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The Trouble With Multilevel Marketing Schemes

Daniel B. Kline, The Motley Fool

Multilevel marketing is better known by the companies and products and uncomfortable/ annoying pitches associated with it -- think Herbalife (NYSE: HLF) and Tupperware (NYSE: TUP), among other things. Are they a scam? Does anyone actually make money selling supplements and tchotchkes to their family, friends, friends of friends of friends, etc.?

On this week's episode of Industry Focus: Consumer Goods, host Dylan Lewis and Motley Fool analyst Dan Kline explore the industry. Find out what precious little we know from company reports and external studies, how most MLMs create deeply flawed incentives for their distributors, why most people won't have much success selling these goods as a sideline, some advice and red flags for would-be distributors, and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on May 14, 2019.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, May 14th, and we're talking about MLMs. I'm your host, Dylan Lewis, and I've got fool.com's Dan Kline with me on Skype. Dan, what's going on? 

Dan Kline: Not too much here in West Palm Beach. We moved from summer to super summer, where it's impossible to go outside unless you're going to the beach or the pool. 

Lewis: [laughs] Here in D.C., we haven't decided whether we're in spring, summer, or fall, it seems. We've been dealing with a ton of rain. It's been pretty dreary here, Dan. 

Kline: It's actually rained a lot here, too. We have these weird things where, I was in the pool, it's raining, there's not a cloud in the sky. I get out of the pool, it's torrential. By the time I get three floors down on the elevator back to my condo, it's perfectly nice again. [laughs] 

Lewis: I've got family that lives on the Gulf side of Florida. And they say, if it's raining and you don't like it, just wait 20 minutes. 

Kline: Yeah, that's often how it is. 

Lewis: Well, Dan, I'm having you on today because I wanted to do a show on maybe a concept that some people are a little familiar with, the idea of a sin stock. This is something that is often applied to the tobacco, alcohol, gambling field where you have companies that are putting stuff out that people may have some moral objections to and they don't want to put their investing dollars behind. I want to enter a different category of company to the sin stock consideration. I have some objections to what is going on in the MLM or multilevel marketing space. You know a little bit about this, and I wanted to bring you on to talk about it. 

Kline: Yeah, absolutely! Multilevel marketing is something we've all probably been exposed to. If you've ever been to one of those parties where there's games and then at the end of it, they're trying to show you a bunch of merchandise and sell you stuff -- maybe it's Tupperware, sadly adult toys has been a popular one, maybe it's nutritional items. It's a business model that works based on commission salespeople, nonsalaried salespeople, getting paid based on how much they sell and recruiting new people into the organization, to create a pyramid -- we'll delve deeper into the word pyramid later -- where the person at the top gets a cut from everyone from the bottom. You only make money if you're selling, but the company makes money in a variety of different ways. Sometimes you pay joining fees, sometimes you have to buy product, sometimes you have to buy kits for these parties. And it's really a very appealing idea to people because it's owning your own business; but there are a lot of caveats to that. 

Lewis: Yeah. Importantly, you can also make money once you have people underneath you, aka downlines, who are buying product to sell to the general public theoretically. This is very often referred to as direct selling, social selling, network marketing. There are a lot of different names for it. They all broadly fall under the multilevel marketing umbrella, though. 

One of the first things that you immediately hear people ask when you're talking to MLMs is, "Are MLMs a scam?" 

Kline: Scam is a tough word. It can be a scam, but sometimes it isn't. It's really just, are you good at selling? If you're someone who's very comfortable starting with your friends and family, and not only having them over or going to their house and selling them stuff, stuff they may need and stuff they may not need, but also willing to recruit people into that, and then continually develop a new market -- let's pretend I'm selling nutritional supplements. I could call all my friends and have an event. Maybe the first week, I do really well. How long is it until I've exhausted not just my friends, but my friends of friends of friends? So it's not a scam, but it's often presented as the way it works for the top 1%. The videos show people on yachts, driving fancy cars, being flown into conventions, all sorts of exciting stuff, rah rah. The reality is, that is possible, but it's not likely for most people. And honestly, it's the same if you went to any sales job where you're being paid by commission. If you're a newspaper salesperson and you're not good at selling, you're probably not going to succeed in sales. Multilevel marketing companies, it's much more complicated because you're not getting leads, you have to do every piece of the business yourself, and in many cases, you have to explain a product that isn't necessarily something people want, even if it is something that would be useful to them. 

