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Pyramid Schemes

written by: •edited by: Brian Nelson•updated: 5/1/2009

Pyramid schemes can be tricky to identify. This article explains how they work and what to look for so you won’t waste your time and money.

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    Pyramid schemes can be tricky to identify. With a pyramid scheme, the members pay an up-front fee and can only earn money by recruiting new members. The main feature of pyramid schemes is the promise that the more members you recruit, the more potential for unlimited earnings. Pyramid schemes are illegal in the United States. Multi-level marketing programs, sometimes called multilevel- or network-marketing plans are legitimate. MLM members sell products to the general public and earn commissions on products sold besides earning commissions from the sales of recruited representatives. Also with MLM, the general public isn’t required to become a member to purchase the products or services.

    Commissions or earnings from a pyramid scheme are entirely based on the number of new members or distributors, not from sales of a product or service. The problem with pyramid schemes is that the majority of sales are to the distributors, not to the general public. In addition, the company incentive program with a pyramid scheme forces members to purchase, usually at inflated prices, more products than they could ever sell or products that simply aren’t marketable and don’t sell. The company incentive program of a pyramid scheme doesn’t offer any real investment to the members such as stock options or health insurance. It simply claims to reward the member for purchasing more products or services.

    The goods and services advertised to prospective members only cloud the distinction between the company being illegal versus legitimate or being a pyramid scheme versus a legitimate multi-level marketing company. Products and services offered through pyramid schemes vary tremendously. Products and services can vary from car leases, health care products, insurance, jewelry and offshore credit cards to vitamins.

    A common work-at-home scam, envelope stuffing, is a pyramid scheme because instead of the advertisers providing the materials necessary to stuff envelopes, they send you an instruction sheet that tells you to post an advertisement similar to the one you answered. Your earnings are the checks you receive from persons who respond to your advertisement. There isn’t a product or service being offered with envelope stuffing scams, only the instruction sheet.

    Ponzi schemes are similar to pyramid schemes except that there aren’t any products or services to sell that can generate any commissions and the recruiter uses the up-front fees (the advertised initial investment) paid by new members to provide the promised high rate of return to existing members.

    When considering becoming a representative of a company, research the company first. Find out if the company is a member of the Better Business Bureau, how long they have been in business, how their track record compares to local competitors, and if there have been any complaints filed against them. Find out about the products and services they offer, if they sell to the general public, if you can independently verify their claims about the product or service, and if there is a market and need for the product or service. Also find out how much it costs to become a member, if you are required to purchase a “start-up kit” and if there is a minimum monthly sales quota you must meet before you can receive your earnings.

    In America, independent distributors are responsible for all claims made in all advertisements, promotional media and any marketing efforts targeting potential customers and recruits. Avoid the company whose recruiter uses pressure tactics, scare tactics or inflates the prospective earnings potential. So, it is important to independently verify each claim made by the company recruiter. As always, take your time before signing any contract or surrendering money. Have an attorney or accountant review the contract before signing.

    You can file a complaint with the Federal Trade Commission in the USA or with the RCMP in Canada if you have been the victim of a pyramid scheme. Remember, “if it sounds too good to be true, it probably is.” Review what all scams have in common with this article.