Everybody loves making money, and that’s exactly what pyramid schemes count on.
Though they may sound like a tempting, exciting business model, pyramid schemes are actually scams.
Make sure you can identify a pyramid scheme and quickly say “no way” before you become its next unsuspecting victim.
What Are Pyramid Schemes?
A pyramid scheme begins with a few founders who create the “top” of the pyramid. They design a compelling business proposal and convince others to enroll by paying high up-front costs. In return for their initial investment, the pyramid schemers claim, recruiters will make a fortune in a short amount of time by bringing in new members who also pay the same up-front costs.
For example, say Daniel leads a pyramid scheme in the guise of a sexy new business venture. He convinces 10 people to pay the $500 entry fee for the “privilege” of joining his business and gaining the ability to make money. This puts $5,000 into Daniel’s pocket. Each of Daniel’s 10 recruits then signs up 10 people of their own, all of whom must also pay $500. A percentage of that $50,000 gets split among Daniel’s original 10 recruits, while the remainder goes directly to Daniel.
The tier-three members recruit their own members, who recruit their own members, and the cycle continues until all of the “company’s” members create a pyramid-like hierarchy. Members near the top of the pyramid make much more money than members near the bottom.
Despite the persuasive claims of making a great deal of money on new recruits, most pyramid schemes fizzle as the pool of prospective members shrinks and disenchanted recruits quit. The lower-level members suffer major losses while the higher-level members walk away with major profits.
Most notably, pyramid schemes rarely sell actual products or services with legitimate value. They usually rely on fees from new recruits for the income they generate.
Types of Schemes
Pyramid schemes take many forms, but most fall into two basic categories.
Naked Pyramid Scheme
A naked pyramid scheme does not involve any type of service or product at all. Instead, new members are tempted by a “no-fail investment opportunity” promising rapid high returns. They pay a membership fee and convince other people to join under them in the same manner.
However, these types of pyramid schemes eventually topple because they require too many members to support the bottom of the base.
Product-Based Pyramid Scheme
A product-based pyramid scheme is similar to a naked pyramid scheme but uses products or services to charge the membership fee instead. For example, hopeful salespeople might pay $100 for a starter kit to sell a specific product like candles, oils, or cookware. The salespeople earn a percentage of the revenue generated from the items they sell and a percentage of the membership fee paid by new members they recruit.
As with a naked pyramid scheme, the people at the top receive commissions from everybody they’ve recruited, and every member their recruits have recruited, and so on.
These product-based pyramid schemes fail if the products don’t sell well or have slim profit margins. Eventually, the market becomes too saturated, too many people are hustling the same products, and the pyramid scheme falls apart.
Notable Examples of Pyramid Schemes
Herbalife
In March 2014, diet supplement and health food company Herbalife came under investigation by the U.S. Federal Trade Commission and the state of Illinois. The company, which relied heavily on a member/distributor network, faced accusations of running as a pyramid scheme—of profiting more from recruiting new distributors than from actual product sales. Herbalife addressed these concerns by restructuring and paying a hefty $200 million fine in 2016.
Herbalife still exists today, but in a different form than it once did. The company now must demonstrate that at least 80% of its sales are direct to consumers, outside of member networks. And member distributors must document their sales more fully. The company’s stock price has enjoyed a rise in recent years as a result.
UltraLife
Back in 2008, many Canadians fell victim to the UltraLife pyramid scheme that promised get-rich-quick results for members who paid the $3,200 membership fee to qualify to sell low-cost travel club membership plans.
More than 2,000 people paid the hefty membership fee believing they’d earn $5,000 for every travel club plan sold. However, it turned out that they could only earn money after making at least $100,000 in total sales. Investors filed a class-action lawsuit that ultimately toppled the enterprise.
The bottom line? Stay far, far away from anything resembling a pyramid scheme, in which your return on investment depends primarily on your bringing others into the fold. Unless you’re one of the people sitting at the top, it’s very hard to make enough money to justify the cost of entry.
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