Consumer Protection / Direct Selling in the US / Income and Earnings

Breaking Down The FTC’s Updated Business Guidance Concerning Multi-Level Marketing and Income Disclosure Statements

By Branko Jovanovic and Monica Zhong^[1]

Ensuring that direct sellers’ Income Disclosure Statement (“IDS”) reliably and accurately reflects the actual experience of a typical distributor has long been the FTC’s requirement. On April 30, 2024, the FTC published updated Business Guidance Concerning Multi-Level Marketing (“2024 Guidance”)^[2] that details the current principles and practices that the FTC considers in its assessment of whether an MLM is offering an unlawful compensation structure and operating as a pyramid scheme. While the FTC continues to emphasize that representations about income opportunities should reflect the earnings of a typical distributor^[3] and that any income claims must be based on reliable empirical evidence,^[4] the 2024 Guidance outlines a number of requirements regarding what constitutes deceptive earnings.

Following the release of the 2024 Guidance, on September 4, 2024 the FTC published a staff report titled “Multi-Level Marketing Income Disclosure Statements” (“Staff Report”).^[5] The Staff Report “documents an analysis of 70 publicly available income disclosure statements from a wide range of MLMs”^[6] and shows that many of the reviewed income disclosure statements: “(a) present income data that does not take account of participants who made little or no income, often without clearly explaining the limitation; (b) do not account for expenses incurred by participants, often without clearly stating the limitation; (c) emphasize high dollar amounts received by a relatively small number of participants; (d) do not include information about the limited income that most participants receive, or provide this information only inconspicuously; and (e) use terms and present income data in potentially confusing or ambiguous ways.”^[7]

In this paper we discuss, from an economic standpoint, several ways for MLMs to adapt their income and earnings reports (which are typically in the form of IDSs) to be better aligned with the 2024 Guidance and to alleviate some of the criticism levied in the Staff Report. While these adaptations generally require direct sellers to adopt conservative measures of participants’ earnings and treat the IDS as a risk management tool, we are cognizant of a potential tension between this approach and the IDS as a marketing tool meant to attract potential participants.

Defining “I” in the IDS

The Staff Report notes that “none of the reviewed income disclosure statements clearly explains what data is being presented to consumers. They prominently state that they are sharing information about ‘income’ and ‘earnings,’ but do not conspicuously explain what the terms mean.”^[8] Furthermore, the Staff Report states that “nearly every disclosure statement uses prominent headings that describe the data provided as ‘income’ or ‘earnings’ without further qualification” and that “terms such as ‘earnings’ can mean different things in different contexts.”^[9]

As recognized in the Staff Report, the IDS generally captures the amount of money the direct seller paid to participants, including commissions, bonuses, overrides, and awards.^[10] While retail sales are recognized as a potentially significant source of earnings for distributors, the IDSs typically do not report retail profits because direct sellers usually do not track distributors’ sales to final customers.^[11] Including these retail profits in the IDS would not only improve the document’s accuracy but could also potentially make the IDS more attractive to potential participants.

Capturing Participants’ Costs

Perhaps the most important requirement that the 2024 Guidance repeatedly insists upon is that “claims about earnings should take into account both what participants earn and what they spend.”^[12] In particular, expenses, such as costs for product purchases, travel for conferences, tools or services, and training, must be subtracted from any revenue earned to determine whether the participant has made a profit or lost money.^[13]

While the FTC insists that the IDS ought to account for all costs incurred by individuals pursuing the business, currently, IDSs generally do not disclose or quantify business expenses incurred by the typical distributor that reduce their net earnings.^[14] These expenses fall into two broad categories: those observable in the companies’ business intelligence (distributor-level) data, and those that are generally unobservable.

