Posted in Marketing & Strategy Articles, Total Reads: 4012
, Published on 09 July 2013
One of the fastest growing businesses in recent years is multi-level marketing or network marketing. There are several companies such as Amway and Avon that have employed this business model and have been successful However, with the growth in the use of this business model, there has been growth in unethical companies and business practices. A large number of illegal pyramid schemes have been reported in the U.S. as a result of the growth of network marketing. The subsequent paragraphs discuss unethical network marketing practices and ways and means of operating a legitimate network marketing business.
There is a lot of debate on the definition of network marketing. However, all definitions seem to agree that network marketing involves the sale and distribution of products or services through a network of a large number of independent agents. This network is created by an initial recruitment of agents who then recruit agents and this goes on till a large network is formed. These agents are paid consideration for the products that they sell and also for the products that are sold by the agents recruited by them. The agents who recruit form the ‘upline’ while the recruited agents form the ‘downline’ of the recruiter.
It is necessary to know why network marketing as a business model appeals to individuals and businesses. For businesses, the obvious reason is the savings in terms of not having to hire full-time sales people for marketing their products. Most schemes recruit people through promises of unlimited rewards and financial freedom. They also circulate success stories of people who have worked as sales personnel and who now earn loads of money. In short, these schemes appeal to the greed of people. To most individuals, these schemes seem to be more beneficial than traditional retirement plans. This is however, far from the truth.
Most network-marketing schemes however, eventually turn out to be pyramid schemes which are recruitment-driven rather than being retail-focused. Pyramid schemes ask individuals to make sizeable investments and in return grant them the license to recruit others. The investor makes money when his or her recruit gets other recruits into this network. These schemes are fraudulent and exploitative as people who enter the network at an early stage make money while those who enter late often lose money as there is a limit to the number of people who can be recruited into the network. Also, the compensation given to the investor comprises of the investment made by his or her ‘downline’ as they enter the network.
An example of a pyramid scheme is the Ponzi investment scam. Ponzi invested $150 and asked a group of his friends to invest the same amount and promised them a return of 50% in 3 months. He then asked a bigger set of friends to invest the same amount and used this investment to pay back the first set of friends with the said rate of return. Thrilled by the returns, the first set of friends enthusiastically promoted this idea and this scheme spread rapidly. Although the initial set of participants received handsome returns, the people who entered the network at a later stage lost money as there were no more people who were left to be recruited. This clearly is a recruitment-based scheme. The scheme looks the same even if a product is introduced to make it seem retail-focused.
Businesses based on network marketing can also be operated by legal means. Since a network marketing scheme can easily transform into a fraudulent pyramid scheme, requirements need to be followed for the scheme to be declared as legitimate. A legitimate network marketing scheme must monitor the performance of its recruited agents to ensure retail sales and should charge low one-time fees for an individual to purchase the right to market the product. Also, it should have buy-back policies for situations when an agent is stuck with excess inventory when the market becomes over-saturated. These requirements are necessary but not sufficient to ensure a legitimate network marketing business. The subsequent paragraphs examine these requirements in greater detail.
The first requirement mentioned involves monitoring of the sales force to ensure retail sales. It could however be possible that the uplines in the business are pressurizing the downlines to increase purchases in order to reach a higher level in the scheme in order to avail better commissions. This would again become a fraudulent scheme where are sales are being made to other sales personnel or for self-consumption instead of being made to end-users. A business using the network marketing model should therefore document the sales being made to end-users and compensation should be tied to the same in order to be ethical.
The second one requires businesses employing such schemes to have low one-time charges for an individual joining the business in order to be ethical. If a business is making most of its money from the one-time fees charged to an individual for joining the company, then it could be possible that the business is recruitment-centred and hence unethical. But determining whether the one-time fee charged is low or high is difficult as it would depend upon the context of operation of the business and the purchasing power of individuals in the country of operation of the business. To ensure that the business remains ethical, the company must frequently monitor its upline accounts to ensure that they do not charge higher upfront fees than that declared by the company in the beginning. It should also provide protection to its new recruits by providing for return of inventory and sales kits for those who have second thoughts about entering the network. Also the upfront fee should be clearly defined. As stated by the Federal Trade Commission, the upfront fees include rental spaces, telephone charges and the like. A company might charge low one-time fees in the beginning but then pressurize new recruits to pay charges of the nature mentioned above which might be substantial. This could also lead to the business becoming more recruitment-oriented and hence unethical.
The third condition that is required to be fulfilled by network marketing schemes in order to be legitimate is that companies should have a buy-back policy for its inventory so that its distributors can exit the network easily. This policy would help provide protection to the sales personnel and also enable them to get back some portion of the money that they might have spent in acquiring inventory. To make this policy effective, the company must ensure that the downlines are aware of such a policy. The downlines, however would continue to remain at risk if they have to persuade their uplines to buy back their inventory and if the upline is to set a price for the inventory since they have absolutely no incentive to buy back inventory at a fair price. To provide true protection to the downlines, the company should set a minimum fair price for returned inventory and in case the uplines do not provide a fair price, the company itself can buy back the goods at the minimum price declared. It is important that companies employing network marketing schemes make it easy for downlines to exit the network. This is because the uplines who often coach and mentor them would pressurize them to stay back as they make money out of sales made by the downlines. For this buy back policy to be effective, the company should have clear guidelines and not play games with the sales personnel who want to exit.
Network marketing poses many ethical challenges as is evident from the above discussion. Employing such a business model and succeeding in that endeavour is difficult. Network marketing cannot exist without recruiting a large network of independent agents but in order to be sustainable, it is necessary that it follow ethical practices. However there are true success stories such as that of Amway which believe in ethical network marketing. However, ethical network marketing is possible only if the people joining the network are aware of its many fallacies. As long as people enter the network to satisfy their greed, such unethical schemes will continue to rise and exploit individuals financially.
The Article has been authored by Ananya Rath, IIM Ahmedabad.