Great take on what's become an emotional topic. MLM's are not by nature horrible things, but they are a flawed business model just by virtue of the fact that they don't concentrate enough on how the money needs to be generated -- namely SALES of product rather than the sale of "the dream" to enlist hoards of people. It would seem that ITTT ("in these troubled times") there's a huge opportunity for MLM's to re-think, re-invent and take advantage of the need for so many out-of-workers to earn a living. And no, don't contact me...I'm not interested!

The biggest difference I see between flavors of MLM are that some are based on how big your downline can get, while others emphasize your own sales. When I see the pitch talk about how much money you make from the people you recruit realizing that they can make money by signing up underneath you and then signing more people below them, I see this as the bad reputation MLM.

The other few "home sales" businesses I've seen seem to emphasize how people can sign up and make extra money holding parties and selling to friends and family. When was the last time someone tried to sign you up to sell Avon or Tupperware while they were also asking you to buy?

Your premise that MLM's should be focused and incentivize their sales teams to sell more product rather than recruit, falsely assumes that the MLMs' business model is based on selling product rather than recruiting. It is not.

My understanding of many MLM's is that their very business model is built on the churn of affiliates and revenues generated from the new affiliate's initiation and monthly fees. Many MLM's don't care about selling product at all, just recruiting more affiliates.

I would contend if MLM's built their business model as a hybrid as you suggested, they might be more successful, however, they would then need to put more empathesis and standards on the people whom the MLM's recruit. Which, would make their jobs more difficult and their margins smaller.

I think Rob is right on the mark. The real profit for the originators of an MLM is often not the fraction of revenue they get from their downstream recruits. It is in, as Rob said, the initiation and monthly fees, and then in additional materials to help affiliates sell the product.

The real problem with MLMs, in my opinion, is that their products are often undifferentiated and so there is no compelling reason to buy, apart from getting lured in by a good sales pitch.

Another difference between MLMs and a sales hierarchy is that the middle men in the hierarchy are penalized for poor performance of those below, so there is a disincentive to recruit as many people as possible in the hopes that they make a sale.

It seems to me that once you remove all the elements that make an MLM such a poor business model (with all the attendant problems of deceptive sales practices, etc.), what you're left with is essentially a genuine non-MLM business with a specific kind of structure to its sales organization. In other words, you've taken the MLM out of MLM. So why not just start with a good business model based on a good product in the first place?

I agree with Rob also. MLM got their bad reputation because they are too aggressive recruiting sales people. When you have a company, you have a brand and product. You have a mission statement to go with that product. Recruiting so many sales people don't really help build the brand, or product. Companies should step back and look at how they can give value back to customers. That's the basic business model for all business — give value.

I listened to one of Rob's podcasts where he had a guest by the name of Jon Taylor who wrote a book on MLMs. It motivated me to write a blog posting on it called 'The Mathematics of MLMs' which shows in a mathematical sense why MLMs can never generate a livable income for more than .5% of their members. (That posting is linked to my name below.) The fact of the matter is that nearly all of the people recruited into an MLM are expecting to achieve enough income to live on and a large percentage of them are lured in with the promise of not just a livable income, but a luxurious income which makes for disappointment when they find that they must build a large organization under them where everyone is either losing money or at best breaking even.

The true problem with MLM is that 50 cents of every sales dollar is paid out in commission to the "downline". Since the company still has Marketing expenses, R & D, Admin exp and Corporate management salaries and "profits" there is little left to put in the product itself. I would guess you end up with about 5 % worth of value (COS) in the product. This is too high a markup. Normal selling expense for a company like HP or Apple is 10-15% not 50%. The top leaders in a MLM structure take down 95% of the commissions and feed off the little guy down stream who is paying too much for products, sign-up fees and sales kits, etc. There are other elements of MLM. Always a "cause" to support, always an attempt to tie "science" in and yes the top "SALES" guy with THE Mercedes and McMansion.

Unfortunately both the main post and a number of the comments are based on quite flawed understandings of the legitimate MLM business model. I'll take the comments first then do a separate comment on the post itself.