The observable expenses include direct expenses (fees for registration and renewal, fees for distributor websites, marketing and sales aids, etc.) and expenses associated with enrollment and rank/eligibility maintenance. Direct expenses can generally be assessed using company-wide data and/or the data on distributor-level purchases (often referred to as order-line data).^[15] Some typical and recurring expenses, such as general enrollment costs and costs to attend mandatory training or conferences, can be inferred from company-wide data. However, this data usually cannot capture the disparity in costs incurred by individual participants, as some may meet different enrollment requirements. The order-line data on the other hand, can track participant-specific expenses associated with enrollment (including starter kits and any administrative fees) and eligibility maintenance (minimum purchase requirements). While these costs are relatively easy to identify in the data, their treatment is less clear because they generally provide the purchaser with some consumption value and incorporating them into the IDS could overstate distributors’ expenses.

Unobservable, distributor-specific expenses can include the cost of setting up and maintaining the business, as well as the cost of travel to conventions and other events. While business intelligence and order-line data provide little information on these expenses, a well-designed and executed survey could shed some light on these costs.

Challenges Associated with Reporting Typical Earnings: Projections and Extrapolation

The 2024 Guidance explicitly states that “[t]he IDS should not misrepresent participant earnings, including by annualizing or projecting income that was not actually earned by a participant in the time period the IDS covers.”^[16] This requirement addresses the treatment of distributors who did not participate throughout the period covered by the IDS.

To understand this requirement, consider a simple example: A distributor joined a direct selling company in June and earned $25 in November and $75 in December for a total of $100. Annualizing this distributor’s earnings (i.e., stating that this distributor would have earned $1,200), or using the distributor’s average monthly earnings ($50) to impute this distributor’s earnings for each month of the period covered by the IDS would likely be seen as deceptive by the FTC.^[17]

Consider also a scenario where distributor A earns $50 each month for the first six months and nothing afterward, and distributor B earns $50 each month for the last six months, and nothing in the first six months. If the average monthly earnings are calculated ignoring the zero-earning months, the average monthly earnings would be $50 for each month, and the annual average earning would be $600 (the sum of the average monthly earnings). Essentially, the average monthly earnings would be extrapolated for the months where distributors A and B had no earnings, leading to a 100% overstatement of the annual average earnings.^[18]

Challenges Associated with Reporting Typical Earnings: Exclusion of Certain Categories of Participants

The Staff Report states that “most of the income disclosure statements reviewed do not depict the distribution of income across all participants, but instead present a distribution that excludes certain groups of participants.”^[19] The exclusion of certain categories of participants when reporting typical earnings is a common practice among direct selling companies and is not necessarily a form of deception; every direct selling company has some participants who merely signed up to receive a discount on the company’s products and have no interest in selling the company’s products or building a business. These participants are often merely end-user consumers, who will earn little to no income from the company; including these participants in the earnings report deflates the typical earnings across all distributors.^[20]

However, excluding such distributors risks allegations that the IDS artificially inflates earnings by including only those distributors who have achieved some degree of success.^[21] Indeed, the 2024 Guidance explicitly states that “excluding the participants who lost money or earned no money, who failed to qualify for bonuses or commissions, or who are considered ‘inactive’ because they didn’t get any compensation or qualify for a certain type of compensation during a particular time period, is misleading.”^[22]

To illustrate the effect of exclusion of certain categories of participants when reporting typical earnings, consider the following example: A distributor purchases every month, meets the minimum purchase requirement in 10 months, and earns in three months only. The FTC would likely find that the IDS that calculates this distributor’s earning over either 10 months in which the minimum purchase requirement was met, or three months when this distributor earned as an active distributor (those who by definition of the compensation plan are eligible to receive earnings) is deceptive.

Characterizing Distributor Earnings

The 2024 Guidance states that if “the MLM or participant does not have a reasonable basis to know what the typical person in the group is likely to achieve in earnings, they should not make any earnings claims, including lifestyle claims.”^[23] In particular, the FTC states that “if they are atypical, then discussion of those atypical earnings must be accompanied, at a minimum, by a clear, prominent, and unavoidable presentation of the typical participant’s revenue and expenses.”^[24]

Further, the FTC also explicitly states that in order to make any claim of “modest or supplemental income,” the MLM needs to obtain information on the typical net earnings of participants and establish the exact definition of what “modest and supplemental income” represent to consumers.^[25] In essence, this requirement seems to ask that a direct seller conducts an annual survey that would establish the participants’ perception of the terms “modest” and “supplemental” income. However, given the FTC’s general skepticism of survey evidence, it is unclear what type of analysis would be considered sufficient to establish the meaning of these two terms.

