Multilevel marketing (MLM), or network marketing, is a system of direct selling that relies on networks of independent distributors, usually private individuals, to reach customers by word-of-mouth. Multilevel systems provide an alternative to conventional arrangements that involve wholesalers and retailers. Besides eliminating costs associated with middlemen, network marketing reduces advertising and promotion expenses and, in theory, passes savings to the independent distributors and customers.
However, because MLM frequently involves constant recruiting of new distributors and a pyramidlike financial structure, it has been a controversial practice for most of its history. In scores of massmarket books aimed at would-be entrepreneurs it is presented as little more than a get-rich-quick scheme—gushing about achieving "financial independence" through MLM—and historically MLM organizations have more than once crossed the line into criminal activity.
According to the Direct Selling Association (DSA), the leading trade group for MLM and other direct-selling organizations, as of 1998 MLM in the United States generated more than $17 billion in annual sales. MLM that year accounted for 73.5 percent of all U.S. direct-selling revenues. Nearly 8 million people were involved in selling via MLM, for a national average of just $2,125 a year in sales per worker, highlighting how little the typical MLM salesperson actually makes—and this is before deducting the cost of the merchandise. By contrast, most other areas of retail trade, such as grocery stores, clothing stores, or health and beauty stores, tend to bring in well over $100,000 per worker, although admittedly these businesses have a much higher overhead. Based on DSA statistics, approximately 58 percent of the direct-selling workforce (including MLM and other direct selling) was female, and almost 83 percent worked fewer than 30 hours a week at direct selling.
Household products such as cleaning preparations and kitchen utensils are by a slim margin the most popular direct-selling products, according to the DSA. Personal care products like cosmetics and toiletries rank second, followed by wellness products (e.g., vitamins), household leisure and educational products, and a variety of other products and services. The first three categories—household, personal, and wellness items—represent a full 76 percent of all direct sales by value. Nearly 70 percent of all direct sales occur face-to-face in homes, while 10.9 percent are conducted over the phone (usually as a follow-up to a personal demonstration), 10.7 percent at the salespeople's other workplaces, and the remaining 9 percent in various other ways.
Some of the largest MLM-based companies in the United States (and in some cases, the world) are Amway Corp., Excel Communications, Inc., Herbalife International, Inc., Mary Kay Inc., Nu Skin Enterprises, Inc., Pampered Chef, Ltd., Shaklee Corp., and Sunrider International.
MLM was pioneered in the 1940s by Carl F. Rehnborg, an American. Rehnborg learned about the value of nutrition while scavenging for food in a Chinese internment camp in the 1920s. After he was freed, he started Nutrilite Products Inc., a manufacturer of vitamin-enriched food supplements. Rehnborg was extremely successful at marketing his products through an innovative distribution process that would become known as multilevel marketing. Nutrilite flourished throughout the 1940s and 1950s and was eventually purchased in 1959 by Amway Corp., a company founded by former Nutrilite distributors. Using similar MLM tactics, Amway, now a multibillion-dollar enterprise, thrived and spawned a string of imitators during the 1960s and 1970s.
During the 1960s and 1970s, fraudulent pyramid schemes exploited the success of MLM companies. Although they closely resembled MLM organizations, pyramids bilked investors and members out of millions of dollars. A mass of legislation passed during the 1970s almost ended MLM altogether, including organizations like Amway. However, laws were eventually modified to accommodate legitimate multilevel marketers and similar organizations.
Tupperware, for example, achieved stellar sales during the 1960s and 1970s with techniques that mimicked MLM systems. In fact, network marketing has traditionally been associated with cosmetics and household items. Still considered in its infancy, MLM was increasingly used in the 1980s and early 1990s to sell products and services ranging from vacations and books to software and food items. During the 1990s, services were an increasingly important growth category for MLM, which made inroads into such service industries as legal services, broadcasting and computer network services, and long-distance telephone services.
In essence, MLM uses customers to distribute products (or services). A company begins by selling its product to selected customers in specific geographic areas. Those customers then become salespeople by telling friends, associates, and contacts about the product and trying to get them to buy. The salespeople are usually paid a commission for the products that they sell. More importantly, they also receive commissions for the products that their customers, or recruits, sell. In other words, new customers are added to the sales network, many of whom also become distributors. As the number of levels of customers grows, so does the distribution network. Thus, by trying to sell the products themselves, customers also become recruiters for the company that represents the products.
MLM organizations are based on commissions that accumulate exponentially. For example, assume that Sandy buys some products from a distributor in the MLM company. She then sells the product to five of her friends and receives a commission. Next, three of her friends sell the products to six of their friends. Not only would those three salespeople receive a commission, but Sandy would also receive a (usually smaller) commission for each of the sales. If four of the six new customers each sold to four contacts, the number of people that could potentially be selling products to Sandy's benefit would suddenly lurch past 15. It is easy to see how the sales network originated by Sandy could quickly jump into the hundreds or thousands. In theory, all of the people in the network would benefit from the efforts and purchases of the people below them.
The compensation system is the infrastructure that supports and drives a MLM program. Sellers in the network usually receive relatively large commissions on sales that they make personally. The commission is the difference between what the salesperson sells the products for and what he (she) must pay to buy them from the company. In addition, purchases made by the same customer at a later date will often result in "residual income" to the person that made the first sale to that buyer. As sellers build a network of customers that also become sellers, they also earn group bonuses, or "overrides." An override is the fraction of sales that is paid to the originator of a network. In general, sales made by distributors further down the network, or at lower levels, pay a lower bonus.
