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How Are MLMs Legal?

A notebook says multi level marketing.

In the summer of 2012 I’d just graduated college and like any new grad, I was broke. I needed a way to make some extra money outside of my day job, but finding extra work that fit around my schedule proved to be impossible.

I had a friend on Instagram showing off her new car, paying off her student loans, and making a full-time income without going into a day job. All from selling workout videos and protein shakes, or so I thought.

So I decided to give it a try. I spent $99 to join her organization and realized very quickly that I was trying to sell the same products to the same people in the same way she was. And not just her, but a whole bunch of other people too.

She suggested I recruit some other friends to sell in hopes that they’d have a bigger network and I’d make a small cut of their sales. After a few months of this I’d sold no product (I was actually out another $100 for the product I’d bought) and recruited no people.

By the end of my career in direct selling, I realized my friend wasn’t making the bulk of her money by selling products. She’d made it by recruiting strangers on social media to “join her organization.” And even though that sounded like it should be illegal, it was done in a completely legal way — that’s essentially the grey area where multilevel marketing (MLM) operates.

Differences between MLMs and pyramid schemes

The type of business I and millions of Americans get duped into participating in every year is called multi-level marketing, also known as direct marketing. The MLM business model is presented as a business opportunity but very few people actually make money selling product through MLM companies.

Multi-level marketing, MLM, is a form of direct sales often associated with pyramid schemes, a business model where a few people at the top recruit members to pay an upfront fee and tell those members to recruit more people while sending a portion of every recruitment fee up through the organization.

The key difference between MLMs vs pyramid schemes is that MLMs sell a product while pyramid schemes do not. However, even with a product, less than 1% of MLM participants ever make a profit. In fact, the Federal Trade Commission (FTC) stated MLMs are worse than classic, no-product pyramid schemes where around 10% of participants actually made a profit.

Basically, you join under the guise of selling the company’s products. Unlike retail sales, MLM products are sold direct. As the salesperson, you’re working with a company that acts as the MLM distributors and to a point a marketing MLM. That company makes money if you sell its wares but in many cases it makes most of its money from salespeople recruiting more downline salespeople. (The person who recruited you is upline).

It’s often called pyramid selling because most of the money is made by the very few people at the top. It’s a business opportunity if you’re really good at direct selling, but that’s not easy for most people — and your compensation plan at an MLM revolves around selling or recruiting.

So how are MLMs legal?

A legitimate MLM business is different from a pyramid scheme in that it offers a product. But many of the products by MLMs are premium or overpriced and hard to sell without an audience that’s already looking to buy premium products.

And many MLMs with useful products still use deceptive practices to recruit distributors and get them to spend more and more money to advance with the company.

The FTC doesn’t have a scientific way it differentiates MLMs from pyramid schemes. They evaluate them on a case by case basis. One factor they look at is how their gross income is received.

If a company receives most of its income through the selling of goods or services then the company is legal. If it’s from membership onboarding, dues, or wholesale inventory to distributors then the FTC will likely determine it to be a pyramid scheme.

However, many MLMs stay legal because the FTC includes products purchased by distributors for personal use in their calculation of “sales” income. And many inventory purchases made by distributors are not classified as wholesale purchases. On the brightside, the FTC is catching on to this loophole.

What to know if you want to run an MLM business

If you believe in a product and have the infrastructure in place to sell it, you can make some money in an MLM business. But you should do in-depth research into any company whose products you want to sell.

Before you get too deep, there are some questions you can ask right off the bat to determine if a direct sales business is worth your time.

What are they advertising?

If the MLM company makes more money from onboarding distributors and the products they buy for themselves then it’s probably a pyramid scheme.

But that information can be hard to find. Instead, you can look at their marketing materials. A business will spend more effort marketing what makes them more money and if the company puts an emphasis on recruiting, you can infer they’re not making as much on products.

In 2019, The FTC fined one of the most well known MLMs, AdvoCare, $150 million and banned it from multi-level marketing for doing just that.

Participants were charged $59 to become a distributor, making them eligible to receive discounts on products, and to sell products to the public. But to earn the most compensation, participants had to become “advisors,” which required them to purchase between $1,200 and $2,400 in AdvoCare products and accumulate thousands of dollars of product purchase volume each year. Things that could only be done by purchasing for yourself or recruiting other sellers.

Top distributors named in the charge advertised that advisors could make millions of dollars a year by selling AdvoCare. Though the FTC found in 2016, 96% of distributors earned less than $1,000 and 72.3% of them earned $0.

What’s the buyback policy?

In the real world, most of the time you can return unsold and unused inventory for what they paid. However, some MLMs refuse to buy back unsold inventory, at least not dollar-for-dollar.

LuLaRoe, for example, requires distributors to buy a minimum of $5,000 worth of inventory to start, but if a distributor wants to end their business they’ll only reimburse 90% of the wholesale price and won’t cover shipping and handling.

One distributor who wanted out calculated the shipping costs to return her inventory back to LuLaRoe to be $600. Because of the high cost to ship boxes of leggings and dresses, many LuLaRoe distributors opt to sell their product at a discount in private sale groups on Facebook.

Is network marketing a scheme?

At its core, being a network marketer for a company is simply a modern version of being a door-to-door salesman. But in an age where you can get so many products online at a fraction of the cost these MLM companies are pricing them, it’s unlikely you’ll make a full-time income from just selling products.

As the FTC cracks down on direct sales companies, more companies may be forced to end the multi-level marketing portion of their business. While it can seem like fun to sell someone else’s products, the only sure bet you have at controlling your income is starting your own business.

–By Jen Smith

SmartCents Mom

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