Rob McNealy, backed up by a few other commentators, says -
"My understanding of many MLM's is that their very business model is built on the churn of affiliates and revenues generated from the new affiliate's initiation and monthly fees."

Rob, this completely false. What you are describing is an illegal pyramid model, not MLM. The MLM industry unfortunately suffers greatly from a large number of companies that *call* themselves MLM in order to claim respectability (and legality). Sometimes this is deliberate scams, sometimes it's through poor legal advice.

In legitimate MLMs, there is no money made through recruiting or "monthly fees". It's made solely on product sales. If a company, and it's reps, are making money through recruiting and fees, then they're not an MLM, they're probably an illegal pyramid, and many have been shut down for exactly this reason. Just because someone *claims* to be an MLM doesn't make it so, and doesn't mean legitimate MLMs operate the same way.

Lee - Jon Taylor's claims about MLM are essentially based on the same type of circular thinking. Assuming MLMs operate the same way as illegal pyramids, then analyse the operations based on this assumption. Throw in a few other false assumptions, and Taylor comes to a logical conclusion. Unfortunately if your assumptions are rubbish, chances are so are your conclusions. I haven't read the article on your site, I'll do so and respond further there.

Greg - there's a few problematic assumptions in your comments also. Product value is an important issue, and if you operate a business marketing products at a price higher than the perceived market value, then you have a problem. That problem applies whether you're talking MLM or not. Similarly, the actual operating margins are important. Products with small margins and low turnover, such as electronic equipment, are not sensible products for an MLM business model. Sensible products have high margin and high turnover - consumables, and preferably higher-end consumables. For example, Amway's two major brands are for example Artistry and Nutrilite. They're high margin, high-quality products with a high repurchase rate. Artistry has been independently judged as competing in the same market category as brands such as Estee Lauder and Clinique. I can guarantee you the margins on those brands is significantly more than 10-15%! Indeed from manufacture to end consumer the total markup is often in excess of 90%.

If MLMs were trying to sell computers, your objection would be perfectly valid, but I'm not aware of any MLM trying to make money doing that. If any tried, they'd suffer the same fate as any other business with expenses outstripping margins - they'd fail.

The very fact that an MLM company like Amway is celebrating 50 years of operations and is at or near the top of the sales data rankings in the main categories in which it competes should be a bit of a hint that perhaps the model does work and there might be some flaws in your assumptions.

Now to the main post. Dave, your analysis is flawed because you've completely missed 2 major components of the MLM model. First of all, the "big money" for reps in MLM is not generally made through retail sales (sales direct to the end user), it's made through wholesale sales (sales to others who resell the products). When you start an MLM business you primarily earn income through sales direct to customers, retail sales. That component is perfectly comparable to any other sales business, and I have a friend who earns thousands of dollars a month with Amway purely through that model. The "wholesale" sales earn a smaller per-item product, but by generating more of them (and thus more eventual customer sales volume), that ends up being a larger amount in real terms.

You can't however compare this wholesaling component to another retail model, which is what you're doing by comparing it to sales teams. What it can be compared to is traditional product distribution, where there are various levels of markup between Manufacturer and Consumer. For many products in the world today the chain goes something like this - Manufacturer -> Exporter -> Importer -> Regional Distributor -> Retailer -> Consumer. For the big box type chains it might be - Manufacturer -> Warehouse -> Consumer. On the internet today it can even be Manufacturer -> Consumer.

Profit is earned essentially through volume discounting. The exporter buys in large lots and sells in smaller lots at a markup to a number of different importers, who sell at a markup in smaller lots to a number of distributors etc etc.

These is just a standard distribution model. How does MLM differ? It doesn't really, and this is where a lot of the misunderstandings about MLM come about, like the idea of an "endless chain". It doesn't exist. In the FTC's investigation into Amway in the 70s for example, they found the average length of the distribution chain was less than 4 most of the time, and 7 or less virtually all of the time.

