Pyramid schemes are a species of investment scams that bear a close resemblance to Ponzi schemes. As the name implies, Pyramid schemes denote a hierarchical structure of people, where those in the upper layers get to those positions by recruiting others (those in the lower layers) and earning part of their recruitment fee. Pyramid schemes like Ponzi Schemes are considered illegal because such schemes are doomed to fall apart as it is impossible for there to be an unlimited number of participants. As soon as new recruits dwindle, so these schemes die and the majority on the lower levels make a loss.
Types of Pyramid Schemes
Pyramid schemes can be classified into two broad categories, Naked Pyramid Schemes and Product-based Pyramid Schemes. Naked Pyramid schemes are the classic Pyramid schemes we are used to in which participants at the upper levels are paid from the funds of those newly recruited into the scheme. No goods, services or products are sold in Naked Pyramid schemes and the emphasis is clearly on recruiting new participants. Product-based Pyramid schemes are in most respects like Naked Pyramid Schemes but with the crucial difference that the buying and selling of products are attached to payouts and ascendancy to higher levels in the scheme. This added feature of the buying and selling of products makes it notoriously difficult to differentiate such pyramid schemes from multi-level marketing, another business activity which also has participants selling products in hierarchical levels.
Spotting Naked Pyramid Schemes
This type of Pyramid scheme is not hard to spot. If you are asked to join an “investment” scheme which promises huge profits without having to buy and sell products but depends on you getting other people to sign up and you are going to be paid a percentage of their sign-up fee, then you are dealing with a Naked Pyramid scheme.
Spotting Product-based Pyramid Schemes
As already alluded to, spotting these kinds of Pyramid schemes is more difficult, this is because proponents of these schemes set them up to look like multi-level marketing campaigns. Some are complex with matrix, binary and stairstep hierarchical structures with corresponding compensation plans. Nevertheless, here are some signs that can aid you in spotting such schemes.
There is an emphasis on recruiting more than selling products. Some proponents of such schemes are very clever and try to mask the fact that the concentration is on recruiting rather than the selling of products. Here are some pointers to help you spot when the emphasis is on recruiting.
a) Study their compensation system. If distributors far up the hierarchy (pyramid) receive a larger payout than those at the bottom who sell products directly to the customer, then you will have a situation in which the emphasis will be on recruiting. A legitimate MLM program will offer more rewards to those selling the products directly to the end user.
b) Advancement in the scheme is by recruitment. If to get to upper levels in the distributorship hierarchy depends on recruiting people (downlines) instead of selling products or by appointment, obviously the emphasis will be on recruitment.
c) A distributor hierarchy that is excessive. Functionally, there is no reason for multiple levels of distributors except to make people believe they can earn more money the higher up they are placed in the scheme. This in turn leads to an excessive drive to recruit others (downlines) into the scheme.
2. Lack of Financial Transparency. Pyramid schemes will keep their financials hidden or if made known it will be vague. Always request company financial statements audited by a known and reputable auditing firm. If this is made available to you, get someone who can interpret it for you to show if the company’s revenue is from selling products or from monies made by recruiting people into its scheme.
3. Use of High-Pressure tactics. Pyramid schemes use high-pressure sales tactics. Watch out for promises of high returns in a brief period, freedom to live the life you have always wanted, or an insistence to commit and failure to do so would be to miss an opportunity of a lifetime.
In conclusion, we would like to add that when you are approached with an offer to join a scheme you should always ask questions. Seek out present and past distributors and ask for their experience with the scheme. If they tell you that for you to make money in the scheme you must recruit others, know you are dealing with a Pyramid scheme.