904px-Pyramid_scheme.svg

MLM Vs. Pyramiding

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Monday, 17 February 2014 - Last Updated on February 19, 2015
904px-Pyramid_scheme.svg

904px-Pyramid_scheme.svg
“MLM? Hindi ba marami na’ang nadale sa ganyan?

MLM or Multi-Level Marketing can be confused for pyramid schemes because the latter are often presented as MLM businesses.  Although both involve some form of multi-leveling, they are completely different in essence.

MLM is a type of marketing activity where salespeople not only earn income from their personal sales but also from the people they recruit, often referred to as downlines.  They earn income from downlines in 2 ways: commission from downlines’ membership or joining fees, where applicable, and commissions from downlines’ personal sales.  Popular MLM companies in the Philippines include Amway, Avon, Usana, DXN and Nu Skin, among others.

MLM’s primary marketing strategy is direct selling through relationship referrals and word of mouth.  You hardly see ads on mainstream media for such products.  A representative of an MLM company whose orientation seminar I once attended said that the reason they shun mainstream advertisements is to be able to give more financial incentives to their sales force.

Pyramid Schemes

Under Republic Act 7394 also known as the Consumer Act Of The Philippines, Pyramid Schemes are defined as:

“sales devices whereby a person upon condition that he makes an investment, is granted by the company or its representative a right to recruit for profit one or more additional persons who will also be granted such right to recruit upon condition of making similar investments, provided that the profits of the person employing such plan are derived primarily from the recruitment of other persons into the plan rather than from the sale of consumer products, services and credits…”

A very distinct characteristic of pyramid schemes is that people earn primarily from recruiting others instead of selling actual products.  The reference to a pyramid is due to the fact that increasing investments of subsequent investors fund the payments of earlier investors’ maturing investments.  Such dependence on increasing subsequent investments is due to the fact that pyramid schemes don’t have any legitimate underlying businesses that support such operations.

The first investors are at the “apex” of the pyramid and subsequent batches of investors form the base of the scheme.  To illustrate, let’s say a pyramiding scheme offers a 50% return on a minimum investment of Php 1.00 million that will mature in 3 months.

Batch

 # Of Investors

 Principal

 Total Investments

Guaranteed Return

 Maturity Value

 1

 10

 1,000,000.00

 10,000,000.00

50.00%

 15,000,000.00

 2

 15

 1,000,000.00

 15,000,000.00

50.00%

 22,500,000.00

 3

 23

 1,000,000.00

 22,500,000.00

50.00%

 33,750,000.00

 4

 34

 1,000,000.00

 33,750,000.00

50.00%

 50,625,000.00

 5

 51

 1,000,000.00

 50,625,000.00

50.00%

 75,937,500.00

 6

 76

 1,000,000.00

 75,937,500.00

50.00%

113,906,250.00

 7

 114

 1,000,000.00

 113,906,250.00

50.00%

170,859,375.00

 8

 171

 1,000,000.00

 170,859,375.00

50.00%

256,289,062.50

Notice the increasing or expanding total investments base for the succeeding batches.  This is why it’s called pyramiding.  The pyramid will crumble if batch 9’s total investment is less than Php 256.29 million, which is equivalent to the amount of maturing investments of Batch 8.  When investors don’t get paid, panic withdrawals by the others will ensue, new investments will stop coming in and the scheme will grind to a screeching halt.  In this game of musical chairs, the last batch of investors will be left holding a bag of broken dreams and crushed spirits.

Some of the infamous local pyramid scams include the Mateo Management Group (MMG), Multinational Telecom Investors Corp. (Multitel) and just recently, the Aman Futures scam in Mindanao.

MLM Vs. Pyramid Schemes

The following areas of comparison can help us distinguish legitimate MLMs from pyramid schemes:

1.      Products – There are actual products sold with MLM while there are none for pyramid schemes.

2.      Commissions – Under MLM, a person can earn commissions from personal sales or from sales of people he or she recruited, often called downlines. 

In pyramiding, a person commission is through recruitment only.

3.      Legitimacy – Reputable MLM companies are registered with the Securities and Exchange Commission (SEC) and the Department of Trade and Industry (DTI) while pyramiding schemes are not.

Practical Tips For Investing Wisely

One very important principle to keep in mind when deciding where to invest our hard-earned money is the relationship of risk and return:  higher returns, higher risk and vice-versa.  This is where pyramid schemes are easily exposed as such.  The guaranteed rates of return they offer investors are exorbitantly high as to classify them as out-of-this-world!

Take for example, the recent Aman Futures scam, where guaranteed returns of up to 62% in just 20 days (or 1,131.5% per annum) were offered!  At that time, high earning deposits in banks were only between 1%-3% per year and the Philippine stock market registered a year-on-year return of “only” 26.8%.  Pyramid schemes offer such alien rates to compensate for their obscurity and to entice investors to give them their money.  In this regard, keeping up-to-date with market rates is a habit worth acquiring.

Although most MLM companies are legit, it may not necessarily be a right fit for us personally due to our personalities, the products themselves and lack of market for such products.  A good way to test the MLM waters would be to use the product first.  Nothing beats a personal testimony in selling a product and using second hand testimonies may not be as effective.  Using the product first is also a good way of finding out if it’s something you can and will personally use in case you are not able to sell it, which minimizes your risk of loss.  For example, before my wife and I jumped in the MLM bandwagon of a certain supplement manufacturer, we tried the supplements first to see if it will benefit us personally and if it’s practical.  Having personally experienced some of the purported benefits of the supplement and its practicality, we decided to join that MLM company even if our personalities are not naturally predisposed to sales.  Knowing that we will use the supplements included in the starter kit that we bought eliminated the risk of loss even if we aren’t able to sell it because it’s something that we will use.

Putting It Together

As the characters of an old cartoon show would say, knowing is half the battle.  Knowing how to distinguish legitimate MLM companies from pyramid schemes goes a long way in our quest for financial security.  And though legitimate companies can offer unlimited income opportunities, prudence also dictates we should exercise due diligence in assessing whether or not to join the MLM bandwagon in general or MLM companies in particular as a way of achieving financial security.  Take time to carefully study investment options.  It is time well spent.

“The plans of the diligent surely lead to advantage, but everyone who is hasty comes surely to poverty.” – Proverbs 21:5 (NASB)

Photo via Wikipedia.  Some Rights Reserved

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