A pyramid scheme is a fraudulent business model that generates income by enrolling new recruits. Typically, members are tasked to sell goods or services, with an incentive to earn more money for every member who is recruited into the program.
What Is a Pyramid Scheme?
History of Pyramid Schemes
In the history of fraud, few scams are more egregious – and enduring – than pyramid schemes. First introduced to America roughly a century ago, pyramid-style organizations have consistently confounded the unsuspecting public, dashing victims’ financial prospects in the process.
At their core, pyramid schemes prey on basic American ideals, such as entrepreneurship and economic mobility. Pretending to offer real opportunities, these rackets appeal to individuals’ ambitions, and then pressure them to suck in other hopeful recruits.
Unfortunately, as the economy evolves, pyramid schemes have become more difficult to spot. What differentiates a fraudulent organization from a legal multilevel marketing business? In the rising gig economy, what distinguishes a promising opportunity to work for yourself from a totally exploitative scam? With this article, we hope to help readers like you identify and avoid pyramid schemes of all shapes and sizes.
Pyramid Scheme Basics: The Structure of a Scam
While pyramid schemes take many forms, they all share some fundamental characteristics. Essentially, pyramid schemes are flawed or fraudulent businesses, with no legitimate means to turn a profit. These schemes may seem to revolve around selling products, but they actually suck in money by luring in new members.
Instead, a small set of initial members recruit new participants, promising attractive financial rewards for participating in their organization. When these new participants join, they typically pay a set of upfront fees – and part of this sum goes to the person who recruited them. These new members then seek out more recruits, and they receive a fee for each person they bring in.
This pattern continues indefinitely, and the organization grows exponentially through aggressive recruitment. Pyramids schemes derive their name from their organizational structure: There are few members at the very top, but many at the bottom levels, with each new wave of recruits bringing yet more people in.
In many instances, the kickbacks up the chain don’t stop at recruitment. Members get a cut of everything sold by the people they recruit, the people who those people recruit, and so on. This set of connections is sometimes called a “downline.” The more people who kick up to you, the more money you make – and the more incentive for everyone to bring others into the scheme.
A Classic Example: Fortune Hi-Tech Marketing
To clarify the dynamics of such a scheme, an example may be helpful. Fortune Hi-Tech Marketing, a business founded in Lexington, Kentucky, promised regular Americans a sure path to greater income. Participants would pay to enroll, earning the privilege to sell cable packages, cellphone plans, supplements, and hair products directly to consumers. They were supposed to get commissions for selling these products – and bonuses for recruiting new members.
Unfortunately, 98% of members lost more money than they made from taking part in the scheme. The only profit to be made was from massive recruiting, and only those at the very top saw any financial benefit. In 2013, the Federal Trade Commission shut the operation down, declaring it a pyramid scheme.
Pyramid Schemes vs. MLMs (Multi Level Marketing)
Does this structure sound alarmingly similar to that of other major businesses? You haven’t gone paranoid. In terms of their basic dynamics, pyramid schemes can be strikingly similar to multilevel marketing (MLM) companies, which have become increasingly popular in recent years. Indeed, MLM companies do have a pyramidal hierarchy, in which representatives sell directly to consumers and actively try to recruit others. So what is the difference?
To be clear, not all MLM businesses are fraudulent, nor are they necessarily a poor business model. In fact, the clearest distinction between an MLM company and a pyramid scheme is whether the organization is actually a viable business for all involved.
If participants can really profit from selling goods and not just from recruiting members, the organization probably isn’t a pyramid scheme in a traditional or legal sense. This difference, of course, depends on the product. Are they reasonably attractive to customers in terms of quality and price?
Avon, the cosmetics company with more than a century in business, might be a helpful example here. For decades, the corporation has recruited “Avon ladies” who sell the brand’s products door to door. These representatives can make a profit selling cosmetics, although their success is hardly guaranteed. Indeed, many MLM entities are technically legal but are extremely demanding, leaving representatives feeling exhausted and exploited.
By contrast, participants in pyramid schemes quickly discover that the goods they’re supposed to be selling have little intrinsic value. The products are usually overpriced, poorly made, or otherwise undesirable. Having paid for the right to sell these inferior goods, members have only one hope of recouping their initial investment: earning bonuses by recruiting others.
Herein lies a key struggle in spying pyramid schemes: how can you tell whether an organization is in the business of selling products or selling pipe dreams? How can you tell if turning a profit is possible before you commit your hard-earned capital?
