Has anyone ever invited you to be part of their 'network marketing team'? For most of us, the answer is probably, 'this has happened more than once'. As I sit and think about it, I can recall having been 'recruited' 13 times (over the last 20 years or so). My curiosity has lead me to join more than one MLM, but I did not stay in the system very long.
As The Finance Guy, I decided it was time to look at the streetonomics of Multi-Level Marketing. We will look at:
Why MLM members want you to be part of their team
How MLMs are promoted
Can you make money in network marketing
What the numbers tell us about Multi-Level Marketing
Why Do Multi-Level Marketing members want you in their team?
The answer to this is simple: Multi-Level Marketing companies have an intense focus on recruiting new members. They will drum it in that you can only be successful in Network Marketing, if you recruit more members and build what most of them call a 'down line'. In essence, it doesn't matter who you are or what your background is. You are fully qualified to be part of a network marketing team. Everyone is a prospect, and the more you sign, the better.
Members are encouraged to recruit everyone they know to join their network. The mentality is something along the lines of: MLM is 'something that anyone can do'. If you believe in the system, then why wouldn't you invite everyone you know to be part of it? The more people you sign up, the more you can earn from their activity. You can potentially make money from all the business generated from not only the people you recruit, but also the people that they recruit.
Theoretically, to build a network, all you need to do is sign 5 people (first layer down line), if they each sign 5 people (25 second layer down line), you have a network of 30 beneath you. If your second line each sign 5 people (125 third layer down line), your personal network has 150 people. By the time you've got 5 layers in your down line, you'll have a network of 3,905 people. Now imagine if you each recruited 7 people instead of 5, then you'd have a network of 19,607! But why stop at 7? There is no limit to how many people you can recruit! So go out and sign as many people as you can. Sounds pretty simple doesn't it?
How are Multi-Level Marketing Companies Promoted
There are literally hundreds of MLM companies, and new ones are always emerging. Over the years, I've been approached 13 times to join a direct marketing team. The companies I was invited to join were:
Amway - on 5 separate occassions
USANA - twice
Herbalife - twice
A company that sold websites (name forgotten)
A company that sold lottery tickets (name forgotten)
A company formed by disgruntled former Amway members (name forgotten)
I've been approached by strangers at parties, by colleagues at work, and by friends and even one family member. The MLMs and the people recruiting me vary, but they all use a very similar system.
Step 1: The soft invitation -
Someone you know (or have just met at a party), invites you to 'learn about an exciting new opportunity'. This is usually accompanied by some flattery along the lines of 'I am only telling you because I think you'd be amazing at it' and 'I only introduce people if I see they have potential to succeed'. In my experience, these invitations are usually very vague. If you ask any questions, the answer is usually 'come along to the meeting and all your questions will be answered'
Step 2: The Presentation -
The meeting you were invited to, is a presentation of how that particular multi-level marketing company works. This is usually not run by the person who recruited you. At this point you meet someone in the 'up line' who is positioned as senior member of the system and therefore an authority on the subject. These presentations are often done in a group or even seminar a environment.
Regardless of which MLM you are looking at, the presentation, will inevitably follow a similar format and will include high energy explanations about:
Why Network marketing is the way of the future. It removes the middleman and gives money back to you. The philosophy of the company is to sell directly and save money on distribution channels
How easy it is for people to succeed in MLM. This is something 'anyone can do'. You don't need to be a salesman
The products they sell. They are not available in supermarkets because they are 'too good'. The vitamins have helped solve all sorts of medical conditions.
Flashy diagrams showing you how much money you will make with even a modest down line
Success stories, somebody else was hugely successful, therefore you can be too! The stories include a rags to riches tale, and focus on the point that 'this system is your key to financial freedom'.
Step 3: The Hard Sell -
In my experiences, this was usually not done by the person who recruited me. The final push is run by someone in their up line. It's the part when you are told that 'today is the best time to join', and reminded that 'all your dreams can come true, if you are a believer'. In my last encounter with such a person, I said I was unwilling to sign on the spot because I wanted more time to properly analyze the opportunity. This did not go down very well. He acted as if I'd insulted his mother, and his religion at the same time.
Can You Make Money in Network Marketing?