Sellers may also get a "leadership bonus," which is effectively a bonus paid to sellers that help distributors in their network to achieve specific levels of sales success. Leadership bonuses provide an incentive for sellers to train and help their customers to become better distributors and recruiters. "Usage" bonuses are provided to sellers based on the total purchases (product usages) by members of their network. Usage bonuses usually take the form of discounts on air travel or long distance telephone service. They provide an impetus for people in the organization to continue purchasing the goods themselves.
The obvious enticement for members of a MLM network is the seemingly unlimited profit potential. By purchasing as little as, say, $100 worth of a product, they can become distributors in a network that can pay them thousands or, theoretically, millions of dollars. In addition, MLM sellers get to be their own boss, make their own hours, and choose their own course to success or failure. They also get the advantage of buying the product at nearly the wholesale price.
The company that initiates and supports the network and supplies the products or services may also benefit significantly. It will likely incur costs associated with supporting the organization, including those related to making training videos and audio tapes, warehousing, transportation, and printing brochures. However, even after paying commissions, its advertising and promotion costs may be much lower than those of traditional marketing and distribution channels. Start-up capital requirements are usually much lower because the bulk of the marketing costs are not incurred until the products are actually sold. And the company benefits from strong customer loyalty and a solid base of repeat customers. Furthermore, MLM is more effective for some types of products than is traditional mass media because sales are conducted face-to-face.
Despite its many advantages, network marketing possesses several drawbacks that make it undesirable for many companies. For instance, it usually takes a long time to develop a large, profitable customer base compared to selling techniques like advertising through print and broadcast media. Furthermore, administrative duties and paperwork are usually much greater for MLM operations. Perhaps the greatest disadvantage of network marketing, though, is that the company loses control of its distribution process. It may have no idea of the types of people that are representing (or misrepresenting) its products. A corporate or product image can become quickly tarnished by overly enthusiastic or dishonest salespeople hungry for commissions.
MLM also has several disadvantages for sellers. Long hours are typically required to get a sizable network started, particularly if the product or service is perceived to be of average value by potential consumers. Because of poorly contrived or fraudulent MLM schemes, moreover, many people have attached a stigma to network marketing that sellers must overcome. Indeed, a major drawback of MLM to distributors is risk—they may lose their initial investment or be lured into purchasing additional goods or services that they will never use if the company backing the network is ill-willed or poorly operated.
Numerous laws exist that regulate MLM organizaions to protect consumers against fraud. Most of those laws are designed to discourage pyramid schemes, which closely resemble legitimate MLM systems. The difference between pyramids and legal network marketing is that the latter derives income from the sale of products. In contrast, pyramid organizations get most of their income by bringing new members into the network, or pyramid, and charging them fees.
The classic pyramid scheme is the chain letter. For example, a person might send letters to ten individuals asking for a $1. He would give each person ten names to which they should send the same letter. Theoretically, as the chain multiplies into a pyramid massive sums of money will flow from the people at the base of the pyramid to those at the top. As the pyramid continues to expand, people that were at the bottom see levels added, effectively moving them away from the bottom and bringing them cash from newcomers. Unfortunately, pyramids inevitably collapse. People at the top profit from the misfortune of those at the base. The problem is obviously more serious than the chain letter example when larger amounts of money and effort are required of pyramid members and promises of wealth go unfulfilled.
Some pyramid organizations disguise their objective by mimicking MLM companies. They integrate into the scheme a product or service that they "sell" to newcomers—a strategy known as inventory loading—or they simply charge sellers a fee to join the network. Then they encourage members to recruit, rather than sell the product to, other people.
Because of potential abuses in MLM, there are a number of protections for sellers, in addition to criminal laws which outlaw true pyramid schemes. The Direct Selling Association maintains a code of ethics that its 140 member companies must abide by. DSA members include many of the largest MLM companies in the United States. The ethics code requires that member companies buy back distributors' excess inventory at least 90 percent of the purchase price, forbids misleading representations to salespeople and consumers, and discourages high entry barriers that can inflate upstream revenues while leaving downstream sales representatives stuck with excess inventory. The DSA also maintains a complaint resolution process for consumers who believe they've been cheated by direct-selling companies.
The case of Bios Lite Diet exemplifies a successful, legitimate MLM effort. Bios Lite Diet is a vitamin supplement marketed in the early 1990s by Rexall Showcase International, a division of Rexall created explicitly to sell products through MLM. Rexall Sundown, Inc., a leading vitamin and nutritional supplement marketer in traditional retail settings, is headed by Carl DeSantis, who started the company from his bedroom and financed it with a second mortgage on his house. Although DeSantis achieved success with traditional marketing methods during the 1980s, he determined that those techniques were not suited to marketing his newer and more complex Bios Lite Diet.
DeSantis decided to sell his new vitamin using MLM. Because MLM involves face-to-face selling, he reasoned, he would have a better chance of communicating the complicated biochemical benefits of the vitamin to potential customers. Within three years Rexall Showcase was growing twice as fast as Rexall's mail-order and retail divisions and was generating a surprising $36 million of Rexall's sales. By fiscal 1997, Rexall Showcase sales topped $100 million, representing one-fifth of the entire company's sales. DeSantis attributed the success to the seller motivation inherent in MLM.
[ Dave Mote ]