Measuring the Typical Distributor’s Earnings

While the 2024 Guidance does not specify the correct metric for measuring the typical distributor’s earnings, the Staff Report appears to endorse the use of “median reported income,”^[26] the value separating the higher half from the lower half of distributors in terms of their earnings. As there may be wide variation in how much distributors earn within a rank, simply calculating the arithmetic mean tells potential distributors little about how much a typical distributor at that rank earned.^[27] Therefore, applying the median may more accurately capture the typical distributor’s earnings and is less sensitive to extreme values.^[28]

Although the earnings and the rank of a single distributor may change dramatically within the period covered by the IDS, parsing their experience by rank and ignoring their overall experience during the relevant period may not speak to the experience of a typical distributor. The Staff Report is critical of such parsing and appears to endorse an alternative approach where the experience of distributors who may have held different ranks during the relevant period may be better captured by reporting the median earnings by the highest rank they achieved in that period.^[29]

Presentation of Information Should Not Give Misleading Impressions

The Staff Report suggests that earnings metrics presented in a way that appears to highlight the experience of a small percentage of distributors who achieve high earnings and downplays the experience of a large percentage of distributors who earn relatively modest amounts, if anything at all, will be considered misleading.^[30] The Staff Report noted that nearly all of the reviewed IDSs devote most of the visual space in the tables to high income earned by the very small number of participants in the higher ranks or specific percentages of participants at the top of the income scale.^[31] This implies that for direct selling companies that feature a relatively high number of unique ranks, the income disclosure tables may be more susceptible to FTC allegations of emphasizing a small number of participants with high income.^[32]

The Staff Report also critiques that reference and display of important income information in many reviewed IDSs are in a “less prominent or conspicuous manner.”^[33] While the Staff Report points to the use of “prominent unqualified headings” and “less prominent” disclaimers (in fact, the word “prominent” is used on nearly all pages of the report),^[34] the report is unclear as to the exact standards the FTC uses to determine whether the display feature is more or less “prominent” in the context of IDSs. However, the Staff Report seems to suggest that actions such as listing out income information as additional rows in the income distribution table and displaying all information in “proximate, equally-prominent text” is considered as prominent disclosure.^[35]

Conclusion

Given the complexity associated with preparing an IDS that would meet the FTC’s requirement, direct sellers may wonder whether to publish the IDS at all. After all, the FTC states that “if an MLM is not a ‘Business Opportunity,’^[36] it is not required to give any information about earnings to potential participants, but any earnings information it does give must be truthful, substantiated, and non-misleading.”^[37] However, if direct sellers opt not to publish an IDS, their distributors cannot make any earnings claims at all—no matter how truthful. Companies must balance the reality that distributors demand and need a voice to speak about their actual experience with the business and the need to create a truthful and accurate IDS.

While IDSs are intended to be an accurate estimate of the earnings participants can generally expect by engaging with the MLM’s business, we note that there is no disclosure “preferred for all consumers,”^[38] and that each individual company’s unique compensation structure will be reflected in its IDS.

^[1] Branko Jovanovic is a partner and Monica Zhong is a principal consultant at Edgeworth Economics. The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer and its clients. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

^[2] FTC, “Business Guidance Concerning Multi-Level Marketing,” April 30, 2024, available at https://www.ftc.gov/business-guidance/resources/business-guidance-concerning-multi-level-marketing.

^[3] See the 2024 Guidance, question 13: “Any earnings claim should reflect what the typical person to whom the representation is directed is likely to achieve in income, profit, or appreciation.”

^[4] See the 2024 Guidance, question 13: “An MLM or participant making claims about MLM income must have a reasonable basis for the claims disseminated to current or prospective participants about the business opportunity at the time it makes the claims. A ‘reasonable basis’ means reliable, empirical evidence that supports the claim, not subjective beliefs or personal anecdotes.”

^[5] FTC, “Multi-Level marketing Income Disclosure Statements,” September 4, 2024, available at https://www.ftc.gov/system/files/ftc_gov/pdf/mlm-ids-report.pdf.