It is possible to make money with MLM, however we believe it is highly improbable. In his free e-book 'Multi-Level Marketing Unmasked', Jon Taylor found that 99.7% of people will lose money in network marketing. So for every 1,000 people who join a network marketing team, 3 will earn more money than they spend. So if I want to have 5 successful people in my first down line, I have to recruit 1,665 new members, so that 5 of them will be successful.
This may be a system that 'anyone can do', but it's also a system in which, only 1 in 333 people are successful. To try and understand why it is so difficult for network marketers to turn a profit, we looked at the compensation plans for Amway, USANA, Herbalife, and Nu Skin. As expected the system for earning money with each, are congruently unique and similar.
Each MLM has their own version of paying commission, and they are all share similar characteristics. Unfortunately we believer that they are structured in a way that makes it very difficult for anyone to turn a profit in network marketing. For example:
You have to 'qualify' to earn any commission - You are awarded 'points' when you buy products. This creates what we view as 'synthetic demand' for the products. Network marketing members are ordering product in order to remain 'active'. They order in excess of what they would personally use or what they can on sell at a retail margin, which causes them to stock pile the products.
Most of the money spent is by members - Network marketing companies acknowledge that very little of their sales are due to retail demand. Most of the product being ordered is by members for personal use (or to satisfy volume quotas). Sales are not driven by market forces, they are driven by members buying for volume targets. If very little money is coming from outside the network, then the only way for people to profit, is at the expense of people in their own down line.
It is a zero sum game - In the absence of organic sales, your up-line can only make money, if you spend money. The stories you hear about the struggling single parent who is now a millionaire might be true. However they leave out an important detail, which is: Every one of those million dollars came from other members of the network who are below them in the MLM hierarchy (which is not pyramid regardless of how closely it resembles one). Money made by one member of a MLM team, has been lost by another.
A System Prone to Negative Incentives - As we previously noted, the only way most people make any income in network marketing, is from signing new members below them in the system. Once you are in the system, your up line will receive commission on any money you spend. It is in their best interest to tell you to 'you are perfect for the team' and to 'keep spending that monthly quota'. The more you spend, the more they earn. They may believe that you can succeed in multi-level marketing, but in reality, they need your money coming into the system in order for themselves to to succeed.
Multi-Level Marketing Does not remove the middle man - Direct marketing companies will tell you that their companies are 'selling directly to you'. At best, this is a misconception, at worst it's an intentional misrepresentation. You can order products directly from the company, but they will pay a commission to the person who recruited you, and several others above you in the chain. They will tell you that you have the potential to 'earn commission' from your down line. In reality you are becoming another middle layer in the distribution chain between the supplier and your down line.
What the numbers tell us
To analyze the numbers, we looked at the compensations plans as well as the annual reports and income disclosure statements of Amway, Herbalife and USANA. Unsurprisingly, our findings suggest that only people who are very high up the network marketing structure, are making any profit. Below is our interpretation of the data we read for each company:
Your earnings in Amway are based on a combination of PV (points based on how much you and your down line spend) and BV (the dollar value assigned to how much you and your down line spend). The amount you earn, is based on the amount that you spend, as shown in the table below:
You might have a hard time spending $22,500 per month on product, but this becomes easier once you have a down line. Anyone you personally sponsor, will 'pass up' volume to you. If you are new to the system and manage to generate enough volume to qualify for a 3% payment, then your sponsor will get 3% from you sales (6%-3%). Their sponsor will get 3% from your sales (9% - 6%) and so on until the full 25% has been paid.
This 'pass up' system, encourages people to sponsor as many new recruits as possible. However their is no incentive to nurture recruits and help them succeed. All that matters is that money is being spent. If an individual is losing money and earning nothing, the money they spend is still feeding the system, and sending 25% commission up through the hierarchy.
Amway has a disclaimer which appears frequently on all their documentation. It is based on figures from 2010, and states that:
Only 46% of IBOs were 'active', and 'The average gross monthly Income for 'active IBOS' was $202 per month
Based on the figures in the Amway compensation plan, they are telling us - Less than half the people who join remain active. And on average, those who remained 'active' and worked the system, lost money.
54% of all IBOs were 'inactive' and therefore earned nothing. Of the remaining 46%, the average gross income was $202 per month or $2,424 per annum. Based on our calculation, the cost of being active is $300 per month, or $3,600 per annum. We don't know what other expenses distributors incurred, but the average IBO lost at least $1,176 in 2010. Suddenly all that time and effort spent building the system isn't looking so good.
