting a downline of independent distributors who also build a consumer network base, thereby expanding the overall organization.

The combined number of recruits from these cycles are the sales force which is referred to as the salesperson's "downline". This "downline" is the pyramid in MLM's multiple level structure of compensation.[8]

The overwhelming majority of MLM participants participate at either an insignificant or nil net profit. (A study of 27 MLM schemes found that on average, 99.6% of participants lost money.)[14] Indeed, the largest proportion of participants must operate at a net loss (after expenses are deducted) so that the few individuals in the uppermost level of the MLM pyramid can derive their significant earnings. Said earnings are then emphasized by the MLM company to all other participants to encourage their continued participation at a continuing financial loss.[14]

Many MLM companies generate billions of dollars in annual revenue and hundreds of millions of dollars in annual profit. However, profits accrue to the detriment of the majority of the company's constituent workforce (the MLM participants). Only some of the profits are then shared with individual participants at the top of the MLM distributorship pyramid. The earnings of those top few participants are emphasized and championed at company seminars and conferences, thus creating the illusion that participants in the MLM can become financially successful. This is then advertised by the MLM company to recruit more distributors in the MLM with an unrealistic anticipation of earning margins which are in reality merely theoretical and statistically improbable.[15]

Although an MLM company holds out those few top individual participants as evidence of how participation in the MLM could lead to success, the MLM business model depends on the failure of the overwhelming majority of all other participants, through the injecting of money from their own pockets, so that it can become the revenue and profit of the MLM company, of which the MLM company shares only a small proportion with a few individuals at the top of the MLM participant pyramid. Other than the few at the top, participants provide nothing more than their own financial loss for the company's own profit and the profit of the top few individual participants.[16]

The main sales pitch of MLM companies to their participants and prospective participants is not the MLM company's products or services. The products or services are largely peripheral to the MLM model. Rather, the true sales pitch and emphasis is on a confidence given to participants of potential financial independence through participation in the MLM, luring with phrases like "the lifestyle you deserve" or "independent distributor."[17] Erik German's memoir My Father's Dream documents the author's father's failures through "get-rich-quick schemes" such as Amway.[18] The memoir illustrates the multi-level marketing sales principle known as "selling the dream".[19]

Although the emphasis is always made on the potential of success and the positive life change that "might" or "could" (not "will" or "can") result, disclosure statements include disclaimers that they, as participants, should not rely on the earning results of other participants in the highest levels of the MLM participant pyramid as an indication of what they should expect to earn. MLM companies rarely emphasize the extreme likelihood of failure, or the extreme likelihood of financial loss, from participation in MLM.

MLM companies have been made illegal in some jurisdictions as a mere variation of the traditional pyramid scheme, including in China.[11][12] In jurisdictions where MLM companies have not been made illegal, many illegal pyramid schemes attempt to present themselves as MLM businesses.[20] Given that the overwhelming majority of MLM participants cannot realistically make a net profit, let alone a significant net profit, but instead overwhelmingly operate at net losses, some sources have defined all MLM companies as a type of pyramid scheme, even if they have not been made illegal like traditional pyramid schemes through legislative statutes.[13][21][22]

MLM companies are designed to make profit for the owners/shareholders of the company and a few individual participants at the top levels of the MLM pyramid of participants. According to the U.S. Federal Trade Commission (FTC), some MLM companies already constitute illegal pyramid schemes even by the narrower existing legislation, exploiting members of the organization.[23]

Companies that use the MLM business model have been a frequent subject of criticism and lawsuits. Legal claims against MLM companies have included, among other things:

• Their similarity to traditional illegal pyramid schemes,
• Price fixing of products or services,
• Collusion and racketeering in backroom deals where secret compensation packages are created between the MLM company and a few individual participants, to the detriment of others,
• High initial entry costs (for marketing kit and first products),
• Emphasis on recruitment of others over actual sales (especially sales to non-participants).
• Encouraging if not requiring members to purchase and use the company's products,
• Exploitation of personal relationships as both sales and recruiting targets,
• Complex and exaggerated compensation schemes,
• False product claims,
• The company or leading distributors making major money off participant-attended conventions, training events and materials, advertising materials, and
• Cult-like techniques which some groups use to enhance their members' enthusiasm and devotion.[13][24]

In 2015, the Government of Bangladesh banned all types of domestic and foreign MLM trade in Bangladesh.[47]

Multi-level marketing (simplified Chinese: 传销; traditional Chinese: 傳銷; pinyin: chuán xiāo; lit. 'spread selling') was first introduced to mainland China by American, Taiwanese, and Japanese companies following the Chinese economic reform of 1978. This rise in multi-level marketing's popularity coincided with economic uncertainty and a new shift towards individual consumerism. Multi-level marketing was banned on the mainland by the government in 1998, citing social, economic, and taxation issues.[48] Further regulation "Prohibition of Chuanxiao" (where MLM is a type of Chuanxiao was enacted in 2005, clause 3 of Chapter 2 of the regulation states having downlines is illegal).[12] O'Regan wrote 'With this regulation China makes clear that while Direct Sales is permitted in the mainland, Multi-Level Marketing is not'.[11]

