Pyramid schemes: A sketchy scam!

What is Pyramid Schemes

What is a Pyramid scheme?

The Pyramid scheme is a type of fraudulent business model where the participants make money only by recruiting new members/investors. Here a few top-level members recruit newer members, who pay in the beginning to those who recruited them. As newer members recruit underlings of their own, a portion of subsequent fees they received is also kicked up the chain. All pyramid schemes eventually collapse, and most investors lose their money.

As the recruiting multiplies, it becomes impossible for the lower-level members to recruit more people and most members are unable to profit. In some countries, Pyramid schemes are illegal and are banned.

Pyramid schemes have existed for at least a century in different forms. Sometimes Multi-level Marketing plans are incorrectly called Pyramid schemes. Fraudsters frequently promote schemes through social media, Internet advertising, group presentations, seminars, conference calls, and various other means. Pyramid scheme promoters may go to great lengths to make the program look like a genuine business, such as legitimate Multi-level marketing (MLM) program. But the fraudsters use money paid by new recruits to pay off earlier stage investors.

Modus operandi

Pyramid schemes are named as such because they resemble a pyramid structure, starting with a single point on top, which becomes wider as the earlier level members recruit more and more people. The members of this scheme grow exponentially.

In a pyramid scheme, the fraudster manipulates the individuals who wish to join, to make payment upfront. In exchange, the new recruits are promised a share of the money taken from every additional member that they recruit. The directors of the organization up-top also receive a share of these payments. The directors of such schemes get richer without doing any actual work as the members below them do all the earnings for them by recruiting other members.

Let us assume the following scenario: Founder Dan started the scheme. He recruits 10-second tier people to the level directly below him, where each new recruit must give him a cash payment for joining the scheme. Not only does that entry fee goes into the pocket of Dan, but when each tier two members recruit a member of its own, the entry fee collected by the tier two recruiters must send a percentage of their takes back up to Dan.

Sounds simple enough, but here is the problem: Let’s say the initial 10 recruits each find 10 more people. Those 100 new recruits will have to find 1,000 people willing to sign up for the program. And if they somehow find 1,000 people, the next level of the pyramid will need to sign up 10,000 to make a profit. Eventually, there won’t be enough recruits at the bottom of the pyramid to support the level above it. That’s when the pyramid topples and everyone at the bottom loses their investment. It’s mathematically impossible for everyone to make money in a pyramid scheme. 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.

Is Multi-level Marketing a Pyramid scheme?

NO. Multi-level marketing (MLM) is a legal business practice, but unlike traditional pyramid schemes, this model involves the sale of actual goods or services. 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. A legitimate multi-level marketing company emphasizes reliable products or services. A pyramid scheme uses products or services to disguise its quest for collecting money from the investors on the bottom levels to pay other investors further up the pyramid.

Pyramid schemes vs Ponzi schemes

Read more about Ponzi schemes here. Pyramid schemes and Ponzi schemes have many similar characteristics based around the same concept: unsuspecting individuals get fooled by unscrupulous investors who promise them extraordinary returns in exchange for their money. However, in contrast to a regular investment, these types of schemes can offer consistent “profits” only as long as the number of investors continues to increase. Once the number tapers off, so does the money.

Ponzi and pyramid schemes are self-sustaining as long as cash outflows can be matched by monetary inflows. The basic differences arise in the type of products that schemers offer their clients and the structure of the two ploys, but both can be devastating if broken down. One key difference is that pyramid schemes are harder to prove than Ponzi schemes. They are also better protected because the legal teams behind corporations are much more powerful than those protecting an individual.

How to spot a Pyramid scheme and avoid being Defrauded?

  • Recruitment is mandatory. If a scheme solely focuses on recruiting as many people as you can for a fee, it is likely a pyramid scheme.
  • No service is provided. Exercise caution if what is being sold as part of the business is hard to value. Some fraudsters choose fancy-sounding “products” to make it harder to prove the company is a bogus pyramid scheme.
  • High returns in a short period. Proceed with caution if promises of fast-cash are made while recruiting.
  • No demonstrated revenue from retail sales. Ask to see documents, such as financial statements audited by a certified public accountant (CPA), showing that the company generates revenue from selling its products or services to people outside the program.  As a general rule, legitimate MLM companies derive revenue primarily from selling products, not from recruiting members.

Gather all the information regarding the company, its workforce, and its products. If possible get sales literature like pamphlets etc. Avoid promoters who fail to explain their plans clearly and in detail. Find out if there is a demand for the product or the service. Ask if you must buy a product to become a distributor. Find out if the company will buy back your inventory –you could get stuck with unsold products. If ensured above measures you will stay safe from such fraudulent schemes.

Stay Satark. Stay Vigilant.

3 thoughts on “Pyramid schemes: A sketchy scam!

    1. True. Its a race. Whoever is ahead is definitely winning. So we must strive to increase our knowledge about these scams on a daily basis so that we can stay ahead of the scammers.

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