But you can also make money by authorizing and recruiting other people to become salespeople. You make money off their investments, their own investments, the recruits who are salespeople, inventory purchases and so on and any sales they make. Not only that, you can make money on the people that they recruit. So you become put in a position where potentially, you can be at the head of this very large, exponentially unlimited, no cap sales force below you. Every person is told the same story. No recognition of market saturation. No recognition of limited numbers of people available for this sort of thing. So this is a new model. It has inherent flaws in it, of course. It has inherent tendencies to fraud. (Read More: 'Don't Call Me a Multi-Level Marketer'.)
Q: But it's legal.
A: It is questionably legal. It is not a settled matter at all. And in fact, we have no law in the United States explicitly defining a pyramid scheme or explicitly defining multilevel marketing. The Federal Trade Commission did consider a rule recently, this past year, that would define multi-level marketing but it was ultimately dropped.
Q: How many multi-level marketing participants fail?
A: Ninety-nine percent don't ever make a net profit.
Q: How do you know that?
A: Well, I studied the income disclosures that are available from representative companies. And many of them have been forced by lawsuits and regulatory actions to present some basic data. It's presented in a very insufficient manner, but with a little analysis, a little extrapolation, the data is there. (Read More: How Multi-Level Marketers Dodged a Bullet.)
Q: If 99 percent lose, 1 percent does make money. But where does that money come from?
A: It would show that it came from the people's-- that lost the money. It came from their investments. It would disclose that nobody is actually earning a net profit from what the business claims to be -- retail selling, direct selling -- that in fact, the money they made came from the investments of the other distributors who had joined and failed.
Q: You wrote something called "The Main Street Bubble." In there, you said that you believe that the MLM industries-- losses are substantially greater than the Madoff affair. Explain.
A: Well, we're talking millions of people. Madoff conned a relatively small number of people with investment money. Multilevel marketing is using a different system. Instead of taking a million dollars from 10 people, you take $10 from a million people. That's the way the system works. I'm just using that analogously. But the numbers add up to be staggering amounts, year upon year upon year.
Q: You talk about the amount of money that's being lost. How much money is being lost?
A: Ten-- tens of billions.
Q: How do you know that?
A: Well, again, you just take the numbers of people who are involved. Look at how many could and have earned a net profit. Therefore, you can determine the losses. Multiply those losses over years. And you're up into the tens of billions of dollars, far more than Madoff's one single hedge fund scam.
Q: Are all multilevel marketing organizations bad?
A: Well, I haven't studied every one of them. But I think they can be graded somewhat as to the levels of deception and the levels of ultimate consumer losses. The party plan companies where people gather in homes and they demonstrate the product cost significantly less. (Read More: Before You Join: Six Questions to Ask.)
Q: Like Tupperware?
A: Yeah, the difference would come in the harm that it could cause, because the Tupperware's business plan requires holding these parties. And then those parties will generate legitimate customers, who will come in and they will buy the product. The product is a known quantity. It's competitively priced. Okay, now that would be at the upper end of the multilevel marketing.
Q: All right, where's the magic line for a multilevel marketing company?
A: The line is determined by asking one question. Where does the money come from? It's a business opportunity, a business opportunity based on what? Is the money coming from external to the chain? This is the same question, by the way, asked of all Ponzi schemes. Where did the money come from that you paid those earlier investors with? Did it come from later investors, or did it come from profitable business that you were transacting?
Q: How do you determine that?
A: Well, somebody has to ask the question to the company. That's what the business opportunity rule was supposed to be partly about, to figure out "what's this business really?" Because think about this: This company, the multilevel marketing, has the capacity for generating revenue in a most powerful way. (It) would not be legitimate, but it could be done to sell a business opportunity based purely on endless recruiting of other investors.