^[6] Karen Hobbs, “FTC staff report analyzes 70 MLM income disclosure statements,” September 4, 2024, available at https://www.ftc.gov/business-guidance/blog/2024/09/ftc-staff-report-analyzes-70-mlm-income-disclosure-statements?utm_source=govdelivery.

^[7] Staff Report, p. 28.

^[8] Staff Report, p. i and footnote 8.

^[9] Staff Report, p. 19.

^[10] Staff Report, footnote 8.

^[11] The Staff Report notes that “14 of the 70 income disclosure statements include a disclosure that the amounts represented do not include retail income—that is, when a participant purchases a product from the MLM at a discount and then resells it (presumably at a higher price). Most of the disclosure statements give no indication that such a revenue source has been omitted, and a few expressly state that they include retail income.” Staff Report, p. 19.

^[12] The 2024 Guidance, question 13. The Guidance further states that for any direct sellers deciding to publish an IDS, either because they elect to do so or because they offer a “Business Opportunity,” the income and earnings information these direct sellers disclose to current or prospective participants should truthfully consider both participants’ income and typical expenses. See the 2024 Guidance, question 24.

^[13] See the 2024 Guidance, question 13. Note that the FTC’s response to question 14 states that “[i]f an MLM or MLM participant does not have access to data showing what participants typically spend pursuing the business opportunity (e.g., product or service purchases, website fees, party costs, and training or conference expenses), they should refrain from making any earnings claims.” In response to question 23, the FTC states that “[i]f an MLM does not have evidence of the typical earnings of its participants (including any costs that its typical participants incur), it should refrain from making any earnings claims and ensure its participants do the same.” The Staff Report notes that “none of the 70 income disclosure statements reviewed provides income figures that take into account all expenses.” Staff Report, p. 12.

^[14] Note that Noland Court observed that “[a]ffiliate witnesses did not carefully track (and, in some instances, did not even understand the difference between) revenues and profits.” Order In Re Federal Trade Commission v. James D. Noland, Jr. et al., In the U.S. District Court for the District of Arizona, May 23, 2023, 17:26–18:1.

^[15] Even the observable expenses can be challenging to assess, especially in instances where the expenses are not readily identifiable. For example, the assessment of costs associated with sales aids may require a thorough review of product description and associated price and volume points.

^[16] The 2024 Guidance, question 24. Curiously, the Staff Report reports that “[o]ne disclosure statement has a table that lists both average monthly pay and average annual pay—but the annual pay is not 12 times the monthly pay, and the table does not explain how the MLM calculated the figure” in the section titled “Unexplained Discrepancies” (Staff Report, p. 20). But this “discrepancy” simply means that monthly earnings were not annualized, recognizing that some participants enrolled in the year covered by the IDS, and that many do not earn in every month.

^[17] The FTC provided the following example: “According to the complaint, when calculating a participant’s annual income, if a participant worked one year — 24 pay periods — but only earned one paycheck for $100, AdvoCare multiplied the single $100 check by 24 pay periods to calculate the participant’s ‘annual average income’ as $2,400. The FTC alleged that AdvoCare’s IDS, therefore, was deceptive in its portrayal of participant income.” The 2024 Guidance, question 24.

^[18] The risk of misrepresenting the earnings of the distributors in the two scenarios above would likely be minimized by reporting monthly, instead of annual, earnings.

^[19] Staff Report, p. 10.

^[20] The Staff Report notes that “[t]he nature of this exclusion varies, but in at least some cases it excludes all participants who received no income as well as potentially others.” Staff Report, p. 10. The Staff Report further states that “[m]ost of the income disclosure statements do not include a prominent, express explanation of the limited nature of the income distribution depicted.” Staff Report, p. 12.

^[21] A robust preferred customer program that provides appropriate incentives for individuals to self-classify upon registration gives companies a principled and defensible way to exclude from their IDS individuals who have no desire to participate in the compensation plan.

