Benjamin Franklin once wrote:
“…in this world nothing can be said to be certain, except death and taxes.”
If he were alive today, he’d need to amend his quote to say nothing is certain except death, taxes and friends approaching you with multi-level marketing (MLM) “opportunities”. Whether you like it or not, your friends are likely to continue to pitch these ideas to you because word of mouth is exactly how these businesses are spread. Therefore, I’m creating a three-part series to take a deeper look at the math behind joining a company like Amway, explore the techniques that sales agents use in their pitches, and finally I’ll analyze how the incentives for both agents and the people they recruit affect their decision making. In this first article I’ll focus on the math for the consumer as well as the last line of sellers to demonstrate how the expected value of becoming your own boss for Amway can be worse than throwing money at the lottery.
The basic idea behind multi-level marketing is that instead of a centralized marketing team to promote products, there are a large number of smaller sales team who promote and sell a company’s products. Additionally, as part of a MLM structure there are incentives for recruiting new members to your team to help grow the business. The recruitment incentives are typically lucrative because companies like Amway allow you to earn commissions on the products that the people you recruited buy. This often holds true regardless of whether the purchases of that person were for personal consumption, or they are unable to move the inventory. incentives stack as the people that you recruit in turn recruit their own members creating multiple levels of salespersons for the company’s product, hence the name. A MLM structure isn’t inherently illegal, but some businesses in the past that were structured in this way were actually pyramid schemes. The Federal Trade Commission offers additional ways to evaluate businesses built with a multi-level marketing structure.
A defining characteristic between a legitimate MLM business and a pyramid scheme is whether an individual seller can be profitable by selling the company’s products. This is because if the members at the end of the sales structure cannot make money by selling, then the only way to make money is to recruit more people who then face the same dilemma.
How You Make Money as a “Distributor/Business Owner/Contractor”
Different MLM businesses use different names for their salespersons, but the role is the same. Regardless of the official name, you’ll join as a salesperson and a recruiter. The skillsets for both selling and recruiting tend to have a lot of overlap, so if you are good at one of these then you’ll likely be successful at the other as well. While you might aspire to run a team of salespersons under your guidance, your entry at the end of the sales structure means that you should be focused more on selling. If the focus were instead only on recruiting, then that would be a sign of a pyramid scheme.
Sales is fairly straightforward; you make a profit on the difference between the wholesale price of the company’s product and the retail price that you charge consumers. You’ll also likely be eligible for some sort of performance-based bonuses as well. Profits based on sales can then be defined as a function of your sales volume, average selling price, and margin. Selling more high-value and high margin products will result in greater compensation.
Recruiting can pay out immediately in the form of bonuses as well as over time as a percentage of sales that gets sent back to you as the recruit’s upline representative. These bonuses often stack across multiple levels of the MLM structure so that you are eligible for bonuses based not only on the volume of the people you personally recruit but also on the volume of the people that your recruits recruit. In a MLM structure it pays well to have a large team working for you as much of the (often significant) product markup flows back to upline salespersons as incentive pay.
For a sustainable business model i.e., not a pyramid scheme, a salesperson must be able to profitably make sales without needing to recruit others. However, for Amway and other MLM companies it can be difficult to find buyers for their products. In addition to finding potential consumers, you also need to convince them to switch their product loyalty from a different brand. Since the prices at Amway are often higher than name brand products it can be difficult to convince consumer to place themselves in a worse financial position than they would be in had they simply shopped at Walmart, Costco, Amazon, or any other major retailer instead of through an Amway sales agent.
It’s a hard sell for consumers
Not everyone can be a net seller of goods, mathematically there must also be net consumers. For potential customers it doesn’t make sense to switch from a known brand-name product to an unknown generic competitor especially when that competitor costs more than the name brand product. The markups at Amway vary, but the products are often priced 50% higher than leading competitors and even exceed 2000% for some items like their multivitamins! Amway and other MLM companies might claim that despite a lack of brand recognition or product reviews that their products are superior. While it might be possible to convince some consumers to switch to higher cost products, many will be turned off by the (much) higher price point. For example, a single adult who switches their multivitamin and caffeine consumption from known brands shown in the table below to Amway products will spend about $1000 extra each year to maintain their same standard of living. A $1000 is not an insignificant amount for the average income earner and can grow to quite a substantial amount over time with compound returns. For example, if that same consumer invested that $1000 per year in an index ETF or mutual fund and earned a 6% return, then they would save an inflation adjusted $90,000 over the next 30 years!
