Countless articles have been written on this subject and numerous speeches have been given. Yet borders between these three concepts have generally remained fuzzy in minds. This lack of clarity is important because it leads to unfair criticisms on legitimate businesses.
Pyramid Schemes
According to the World Federation of Direct Selling Associations – WFDSA), “Pyramid schemes are illegal scams in which large numbers of people at the bottom of the pyramid pay money to a few people at the top. Each new participant pays for the chance to advance to the top and profit from payments of others who might join later.”
U.S. Federal Trade Commission (FTC) states, “The promoters of a pyramid scheme may try to recruit you with pitches about what you’ll earn. They may say you can change your life — quit your job and even get rich — by selling the company’s products. That’s a lie. Your income would be based mostly on how many people you recruit, not how much product you sell. Pyramid schemes are set up to encourage everyone to keep recruiting people to keep a constant stream of new distributors — and their money — flowing into the business.”
Reading all this, it seems pretty straightforward: If a participant’s income is not based on exchange of goods or services, but is earned against bringing in new people, then what we see is a pyramid.
So, where does the confusion stem from? Obviously, from the existence of those that are called “disguised pyramid schemes”. These businesses operate in a deceptive way in an effort not to be caught by the authorities. Typically, participants are forced to buy large amounts of inventory that they can neither sell nor consume. In some other cases, they are expected to purchase worthless products that no other people would buy under normal conditions. If these exist, it is clear that organization members earn money based not retailing the products but merely on people recruited.
A related issue here is “internal consumption”. This concept refers to products being bought by direct sellers not for the purpose of retailing them to end-users. When considered together with the previous paragraph, this is obviously an important issue. From another perspective though, the existence of internal consumption is inevitable. At the end of the day, direct sellers would naturally buy and consume the products that they recommend to others. Within this context, you might want to read the two brilliant articles Jeff Babener (1948-2020) wrote following the FTC – Herbalife settlement: FTC v. Herbalife Settlement: First Take and FTC v. Herbalife: Post-Settlement Legal Guidance for the Direct Selling Industry.
Ponzi Schemes
These are named as such after Charles Ponzi’s fraudulent scheme in the U.S. he ran in the 1920s. In broad terms, a Ponzi scheme is an investors’ pyramid. Here, the scheme’s operator promises unreasonably high returns to attract new investors. These returns are so high that the founders know from the beginning that they are not economically sustainable. And an investor’s source of income is not the return generated by the funds invested by themselves. Income here is derived from the new investments coming in from others.
Needless to say, the chain breaks at a certain point soon after a few people make huge amounts money… and after many lose whatever they have.
The most famous Ponzi scheme of the last decades was led by Bernard Madoff who was a former Chairman of NASDAQ stock exchange. It was estimated that the investors had lost about $18 billion in his scheme. In June 2009, Madoff was sentenced to 150 years in prison.
Direct Selling
Both pyramid and Ponzi organizations are fraudulent, illegitimate and illegal. They are prosecuted and shut down wherever spotted. Direct selling on the other hand, is a legitimate way of making business.
First and foremost, the participants in direct selling earn money not based on others’ losses. It is a micro-entrepreneurship model, in economic terms. I believe this draws a clear line.
Consultants take their shares from the commissions pool that accumulates from the sales of goods or services in this model. Looking from another perspective, if the products are not sold, nobody will be able to earn anything. Taking this a step further, registration fees, starter kit sales or anything that a new member is required to make a payment for do not and should not generate income for those who joined before.
So, where to stand on the issues of “personal use”? In my understanding, participants’ purchases for themselves in reasonable amounts are just as legitimate as the purchases made for the purpose of retailing. And to me, there is nothing wrong with the upline or the consultant himself / herself earning commissions on them.
Unlike a pyramid or a Ponzi, direct selling is an economically sustainable model. As long as they are managed well, just like in any other industry, direct selling companies successfully survive for decades. While there is no such an example to this among pyramid schemes, there are numerous examples in the direct sales industry.
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Hakki Ozmorali is the Founder of WDS Consultancy, a management consulting and online publishing firm in Canada, specialized in providing services to direct selling firms. WDS Consultancy is the publisher of The World of Direct Selling, global industry’s leading weekly online publication since 2010. Hakki Ozmorali is an experienced professional with a strong background in direct sales. His work experiences in direct selling include Country and Regional Manager roles at various multinationals. You can contact Hakki here.
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