^[22] The 2024 Guidance, question 24. In addition, “participants should not be omitted from earnings statistics unless the MLM has evidence that they have affirmatively opted out of the income-earning opportunity, not merely failed to qualify for it or not merely exercised any inventory buy-back program.” See the 2024 Guidance, question 24.

^[23] The 2024 Guidance, question 18. The FTC repeatedly emphasizes the differentiation between typical and atypical earnings and considers it potentially deceptive if the earnings claims do not “reflect what the typical person to whom the representation is directed is likely to achieve,” including the disclaimers that “results are not guaranteed” or similar statements. See the 2024 Guidance, questions 13 and 18.

^[24] The 2024 Guidance, question 18.

^[25] The 2024 Guidance, question 19.

^[26] Staff Report, p. 17 and footnotes 39 and 40.

^[27] The Staff Report correctly notes that “while an average can be a useful summary of data that has a relatively small degree of internal variation, it can be misleading when the data is largely consistent but has a small number of outliers.” Staff Report, p. 16.

^[28] Consider, for example, a situation where nine distributors earn nothing and one distributor earns $110. The arithmetic mean in this example is $11, which overstates the earnings of all but one distributor. The median equals zero, which more accurately reflects the experience of the majority of participants.

^[29] Staff Report, pp. 18–19.

^[30] Staff Report, p. 13.

^[31] Staff Report, pp. 13–16.

^[32] By reducing the number of ranks defined for high-performing participants, direct selling companies can not only potentially alleviate the risk of this criticism, but also simplify their compensation plans.

^[33] Staff Report, p. 20.

^[34] Staff Report, pp. i, 4, 7–11, 12, 16, 19–21, 23, 29.

^[35] Staff Report, p. 21, footnote 22.

^[36] Business opportunity, as defined by the Business Opportunity Rule (https://www.ecfr.gov/current/title-16/chapter-I/subchapter-D/part-437), means a commercial arrangement in which:

A seller solicits a prospective purchaser to enter into a new business; and

The prospective purchaser makes a required payment; and

The seller, expressly or by implication, orally or in writing, represents that the seller or one or more designated persons will:

Provide locations for the use or operation of equipment, displays, vending machines, or similar devices, owned, leased, controlled, or paid for by the purchaser; or

Provide outlets, accounts, or customers, including, but not limited to, Internet outlets, accounts, or customers, for the purchaser’s goods or services; or

Buy back any or all of the goods or services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides, including but not limited to providing payment for such services as, for example, stuffing envelopes from the purchaser’s home.

^[37] The 2024 Guidance, question 23.

^[38] See Miller, A. M., Snyder, S., Bosley, S. A., & Greenman, S. (2023). Income disclosure and consumer judgment in a multilevel marketing experiment. Journal of Consumer Affairs, 57(1), 92–120, at p. 95. See also Bosley, S. A., Greenman, S., & Snyder, S. (2020). Voluntary Disclosure and Earnings Expectations in Multi-Level Marketing. Economic Inquiry, 58(4), 1643–1662.

Consumer Protection / Journal of Direct Selling Research

Consumer Protection Against Pyramid Schemes

By JDSR Staff

Concern about pyramid schemes is rightly focused on the victimization of consumers. It is also important to recognize that pyramid schemes damage legitimate businesses, which further harms consumers.

Pyramid fraud works like the classic chain letter scheme where an individual is asked to send money to the sender of a letter, and then forwards the letter to others asking for money from them. The scheme eventually collapses when the last recipient of the letter cannot find new recipients willing to send him or her their money.

So, too, with pyramid schemes, are financial transactions not based on the transfer of goods and services of commensurate value, but rather mostly or exclusively on recruiting members into the scheme. Not only do they facilitate the transfer of wealth from one person to another without the consumption of products, and ultimately collapse when no other willing recruits can be found, they create nothing of social value in the process. Worse, they can injure retail enterprises that do not operate in traditional brick-and-mortar stores by undermining consumer confidence in their legitimacy.

The retail channel most vulnerable to consumer doubts sown by pyramid frauds is direct selling. Direct selling is a decentralized form of retail selling in which companies engage a salesforce of independent contractors to sell their good and services to customers they locate, usually in person and sometimes in the customer’s home.