Here are a few other product comparisons I pulled.
|Multivitamin||Men’s One a Day 1-Year Supply – $30||$708||2260%|
|Energy Drink||Red Bull 1-Year Supply @1 Can per day – $517||$760||47%|
|Deodorant||Old Spice Sport 6 sticks – $24||$45||88%|
|Body Lotion||Nivea 4×16.9oz Bottles per year – $24||$60 (5×13.5oz bottles)||150%|
|Glass Cleaner||Windex 2x23oz Bottles – $6||$14||133%|
|Air Purifier||Levoit Core 300 – $100||$1560||1460%|
|HEPA Filter Replacement||Levoit Replacement w/Activated Carbon Core – $30||$295||883%|
Of course, we live in a world with luxury goods that people pay a premium for and there isn’t anything inherently wrong with that. However, that doesn’t mean that paying a premium is a financially savvy move. Someone who wants to achieve financial independence can instead get a similar benefit from a product without a price premium and gain a lot more value from their purchase.
Your “Mentors” will encourage you to increase your expenses
For people who buy into the MLM pitch and become a salesperson for the company, there are additional expenses that you might be encouraged to pay for. For example, in addition to the $76 annual fee paid to Amway corporate, your “mentor” might ask you to purchase a $180 starter pack of products. Once you’ve made these initial purchases then you’ll be further encouraged to spend money each month on products that earn a specific minimum of point values. Your “mentor” is unlikely to care how you reach these minimums so long as you hit the point values. This is because due to the structure of MLM businesses, the people who introduce you to the business and convince you to become a seller benefit financially from both your personal consumption of company products as well as any sales you make. It is in their interest for you to consume more rather than less.
In addition to buying product, you might also be encouraged to spend hundreds of dollars to attend business seminars based on claims. On one of the calls I attended, the presenter pitched a $175 seminar ticket as a way to grow your business six months faster than those who do not attend. He never explained what the typical growth trajectory of the business looked like to quantify what six months faster meant but it was clear that new salesperson would be pushed to attend these sorts of events in the future. A $175 fee is not cheap to begin with and could be only a small cost of a trip that involves airfare, hotel, and dining costs which can quickly add up.
In reality, salespersons or IBOs (independent business owners) are unlikely to make much money
Purchasing overpriced products and spending money to attend expensive seminars aren’t typically hallmarks of a successful business model. Unsurprisingly we find that Amway’s most recent disclosure notes show that in 2016 less than half of their IBOs were active. The bar for being considered active according to Amway is that a person attempted to make a sell, pitch a presentation, or received some bonus compensation. Since less than half of IBOs did anything or made any money, this suggests that over half were not even in business. Of the active IBOs who did not go out of business, they made an average of $207 each month excluding additional business expenses like attending said seminars or paying for training. Since the averages that Amway provides in the disclosure cover all IBOs, including long established individuals with many sales, the average is likely to be skewed higher by older and more successful salespersons. The inclusion of all IBOs as opposed to focusing on the more relevant newly started IBOs leads me to believe that the numbers for new IBOs are more pessimistic than even the paltry average of $207. That $207 number itself is deceiving as it glosses over the fact that the median or typical IBO is out of business at any given time and making exactly $0.
Making a losing bet
I noted earlier that a multi-level marketing model isn’t inherently illegal. While MLMs can be legitimate businesses, it pays to do your due diligence. Even longstanding MLMs like Amway that operate legally may not be a good bet financially. These companies sell a dream of financial freedom even as their sales teams push consumers into higher cost products and encourage their newest sales agents to incur large expenses. Switching from brand name products sold on Amazon or at Walmart to Amway alternatives can easily cost a consumer a $1000 each year. When a Business Insider author estimates the expected value of a lottery ticket to be -$0.89 then these additional consumer costs are equivalent to buying over 1,100 lottery tickets!
Instead of joining a MLM business or buying lottery tickets, I plan to do the financially savvy move and invest in index mutual funds, ETFs, and in real estate crowdfunding platforms to generate income. With better valuations today than a few months ago I plan to continue to dollar cost average even as I’m unsure when the bear market will turn.
For more information on multi-level marketing businesses and how to identify pyramid schemes, check out this article from the FTC and stay tuned for my upcoming part II.Log in or Register to save this content for later.