Layers are not continually added, there's a limit based on volume. For example, in Amway in the United States, the multi-level payment compensation structure stops when an individual generates around a certain amount of sales volume in a month. After that various other profit-sharing arrangements come into place. Before that, profit is simply earned through volume discounting. The "platinum" (formally called Direct Distributor) effectively buys around $18,500 worth of goods, then resells it at a retail markup direct to customers and at a (smaller) wholesale markup to other distributors. These distributors then do the same. At each step someone is buying product in smaller lots at a markup, with the chain ending when it reaches the final consumer (which can be anywhere along the chain)

This isn't really any different to traditional distribution, there comes a point where if you continue to add layers of markup, the product out-prices the marketplace.

So, the point is the number of "layers" in the distribution chain are very similar to traditional distribution.

Which brings me to the next point, your idea of "limiting" by time how long a participant earns an income through downline volume. If you understand that we're looking at a distribution chain, not a sales incentive chain, then the idea is obviously silly. The equivalent would be to say that after a wholesaler has had a retail store as a customer for a certain period of time, they have to stop adding a markup to the sales to that retail store, no longer profiting.

Doesn't make sense looked at that way does it?

There's more, but that's enough for now, except to address the original question about where the poor reputation comes from. One MAJOR component is the many, many scams *claiming* to be MLM when they are indeed pyramid and other scams. It's poor logic, but also perfectly human, for people to attribute the failings of these scams to companies that are legitimate MLMs.

The other issue is poor field behaviour, and this is a legitimate weakness of the MLM model. With virtually no barriers to entry it's very difficult to properly train and monitor the field, and some folk do some pretty whacko things. Given the sheer numbers involved, even a tiny, tiny, percentage of folk operating like this can be a substantial number, and by their very nature they're more visible.

I have spent a good amount of time with "Network Marketers" as they call themselves. The ones at the top are very successful and excellent at motivating people to "create a business". Some of what they promote is very positive, but I also have some problems with the business model. It does rely heavily on signing up new distributors and the ones that make the most money focus solely on that. Top distributors can make over a $1 million a year with true "life time earnings" from residuals. I have witnessed it. Companies like nuskin and herbalife are rather large companies and do sell some decent products. I gather that a lot of product is sold by distributors buying their own stuff, but there is some selling to family and friends and maybe more. Therefore there is a massive amount of people and sales resources provided to sell a relatively small amount of product. I do know that the FTC has some guidelines / regulations on how much product these companies need to sell relative to just "sign up fees" so the bigger legit companies do push distributors to sell, rather then just sign up people.

That being said while I have been happy to be a service provider to this industry, its certainly not for me and for the most part the ones I have worked with have not tried to "pitch me".

I think if one was going to go down that path they need to be very hard workers willing to do lead generation from the internet and other sources and spend on marketing. That is what the good ones do. You however cannot go into it expecting easy money for little time, which is how it is often promoted.

Response to David Steadson. I believe you prove my point. In MLM there is little left after all other costs for product value. If as a distributor I have to buy a $100 in product every month to be "qualified" I end up with something worth perhaps $5.00 at cost. The other $95 ends up in other people's pockets. And to make it worse $45-$50 goes to those in the sales upline. Of course they want me to "sign-up". In order for me to make money I have to take advantage of others I can sign up so I start making my small share of the $50. This is a poor way to build a value chain. There is something honest about buying a disk drive for example when I know that is costs Seagate 45-50% of my dollars just for the parts and labor they put into my purchase. Its all about value. Your example of cosmetics is a poor one. (hope in a bottle) There is little value in all that fancy packaging and again its all about over-hyped marketing.

Thank you for writing the is article. It certainly helped to clear up several issues for me regarding MLM. I fully agree that MLM by itself not inherently negative, it really comes down to the organization and members who sell the products.

M Baron
The Business That Gives

The great thing about Network Marketing is that anyone can start a business. The worst thing about Network Marketing is that anyone can start a business.

Without the proper training, and without a company that works with integrity from the top down, a new person coming into the business can be quite annoying and way too agressive. That just means they are doing the business the wrong way.

