Pyramid schemes are business models that require investors to recruit new members through the promise of earnings from sales or encouraging others to join the scheme. Traditionally, a pyramid scheme will make false promises of a high return over a short period of time. In some cases, a pyramid scheme may not require you to make any actual sales; instead, the primary emphasis is on recruiting new participants.
Pyramid schemes are frowned upon, illegal, and an unsustainable business model that creates a scam based on a hierarchy of people continually recruiting other people. Discover the nuances of what a pyramid scheme entails and how you can avoid getting caught up in one.
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How Does a Pyramid Scheme Work?
Pyramid schemes are named the way they are for a reason. The scheme starts with a single person or a few people in some cases. As the leader recruits new hires to work under them, a pyramid slowly starts to form, with the person at the top earning the most. The earnings progressively trickle down, with those at the base of the pyramid earning the least.
More specifically, some pyramid schemes require the sale of a product, but not always. Often, the product is used to disguise what’s actually going on. Pyramid schemes use inventory loading and a lack of retail sales, incentivizing recruits to either buy more product than they can sell or earn more money by adding people to their “pyramid.”
The people at the top of the pyramid are the only ones who ever really see a profit. People at the bottom of the pyramid often have difficulty moving inventory or finding new recruits to bring on board. Eventually, a pyramid scheme becomes impossible to enter into, causing the entire business model to fail.
Say, for example, that Jill recruits five people under her while requiring them to provide payment for joining. Then those five people are tasked with doing the same — recruiting five more people to pay and join. This continues on and on until eventually, there are no more people to recruit. Those at the bottom of the pyramid end up losing money, with approximately 90% of everyone involved losing their money.
Types of Pyramid Schemes
There are various forms of pyramid schemes that exist, which means they can be broadly identified. Below, we’ll take a look at some of the most common types of pyramid schemes and how they operate.
Multi-Level Marketing Pyramid Scheme
Unlike traditional pyramid schemes, MLM companies rely on the sales of goods or services with no mandate on the number of sales. These businesses create a new product and share it with the world, often recruiting friends and family to join the pyramid scheme as well. These recruits have to pay fees in exchange for a bulk amount of that product.
Often, all you have to do to join an MLM company is sign up online or be recruited by a current member of the sales team. Although multi-level marketing (MLM) companies are legal, these types of companies have a lot in common with illegal schemes. There are still debates as to whether MLM is a good thing;they’re still extremely popular because they are disguised as legitimate businesses.
Chain Emails Pyramid Scheme
Chain emails convince credulous individuals to donate large amounts of money to other individuals in an email list in hopes of forwarding the same email on and receiving funding back.
In a chain distribution scheme, a person makes an investment of cash or property and then expects compensation by soliciting or recruiting others to make similar investments. Unlike traditional pyramid schemes, chain emails make earning money seem fast and easy, without traditional sales or gimmicks.
Chain emails contain a list of a certain number of people. The recipient is supposed to send money or goods to the person at the top of the list, with the promise of funds in return. Then the person at the top of the list is removed from the list and the person below them gets bumped up. The email with the new list and monetary terms is then passed on to the rest of the list, promising a return to do the same.
Ponzi Pyramid Scheme
Ponzi schemes often involve a promise that your investment will generate high returns with little to no risk. Although they may not have the same hierarchical structure as a traditional pyramid scheme, Ponzi schemes promise implausible returns on initial investments. In most cases, the people who are convincing you to invest are the ones pocketing your investment.
Because there are little or no earnings in a Ponzi scheme, a constant flow of cash is required. This is where recruiting new investors comes in, but even that becomes difficult over time. Ponzi schemes will crumble if enough investors cash out.
Pyramid Scheme Examples
There are several infamous pyramid schemes that duped a large number of people. Below, we’ll take a look at some of the most famous pyramid scams throughout the history of pyramid schemes.
- BurnLounge: This online music store was actually an illegal pyramid scheme that generated money not through music sales, but through digital entrepreneurs investing in the scheme. Nearly 94% of investors lost their investment and more, while top executives were earning six-figure incomes. BurnLounge shut down in 2007 after the Federal Trade Commission (FTC) filed a lawsuit.
- Fortune Hi-Tech Marketing: This Lexington, Kentucky-based company recruited people to sell products and services and made them pay exorbitant fees and startup costs. The company was known for its low-profit-margin products, paying one of the lowest commissions ever in the history of MLM.
- Advocare: The FTC found this Texas-based fitness drink and supplement company required people to pay AdvoCare thousands of dollars to become “distributors,” buy inventory and become eligible for cash bonuses and other rewards — the tell-tale signs of a pyramid scheme.
- United Sciences of America (USA):This multilevel company predicted gross sales of $150 million for 1986 and $1 billion by 1989. Distributors were given a success system kit and tasked with using high-tech videotapes and a prominent scientific advisory board as sales tools.
How to Avoid Pyramid Schemes
Despite the fact that pyramid schemes still exist, there are certain things you can steer clear of to avoid them. Protect yourself from pyramid schemes by:
- Proceeding with caution: Even if you’re familiar with the products or services being sold, be wary of companies that aren’t legitimate — or ones that boast about celebrity members.
- Understand the tell-tale signs: Certain pyramid schemes will disguise themselves as MLM companies. Be aware of the commonalities most pyramid schemes share.
- Asking questions: Inquire about their emphasis on recruiting, how payments are structured, and what your potential expenses could be. If you’re asked to invest, have a thorough understanding of where your investment is going. To be certain, get answers to these questions to find out if you’re truly getting caught up in a pyramid scheme.
Before you invest in something, be sure to do your research to ensure it’s not a pyramid scheme. If you are the victim of a pyramid scheme, you can file a report with your Attorney General or the Department of Justice.
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