Editor’s note: This article was first published in October 2012, and its references to the Spanish preferred-shares mis-selling scandal and to Kiyosaki and Trump’s involvement in multi-level marketing promotion describe October 2012.
After I wrote the article about Robert Kiyosaki’s supposed bankruptcy, in which I made clear how strongly I disagreed with both Kiyosaki and Trump throwing themselves into multi-level marketing, my inbox filled up with messages from readers who were somewhat indignant at my supposed ignorance in failing to tell a pyramid business from a multi-level one.
I have to say that I know the differences between the two perfectly well, and in fact we’ll see in a moment that pyramid systems are not illegal, since they are used by hundreds of entirely legitimate companies. What is clearly illegal is pyramid scams (since the Madoff case, I think we’ve got lost in technicalities).
The engine of a multi-level business is a (legal) pyramid system. Just look at the typical diagram used to represent multi-level businesses, affiliate programs, network marketing and the like: the scheme draws a pyramid. Let’s go through the definitions of the two systems and the differences between them. Although we’ll conclude that one system is legal and the other illegal, at the end I’ll explain why I think that both Kiyosaki and Trump, along with their multi-level systems, lack ethics when it comes to recruiting new affiliates or referrals, even though those systems are legal.
What is a pyramid system (network marketing, MLM, affiliate system, etc.)?
Multi-level businesses involve selling a product or service, where a member of the chain recruits other people to sell the same product or service. You then earn commissions on your own sales and on those of the people you recruit or bring into the system (your referrals). The people you recruited will in turn bring in new referrals or affiliates, and you’ll also take a commission from them. In multi-level systems, every sale made at the base of the pyramid pays a commission to all the higher levels of the system, right up to the top of the pyramid.
Most multi-level companies ask the recruit (the referral) for a small investment, which is distributed as commissions to the higher levels. Likewise, when that person recruits others, the recruiter takes a share of the amount the newcomers pay in and of their sales.
What is a pyramid scam?
When it comes to pyramid scams, there’s no better example than the Madoff case. In a pyramid scam, the product is the flow of money itself. The original idea may be legitimate, but the scam happens when no new recruits or referrals come in, and so the people already inside the system stop getting paid. In the same way, whether new users stop joining or existing ones ask to withdraw their money, the pyramid collapses. That’s how the scam comes to light.
Basically, put simply, it’s a scam because a person pays in some money (€1,000) in exchange for the promise that they’ll receive a certain amount every month or every year, whether or not they bring new people into the system. Obviously, if they do bring in new people, the commissions will be much higher. The catch is that those commissions are paid with the money of the newcomers entering the system. If no new people come in, there’s no money to keep paying those commissions.
So the only difference between a multi-level business and a pyramid scam is that in a multi-level business there’s a product or service on offer, whereas in a pyramid scam the product is the money. But I insist: the multi-level system is based on a pyramid system, which is not the same as being inside a pyramid scam.
Why do I think Kiyosaki and Trump lending their image to multi-level systems is unethical?
We already have our conclusion: multi-level systems (earnings based on commissions in a pyramid structure) are completely legal. Preferred shares (the preferentes that Spanish banks sold to small savers) are also a perfectly legal investment product, and can even be an excellent investment opportunity, but as we’ve seen, many people feel cheated. It isn’t the product; it’s the way the product is presented and the lack of scruples in recruiting customers for it.
For me, a multi-level system is perfectly legitimate as long as people know what they’re getting into, know from the start that they won’t get rich in 3 months, and understand that they could lose the money they’ve invested (however little) if they don’t recruit new referrals.
Why do I say this?
If you’ve ever attended a presentation of a product sold through multi-level marketing, you’ll have noticed that the presentations usually feature success stories of people who work in the system. They’ll show you the Porsches, the Ferraris and even the €15 million mansions some of them have bought thanks to the system. What’s more, nobody in the room earns less than the prime minister, and they’re offering you the chance to get the same as them for a minimal investment.
Who wouldn’t want the same lifestyle as everyone else in the room? Holidays three times a year in exotic paradises, all the free time you want and a mansion like Bill Gates’s. But take a look at the attendees’ car park and reality changes: there are no Ferraris or Porsches, and most people wear that worried look of not knowing whether they’ll be able to pay their mortgage next month. Whether they can or not will depend, among other things, on 40% of the people in the room joining the business.
Does that mean you can’t make money in multi-level businesses?
Of course you can make a lot of money with these systems, but a very high percentage of people won’t, and not for no reason. Just as investing in the stock market requires some knowledge, a multi-level system requires a strong mindset in the face of setbacks, a financial cushion or a job that lets you get into the business part-time, and… being an outgoing person? (something of a salesperson).
If you quit your job to go all in on multi-level marketing without financial backing, you’ve committed financial suicide, because it rarely works out. Of course, many people think that having a referral who is desperate to sell (because they can’t keep up with their payments) will be good for business. That shows a lack of ethics and morals, just like selling preferred shares to a retiree who knows nothing about investing. On the other hand, if you know what you’re doing and what you’re getting into, you’re prepared and you have a well-thought-out strategy, you can make multi-level marketing a profitable business.
That said, for me, seeing Trump and Kiyosaki offering these systems is like watching Eduard Punset (the well-known Spanish science broadcaster) claim that a loaf of bread is natural because double baking keeps it from going hard. I know for a fact that some people are making a lot of money with these systems, because they’re at a much higher level of the pyramid and have spent more than 10 years building their network of referrals.
I hope I’ve made it clear that when I talk about pyramid-structured businesses, I’m not talking about pyramid scams. The army’s chain of command is a pyramid, company org charts are pyramids, and practically 100% of companies that pay their sales reps, team leaders and sales directors through a progressive commission system use a pyramid system. Now, if Wikipedia has changed the meaning of what I’ve always considered a pyramid system, that’s another matter.
Featured image: Red Carlisle, CC BY 2.0, via Wikimedia Commons.