Lewis: And there are some telltale signs of MLMs that are more in the scam category. I think ultimately, you want to look at the stuff that you're selling and its utility. There are some MLMs where you're truly selling a good product, it's something that is useful, it's something that people want; it's in the kitchenware space -- Tupperware is a great example of that. People legitimately want it. There are some other ones, where you're in the supplement game, nutritional stuff. And there are some dubious claims about what the product is capable of doing. I think that's a red flag. 

Kline: Absolutely! You want to sell things that people would have bought otherwise, or that would replace other expenses for them; not things that you have to put a hard sell on. The other major red flag is: do you have to fill your garage with a lot of inventory? If you constantly have to buy merchandise to maintain your discount or meet a status, that's not a great sign. You want to be in a situation where, if this is something for you, you have to order a minimal amount of product or test kits or samples, where you can show it to people and then take orders. That puts the risk back on the company; as opposed to, if you have to buy a whole bunch of stuff that's not returnable, all of a sudden, what does the company care if you sell it or not? You've already bought a bunch of stuff. You might continue to buy it just to meet your status level and stay where you are. So you really want to monitor how much money you have to put out in order to go into this type of business. 

Lewis: Right. The common criticism of MLMs is that many of them operate seemingly like a closed system, which is an economic term that basically explains how the people that are the end customers of a product are within an organization, not the general population. Rather than products funneling from the company to the distributors out to John Q. Public, they wind up going from the company to the distributors and then sitting there. If the bulk of the sales are happening because of that, and the company doesn't really seem to care where the product goes once it goes to the distributor, another red flag.

Kline: Right. The biggest goal of the company should be growing its audience with the public, not growing its distributor base to continue selling to distributors, that you can't make money if this doesn't go beyond your immediate circle. One of the things you want to think about is, is the public aware of this product? Has there been some advertising or some marketing? Does the company have a robust social media that isn't just you? Or is the entire sales proposition for this recruiting new salespeople? 

Lewis: Right. That's the telltale sign that you might want to give it a harder look. I think this is something that people are increasingly encountering, because a lot of these MLMs are telling people, "Post on social media, get it out there and tell your friends and family about it, and become an evangelist for this brand." Not only are people seeing it on social media, it's showing up more and more because it's a pretty big chunk of economic activity. Looking at some data from the Direct Selling Association, in 2017, direct selling made up just about $35 billion in retail sales. There were 18.6 million Americans involved in direct selling activity in one way or another. Both those numbers, slightly down from 2016, but still pretty big, Dan. 

Kline: It's really obvious why this has an appeal. Pretend you're a stay-at-home parent. You used to work, you're used to making money. This is something you could in theory do very part-time. You might spend an hour a day organizing an event, hold the event one or two nights a month. In theory, the money comes in. The problem is, the reality for most people is that, a) they're bugging their friends by inviting them to a party to come over and buy stuff that they may not want; and, when they exhaust their immediate contacts, all of the reasons you're not at work in the first place come into play. If you're a stay-at-home parent looking for a side hustle, are you really meeting a lot of new people so you can continue to grow your business? That's a real big challenge. Are you the type of person who walks up to a stranger and says, "Hey, would you like to set up a party so I could sell meal plans or nutritional supplements or Tupperware or whatever it is to your friends?" That's not an easy thing to do. But, wow, owning a business and making your own money, I can see why people go for that. 

Lewis: Yeah. And early on with a lot of these organizations, there is quite a bit of fertile ground. If there are not a lot of people out selling a specific kind of product, and you enter the market as a salesperson, it's going to be a lot easier for you to sell that product. If you're instead the tenth person in a relatively small town, or smaller area that is trying to sell something, well, that market's going to be saturated already. 

Kline: Yeah. You also have to believe in what you're selling. I had a friend who sold children's books through a multilevel marketing company. They were good books. She liked the books. She actually did a really good job selling them. She'd been a teacher, so she had a very broad network. And for a number of years, she made a nice side income. The problem is, at some point, her kids aged out, and then it became harder to meet people and continue to grow that business. You really have to think about what your addressable audience is, and how you're going to deal with the fact that your next-door neighbor could become a distributor, too, and all of a sudden, you're competing for the same people. 