MLM companies have been made illegal in China as a mere variation of the traditional pyramid scheme.[11][12] MLM companies have been trying to find ways around China's prohibitions, or have been developing other methods, such as direct sales, to take their products to China through retail operations. The Direct Sales Regulations limit direct selling to cosmetics, health food, sanitary products, bodybuilding equipment and kitchen utensils, and they require Chinese or foreign companies ("FIEs") who intend to engage into direct sale business in mainland China to apply for and obtain direct selling license from the Ministry of Commerce ("MOFCOM").[49] In 2016, there are 73 companies, including domestic and foreign companies, that have obtained the direct selling license.[50] Some multi-level marketing sellers have circumvented this ban by establishing addresses and bank accounts in Hong Kong, where the practice is legal, while selling and recruiting on the mainland.[11][51]

It was not until August 23, 2005, that the State Council promulgated rules that dealt specifically with direct sale operation- Administration of Direct Sales (entered into effect on December 1, 2005) and the Regulations for the Prohibition of Chuanxiao (entered into effect on November 1, 2005). When direct selling is allowed, it will only be permitted under the most stringent requirements, in order to ensure the operations are not pyramid schemes, MLM, or fly-by-night operations.

MLM marketing is banned in Saudi Arabia by imposing religious fatwa nationally, for this reason MLM companies like Amway, Mary Kay, Oriflame and Herbalife sell their products by online selling method instead of MLM.[52]

MLM businesses operate in all 50 U.S. states. Businesses may use terms such as "affiliate marketing" or "home-based business franchising". Some sources say that all MLM companies are essentially pyramid schemes, even if they are legal.[13][21][22]

The U.S. Federal Trade Commission (FTC) states: "Steer clear of multilevel marketing plans that pay commissions for recruiting new distributors. They're actually illegal pyramid schemes. Why is pyramiding dangerous? Because plans that pay commissions for recruiting new distributors inevitably collapse when no new distributors can be recruited. And when a plan collapses, most people—except perhaps those at the very top of the pyramid—end up empty-handed."[53]

In a 2004 Staff Advisory letter to the Direct Selling Association, the FTC states:

Much has been made of the personal, or internal, consumption issue in recent years. In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme. The critical question for the FTC is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture.[54]

The Federal Trade Commission warns "Not all multilevel marketing plans are legitimate. Some are pyramid schemes. It's best not to get involved in plans where the money you make is based primarily on the number of distributors you recruit and your sales to them, rather than on your sales to people outside the plan who intend to use the products."[23]

In re Amway Corp. (1979), the Federal Trade Commission indicated that multi-level marketing was not illegal per se in the United States. However, Amway was found guilty of price fixing (by effectively requiring "independent" distributors to sell at the same fixed price) and making exaggerated income claims.[55][56] The FTC advises that multi-level marketing organizations with greater incentives for recruitment than product sales are to be viewed skeptically. The FTC also warns that the practice of getting commissions from recruiting new members is outlawed in most states as "pyramiding".[57]

Walter J. Carl stated in a 2004 Western Journal of Communication article that "MLM organizations have been described by some as cults (Butterfield, 1985),[58] pyramid schemes (Fitzpatrick & Reynolds, 1997),[59] or organizations rife with misleading, deceptive, and unethical behavior (Carter, 1999),[60] such as the questionable use of evangelical discourse to promote the business (Höpfl & Maddrell, 1996),[61] and the exploitation of personal relationships for financial gain (Fitzpatrick & Reynolds, 1997)".[59][62] In China, volunteers working to rescue people from the schemes have been physically attacked.[63]

MLM companies are also criticized for being unable to fulfill their promises for the majority of participants due to basic conflicts with Western cultural norms.[64] There are even claims that the success rate for breaking even or even making money are far worse than other types of businesses:[65] "The vast majority of MLM companies are recruiting MLM companies, in which participants must recruit aggressively to profit. Based on available data from the companies themselves, the loss rate for recruiting MLM companies is approximately 99.9%; i.e., 99.9% of participants lose money after subtracting all expenses, including purchases from the company."[65] (By comparison, skeptic Brian Dunning points out that "only 97.14% of Las Vegas gamblers lose money .... ."[66]) In part, this is because encouraging recruits to further "recruit people to compete with [them]"[13] leads to "market saturation."[24] It has also been claimed "(b)y its very nature, MLM is completely devoid of any scientific foundations."[67]

Because of the encouraging of recruits to further recruit their competitors, some people have even gone so far as to say at best modern MLM companies are nothing more than legalized pyramid schemes[13][21][22] with one stating "Multi-level marketing companies have become an accepted and legally sanctioned form of pyramid scheme in the United States"[21] while another states "Multi-Level Marketing, a form of Pyramid Scheme, is not necessarily fraudulent."[22] In October 2010 it was reported that multi-level marketing companies were being investigated by a number of state attorneys general amid allegations that salespeople were primarily paid for recruiting and that more recent recruits cannot earn anything near what early entrants do.[68] Industry critic Robert L. FitzPatrick has called multi-level marketing "the Main Street bubble" that will eventually burst.[69]

Many Islamic jurists and religious bodies, including Permanent Committee for Scholarly Research and Ifta[70] of Saudi Arabia, have considered MLM trade to be prohibited (haram). They argue that MLM trade involves deceiving others into participating, and the transaction bears resemblance to both riba and gharar.[71][72]