The popular misconceptions that MLM is all a scam or pyramid scheme, that only the top 1% make any money, that to make the big money you need to get in on the ground floor and that the only people buying the products are people doing the business is NOT my experience.

The company I'm with (not Amway) has paid out over $4 billion in bonuses. At our most recent National convention there were 6000 distributors there and 1 in 6 had earned over $1 million dollars in their career. Not bad for a part-time business.

I myself have hundreds of customers/members buying the product each month who are not "in the business". I also have built an organization of trained distributors who don't annoy their friends and family and earn good money working part-time from their home. I make more money then my upline (so much for the pyramid thing) and I started my business when the company was 36 years old (so much for needing to be on the ground floor)

Network Marketing done right, with the right company, and exceptional products is an excellent way to market products that have significant differences from what is available in the typical retail marketplace.

Because of its accessibility through a low-cost start up, it allows just about anyone, regardless of age, race, sex, income and educational ability, to join the entrepreneur ranks. This makes Network Marketing the highest form of free enterprise we have created to date.

Thank you for clarifying a subject which, up until now, I have found confusing. I particularly enjoyed your comparison between a MLM and a traditional corporate sales team. MLMs are a dicey subject, personally I have reacted negatively when confronted by one. I am not even sure why as I have never purchased anything through a MLM, however my guess is you are right on the money - it was the individuals pushing the product. My gut feel has always told me to stay away from such arrangements, which of course is tough to quantify, however I have learned to trust it over time.

If you want to sell your products or services there are 2 ways to do so.

1. through advertizing with internet, magazine, radio, tv,and regular shops etc,

2. by the word of mouth, some time is much better.

MLM is the later one where the company gives the advertizing money to its distributors to sell its products.

If you want to be successful you need hard work and leadership just like the tradition sale through the shops.

The reason MLM gets a bad name is because the participant does not understand the business model and don't know how to operate the system therefore they fail and blame on the system.

The system MLM has no problem. Avon has a 9 Billion sale and Amway has a 7 Billion sale.

Study the system better, make sure the products are good and put effort in it. You will be successful

Hello Mr. Taylor,

Beijing has recently opened a China Science and Technology Museum adjacent to their famous Birds Nest. They have a wing devoted to mathematics and inside this is an excellent exhibit about multi-level marketing. The animated video presents MLM as an inverted pyramid where the investors' money drops down on the few; once these originators leave, the pyramid collapses.

Dave,

Your article articulates perfectly the widespread confusion over network marketing as it's typically practised. The problem is that what's typically practised is a bastardized, distorted version of the concept, one created by company owners and high-flying team leaders to maximize their own incomes.

In life (and business) it's rarely WHAT we do that makes something legal or illegal, ethical or unethical, desirable or undesirable... it's WHY and HOW we do it. Our motives and methods/means.

This is one of the reasons why countries have such difficulty legislating against pyramid selling schemes: you can only legislate for specific behaviour -- actions and practices -- not for motives or attitudes. So the laws become too technical. There are too many loopholes or the laws impinge on constitutional rights, etc.

One of the earlier responders raised a salient point: many of the companies CLAIMING to be MLM simply aren't. They're either clever counterfeits or ignorant clones of counterfeits. The reason they're so hard to spot is because there are so few examples of what REAL network marketing companies should be.

As a marketing professional for more than 40 years (including 30 years of teaching marketing at leading business schools), I'm still surprised by people's ignorance of how much of the prices they pay for products is spent on marketing-related costs. If we disregard the retailer's mark-up (which is also part of the marketing cost) and focus on the wholesale price, marketing costs -- for market research, testing, distribution, market communications (including advertising, branding, corporate identity, public relations, etc) and sales -- typically vary between 60%-70% of the wholesale price.

Manufacturers typically retain only 30% to 40% to cover cost of manufacture, overheads, administration and profits.

As a management consultant to direct selling companies (including home party and MLM companies) for more than 20 years, I can tell you, categorically, that very, VERY few MLM companies pay out more than 30% to 40% of the wholesale price in reality, even when the potential payout of their compensation plans claim to be as high as 80% payout or more.