We calculate that, to be active in Herbalife, you need to spend approximately $370 USD per month, or $4,440 per year. The most telling document we found, was the Herbalife Income Disclosure Statement from 2013. In their own disclosure they state that:
88% of Distributors received no payments from Herbalife during 2012
Based on the figures in their table, we calculate that 10% of all distributors earned less than $4,440 in 2013, and therefore also lost money - They spent more on product to remain active, than they earned in commission. In 2013 98% of Herbalife distributors did not turn a profit.
It is sold as a system in which 'anyone can succeed', but according to their own documents, only 2% actually will. Herbalife will defend this data by claiming that most people do not join with the intention of making profit. In fact the same income disclosure document states:
The majority (73%) primarily join us to receive a wholesale price on products
We are not going to challenge the legitimacy of this claim, but we do wonder how these people are obtaining a 'wholesale price'. They buy the goods at a the distributor price, which includes commissions to everyone in their up line. They are ordering directly from Herbalife, but they we don't agree that this is a 'wholesale' price. The are ordering through a long line of middle layers who they know as 'their up line'.
We could not find a more recent income disclosure statement, but we did look at the Herbalife 2014 Annual Report. We built the table below using data from this annual report, as well as our own calculations:
Again the figures do not illustrate a system in which 'anyone can succeed'. Firstly we can see that in 2014 the retention rate was 52%, would you join a business if 48% of the sales force quit in a single year?
Almost 30% of every dollar spent is used to pay commission, at first this may look like a positive, but when we break it down, we see that the average 'sales leader' lost money. Those who are making a profit are the 2% who are very high up in the chain.
There is no denying that money is being made at the top of the USANA network. In early May, USANA Founder Myron Wentz became a billionaire. He's been at the top of the network for 23 years, and is a 51% owner in the company. It must be lonely at the top, because based on what we can see, most associates are not making any profit at all.
To remain active in USANA, you need to spend 100 points per month, which equates to USD $117.50 per month or $1,410 annual. That is according to the USANA associate price list. This money is your personal spending and you do not get any commission back on it, but the person who recruited you might.
We read through the USANA income disclosure statement, which is based on data from 2011. The information contained in this document is presented in a format which is consistent with network marketing. The most prominent feature, is a table showing how much the top 14% of all associates earned in 2011. Conveniently hidden in the fine print at the bottom, it is stated that if all associates are included then:
The average yearly income was $616.72, with nearly one in three earning a check
Would you join a business if your chances of earning a single payment were less than 1 in 3? Even if you were lucky enough to earn a payment, on average, associates who got paid lost $793.28. (if they spent $1,410 to remain active for 12 months and received $616.72 in commission) According to their own income disclosure statement, USANA won the Network Marketing Today 'Best Company' award 15 years in a row. A system where 84% of the members lose money, may not sound like the 'best company' in the industry, but they are the best of the three we looked at. If losing almost $800 a year makes you the best, then why look at the rest?
For more recent data, we looked at the 2014 USANA annual report. We built the table below using data from this annual report, as well as our own calculations:
The numbers tell a familiar tale. The 'direct sales approach' adds a margin of 44.16% to the price of products. On average associates lost $410. With more than 2 thirds earning nothing at all. Based on the numbers we found in USANAs documents, they may be the best multi-level marketing company in the world. After all, their numbers suggest that 16% of USANA associates made a profit in 2011.
What are Others Saying About MLM
Over at Wikihow they agree that MLM companies closely resemble pyramid schemes. The only way you are going to make money with one, is if you are very good at recruiting!
A detailed review done by the balanced small business, agrees that mlm is everywhere. It’s tough to find someone who hasn’t been recruited at least once. They also confirm that the drop out rates in MLM are very high. In fact 90% of members drop out of MLM within 5 years.
Over at Jungle Scout, they raise another interesting point. There are other ways to become a self employed salesperson. It turns out that you could make more money with traditional sales roles that aren’t MLM
Why is it Difficult to Make Money with MLM
Dr Taylor developed a 5 Step MLM evaluation system, which identifies 5 red flags. His research found that if any MLM raises 4 or more of these flags, then your chances of turning a profit are less than 1%. If you look at any MLM, we believe you’ll be able to recognize at least 4 of the following:
Red Flag 1 - Constant Recruitment of New Members
Most MLMs have some sort of incentive for recruiting new members. It might be in the form of a special bonus or some other incentive which encourages you to recruit as many people as possible, as quickly as possible. The problem with this, is that the focus is on finding new recruits, instead of building retail customers. This means that the majority of money comes from inside the MLM system, making it unlikely for anyone who isn’t near the top of the system to earn a profit.