Lewis: Right. And a lot of people are incentivized to bring more people into the fold.

Kline: Which actually creates more competition. If I'm selling something, and I recruit you to it -- obviously, we know lots of different people, but we also know a lot of the same people. We'd both be approaching people and saying, "Hey, want to come to a party to buy whatever it is?" And at some point, the audience has either bought everything they want, they've sat through all the courtesy parties they want to, and there does become consumer fatigue. And then there's fights over the reorders -- it's a very competitive thing where you're also building your own competition as you grow your network. 

Lewis: Yeah. As these get larger and larger, it gets harder and harder. For these more established ones, it's very difficult for new salespeople to make meaningful amounts of money. John M. Taylor, a researcher over at the Consumer Awareness Institute, spent years studying MLMs. He has a report, The Case [for and] against Multilevel Marketing available on the Federal Trade Commission's website. From it, of the 350 MLMs I've analyzed for which a complete compensation plan was available, 100% of them are recruitment-driven and top-weighted. In other words, the vast majority of commissions paid by MLM companies go to a tiny percentage of to TOPPS -- top-of-the-pyramid promoters -- at the expense of a revolving door of recruits, 99% of whom lose money. That losing money comes when you factor in all the expenses that go into running a business like this. Not only do you have product, but you have whatever you're going to be putting out for these parties, whether it's food, alcohol, flyers, you're going to be creating a website, all this kind of stuff. When all of that starts to add up, at slim margins on some of these products, it becomes very hard to make a meaningful amount of money. 

Kline: What this shows is that it is possible for the top 1% to make money. Generally, that involves recruiting a lot of people under you. But sometimes it is just being a really good salesperson. It's not impossible. But it's improbable. If you find yourself needing a side hustle, and you're a salesman in your day-to-day job or have a history of being able to do cold-calling and sales, well, this might be better than other side hustles for you. But if you've never sold before -- and trust me, I have sold, it is a difficult, difficult thing to do -- think about how willing you are to ask your friends and family, and then strangers, to spend money. It's easier to do that if you believe in the product. It's also hard to do that when you know that someone is maybe spending money they can't afford, or maybe the product isn't quite a perfect fit for them. You really have to think about your willingness to be competitive and be a salesperson. That's not for everyone. 

Lewis: Alright, Dan, we're going to pull some stats from a few major MLMs just to give a sense of what the numbers look like and the earnings that people have on them, one of the main reasons why I have an objection to this industry. 

Alright, Dan, we have that big industry number from the researcher, but I want to get into what some of these companies put out in terms of estimated compensation. I think that it is perhaps even more telling than the broad-stroke number that we just threw out there. 

Kline: Yeah, and I think it's important as we bring up specific company names to note that it's hard to find these statistics for specific companies. We're not calling out these couple of companies just because we're deciding to pick on them. We're calling them out because they're actually sharing their information and putting it out there, and they're in line with the broader numbers we saw on the research you cited earlier. 

Lewis: Right. The first one we're going to talk about is Herbalife. This is a company that sells nutritional products. It has been in the news a ton recently. [laughs] The hedge fund managers Bill Ackman and Carl Icahn have just been duking it out for quite some time on this company. It's been a controversial name, Dan. 

Kline: Yeah. Bill Ackman basically said, "This is going to go to zero." He doesn't believe in the business model. He felt it was a scam. Carl Icahn said, "No, this is a legitimate multilevel marketing company selling a legitimate product." The reality is, it didn't go to zero. The stock has been doing reasonably well. But, when you dig into the numbers, they do show what we were talking about before -- only 14% of its members, its salespeople, its reps, whatever you want to call them, made any money. Half of those made less than $245. Only 10% made more than $4,350. That's maybe a little bit better than the 1% model. But if you look at people who are actually making a living, it's probably a very tiny percent of those 1%. So, yes, you can make money selling this, but clearly, the path with Herbalife to make money is very, very difficult for most people. 

