Pyramid Scheme vs. MLM: Definition, Difference, and Legitimacy

FT Contributor
An open notebook with the words "multi-level-marketing" written in it with a drawing of a pyramid of people underneath it.

At first glance, it can be difficult to differentiate between a pyramid scheme and multi-level marketing (MLM), as they both operate on multiple levels. Generally, MLM companies operate legally, as there is a product or service being sold. That’s not always the case with pyramid schemes.

What Is a Pyramid Scheme?

A pyramid scheme is a fraudulent scheme where no real product is sold. Instead, pyramid schemes make money by recruiting new participants. The person recruiting puts an emphasis on encouraging others to join once you join.

Pyramid schemes often require you to buy a certain amount of product and produce sales at regular intervals. Most of the time, you earn more money for recruiting new members than you would for making actual sales. This allows for a constant stream of cash to flow into the scheme, benefiting those at the top of the pyramid.

Pyramid schemes do not benefit the people at the bottom. Most often, the later investors are the ones who lose the most. A pyramid scheme can only recruit so many people, after all. When recruits run out, people lose money.

Other hallmarks of a pyramid scheme include:

  1. The need to recruit people and develop a team under you.
  2. The promise of high returns over very little time.
  3. The ease of earning a passive income.
  4. Revenue from sources other than sales.
  5. A difficult commission structure that makes it hard to earn money from sales.

Recognizing a Pyramid Scheme

There are certain warning signs that can help you identify pyramid schemes. Watch for these red flags:

  • If there is no emphasis on selling products, but there is an emphasis on recruitment, it’s probably a pyramid scheme.
  • There’s the promise of making a substantial amount of money in relatively little to no time at all.
  • High-pressure sales tactics are involved to get you to sign up. If you hear that this is a “once in a lifetime chance,” it’s probably a pyramid scheme.
  • Other distributors involved have an excess of inventory they can’t turn over for profit. In most pyramid schemes that sell a product, distributors must continue to buy the company’s new products regardless of what they have or have not sold.

What Is a Multi-Level Marketing Scheme?

MLM is a type of marketing strategy that makes money based on enrollment as well as through sales of a tangible product. These strategies offer multiple levels of compensation that inspire sales representatives to turn a profit.

The more recruits a promoter brings on to their team, the more they make in commission. With MLM companies, promoters earn a portion of their team’s commission. In other words, they’re paid to bring new salespeople on as well as whenever those people make a sale.  

Today’s MLMs go after non-salaried workers who can work from home and earn money selling products like vitamins and makeup. While it’s not mandatory, recruits are encouraged to develop a downline, or a team below them who also make sales and generate a commission for the people above them.

Multi-level marketing schemes like these do resemble pyramid schemes in structure but don’t solely require an investment. With MLM, sales are a mandatory part of the job.

Pyramid Scheme vs. MLM

While they are similar in nature, there are specific differences between pyramid schemes and MLM that will help you differentiate the two.

  • The Federal Trade Commission recognizes certain MLMs. They do not recognize any pyramid schemes.
  • Products are a huge differentiator between the two. If the product is what drives profit for the company, it’s probably a legitimate MLM. If investments are the sole source of profit or you’re required to buy more products despite a lack of sales, it’s probably something else.
  • Pyramid schemes only compensate those at the top of the pyramid. Generally, the profitability rates vary in MLMs.
  • You’re required to recruit new members in a pyramid scheme. In an MLM, you can make more money if you bring new recruits on to your team, but it’s not mandatory.
  • Most pyramid schemes will charge a mandatory fee, presenting it as the cost of training and set-up for new members. MLMs typically allow you to earn that money back over a certain period of time.

Pyramid Scheme vs. MLM Legitimacy

To put it simply, pyramid schemes are illegal; most multi-level marketing organizations are not.

Most MLMs sell reputable products, promote consumer protection, provide customer guarantees, and go beyond the standards set by the Federal Trade Commission. While many MLM companies are legitimate, not all of them are. Legitimate MLMs abide by strict rules that protect their salesforce and the consumer.

Pyramid schemes, also referred to as “franchise fraud” or “chain referral schemes,” are marketing and investment frauds. Instead of receiving the high return you were promised, your money is used to pay out other investors.

While there are alternatives to careers in MLM, some people find they can earn a substantial amount if they commit themselves to it. If you feel you have found an MLM that is actually a pyramid scheme in disguise, report it right away.

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