MYTH: Amway is a Pyramid

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Pyramid Schemes aka Pyramid Selling, Pyramid Games, Illegal Pyramids, Pyramid Scams are illegal in virtually every country of the world, and for good reason - they are mathematically doomed to failure and are little more than a method of transferring money from a large number of people to a smaller number of people. Their essential feature is that you make money by getting other people to join the scheme, and if no further people join, the scheme collapses, leaving those who were last to join out of pocket.

Examples

AirPlane Game

One example is the infamous airplane game of the 1980s. People were encouraged to buy tickets as passengers on an imaginary airplane. The plane would have 8 passengers, 4 flight attendants, 2 co-pilots, and a pilot. The Pilot would collect all the ticket money, and afterwards the 2 co-pilots would separate into 2 new planes, taking the roles of pilot, with the flight attendants becoming co-pilots, and the passengers flight attendents. The flight attendents would then be responsible for recruiting new passengers. The game would eventually "collapse" when there are no more people willing to pay their $1500 to buy a "ticket".

Product Based Pyramid Schemes

More sophisticated pyramid schemes operate in much the same way, except that instead of a ticket on an imaginary airplane, participants receive some kind of product or service in return for the cash they put into the scheme. The products and services however, have little intrinsic worth. Participants then receive a payment for each additional person they bring in to the scheme. The products/services are essentially worthless; participants do not use or consume them themselves, do not reorder them, and have no possibility of selling them to others; thus there is no way to earn money after joining except through recruiting of others into the scheme. Eventually there will be no further people able to be recruited, and the scheme collapses.

Laws regarding Pyramid Schemes

United States

The Federal Trade Commission (FTC), along with individual states, is responsible for policing illegal marketing schemes in the United States.

Definition of a Pyramid Scheme

In 1998, Debra Valentine of the United States Federal Trade Commission, had the following to say about Pyramid Schemes -

Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure. There are two tell-tale signs that a product is simply being used to disguise a pyramid scheme: inventory loading and a lack of retail sales.

In Webster vs Omnitrition, United States Court of Appeal, Ninth Circuit, had the following to say -

The Federal Trade Commission has established a test for determining what constitutes a pyramid scheme. Such contrivances are characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users.

The satisfaction of the second element of the Koscot test is the sine qua non of a pyramid scheme: "As is apparent, the presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed.

sine qua non is a legal term meaning "without which it is not". Clearly, in the United States the key feature, indeed a necessary feature of an illegal pyramid scheme is that participants receive payments when they recruit other participants.

European Union

In 2005, the EU parliament introduced The Unfair Commercial Practices Directive. The directive took force throughout the EU on December, 12, 2007 and required member states to outlaw numerous practices including Pyramid Schemes. The directive required the introduction of laws banning, amongst other things -

14. Establishing, operating or promoting a pyramid promotional scheme where a consumer gives consideration for the opportunity to receive compensation that is derived primarily from the introduction of other consumers into the scheme rather than from the sale or consumption of products.

As with the United States, in a pyramid promotional scheme, participants earn compensation primarily through the introduction of others to the scheme. Interestingly, the directive explicitly considers the possibility of legitimate schemes having participants as the consumers of the products.

United Kingdom

In the United Kingdom Pyramid Selling comes under the jurisdiction of the Fair Trading Act, as amended by the Trading Schemes Act 1996 and the Trading Schemes Regulations 1997. It is enforced by the Office of Fair Trading and The Department for Business, Enterprise & Regulatory Reform (BERR), formally known as the Department of Trade & Industry (DTI).

The Office of Fair Trading website says -

Pyramid schemes are illegal. They are 'money-making' clubs which promise, once you've paid a joining fee, that you can earn large amounts by recruiting new members. However, only those at the top make money and the schemes always collapse, leaving you out of pocket.

No new money is created in pyramid schemes. An endless supply of new members would be needed for everyone to receive the money on offer in a pyramid scheme. Since this is impossible, these schemes must eventually collapse and result in most members losing their money.

BERR's website states -

* Trading schemes become illegitimate and illegal if, while purporting to offer business opportunities, the sole purpose of the scheme is to make money by recruiting other participants, rather than trading in goods or services. This form of bogus scheme is sometimes referred to as "pyramid selling".