Lewis: Yeah, Dan. Those numbers that you cited were from 2016, the company's statement of average gross compensation. To give you a sense of how big their distributor base is, that is over 400,000 people we're talking about. When you talk about over 80% of U.S. membership not receiving any earnings, that's several hundred thousand people that didn't receive any earnings. This isn't some small operation.

Kline: Right. And those are people who are buying in. The company's revenue is coming from its rep base. It's not coming from sales to the public. Now, that's something they've tried to work on. They acknowledge that it's not how they want it to be. But that's the plain reality of what they're doing. And it's matched by the next company we're going to talk about, Tupperware. You know what Tupperware is. Dylan, we often talk about our age difference. But even being younger than me, you're familiar with Tupperware, I assume?

Lewis: Yes. Tupperware transcends, Dan. It is one of those names that just has become the default for an entire category. 

Kline: I feel like it had its heyday maybe the '80s, maybe even the '70s. But it's still around. Tupperware kind of created the model of having a party, where you play games, there's free prizes, and then at the end of the night, someone takes orders. The positive about Tupperware is, it's a very good product. It's a top-of-class product. Everyone probably has some in their house. If they don't, they have a poor knockoff, and they should get some Tupperware. We're not against it. 

But the reality is, you pay $99 to join and you get a 25% discount. In theory, if you're buying a whole bunch of Tupperware because you just got married or bought a house or whatever it is, you might actually come out ahead just on your own purchases. But a 2016 income distribution statement from the company said that 96.9% of all participants made less than $500 from August 2015 through May 2016. That's with over 35,000 distributors. Again, a very small percentage are making any real money. 

Now, some of those people might have just spent the $99 to sell a little bit to friends and family and buy themselves. Clearly, not all of them have tried to make this a side hustle or a business. For some of them, it might just be a discount plan. But if you think you're going to start selling Tupperware and turn it into a meaningful business, the numbers are very much against you. 

Lewis: Yeah. There's this common line in MLM parlance where they say that a large portion of the distributors are hobbyists that enjoy getting discounts on the products they'd be buying anyways. I'm going to quote directly from a piece of Herbalife literature. "Most people join only to receive a discount on Herbalife products and do not participate in the business," talking about their distributors. I take some exception to that because I think the way that these are generally pitched is: "This is a business opportunity. This is a way for you to quit your job. You can have some fancy car in your driveway and tell your boss, 'I'm done.'" That's kind of at odds with that. But, that's how they talk about some of those numbers. And I think that's true to some extent. I don't think it's true for thousands of people.

Kline: Yeah. It does feel like they should separate those businesses. If they want to offer a membership program where you have the right to sell to friends and families and you get a discount, you should be opting into that program, and not the overall model of, "This is going to be something you do," even if it was only so they could honestly say what their salesforce is, versus what their membership is. I'm a member of Costco. I could in theory become a business. If you have a selling license -- it varies in every state what you need -- you could go to Costco and buy a case of Coca-Cola or a box of Milky Ways and resell them and make a profit compared to what they charge for one individual can of soda in most places. But most people aren't joining Costco for that reason. In the case of Herbalife or Tupperware, I think it's fair to say that the vast majority start out thinking it's going to be a business for them. 

Lewis: Yeah. And so that we're not just picking on some publicly traded companies, Rodan + Fields, the skincare company, had over 400,000 enrolled consultants in 2018. Over 200,000 of them received payment, about 54%, in at least one month for sales that occurred during 2018. Of the people that did receive income from Rodan + Fields, half earned less than $600. Again, those numbers that we threw out there, broad strokes, they seem to jibe more or less with what we're seeing from these companies specifically, Dan. 

Kline: Yeah. And we're seeing the same thing over and over. Part of your research was looking at Berkshire Hathaway, Warren Buffett's Pampered Chef company, a company using this model, and how they present the business to the public. There's no one more reputable than Warren Buffett. But, Pampered Chef is using marketing materials like: "See what you can earn! Your earning potential is endless!" And they show charts and graphics about how you could make all sorts of money. The reality is -- and we keep saying this -- you could make all sorts of money; technically, that ability is part of the program. But the reality, and we see it company after company, public or private, is that you're not going to make that kind of money. And if you're happy just making a little bit and bringing some of these products -- because you really love Pampered Chef and you want your friends and family to have it or use it yourself -- you really have to think about what you're getting out of it and what the company's getting out of it. 