This is due to various factors, including breakage (unclaimed bonus income that flwos up to the company through distributors' failure to qualify) and the use of point systems for qualification that can reduce the potential payout dramatically.

That leaves a substantial amount available for other incentives and promotional activities by the company.

So, from a company standpoint, the MLM business model can be extraordinarily profitable.

From a distributor standpoint, provided that the compensation plan being used is balanced and fair (rarely the case, sadly -- breakage is like corporate catnip: once an owner gets even a whiff of it, they're hooked!), the business model is also sustainable, because there is always a finite limit to the number of levels on which commissions and overrides can be paid. As you so rightly point out, a company will go bankrupt if it pays out more than it earns.

Companies go to sometimes ridiculous lengths to try to distract people from this reality, such as "infinity" bonuses that "pay you to infinity". They don't -- they always get blocked by someone downline qualifying at the same level as you. And if a leg of your business does pay you to "infinity" (actually, until the leg runs out), it's such a short leg, or the sales performance is so poor, that your "infinity" bonus is pitiful.

But it sounded great, and it attracted LOTS of people whose trust exceeded their reason.

So, regardless of the hype, buzz and spin surrounding compensation plans and the projected earnings possible, the reality is that, at some point, for EVERY distributor, the payout gets blocked. The feasible payout from the wholesale price reaches its limit. The money runs out.

Where MLM lost its way was when these myths became entrenched in the recruiting pitches:

* Anyone can be successful in this business.

* Everyone can get filthy, stinking rich in MLM.

* You can create walk-away income for life.

* You don't have to sell, just recruit.

* All you do is switch brands, consume and recruit others who do the same.

These are demonstrable fallacies -- but they do NOT make the fundamental concept underlying MLM invalid or unworkable. Yes, they result in huge damage to the public perception of MLM as people discover that they're what they always were -- fallacies.

So we're left with a situation, today, where critics of MLM constantly quote fallacy as fact to support their claims and accusations, when they've done nothing more than ASSUME, incorrectly, that these things represent the truth of MLM.

They may represent the way most people practise it, but that doesn't make it any more accurate. China, North Korea and East Germany were all "Democratic People's Republics", but that didn't make them either democratic or popular.

It's understandable, but it's about as accurate as assuming that the Roman Catholic Church is utterly corrupt because a few well-meaning, but misguided, senior regional leaders tried to protect the reputation of the Church by not acting promptly and appropriately against pedophile priests and simply hid the problem from public view.

Too many people have been peeing in the MLM pool for far too long, either for reasons of their own (usually from higher above the water line) or because the others have told them that's what they should do. The water's become so unsafe that, unless we make a concerted effort to clean up the water -- by exposing the abusers and re-educating the abused -- it will be no surprise if regulators step in to do it for us.

There's no such thing as a sensitive, understanding, sympathetic, well-informed regulator. It's the last thing anyone needs or should want. But we'll only have ourselves to blame if it happens.

John Counsel
CEO, The Profit Clinic

In your closing paragraph, you asked how selling Clickbank products as an affiliate was any different from selling Avon or Amway products. There is a huge difference, both in terms of compensation as well as where in the totem pole you are located.
The Clickbank model is basically a flat sales distribution arrangement with every affiliate at the same positon and compensation rate. The Amway model has many different compensation determined by when you started up with them and how successfully you've grown your pyramid base under you.
With Clickbank, I can do my own marketing through PPC or SEO to be successful whereas with Amway, my success is dependent on the activity of the pyramid workforce linked under me.
Personally I am more comfortable with controlling my PPC and SEO eforts than motivating people with a diversity of business and sales competencies!

I am curious as to what you think of my business model, as you asked, "Seems to me that there should be hybrid MLMs that enjoy the benefits of a highly motivated, distributed affiliate-only sales team while avoiding the trap of motivating your team to the wrong end goal: finding more team members rather than selling products. Is there?"

I think there is.