Part of direct selling’s appeal to the parent company are the lower overhead costs of the operation, bypassing, as it does, the costs of shelf space and advertising to compete with established brands, and the expense of employing a salesforce rather than contracting with independent salespeople, who decide for themselves the extent to which they are willing to be involved in the enterprise.

That flexibility is, along with the low start-up costs involved, the main appeal of the enterprise to most independent direct sellers, who are, in effect, running their own small businesses according to a business plan and schedule they designed in accordance with their financial, social and family needs. Most direct sellers work part time to supplement their families’ incomes modestly.

There are direct sellers who aspire to build bigger businesses by recruiting a network of salespeople and share a percentage of their sales, what’s known as multilevel marketing. Lastly, there are individuals who are involved in direct selling solely or mostly because they enjoy the product and want to purchase it at a discounted price for themselves or their family and friends.

Internal consumption is a perfectly reasonable purpose for involvement in direct selling and constitutes a legitimate sale, no different in kind than a salesperson in a brick-and-mortar store who enjoys the products she sells and uses her employee discount to purchase them.

What distinguishes pyramid schemes from legitimate retail enterprises, including direct selling, is how compensation is earned. Compensation in pyramid fraud is mostly or exclusively earned by recruiting others to the scheme. Direct selling compensates distributors for sales of a good or service to ultimate users, who can be the distributors themselves as long as they are actually using the product. Direct selling companies allow unsold inventory to be returned to the parent company for a 90% or more refund.

Internal consumption is recognized as a valid retail sale in state and federal case law, particularly Federal Trade Commission v. BurnLounge (2014). It is exempted from proscribed activities in model anti-pyramid scheme laws in eighteen states, which were based on the recommendations of the Council of State Governments.

Editor’s note: Read full study by Dr. Chetan Sanghvi and his colleagues at NERA Economic Consulting: “An Economic Analysis of the Criteria Used to Distinguish Legitimate Direct Sellers from Pyramid Schemes,” an insightfully relevant study for policymakers today as they seek to protect consumers and legitimate businesses from bad actors masquerading as direct sellers.

Consumer Protection / Direct Selling in the US

Direct Selling Under Scrutiny: Separating Fact from Fiction

High-level academic task force rebuts myths and misinformation about direct selling channel.

By Dr. Patrick Brockett, Dr. Anne C. Coughlan, Dr. Linda Ferrell, Dr. O.C. Ferrell, Dr. Linda Golden, Dr. Charles Ingene, Dr. Lou Pelton, and Dr. Robert A. Peterson

Abstract and Executive Summary

Direct selling (DS) is simultaneously a business model, a channel of distribution, and an activity engaged in by its distributors. In this paper, we provide a framework for analyzing and discuss academic research on the DS distribution model.

We focus in particular on research that develops economics-based analytic models to examine business and legal issues. This focus is motivated by the fact that analytic models are sometimes used as part of the assessment of whether a DS firm operates a legitimate DS channel or an illegal pyramid scheme. These models potentially have a significant economic impact on, and affect the outcomes of legal cases against, the affected DS firms. They may also be cited in the business press and in academic circles, influencing opinions of the viability or legality of the DS business and distribution model. It is therefore particularly important that such research be carefully grounded in sound logical and analytic bases, and that it appropriately reflect whatever key facts about the firm (or about DS in general) are relevant to the model’s scope of analysis.

We first describe direct selling as an economic activity and business model. We contrast illegal pyramid schemes with legitimate DS firms and outline the key definition of an illegal pyramid scheme. This definition is distinguished from the many possible indicia of pyramid schemes that can result from pyramid scheme operation, but do not themselves prove the existence of a pyramid scheme.

