Is This a Pyramid or a Legitimate MLM?

By Jeffrey A. Babener
  2003

The Inevitable Question

OK, you have either been recruited for a network marketing opportunity or you are the one doing the recruiting. Inevitably, this question will come up: Is this a pyramid scheme or a legitimate business opportunity?

This Tuna's for Selling

A Checklist

1.  Product and Price

2.  No Investment Required

3.  Purchase and Inventory Requirements

4.  Sales Commissions Sources

5.  Buy-Back Policy

6.  Retail Sales

7.  Active Role for Distributors

8.  Earnings Misrepresentations

9.  Good Training

Although this is a complex legal area, a simple story draws a clear line in the sand. Party No. 1 sells Party No. 2 a case of cans of tuna fish for $10. Party No. 2 sells the same case to No. 3 for $20 and so on until No. 9 sells the case to No. 10 for $500. No. 10 opens the case and opens one of the cans, which turns out to be rancid. He goes back to No. 9 who refers him to No. 8 and so on until No. 10 goes to No. 1 to complain.

"I have major problem," he says.

"So, what's your problem?" says No. 1.

"Well," says No. 10, "the tuna is rancid, it's inedible."

"So, what's your problem," No. 1 says again.

No. 10 says, "Like I said, this tuna is no good."

 "Well," says No. 1, "the way I see it, you don't really have a problem."

"What do you mean?" says No. 10, "this stuff is worthless."

"You don't understand," said No. 1, "this tuna is for selling, it's not for eating!"

And there lies the difference. Distributors in a network marketing program that are merely buying product to buy into the deal as opposed to an intention of really making a market for it, are really working a pyramid scheme, not a legitimate direct selling business. Remember, when you offer this opportunity to your next-door neighbor or your best friend, it's your credibility that's going to be on the line for years to come.

What to Look for - A Checklist

So, what do you look for with respect to legitimacy vs. pyramid? Here's a good checklist to consider.

  1. Product and Price
    Does the company offer a high quality product for which there is a strong demand in the real world marketplace? Is the product fairly priced and priced competitively with similar products? Can the product be demonstrated, and does it stand out when you show it to friends? Is the product proprietary to the company, and available only through its distributors? (Have you ever noticed that you can't buy Avon products in stores or Shaklee vitamins at pharmacies?) Is it backed up with a customer satisfaction guarantee?
    Is post-sales service or customer assistance available? Do the people who participate in the program buy the product enthusiastically based on its own merits, even if they don't participate in the compensation program?
     
  2. Second, No Investment Requirement
    Can you participate in the company's program without having to make any investment other than purchasing a sales kit or demonstration materials sold at company cost?
     
  3. Third, Look at Purchase and Inventory Requirements
    Can you become a distributor or sales representative without having to fulfill a minimum up-front purchase or inventory requirement? (When you are pitched to put thousands of dollars of inventory at the very beginning, run fast in the opposite direction.) Does the company's compensation plan discourage inventory loading? Garages and backrooms filled with product serve no useful purpose to anyone.
     
  4. Fourth, Look at the Sales Commissions Sources
    Are sales commissions paid only on actual products or services sold through distributors in the network to the end-user or ultimate consumer? (This means that products don't end up in basements and closets. They are used, because they have genuine value.) Does the compensation plan avoid paying commissions or bonuses for the mere act of sponsoring or recruiting? (If it pays headhunting fees, it is illegal.)
     
  5. Fifth, Check the Buy-Back Policy
    Will the company buy back inventory and sales kit materials from distributors who cancel their participation in the program, as long as these items are in resalable condition? (This policy is required in states that have adopted multilevel distribution statutes.)
     
  6. Sixth and Very Important, Look for Retail Sales
    Is there an emphasis on actual retail sales to end-consumers? Can the company demonstrate efforts to market products to the ultimate consumer? Do the company's distributors have ongoing retailing requirements to qualify for commissions? What is a "retail sale?" The industry and many MLM statutes include both sales to nonparticipants and purchases in reasonable amounts for personal use by distributors. Some regulatory groups, including the FTC, have historically rejected personal use as a legitimate retail sale. Stay tuned as this debate continues. The legislative trend is definitely supportive of the industry position.
     
  7. Seventh, Expect an Active and not Passive Role for Distributors
    Are distributors in the company required to actively participate in the development and management of their networks? (Many of the MLM statutes require that distributors perform bona fide, supervisory, distributing, selling, or soliciting functions in moving product to the ultimate consumer.)
     
  8. Eighth, Watch Out for Earnings Misrepresentations
    Do the company's literature and training materials scrupulously avoid claims of income potential that is promises of specific income levels other than demonstrations of verifiable income levels within its program? (The Federal Trade Commission, attorneys general, and postal inspectors all have their eyes on the matter of earnings representations. The acceptable approach emerging is that there should be no earnings representations unless they are based on a verifiable track record of the average earnings of distributors. For instance, a company should have statistics to show the percentage of active distributors and the average earnings of active distributors.)
     
  9. Finally, Look for Good Training
    Does the company offer its independent distributors solid training opportunities in sales and recruitment? Are different levels of training offered to match the increasing levels of experience and responsibilities of distributors?

The Journey Begins

OK, is this the end of your journey? Obviously not. You have now looked at some legal issues and its time to move on to some solid business analysis. But it's a great start.


Jeffrey A. Babener
Babener & Associates
121 SW Morrison, Suite 1020
Portland, OR 97204
Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad.

www.mlmlegal.com

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