Multi-Level Marketing Business Opportunities: Analyzing Net Economic Return and Avoidable Economic Loss to Distributors

This paper analyzes the operation of multi-level marketing (MLM) distribution channels, with an eye toward analyzing Net Economic Return (NER), and the possibility of Avoidable Economic Losses (AEL), to individuals from joining as MLM distributors. The analysis takes account of possible ex ante and ex post information sets of distributor prospects and the MLM firm. Protecting prospective and incumbent distributors has been an issue of policy importance in the many cases brought by the FTC against firms accused of operating illegal pyramid schemes and/or misleading prospective and current distributors. Accordingly, the current work posits a definition of AEL that is based on both the elements of the NER from participating, and avoidable and unavoidable informational limitations on the parts of the distributor and the firm. The paper’s model allows investigation of distributors’ joining decisions, work behaviors, income, and MLM profitability under these various scenarios, and informs the question of when and whether an AEL can be argued to have occurred. The paper first examines one of the only other academic analytic modeling articles evaluating the MLM distribution channel and highlights an implicit, but crucial, assumption in this model that creates an unnecessarily aggressive criterion for distinguishing between a legitimate MLM and a suspected illegal pyramid scheme. It then develops a definition of distributor AEL that may be caused by participation as a distributor in an MLM enterprise, specifying that an AEL occurs when the MLM firm or an upline sponsor possesses information of use in evaluating the quality of the business opportunity that would cause prospects not to join the MLM, and purposefully conceals this information when it could have effectively revealed it to prospects, thus leading some to join who would otherwise not join, and resulting in their NER less than the opportunity cost of participating. An emended modeling structure is next presented, which examines MLM business opportunities when the implicit assumption of the prior article is relaxed. The model focuses on non-business-building distributors who are likely to be the most at risk to suffer an AEL. Analysis of several sub-models of the emended model structure provides a characterization of the difference between misapprehension or imperfect information (which need not imply an AEL) and purposeful misrepresentation of the nature of the MLM business opportunity to prospective distributors (which may, but does not always, imply an AEL). Among the results of the model are that it is economically rational for a person to join the MLM as a personal-consumption-only distributor; that distributors with full information do not suffer an AEL by joining an MLM, regardless of their type; that the MLM firm may reasonably target both low and high achieving distributors in a “pooling” strategy, or only high achievers in a “separating” strategy; that a pooling strategy generally grants high-achieving distributors economic rents relative to low-achievers but that an AEL does not universally accompany this difference; and that an AEL can – but may not always – result from purposeful over-stating of the quality of the business opportunity by the MLM firm. The paper concludes with implications for MLM firm information dissemination strategies and for emended criteria for assessment of possible pyramid scheme operation.