To be sure, the line between MLM businesses and pyramid schemes can be uncomfortably thin at times, and it may be safest to avoid both altogether. However, there are some clear indications that an organization is built on shaky premises. Likewise, no upstanding business would dare to engage in certain practices for which pyramid schemes are notorious.
Knowing the signs can help you stay far away from such scams. Below, we’ll break them down for you.
How to Spot a Pyramid Scheme: 8 Major Warning Signs
- Recruitment efforts involve extreme pressure.
In business and in life, true opportunities tend to speak for themselves. If you have to sell something aggressively, there’s a pretty good chance that it’s not all that great.
Pyramid scheme participants, however, will go to extreme lengths to recruit new members, taking persistence and pressure to uncomfortable new levels. They may call at times that seem inappropriate, insist that you attend meetings about the scheme, or take a strikingly personal approach. In some cases, they may suggest that the opportunity is time-limited, urging you to decide before you can really consider your options.
Don’t fall for it. If the opportunity is legitimate, the approach won’t reek of desperation.
The company resists questions and provides little information.
If you’re considering entering a business, you are entitled to ask tough and specific questions. If anyone tries to convince you otherwise, it’s time to doubt his or her motives.
Often, pyramid scheme operators will scold people who ask reasonable questions, accusing them of lacking the positivity or drive necessary to succeed. This approach causes many to put their concerns aside. You don’t want to put a damper on the mood or seem unworthy of the opportunity.
According to federal regulators, MLM businesses must be realistic and forthcoming in describing their operations and compensation to prospects. If these details are hard to come by, don’t get involved.
The pitch is suspiciously light on the details of selling products.
As we noted above, pyramid schemes aren’t really about selling products. In these scams, the few people who make money do so through extended recruitment networks.
As a result, the people involved in pyramid scheme recruiting hardly discuss what they actually sell or how they acquire new customers. After all, the sales process is usually discouraging – why give it more than a passing mention?
There are better or cheaper products out there.
In a similar vein, the items or services being sold may seem distinctly unappealing. You might notice that you can get equivalent or superior goods at prices far below what the organization demands for their own products.
In some cases, organizations justify this obvious issue by claiming unique properties, but if they can’t prove it, you probably won’t have much success convincing potential customers.
Members make sweeping claims and big promises.
Your life will change. You’ll be your own boss. You’ll have a summer home, retire early, and leave a vast fortune to your family.
No legitimate business proposal rests on these kinds of fantasies. People engaged in real ventures set realistic expectations backed by hard data. On the other hand, pyramid scheme participants know they’re selling a dream. They’ll entice you with wild possibilities, neglecting to substantiate their claims.
You may own a summer home one day, but no MLM representative can guarantee it. If someone claims to see far into your future, you know they’re short on evidence in the present.
There are a ton of fees and expenses – both upfront and ongoing.
Pyramid schemes make money at every opportunity just from their members, not their products. New recruits sometimes get charged obscene amounts, paying huge sums to get started.
Even longtime members continue to rack up costs, paying for training and events. These fees head up the pyramid, and most members lose money. Tragically, some people imagine success is just around the corner; they just need to invest a little more.
Rules for compensation are extremely confusing.
If pyramid schemes were clear about their compensation structures, they’d quickly undermine their own pitch. Accordingly, many of these organizations have arcane rules for allocating money, baffling members with complex math.
These same opaque calculations keep people engaged despite tiny paychecks: If you don’t understand the rigged system, you can still hold out hope for riches down the line. At the very least, an organization should be able and willing to tell you how much the average representative makes. If they don’t, they’re not dealing with you honestly.
Concerning complaints are easy to find online.
In the age of the internet, scams don’t usually stay quiet for long. You can usually find the perspective of disgruntled participants on review platforms and social media, no matter how hard a company tries to cleanse its public image. Better Business Bureau ratings are another solid indicator of a company’s ethics. Lawsuits can also highlight a problematic pattern of poor conduct, so look online for any coverage of such cases.
Opportunity vs. Catastrophe: Finding the Right Path
We hope this article will help you avoid the financial pitfalls presented by pyramid schemes. After all, the instincts that drive people toward these scams are actually admirable. Many Americans are looking for more fulfilling, flexible, and lucrative employment. They may be stymied in their own careers, or simply eager for something better. When they hear an appealing pitch that speaks to these desires, they jump at an illusory opportunity.
Thankfully, you don’t need to take extreme risks to find a better way to earn a living. Every day, we help people like you find new and exciting professional possibilities. Give our site a spin. You might just find a job you love, no recruitment necessary.