What Is a Pyramid Scheme? & How to Spot One


Pyramid schemes are illegal in America and most other countries. However, there are plenty of sales organizations that are built in the form of Multi level marketing (MLM) also called network marketing.

There are also schemes that pretend to be MLM but which are rather to be regarded as pyramid schemes.

So, what is a pyramid scheme?

A pyramid scheme (formerly also referred to as a chain letter game) is an event where you as a participant make a profit by recruiting new participants. All participants pay a stake that goes up the ranks.

The basic idea of the pyramid scheme

A pyramid scheme is based on each participant recruiting two or more new players who pay a bet.

The bet is split between the recruiting player and the person or persons over him in the pyramid.

At a glance, it may seem that all players will benefit from this, but the problem is that the system is based on an unrealistic notion that the number of participants can increase indefinitely and exponentially.

In practice, only the people who joined early or the one who started the pyramid have the opportunity to get rich.

How do you spot a pyramid scheme?

  • Do you have to buy a starter kit / training package to join and is it a requirement that you must recruit new participants for the concept or sell starter packs / training packages to new customers?
  • What does the company behind the concept seem to want to achieve, to get as many participants as possible or sell as many products as possible?
  • Is it not possible to buy a possible product without becoming a distributor yourself?
  • Are you tempted to make money without having to do anything?
  • Are you talking about that it is a unique opportunity to join at the start of the business and that it is those who join at the start who make big profits?
  • Do you not get to know any details about the business directly, but must accompany to a special meeting where a spokesperson for the concept describes it?
  • If something seems too good to be true – it usually is! If it is attracted with a passive income, there is always a catch. These are usually large bets that a consumer must invest and when the pyramid scheme collapses, this money is lost.

Example of how a pyramid scheme works

Participant A recruits a new participant B, participant A then receives part of participant B’s contribution. If participant B then recruits participant C, both participants B and A may take part in participant C’s contribution.

In order for the participant to get a return on their bet, it is required that participation in the game constantly increases in each stage.

In some arrangements, in addition to recruiting, there is also the sale of a product or the like.

The initiative can then instead be called a start-up package or a training package, or presented as an investment.

In such a case, a participant must sell start-up packages / training packages to new participants, or alternatively get new participants to make an investment, which is the same as recruiting new participants to the event.

What is MLM (Network Marketing)?

Multi Level Marketing (“MLM”) is a way of organizing a sales organization.

Companies that organize their sales according to direct sales, relationship marketing, network marketing or MLM also need salespeople.

Unlike traditional companies that employ their salespeople, they let customers who buy and use the products through the word-of-mouth method tell others about the product and that they give their customers the opportunity to become sellers (distributor, ambassador, resellers, etc.) of the company’s products and you pay a commission on the sales the seller makes and often also on what his customers sell in one go.

Difference between pyramid schemes and MLM

To assess whether it is about some form of pyramid scheme or a more serious network marketing, one should look at what is it that you get paid for?

Is it primarily for the sale of the products or to recruit new sellers?

A warning sign is if there is a strong focus on an expensive starter pack or entry offer or expensive subscription costs where you can not return unsold or unused products.

With such an arrangement, it becomes more important to acquire new customers who buy starter packages than to sell to end customers.

Why pyramid schemes and MLM don’t work in the long run

Pyramid schemes and MLM don’t work in the long run because they can no longer find people to recruit and then the whole thing collapses.

A pyramid scheme thus focuses on recruiting new participants, either completely without any product that is sold in addition to the participation itself or a product that is included for the sake of visibility.

The question to ask is what proportion of potential customers can be expected to take up the offer. I.e. if you asked 100 people if they would like to buy the product at the stated price, how many would say yes?

Probably less than you think. The outcome of course depends on the product and how you sell it, but since it is often about the customer becoming so engaged that he also wants to become a seller or at least become a repeat customer who buys regularly or buys some form of subscription.

Even if you count on between 0.1 – 1% that could be activated, it is probably high counted because some are probably not interested at all in the type of product you sell and some may be interested in the product but choose another product.

This is not about how large a share you sell to e.g. at an information meeting without the proportion of the entire population.

(So ​​if you contact 100 random people and 10 of them agree to come to an information meeting and one of them becomes active in the network, then it is about 1 percent.

To reiterate, why it fails? Simply becase they eventually run out of people to recruit.

Sources

https://www.tandfonline.com/doi/abs/10.1080/00031305.1977.10479200

https://www.tandfonline.com/doi/abs/10.1080/10528008.2004.11488877

https://www.proquest.com/openview/e0f1f1072db112060dca5166e917c29f/1.pdf?pq-origsite=gscholar&cbl=41065

https://www.sciencedirect.com/science/article/abs/pii/S2214804318304427

https://www.sciencedirect.com/science/article/abs/pii/S0378437120308463

https://sequenceinc.com/fraudfiles/wp-content/uploads/2011/03/illegalpyramidscheme.pdf

https://kluedo.ub.uni-kl.de/frontdoor/index/index/docId/605

https://iopscience.iop.org/article/10.1088/1126-6708/2009/07/046/meta

https://journals.sagepub.com/doi/abs/10.1509/jppm.13.086

https://link.springer.com/article/10.1140/epjc/s10052-012-2185-9

Kevin

This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policies.

Recent Posts