A pyramid scheme is a business model that involves the exchange of money primarily for enrolling other people into the scheme, without any product or service being delivered. Pyramid schemes have been in existence for at least a century. The method of conducting business known as multi-level marketing (MLM), as well as matrix schemes, often closely resembles pyramid schemes.
Pyramid schemes come in many variations. The earliest schemes involved a chain letter distributed with a list of 5-10 names and addresses on it. The recipient was told to send a specified small sum of money (typically $1 to $5) to the first person of the list. The recipient was then to remove this first person from the list, move all of the remaining names up one place, and to add his own name and maybe more other names to the bottom of the list. Then he was to copy the letter with new name list to the individuals listed. And hopefully this procedure was to be repeated and pass on and then he would be moved to the top of the list and receive money from the others.
Success in such ventures rested solely on the exponential growth of new members. Hence the name "pyramid", indicating the increasing population at each successive layer. Unfortunately, simple analysis will reveal that within a few iterations the entire global population would need to subscribe in order for all of the members to earn any income. This is impossible, and the vast majority of people who participate in these schemes simply lose their money.
Although pyramid schemes have been declared illegal, they still persist in many forms. While schemes simply involving the blatant exchange of money have generally disappeared, many schemes persist that purportedly "sell" a product to mask the primary intention of simply enrolling new members. One debatable example is Quixtar, a reincarnation of Amway, though the Federal Trade Commission determined in 1979 that Amway was not an illegal pyramid scheme, and Quixtar is structured very similarly. While they both are structured with sales in addition to membership commissions, the support structures for these companies appear to derive income solely from new member acquisition. People who decide to join solely because of the "motivation" without the understanding that they are also sales organizations are most likely just sending money higher up the support pyramid.
The distinguishing feature of these schemes is the fact that the product being sold has little to no intrinsic value of its own. Examples include "products" such as brochures, cassette tapes or systems which merely explain to the purchaser how to enroll new members, or the purchasing of name and address lists of future prospects. The costs for these "products" can range up into the hundreds or thousands of dollars. A common Internet version involves the sale of documents entitled "How to make $1 Million on the Internet" and the like.
Pyramid schemes are popular on Ebay. A person will auction a "link" to a website that specifies where a product can be bought for £20, usually an unreleased mobile phone model, mp3 player or other electronic goods. These websites are bogus, and you will be required to subscribe other people to the pyramid scheme before you get your product.
There are numerous pyramid schemes that sell such intrinsically worthless products which market themselves as "multi-level marketing" programs. This is unfortunate, because there are in fact a number of perfectly legitimate businesses which use this MLM business model.
The key identifiers of a pyramid scheme are:
- A highly excited sales pitch
- Vaguely phrased promises of limitless income potential
- No product, or a product being sold at a price ridiculously in excess of its real market value.
- An income stream that chiefly depends on the commissions earned by enrolling new members.
- A tendency for only the early investors/joiners to make any real income.
The key distinction between these schemes and "legitimate" MLM businesses (e.g. Excel Communications) is that in the latter cases a meaningful income can be earned solely from the sales of the associated product or service. While these MLM businesses also offer commissions from recruiting new members, this is not essential to successful operation of the business by any individual member.