What Is an MLM?

Definitions and Examples of MLMs

Rather than having a storefront operation, multilevel marketing companies rely on independent distributors to sell their products directly to consumers and bring other salespeople into the company. Sales are often online or in customers’ homes. These distributors aren’t hourly or salaried employees. Instead, they are independent contractors and only make money when they sell the product. The company encourages each distributor to recruit new participants to join their downline. Then, the distributor earns a percentage of all sales their recruits generate.

Many people use the terms “MLM” and “pyramid scheme” interchangeably. And while they’re not entirely the same thing, some MLM companies are pyramid schemes and in violation of federal law.

An illegal pyramid scheme is a company that recruits distributors, just like an MLM would. But in the case of a pyramid scheme, participants can’t really make money selling a product or service; rather they make money by recruiting new distributors to join under them. Pyramid schemes are illegal, and the Federal Trade Commission (FTC) works to shut them down. 

A good example of FTC action against a pyramid scheme is its January 2020 temporary shutdown of an instant-coffee pyramid scheme called “Success by Health.” The FTC’s press release about the action indicates the company’s founders received $7 million from their distributors and pocketed more than $1.3 million of it.

“The FTC alleges that less than 2% of participating consumers received more money from the defendants than they paid to them, and that those lucky few averaged less than $250 per month—a far cry from the defendants’ promises of ‘financial freedom,’” the FTC’s release noted.

The difference between a pyramid scheme like Success by Health and a legal MLM is that legal MLMs have a legitimate product and distributors can make money by selling that product. And while legitimate MLM companies also encourage distributors to recruit new participants into their “downline,” they don’t necessarily have to do so to make money.

How MLMs Work

MLMs rely on more people continually joining the organization so the people at higher levels can earn money from the sales of people who are newer to the organization. You may be expected to pay money upfront to join. You'll have sales quotas you'll be urged to meet, and you may also be expected to bring a certain amount of people to the organization who will form your downline.

There are hundreds of MLM companies operating in the U.S., and it can be tricky to figure out if a popular new product or job opportunity from a friend is an MLM in disguise. You may have had the experience of a casual conversation with an acquaintance turning into a sales pitch to join their MLM team. When you join a team at the invitation of a friend or acquaintance, you become part of their "downline." This puts you lower in the hierarchy and in a position where those above you earn money from your sales. The people you bring into the organization then become downline from you. Here are some things most MLMs have in common:

• You can only buy a product from a distributor: MLM companies typically only sell their products via distributors; you can’t buy the item from a retail store. 
• Someone only promotes products from one company: There’s no shortage of influencers promoting products online. As a result, you might have a hard time figuring out which are MLM products. If an influencer you follow or someone you’re friends with on Facebook only promotes products from one company, they might be an MLM distributor.
• A recruiter approaches you with promises that seem too good to be true: A job opportunity might make assurances of making a lot of money, but the business model seems unclear.
• You have to pay to join: You’d be hard-pressed to find a legitimate job opportunity where you have to pay to get the job. If a company requires you to buy a product upfront or pay a membership fee, it’s likely an MLM.
• You’re asked to recruit new members: One of the key features of MLM companies is that, in addition to selling a product, distributors are encouraged to recruit participants into their downline to earn more money. This business model is an indication that the company is either an MLM or a pyramid scheme. 

Criticism of MLMs

MLM companies aren’t new. Amway, one of the most well-known MLM companies, has been around since 1959 and was at the center of an FTC decision that helped to distinguish legitimate MLM companies from illegal pyramid schemes. MLMs have only grown in prevalence since then, with brands like doTerra, LuLaRoe, and Scentsy creeping into the mainstream. Roughly 7.7 million Americans generated $40.1 billion in direct sales in 2020, up from $28.6 billion in 2010, according to data from the Direct Selling Association (DSA).

Despite frequent promises of high earnings, few MLM participants ever end up making money. According to an AARP study, about seven out of 10 distributors break even or lose money, 25% make a profit, 27% make no money at all, and a startling 47% lose money.

Considerations for MLMs

While the data clearly shows that direct sales aren’t profitable for most people, many people still join for the promise of financial freedom. And certainly, there are people who make a living in an MLM company. Before joining, here are a few things to keep in mind:

• Make sure you understand the company and the product: If you don’t understand the business model or the product isn’t the main focus of the business, you could be dealing with an MLM that’s an illegal pyramid scheme.
• Ask about financial details upfront: Find out what kind of upfront cost there is. If the company requires you to buy products to sell, make sure they also accept refunds on unsold products.
• Familiarize yourself with sales and marketing: When you join an MLM as a distributor, you’re a salesperson. Your success will be dependent on your ability to market the product. If you’re new to sales, learn the basics of business and marketing.