The Non-Retail "Direct Selling" Company
by Robert L. FitzPatrick
© 2004 Robert L. FitzPatrick
Published in 2004 in Marketing MasterMind, a monthly publication of the Institute of Chartered Financial Analysts, a division of ICFAI University, Bangalore, India.
As market-based economies become the prevailing global model, millions of people are being exposed to sales promotions, income opportunity solicitations, and investment schemes with which they have no experience or knowledge. Vulnerability to deception and the need for consumer education correspondingly reach global heights.
One especially dangerous deception is now luring millions of people in Asia into financial losses. Referred to here as the "non-retail direct selling company", this type of scheme originated in the United States in the late 1970s and is now being exported around the world. Each year, it causes billions in financial losses and is seeking to entrench itself as an accepted form of business. It combines the purchase of costly products with the false attraction of earning an income as a self-employed person in "network marketing" or "multi-level marketing" businesses.
For many people owning a profitable and independent business represents the dream of economic freedom and financial opportunity. However, this dream becomes a nightmare when a consumer is misled into a non-retail direct selling business. The non-retail model results in loss rates of more than 99% for all that sign up as "independent distributors" or sales agents.
These losses in the non-retail schemes have nothing to do with competition, ambition, sales skills or any other normal market factor. Losing money in such a scheme is not failure, and making money is not success. These are not true businesses at all because there is no fair exchange of value. Rather, they are elaborate pyramid schemes in which the profits to a few come directly from the massive losses of many. Failure is therefore predetermined for nearly all. Those who "succeed" do so on the basis of deception, not entrepreneurship.
Pyramid Scheme Alert, an international consumer education group, has had extensive experience with this particular type of scheme. The group has researched the pay plans, business structures, distribution of payments, and costs of participating in the schemes. Some research was gained from serving as expert witnesses in court cases against them.
Like all consumer frauds, the non-retail scheme attaches itself, parasite-like, to a legitimate direct selling, a form of business that consumers know and trust. Many governments have not yet learned how to distinguish these non-retailing frauds from legitimate direct selling businesses.
The non-retail direct selling scheme promotes a "home-based business opportunity" in which an individual consumer signs up to become a sales representative, distributor or marketing agent for the company. In this way, the scheme appears superficially to be a traditional direct selling business in which individuals retail products they have purchased from a supplier company at a wholesale price. The difference between the wholesale price at which they are purchased and the retail price at which they are sold to consumers constitutes the profit to the sales representative.
Yet in these schemes, very little of the products are actually sold to anyone other than the sales people, and virtually none of the salespeople earns a net profit from retailing products to consumers. The typical company of this type will claim it is a direct selling business and will often highlight "retail" sales. However, the average number of retail customers per sales representative is far too small to support a retail business. The retail selling is therefore only part of the camouflage. This business is not based on "direct selling" but on recruiting other sales representatives in a pyramid fashion.
The sales organization of the non-retail direct selling company is structured in a complex multi-level hierarchy. Each new recruit to the business is linked to those above in an "endless chain" with the upper levels receiving commissions from the company based on the volume of purchases made by all the recruits below. This multi-level structure does not facilitate retail sales or sales management. Rather the design serves to create a wider and deeper base of sales representatives on whose purchases those at the top will gain commissions and rebates. The commissions to the higher levels are based not only on the purchases of more people but also increase in rate per sale for each higher level. As one moves up, he or she makes money on more people and earns more per sale on all below as well. In short, the design enriches the top recruiters at the expense of all others.
Why Retailing Does not Occur
Several key factors - in combination - make retailing unfeasible and unprofitable and reveal the company to be a pyramid recruitment scheme, not a direct selling business as its claims to be.
The percentages of commission, the purchase requirements for rising to each new level, and other rules associated with the system are complex and unfamiliar to the new recruit. Few recruits engage in due diligence or ask for actual income or expense information. The scheme is not required by law and does not divulge the actual financial records of success or failure of those who have invested in the past.