Red Flag 2 - Promotion Through Recruitment
MLMs have overly complex payments systems or ‘compensation plans’. The amount of commission you can earn in any MLM will depend on your rank in their system. To earn higher commission rates, you need to grow what’s known as your downline. This can only be done by personally sponsoring new recruits, and convincing them to spend monthly amounts on the MLM goods or services.
While the volume requirements for promotion can theoretically be met through retail clients, you can not reach the higher pay levels unless you recruit new members.
Red Flag 3 - Pay to Play
They might refer to this as being ‘commission qualified’, ‘remaining active’, or something more inventive. The majority of MLMs will require you to personally spend a minimum amount on their goods or services in order to earn any commission at all.
This minimum spend often results in members spending on goods and services which they otherwise might not have purchased. This can lead to hyper-consumption, where members are buying ore than they can use. It is common for them to end up with closets full of unused MLM product.
Due to the pay to play requirement, many people end up losing money while trying to pursue the ‘business opportunities’, offered by MLMs
Red Flag 4 - Most of the Rewards go to your upline
MLMs use their complex compensation plans as a way to lure in new recruits. They show them how much you could earn and build your dreams of some day achieving financial freedom.
The problem with all these generous commissions, is that they are included in the ‘wholesale’ prices charged by MLMs. If you are a new recruit, then the commissions earned by your upline, are included in the price you pay.
Unfortunately less than 1% will ever make it to the upper levels of the MLM system, so that means that the other 99% will struggle to make ends meet, while sending commission to the top.
This is also why if you join a MLM, you’ll find all sorts of people in your upline encouraging you to keep going, and stay active. They’ll tell you stories about how important it is to not quit, but in reality, the longer you spend money, the more commission they earn.
Red Flag 5 - More than 5 levels in the payout plan
Dr Taylor warns that 'Excessive levels in a downline is another sign participants are expected to sell primarily to their downline, rather than to the general public. This makes it an exploitative money transfer scheme, or product-based pyramid scheme'.
This confirms our believe that most of the funds come from inside the MLM system, instead of from actual customers. People are buying from the MLM because they think it will one day make them wealthy, not because they actually like the products or services.
Active members may claim that the love the products, but that’s mostly because they have built an association between the products and their financial dreams. In most cases, you can find better products in regular stores, and they’ll be cheaper than the ‘wholesale’ MLM versions.
Are MLMs Illegal Pyramid Scams
While all MLMs closely resemble illegal pyramid schemes, they are in fact legal. The reason dates back to a 1979 FTC ruling vs Amway. Amway was charged with being an illegal pyramid scheme, but after 4 years in the court system, they managed to survive.
The FTC case did find that ‘Amway had made false and misleading earnings claims when recruiting new distributors’. The FTC found that Amway differed from Pyramid scams because they did not charge a large joining fee. The case also found that Amway did not promote inventory loading, which would leave distributors with a stockpile of product which could not be returned.
This ruling effectively opened the door for other MLMs, who could now differentiate themselves from illegal pyramids based on the same findings. The main result of this is in the paperwork. If you read the terms and conditions or fine print on the MLM joining forms, you might find phrases such as
- Distributors must sell 70% of their stock before placing additional orders
While it’s nice to know that the FTC has set rules to keep MLMs legal, enforcing these laws is proving difficult. The MLMs simply claim that they can’t monitor how much product is sold to retail customers. If distributors make complaints when their financial futures turn out to me little more than a dangling carrot, they’ll say it was a rogue distributor making false claims.
It would be nice if this ruling which is now over 40 years old, was revisited, but for the time being we’ll just do our part in encouraging everyone to stay away from MLMs
Our Final Say
There are thousands of network marketing companies, and our research is in no way comprehensive. Based on the information we have been able to find, it is our opinion, that the vast majority of people who join multi-level marketing companies, will lose money.
We will continue to do our best to do our best to provide an outside perspective on MLMs. We often review individual MLMs at the request of our readers, so if there's one you think we should look at, just let us know in the comments section below.
For more posts like this, look at our list of mlm reviews.