Pyramid Scheme

A pyramid scheme is a fraudulent investing plan that has unfortunately cost many people worldwide their hard-earned savings. The concept behind the pyramid scheme is simple and should be easy to identify; however, it is often presented to potential investors in a disguised or slightly altered form. For this reason, it is important to not only understand how pyramid schemes work, but also to be familiar with the many different shapes and sizes they can take.

The Scheme
As its name indicates, the pyramid scheme is structured like a pyramid. It starts with one person - the initial recruiter - who is on top, at the apex of the pyramid. This person recruits a second person, who is required to "invest" $100 which is paid to the initial recruiter. In order to make his or her money back, the new recruit must recruit more people under him or her, each of whom will also have to invest $100. If the recruit gets 10 more people to invest, this person will make $900 with just a $100 investment.

The 10 new people become recruiters and each one is in turn required to enlist an additional 10 people, resulting in a total of 100 more people. Each of those 100 new recruits is also obligated to pay $100 to the person who recruited him or her; recruiters get a profit of all of the money received minus the initial $100 paid to the person who recruited them. The process continues until the base of the pyramid is no longer strong enough to support the upper structure (meaning there are no more recruits).

A product-based pyramid scheme is the same concept disguised as a legitimate direct sales opportunity. Here's how it works:
•A distributor recruits 10 salespeople who each pay $500 for a starter kit of products to sell.
•The distributor gets 10 percent of each starter kit that's sold.
•The distributor also gets 10 percent of each product that any of his recruits sells, including more starter kits.
•The recruits are told that the fastest way to make money isn't by selling products, but by recruiting more people to buy starter kits.
•The people at the top of the pyramid get commissions from everyone in their downline, the many levels of recruits below them on the pyramid.
The problem with most product-based pyramid schemes is that the products themselves don't sell very well, or have very slim profit margins. So the only way to make money is to find more recruits. Eventually (and surprisingly quickly), the market becomes saturated. There are too many people trying to sell the same unattractive product and there's no one left to be recruited.
It's mathematically impossible for everyone to make money in a pyramid scheme. For example, if each recruit needs to find 10 more people to recoup the cost of his or her initial investment, the eighth level of the pyramid would have to recruit a billion people to make back their money. And the next level would need 10 billion, nearly twice the population of the Earth.
In fact, pyramid schemes don't work unless somebody loses. Those at the bottom of the pyramid are essentially defrauded by those on top. It's a mathematical fact that no matter how many people join a pyramid scheme, 88 percent of the members will be on the bottom level and will lose their money
Pyramid schemes are illegal because people don't lose their money due to normal market forces, but because the system requires them to lose so that a few at the top will win.
Studies show that in a naked pyramid scheme, 90.4 percent of people lose their money, while in product-based pyramid schemes, that number jumps to a shocking 99.88 percent

Multi-Level Marketing and Pyramid Schemes
On the surface, it's hard to tell the difference between a legitimate MLM and a pyramid scheme. That's because they're both built on the business model of "multiple levels" of distributors and recruits. Some critics of MLMs claim that all of them, even the supposedly "legitimate" ones, are pyramid schemes in disguise.
In a landmark 1979 ruling, the Federal Trade Commission found that Amway was not a pyramid scheme. That ruling has paved the way for hundreds of MLMs to follow Amway's business model. The Amway Web site highlights the differences between its unique "business opportunity" and a pyramid scheme:
•Amway doesn't pay distributors for simply recruiting new salespeople.
•The only way to make money through Amway is either by selling products directly to consumers or by managing a team of salespeople. Managers get a percentage of each of their recruits' sales.
•Amway doesn't require its salespeople to buy starter kits or impose a minimum monthly order value to stay a member.

