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Savvy shoppers: How to tell a pyramid scheme from a legitimate direct sales company

Trying to break out of your financial bracket is not always easy as there are many obstacles. If you’re good at it, a job in sales is one of the best ways to break that bracket and move up in life. 

Friday June 09, 2017,

6 min Read

Direct sales is one of the oldest and most lucrative sales models around. For someone who is new to the world of sales, however, recognizing a legitimate direct sales company can be a surprisingly daunting task. It’s true that every business endeavor involves a little risk, but there are also a number of scams out there like pyramid schemes that can take that risk too far. These scams have resurfaced again and again to the point that they have become one of the most common frauds perpetuated in the US. The following will highlight four major points that will reveal if you are dealing with a legitimate direct sales company or a pyramid scheme.

 Structural Issues

One of the main differences between a legitimate direct sales company and a pyramid scheme is the structure. Every business model is essentially pyramid shaped since you can’t feasibly have as many CEOs and executive officers as you entry level employees. This means that you can’t assume that every business you see with fewer higher-ups than entry level employees is a scam. There are still significant structural differences between pyramid schemes and legitimate business models, however, that can be seen by asking a few quick questions.

The biggest issue with the structure of a pyramid scheme is that the primary source of income for participants is their new recruits. In every business, the executives and administrative employees essentially make money from lower level employees. In a legitimate business however, this is done because the entry level employees are selling products, goods, or services to clients who are not a part of the company. These sales generate profits which are shared throughout all employees via their salary, and higher level employees receive a larger cut of those profits. In a pyramid scheme, there is little or no focus on selling to clients outside of the company itself. Instead, profits are made by either collecting investments from or selling products and services directly to, new employees. 

Large Fees

Because of the business structure outlined above, pyramid schemes can only survive by charging entry fees to new employees. In a direct sales company you will effectively be starting your own business, which involves purchasing your own product to sell. The line can be a bit blurry between the two, since in both cases one of the first things that you are required to do when you sign up with a company is spend some of your own money. The biggest thing to keep in mind when a business asks you to invest in them in order to get started is what your money is being used for.

In a legitimate direct sales business, you will be spending money on legitimate goods and services. Often you will need to purchase product to sell, or you may be asked to pay a service fee in order to make use of company resources such as a website, training materials, networking technology, or business licenses. All of these are resources that cost the company money to create and manage, so some sort of spending on your part to access them would make sense. Additionally, a legitimate direct sales company should not be making a profit on you from the first day that you join their ranks. Any money you spend should be just enough to cover the cost to the company, not enough to push them into the profit zone.

If the company you are signing up with is a pyramid scheme, they will ask you for an investment when you sign up. Because pyramid schemes typically have no sources of income other than their new recruits, the fee to join is often extortionate. It will also not grant you access to any resources, products, or materials of your own, all it will do is attach you to their “brand”. The most important thing to look out for is whether or not the individual hiring you is going to make money because you are signing up.

Required Purchases

Some Pyramid schemes attempt to mask their underlying business model by actually marketing a product or service. This can further blur the line, making it very difficult to know whether or not the company you are investigating is legitimate. One good rule of thumb is whether or not a purchase is required. New saleswomen signing up for the direct sales company Mary Kay will be given the opportunity to purchase beauty supplies for sales and marketing. This purchase is strongly encouraged, but not required. If a recruit wants to attempt to sell their products without physical samples and request their clients to wait for their purchases to ship, they are welcome to do so. Since a pyramid scheme’s primary source of income is via recruiting, they will always have a large fee or mandatory purchases for new recruits. Often these fees are extortionate, and if goods are purchased the required purchase can vastly exceed a sensible amount of product.

The Focus

A direct sales company is asking you to be a brand ambassador, and their focus is for you to push their product as mentioned earlier. Pyramid schemes are completely focused on recruitment rather than sales. In direct sales, you are essentially given your own business. This means that there are still benefits to recruiting new employees, such as making marginal residual income from the sales that your recruits make. Because of this, it can seem at times like a direct sales company is operating like a pyramid scheme by heavily incentivizing recruiting. Even global giants like ACN have been mistaken for pyramid schemes in the past. 

Remember to find the focus of the company. If the company has marketable products that they are trying hard to get into the hands of consumers, they are most likely a legitimate business. If they have no product, or only vague or generic products, and none of the higher level employees ever sell those products, you may need to dig deeper.

Try to listen to your gut when it comes to deciding what business you are going to invest in. Another good thing to look at is the history of the company. Since pyramid schemes only income comes from recruiting, they are never sustainable in the long term (after all, you can’t recruit everyone). If a company has been in business for two or three decades they are likely not a pyramid scheme. Hopefully, some of these pointers make it a lot easier for you to weed out the questionable opportunities from the legitimate ones.