Instead, the non-retail direct selling schemes present a compelling and very alluring picture to potential recruits that diverts attention from the flawed structure and its disastrous outcome. Virtually all companies of this type in every country they operate in make the same alluring and misleading promises to recruits:
Sadly, none of these promises is fulfilled. The endless chain structure of the business must inevitably doom the vast majority - as many as 99% - to financial losses. This is because more than 90% will always be in the bottom ranks where there are not enough recruits below to provide an income. This can be illustrated in a simple 6-level chain in which each person recruits just 5 people. At least three levels of recruits (5 + 25 +125 = 155) are needed for each participant to begin to achieve a profit.
Top - 1
Level #1. - 5
Level #2. - 25
Level #3. - 125
Level #4. - 625
Level #5. - 3,125
3,906 participants total
Since only those with three levels below them are profitable, only the Top person and the individuals in levels #1 and #2 qualify. Each of the people in next three levels below does not have enough "downline" to generate a profit. This means that only 31 out of 3,906, or less than one percentage in the six-level chain, have as many as three levels below them and are profitable. More than 99% are unprofitable based on their position.
This basic formula holds true no matter how much further the chain extends. Approximately 99% are at the bottom of the chain where profit is not possible.
For example, if the scheme recruited one more level, Level #6, another 15,625 participants would join. The total would now be 19,531. The number in profitable positions, Top, and the individuals in Levels #1, #2, and #3, would grow to 156 and this number would still equate to less than 1% of enlarged organization.
The big numbers which are cited by the scheme's promoter as the "income potential" are at the deepest level of the "downline." Only a tiny few can ever recruit to this level. This is mathematically predetermined from the start by the MLM pay plan.
The trick of the scheme is to cover up this reality and to convince each and every enrollee that he/she can succeed by building this large and deep downline. Recruits are told that the program is a formula for wealth for all.
The bottom levels could, theoretically, recoup their money by finding new distributors under them, but that would work only if the scheme could go on forever and there were an infinite number of people.
Of course, the schemes do not go on forever. Nor do they continue until they exhaust all possible new recruits. While the scheme is structured as an endless chain, and makes promises to new recruits as if it were "endless" and could fulfill its promises of success to all, in practice, the chain keeps breaking at the bottom and being "repaired."
The way the mathematical limitation works itself out is in the pattern of dropouts. Non-retailing pyramid schemes don't fully or quickly saturate areas with members because most people quit within a year. All such schemes experience a 50-90% annual dropout rate.
Dropouts thwart the recruitment process at the lower levels. The people trying to build the downline are always dependent on others below to "duplicate" the process. When their new recruits become discouraged and drop out, the rebuilding process must start yet again. And while the hopefuls engage in this constant rebuilding effort, they are also continuously paying money to the scheme and its organizers for products and training as well as incurring other business expenses. Eventually, they drop out too.
Since almost no one in the chain is retailing the product, they can only recoup their investments in products and training and other costs by recruiting other sales representatives, but the endless chain structure dooms most to lose in that system.
With its ongoing operation, continuous enrollment of excited new recruits and public displays of wealth and success by the organizers, the organization appears to the uninformed as viable, stable, and successful. Most schemes can go on for many years by successfully recruiting new people to refill the bottom ranks, which become open as past recruits quit the business in "failure." Such is the elusive and tricky nature of the scheme.
Blaming the "Failures"
Many of those who quit are so convinced that they personally "failed" they are told by the organizers that everyone can succeed, so if they do fail it is only their own fault that they do not complain about the scheme to the government authorities or even warn friends about not also joining. In this way, the scheme can continue to inflict losses on very large numbers of people without government interference or media exposure.
Yet, when analyzed more closely, the non-retailing schemes are revealed to have almost no true customers, since almost no products are ever retailed to the general public. Virtually the only people buying the goods are the scheme's own sales representatives and their friends or family. They buy the goods, not on the basis of their value or need for them, but on the basis of false promises of income. Few continue to buy these goods after quitting as sales representatives. Nor does the scheme have a stable or successful sales force. 99% of the sales representatives lose money in the scheme and virtually all inevitably quit in due time.
A business with almost no customers and virtually no profitable sales representatives could not be called a "sales" business and certainly it is not a "direct" selling business. Indeed, cold facts expose it for what it is - a pyramid recruitment scheme that masquerades as a direct selling company. "Sales" are achieved deceptively. The commercial products are part of a disguise and serve to launder the money that is transferred from successive cycles of recruits to the crafty organizers at the top. The true and actual "product" of this type of scheme is a false promise.
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