Amway stresses that the main difference between a legitimate MLM business model and a pyramid scheme is that a legitimate MLM is focused on selling products, not recruiting more salespeople. In a legitimate MLM, it should be possible to make money by simply selling products directly to customers. With that main criterion in mind, here are some other ways to identify product-based pyramid schemes:
•Pyramid schemes offer money for simply recruiting people. This money can come as a commission from the sale of a starter kit or as a recruiting "bonus."
•Avoid any MLM that puts much more emphasis on recruiting salespeople than selling the actual product.
•Pyramid schemes charge steep startup costs for joining, including mandatory training, a starter kit and a non-refundable membership fee.
•Beware of any MLM that allows five or more levels of distributors to collect commissions on a single sale.
•Make sure that the products being sold have real value and a competitive price. Are they reputable brands? Have the manufacturers been involved in recent lawsuits?
•Avoid MLMs that only sell lists of sales leads to other MLM salespeople. This is most likely outdated information that has made the MLM rounds several times before.
•Avoid signing up for an MLM as part of a high-pressure motivational event. Consider the information carefully and take it home to think about it.
•Be wary of anyone who tries to sell you on an MLM by flaunting their personal wealth. Realize that many of the people who claim to have made millions through MLM have actually made their money selling books and videos on how to make millions through MLMs.
•Bottom line: If it sounds too good to be true, then it probably is.

Notable Recent Cases
Internet
In 2003, the United States Federal Trade Commission (FTC) disclosed what it called an internet-based "pyramid scam". Their complaint states that customers would pay a registration fee to join a program and purchase a package of goods and services such as internet mail, and that the company offered "significant commissions" to consumers who purchased and resold the package. The FTC alleged that the company's program was instead a pyramid scheme that did not disclose that most consumers' money would be kept, and that it gave affiliates material that allowed them to scam others
Pyramid schemes may use email to persuade others that they are multi-level marketing (MLM) business plans. MLM plans—such as Amway, ACN, Mary Kay, Tupperware, and Avon Products—are sometimes criticized, but remain legal by offering genuine products; pyramid schemes do not.

Others
In early 2006 Ireland was hit by a wave of schemes with major activity in Cork and Galway. Participants were asked to contribute €20,000 each to a "Liberty" scheme which followed the classic 8-ball model. Payments were made in Munich, Germany to skirt Irish tax laws concerning gifts. Spin-off schemes called "Speedball" and "People in Profit" prompted a number of violent incidents and calls were made by politicians to tighten existing legislation. Ireland has launched a website to better educate consumers to pyramid schemes and other scams.
On November 12, 2008 riots broke out in the municipalities of Pasto, Tumaco, Popayan and Santander de Quilichao, Colombia after the collapse of several pyramid schemes. Thousands of victims had invested their money in pyramids that promised them extraordinary interest rates. The lack of regulation laws allowed those pyramids to grow excessively during several years. Finally, after the riots the Colombian government was forced to declare the country in economical emergency in order to seize and stop those schemes. Several of the pyramid's managers were arrested and are being prosecuted for the crime of "illegal massive money reception".
November 2008: The Kyiv Post reported on November 26 2008 that American citizen Robert Fletcher (Robert T. Fletcher III; aka "Rob") was arrested by the SBU (Ukraine State Police) after being accused by Ukrainian investors of running a Ponzi scheme and associated pyramid scam netting $20 Million USD (Kiev Post also reports that some estimates are as high as $150M USD).
The Federal Trade Commission has opened an investigation to Shop to Earn Shop to Earth.

Specialty Catalogs
Specialty catalogs are a promotion and distribution technique commonly employed by direct marketers. They describe, graphically and verbally, a limited range of products. Specialty catalogs are a good promotion/distribution choice for new products. They are also most effective when using a niche strategy. There are several reasons for this:
•It is less risky than a mass distribution strategy. If it is not successful, it can be altered with only moderate expense.
•It is a stealthy way of testing market acceptance of the product. It doesn't alert the competition, or at least the competition will not perceive it as a threat.
•Specialty distribution is better able to obtain high margins than mass distribution. This will allow a price skimming strategy, where it is possible to capture the consumer surplus over time.
•Specialty catalogs allow the marketer to better target prime segments, like the early adopters and innovators that will be prepared to try a new product.
•Catalog response is immediate. Product problems will become evident before too many products are shipped.
•Catalogs are less expensive than sales forces. The average cost per sale is lower than most forms of advertising where low volumes are involved.
•The printed medium is suitable for new products or any other situation where detailed information needs to be communicated.