The scam that steals from the poor and gives to the rich, the reverse-Robin Hood of modern business. When something sounds too good to be true, it probably is.
How would you react if I said that you can work from home everyday? You can quit your day-job and make over $10,000 a month. You can drive a corvette, wear a fur coat and live by the beach. You can fulfill your wildest dreams while making your own schedule.
If I told you all of those things, I’d likely be trying to sell you a pyramid scheme. Scams like this brought in over 50 billion dollars from 2008 to 2013,[i]that’s 50 billion dollars coming directly from the pockets of innocent people who are just looking to get ahead in life. But that’s how pyramid schemes work, they prey on the vulnerable and exploit them.
By the end of this article you will understand how a pyramid scheme works and the legality surrounding them. First, you must understand how multi-level marketing plans work, hint: they are eerily similar to a pyramid scheme, but legal. Then, I look at pyramid scheme processes and structure. Ultimately, I aim to provide you the necessary skills
Multi-level marketing plans
A multi-level marketing plan is a legal business with three or more levels of participants, where each level earns compensation for the sales happening below them.[ii] MLMs function in a pyramid shape, with a small number of people at the top and increasingly more people downwards.
All people who partake in an MLM are earning money based on the sales of a product, but earn additional money based on the sales by people they recruit (the people below them on the pyramid).[iii]
Though they are formed in a pyramid shape, MLMs are completely legal and (in terms of business legislation) legitimate company models.[iv]They are everywhere, with examples like Vector Marketing, Avon, Scentsy. We’ve all come across a friend or family member trying to sell us things. To many, MLMs are harmless.
But MLMs aren’t legitimate in everyone’s eyes. John Oliver, for example, thinks that MLMs are just as problematic as pyramid schemes.[v]
So, what is a pyramid scheme then?
The main difference between a legal MLM and an illegal pyramid scheme is, according to Canadian legislation, “A scheme of pyramid selling focuses primarily on generating profits by recruiting others and not from the sale of products.”[vi]
Though they both work in a pyramid shape, the money comes from different places. In an MLM, money is funnelled into the lower levels of the pyramid from external sources(customers) and then upwards through the levels. In a pyramid scheme, money comes from people at the lowest levels of the pyramid (“investors”) and is sent upwards, with little to no external income.
Pyramid Scheme Structure and Shape
Like MLMs, pyramid schemes have a composition with very few people at the top and increasingly more near the bottom. People are often recruited by someone they already know, as part of that person’s “downline.”[vii] A downline is a term used in both MLMs and pyramid schemes to describe recruits that earn income for people higher in the pyramid. An upline is the term for the people who recruited the person.
For example, you recruit Bob, who recruits Joey. Both Bob and Joey are a part of your downline.You and Bob are Joey’s upline.
When entering into a pyramid scheme, you are asked to invest in the company or purchase a starter package.”[viii] This money is then partially streamed to those in your upline, with the leftovers going directly to the company.
Though there is sometimes a product to sell, they money is in recruiting and not sales.[ix] You must begin building your downline to start earning your money back and building a profit. And so it begins, a cycle of upwards money transfers that largely benefits the people at the top of the pyramid.
Sometimes people do earn their money back in a pyramid scheme, but is a cycle that cannot be successfully maintained.
The scam comes to a standstill when the people at the bottom are no longer able to earn back their initial fees, which happens much quicker than anticipated. If every person is asked to recruit five people, who then recruit five people, the cycle can only go on 13 times before the entire population of the earth has become part of the scheme.[x] This would never happen, instead the pyramid would end and those at the bottom would never be able to make their money back.
Pyramid Scheme example
A friend comes to you with a ‘business opportunity’ selling candy canes. He says that he’s already made a decent amount of money, and the returns seem promising. To qualify for this opportunity, you must provide a “starter investment” of $500 into the company, which gets you a large amount of the product at a 30% discount.
You can sell all of those candy canes to earn your money back, but there’s a much easier/quicker way to break even and start earning a profit.
For every person that you recruit into the company, you receive $100 of their starter investment. So, you recruit Jessica and get $100. Well, you also get $50 for every person that Jessica recruits, and $25 for every person they recruit.
So to earn your money back, you must sell 600 boxes of candy canes or recruit five people. It’s not surprising that people would choose to recruit people at all costs, lying about the income and benefits or tricking friends and family into participating.
The important thing to remember about a pyramid scheme is that you are leveraging personal relationships, and if the people you recruit aren’t able to earn their money back, they may have you to blame.
Pyramid schemes are wildly successful, especially for the people at the top of the pyramid. Look at the numbers in the above example: each starter fee is $500, with $175 being funneled upwards within the pyramid. That leaves $325 to go further upwards to the company.
[iii] W. Keep, W., & J.Vander Nat, P. (2014). Multi-level marketing and pyramid schemes in the United States: An historical analysis.Journal of Historical Research in Marketing, 6(2), 188-210.
[iv] Competition Bureau (2009).
[vi] Competition Bureau (2009).
[vii] W. Keep, W., & J. Vander Nat, P. (2014).
[ix] W. Keep, W., & J. Vander Nat, P.
This work was created as a part of a project for Humber’s Professional Writing and Communication program. The goal was to write a technical article on how something works.