Lewis: Yeah. Just to put some numbers to what you're talking about with Pampered Chef, they estimate that at three to six hours per week, you could be pulling in an average monthly income of between $611; for eight to 15 hours per week, you'd be pulling in $1,400 to $18,000 in average monthly income, [laughs] a far cry from what we're seeing from some other vendors. When we talk Pampered Chef, it's impossible for us to look at those numbers and then look at the actuals, because in doing research for this show, I couldn't find a disclosure of income summary for the Pampered Chef sellers. My hunch, though, is that it's pretty in line with what we've seen with these other folks. 

Kline: I think that's a red flag. If you've decided, "Hey, I'm great at sales! I want to be in this type of business," I think you want to look for companies that disclose numbers. The reality is, the vast majority of them don't. They're more than willing to show you best-case scenario, but they're not willing to say, "Over 90% of people don't make meaningful money," or in some cases, "99% of people don't make meaningful money." Really ask those questions. If you're being recruited by a company to do this, or you're in discussions on it, push back and say, "Hey, beyond these three people who've done really well, what does the average person make in their first year?" Not their first month, which is going to be easy, but the first year, where it's going to start to get hard. 

Lewis: Yeah. And I don't disagree with you, Dan. I think that they're definitely are people in the MLM industry that make a considerable amount of money. You think about the structure and how you are receiving commissions on the people below you who are placing orders, ultimately, to sell stuff. Yeah, if you get enough people in your downline, it totally makes sense that you're pulling in some serious money. I think, though, that MLMs tend to be very top-heavy in their compensation, and a lot of the wealth that's being generated for those folks comes from people that are being pitched the idea that, "You can start your own business, and it doesn't cost all that much!" I have a problem with that, as an investor. 

Kline: Yeah. I think it's fair to say they're only showing you the rosy side of it. And that's true of anything. If you're looking at a franchise, if you're going to open a convenience store, they're not going to show you the three people that failed, where it didn't work out well. They're going to present, "The average person makes this, here's what their investment pays off." In this case, I think it's hard to ignore that chances are, you will be paying them money and not getting anything in return. Again, that's fabulous if all you want is a discount and to play around with doing a little sales. But before you think this is a way to make a living, realize that this is a very difficult side hustle. This is not, "I drive someone from here to there and get $X." This is, you only get paid if you sell; and in many cases, you have upfront costs that are somewhat significant. 

Lewis: Yeah. It's a lot to work through. Listeners, if you're interested in more on the MLM space, John Oliver has done a remarkable 30-minute breakdown of MLMs and the industry. I would also highly recommend you check out the podcast The Dream. It covers the history of the industry, gives a look at the culture and how it impacts a lot of the people that do become distributors. If you want more on this discussion, those folks have done an incredible job of painting a picture of what the industry looks like. 

Dan, anything else before I let you go today? 

Kline: Well, Dylan, now is when I tell you I'm leaving in order to start -- no, just kidding. [laughs] Yeah, all I want to tell people here is, don't get sucked into the dream. If you want to build a business, do your homework. Talk to other people who do this. Find something that isn't just what the company is feeding you. If you do all that homework, and talk to lots of people in lots of different areas, and believe you can make money selling Tupperware or knives or whatever it happens to be, then go for it, give it a shot. But be very skeptical. Don't just pay your money on the idea that you'll have financial independence. 

Lewis: Yeah. I'd say, hunt for the numbers, and know yourself. If you're someone who is not a natural salesperson, perhaps you're not going to become one overnight just because you have this inventory on hand to sell. You have to know what your strengths are and play to them. 

Kline: Yeah, and you have to think about your comfort level talking to strangers. I mean, asking for a sale is hard to do for a trained salesman. If your training comes from watching some videos online or reading some training materials, you have to think twice before getting into this type of business. 

Lewis: Sage advice! Thanks for hopping on the show today, Dan!

Kline: Thanks for having me!

Lewis: Listeners, that does it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, you can shoot us an email over at industryfocus@fool.com, or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes, or you can catch the videos from this podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass! For Dan Kline, I'm Dylan Lewis. Thanks for listening and Fool on!

Daniel B. Kline has no position in any of the stocks mentioned. Dylan Lewis has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.