* There are also a wide range of bogus schemes which do not claim to trade in goods or services but which are known as "pyramid schemes". Schemes operating as chain letters or games are common examples.

* All these bogus schemes need an infinite supply of new participants for everyone to make money. Since the supply will always be finite, the pyramid must collapse eventually and most participants will lose their money.

Again, the primary feature of "pyramid selling" is that money is earned through the recruiting of new participants rather than trade in goods or services.

Australia

In Australia, Pyramid Schemes are covered by the Commonwealth Trade Practices Act 1974, which is enforced by the Australian Competition and Consumer Commission (ACCC). Section 65AAD of the Trade Practices Act states -

"pyramid selling scheme" means a scheme with both the following characteristics:

(a) to take part in the scheme, some or all new participants must make a payment (a participation payment ) to another participant or participants in the scheme;

(b) the participation payments are entirely or substantially induced by the prospect held out to new participants that they will be entitled to a payment (a recruitment payment) in relation to the introduction to the scheme of further new participants.

The ACCC says about Pyramid Selling Schemes -

Generally, people pay to join and are promised a commission for introducing others. This often looks like an attractive investment with the potential to generate a lot of money later on. However, more often than not, participants end up losing their initial investment.

The scheme could be an illegal pyramid scheme if a proposal offers financial rewards for recruiting people, combined with:

* offers of goods or services of little or doubtful value that serve only to promote the scheme

* an initial outlay of money to purchase large quantities of goods, or

* no goods or services being offered for sale.

As elsewhere in the world, a necessary feature of an illegal pyramid selling scheme is the offering of financial rewards for recruiting people to the scheme.

New Zealand

In New Zealand, Pyramid Schemes are covered by the Fair Trading Act, which is enforced by the Commerce Commission. The Fair Trading Act - A General Guide has the following to say -

A pyramid scheme can take many forms, but has the following essential elements:

* it offers a financial return based on the payments made by new recruits;

* the return is dependent primarily on the continued recruitment of new members, not sales of a product or service.

Commonalties

Clearly, anti-pyramid laws around the world all have a common thread - you earn income through recruiting others into the scheme. If recruiting stops, the income stops. If nobody else can be recruited, the most recent recruits cannot recoup their investment.

Multi-level Marketing

In legitimate multi-level marketing businesses, income is not earned through recruiting, it is instead earned through the sale of legitimate products to legitimate consumers. If 1000 people are recruited, and no products are sold, no income is earned. Conversely, if no people are recruited, but products are sold, then income is earned. Like any business, the income is based on the sale of goods and services, not on recruiting others into the "scheme".

Unfortunately commentators often confuse the marketing strategy of recruiting others as a method to increase product volume with illegal pyramids goal of recruiting others in order to receive compensation for the recruitment. The goal of an illegal pyramid is to recruit as many people as possible. The goal of multi-level marketing is to increase the sale of goods and services as much as possible.

Why the focus on recruiting in Network Marketing?

One word - leverage. Industrialist John D. Rockefeller reportedly said "I would rather earn 1% off a 100 people's efforts than 100% of my own efforts."

"Recruiting" in Network Marketing is essentially done for the same reason a clothing store might employ more staff or open an additional outlet - to increase sales volume through leveraging the time of others. One full-time sales person in the store might be able to sell say $10,000 worth of clothing a month. By employing a second sales person, you have effectively doubled the amount of time being dedicated to generating sales, and hopefully doubled the sales. You will also have increased your expenses, having to pay a new employee, but hopefully this is outweighed by increases in revenue.

The exact same principle applies to network marketing. The major difference is in the degree. Instead of having a full-time sales person dedicating 8 hrs a day to generating sales, in network marketing your additional person may dedicate an average of say 1 hr a day.

In addition, many of the people "recruited" into a Network are not recruited as sales people - they are merely customers. In it's report considering a new Business Opportunity Rule, the FTC cited network marketing company Shaklee as stating that 85% of people who register with that business do so simply to obtain Shaklee products at wholesale price.