We next define and discuss various logical and analytic errors that can lead to the misdiagnosis of a legitimate DS firm as an illegal pyramid scheme operator. While many such error types are possible, we focus on four that we find to be particularly important in evaluating the analytic literature on DS and pyramid schemes:

The “Begging the Question” fallacy, in which the research in effect presumes the existence of a pyramid scheme through its (implicit and/or explicit) assumptions, and as an unsurprising result, concludes the existence of a pyramid scheme;
A variant on the “Begging the Question” fallacy in which the research effectively models a pyramid scheme through its omission and/or misrepresentation of substantive facts on which the determination of legality versus illegality depends;
The “Fallacy of the Converse,” in which the converse of a true if-then logical statement is incorrectly asserted to be true on the grounds that the original if-then statement is true. For example, even if the statement {if a firm operates a pyramid scheme, then one can expect to see some or all of a set of resulting indicia at some point in time} is reasonably true, it is not automatically true that the converse statement {if one observes a set of pyramid scheme indicia at some point in time, then the firm must be operating a pyramid scheme} is also true; and
A special case on the “Fallacy of the Converse,” in which the research ignores standard policies and protections that characterize legitimate DS firms, and therefore starts with an inaccurate premise that these policies and protections do not exist.
All of these modeling errors are substantive. This means that correcting any of these errors overturns the model’s results. Such a model is thus not a reliable tool to assess whether a DS firm does, or does not, operate a pyramid scheme.

We apply this framework to the analysis of a recent working paper, “The Alchemy of a Pyramid: Transmutating Business Opportunity Into a Negative Sum Wealth Transfer” by Andrew Stivers, Douglas Smith, and Ginger Zhe Jin (“SSJ”). We find that this research begs the question, omits and/or misrepresents substantive DS firm facts, and commits a fallacy of the converse by omitting consideration of standard DS firm policies that mitigate a pyramid scheme analysis.

Specifically, SSJ “begs the question” of whether or not a DS firm operates an illegal pyramid scheme by explicitly assuming a pyramid scheme in its list of “stylized assumptions” – which duplicate the conditions for a pyramid scheme defined in the Koscot case. Thus, the authors cannot deliver on their research goal of answering the question “What makes an MLM firm a pyramid?”, because they have already assumed the pyramid scheme outcome from the beginning.

Further, SSJ commits another “begging the question” error in explicitly assuming that the firm in its model commits fraud by purposefully misrepresenting the business opportunity to its prospects and distributors. Because a pyramid scheme cannot persist through time without such fraud, the authors again essentially presume a pyramid scheme outcome.

These first two critiques fully invalidate the SSJ research, whose authors state that its goal is to answer the question: “What makes an MLM firm a pyramid?” One cannot achieve this research goal by assuming a pyramid scheme as the basis for a model that then produces the inevitable result that a pyramid scheme exists.

Nevertheless, other errors further weaken the SSJ analysis. Many substantive facts about DS firms – which are important to the resolution of the model’s claimed purpose – are omitted or misrepresented. Among them are:

Its omission of any income sources to a distributor other than bonus awarded for mere recruitment without regard to sales (such as retail markup income or the economic benefit of personal consumption at wholesale prices);
Its misrepresentation of the basis on which bonus/commission income is awarded by DS firms, by assuming they are only awarded for pure recruitment;
Its omission of products that have market value to consumers;
Its omission of consideration of distributor differences on substantive dimensions that matter for the research question at hand;
Its omission of active choices by distributors concerning what to sell, how hard to work, how to price products for retail sale, how much to invest in training, whether or not to seek to recruit other distributors, or how much to personally consume;
Its misrepresentation of the DS firm’s objective as the maximization of one-period profit, with no consideration of the legal implications of the fraud it implies; and
Its omission of consideration of standard consumer and distributor protections offered by legitimate DS firms.
We discuss other substantive and technical problems with the SSJ model in Appendix B.

The SSJ paper concludes with a set of recommendations to control pyramid scheme threats. Because of the shortcomings we find in the model and analysis, we find that any such recommendations similarly rest on shaky foundations and are unreliable as cures for the question at hand.

We use our framework to offer an analysis of a subset of other economics-based analytic modeling papers in the DS area in Appendix A. We emphasize that our goal is not to argue that all such analyses are flawed. Indeed, economics-based analytic models are productively used in many applications and should continue to be applied to analyze firms’ operations, participants’ decisions, profitability, and growth. We hope that assessment of these efforts will be aided by applying guidelines for reliable and applicable scientific inquiry into various aspects of the DS distribution model. Read full paper →