- How To Handle Pyramiding and Proselytizing in the Direct Selling Industry
(Speech delivered by Josiah Go during the 1st Direct Selling Management Conference held August 9-10, 2001 at the AIM Acceed Center, Philippines)
Ladies and gentlemen, good morning.
I shall divide my presentation into 2 parts: The first part deals with pyramiding, while the second one with proselytizing (or more popularly known as piracy of distributors).
In 1995, a Texas-based company called AuQuest International started offering gold coins, among other products. The company used the binary compensation plan allowing individuals to buy up to seven business centers with US$200 personal business volume qualification for each of these center.
In May, 1996, AuQuest was sued by the state of California and the Monterey County District Attorney’s office. It was charged, among others, with conducting a pyramid or endless chain scheme. The state brought three lawsuits, including criminal felony charges against the owners, an injunction lawsuit against the company, as well as a separate lawsuit seeking to confiscate US$328,000 seized in Houston bank accounts. The company countered with its own lawsuit against the government officials for violation of their civil rights. The Monterey County Superior Court issued a temporary restraining order and a preliminary injunction.
Today, we read parallel cases in the Philippines and elsewhere. Consumers would complain, the Department of Trade and Industry and / or the Securities and Exchange Commission would investigate and file the appropriate charges against these so-called pyramiding companies. The defendant companies, on the other hand, counter sue to convince the Court of Appeals to issue a temporary restraining order against government authorities, so they can continue operations and refer to it as freedom, their mockery of the network marketing concept.
What is Pyramiding?
Pyramiding is an illegal money scam, often confused with legitimate network marketing plans, where people are convinced to pay money for a chance to profit from the payments of others who might join later.
Why is pyramiding illegal?
- Pyramiding violates the Consumer Code of the Philippines, specifically Article 53 of Republic Act 7394, which states “Chain distribution plans or pyramid sales schemes shall not be employed in the sale of consumer products.”
- As far as the Securities and Exchange Commission (SEC) is concerned, they treat this type of scam as an illegal sale of investment contract or securities.In its simplest explanation, a security is best thought of as a “passive investment”, where the return on money invested is substantially caused by one other than the investor, i.e. not solely from your own work. For instance, investing in the stock market is a passive investment.Like the stock market, an investment in a multilevel program which involves headhunting and inventory loading, where distributors expect to profit not by selling products to retail customers but by merely introducing other investors is actually classified as an unregistered investment contract in the United States. I shall share the Philippine scenario before I end this section on pyramiding.
- History has shown that plans that pay commissions for recruiting new distributors inevitably collapse when no new distributors can be recruited. And when a plan collapses, most people — except those at the very top of the pyramid — lose their money.
How to recognize pyramiding vs. legitimate network marketing?
There are many companies using pyramiding schemes today. They manipulate the get-rich-quick mentality of many people. They take advantage of the lack of manpower of the government in monitoring these schemes and they exploit certain ambiguities of the law by going around its real intent.
For instance, Article 4 of the same Consumer Code defines Chain distribution plans or pyramid sales schemes as “sales devices whereby a person, upon condition that he makes an investment, is granted by the manufacturer or his representative a right to recruit for profit one or more additional persons who will also be granted such right to recruit upon condition of making similar investments: Provided, That, the profits of the person employing such plan are derived primarily from the recruitment of other persons into the plan rather than from the sale of consumer products, services and credit: Provided, further, That the limitation on the number of participants does not change the nature of the plan.”
In the above definition, unscrupulous companies offer token products to go around the intent of the law, hiding under the pretext that they are offering products, even if these products:
- have no real world value,
- are priced in an inflated manner,
- or have both no real world value and are priced in an inflated manner.
Fortunately, by defining the 4 basic truths about legitimate network marketing operations, we can easily spot pyramiding. As I present these 4 truths, I shall also present some case studies. You be the one to determine whether these can be classified as pyramiding.
What are the 4 truths about legitimate network marketing companies as practiced by members of the Direct Selling Association of the Philippines (DSAP)?
- Low entry barrier — When distributors signs up, sales kits are sold at cost. There is no other investment required and distributors are not forced to buy training materials or sales aids. This is because companies should not be dependent on selling the business opportunity alone, nor should they resort to merely selling sales aids at exorbitant prices while awarding commissions. Doing so establishes what is actually a headhunting or pyramiding system.
2 tests of low entry barrier exist. The first is to determine if people are recruited and asked to pay amount not proportionate to the reasonable content of the firm’s sales kit and second, whether distributors are paid based on recruiting.Case Study 1 — Suppose some cookware companies would charge close to P3,000.00 registration fee per participant just to attend a hyped-up business opportunity meeting and about half of the amount goes to the upline. Wouldn’t headhunting or recruiting become the prime task here? After all, the distributors can make substantial money by simply recruiting. Imagine, for every person recruited, a distributor makes close to P1,500.00, recruit one every day and the distributor makes close to P40,000.00 a month without selling a single product.
- Fair market value/regular retail requirement — Fair market value is defined as price determined in an open market system, while regular retail requirement is defined as an ongoing buying and selling of a firm’s products to customers who are not distributors.
2 tests of fair market value/regular retail requirement exist. The first is to determine if consumers would still be willing to buy a product at its quoted price even without participating in the compensation plan. The second is to ask “If all recruiting stopped today, would the company still be able to pay monthly commissions in the immediate future?Case Study 2 — this type of companies offer compensation plans that only require a one-time purchase. The rationale is quite simple, would products of no real world value or sold at inflated price be able to really attract retail customers? If not, wouldn’t their real product be the business opportunity. But think about this for a moment. If only one-time purchase is required, where is the new money coming from to pay the commissions? A company can only pay to the extent of the money they received, so the only way the program can continue is if the participants continue to do recruiting. Is this not a type of pyramiding? For instance, do you think people will buy gold coins at US$700 without joining the compensation plan when the market value is less than half of that? Can evidence be presented that there exists substantial retail sales to non-plan participants at US$700?
- No inventory loading — direct sellers make money by simply booking orders, not committing to a substantial investment that may cause financial distress to the distributor subsequently. On the other hand, pyramiding companies do not ask their distributors to buy products to sell to consumers, they are instead asked to buy into a position.
To circumvent the law, tangible products are added as a way to go around encouraging people to invest and “to move money” to make money!
A test if inventory loading is not being practiced is to determine whether firms have a safeguard policy against excessive purchases. Firms can actually enforce a policy not to sell to distributors unless at least 70of previous stocks bought have been sold, plus a reasonable buy-back provision, which I shall discuss later.Case Study 3 — Certain types of compensation plans, often called binaries, offer potential to earn more by investing in multiple business centers, with the requirement to invest more money in each business center, isn’t this inventory loading in disguise? Wouldn’t inventory loading be considered a substantial investment subject to the SEC rules? In the United States, an investment of US$500 to US$1,000 is already considered substantial. It would be interesting to know how many percent of those involved in binaries actually have multiple business centers, because the emphasis of many binaries program appears to be that to convince people to buy multiple business centers than the purchase of product for resale to the ultimate non-plan participant consumer.By the way, for those not familiar with binaries, these are actually a relatively new innovation in compensation plan where a distributor is limited to recruiting only 2 people directly under them. This allows for “spill over”, which means that new distributors are enrolled in the next available position below existing distributors who have already filled up the maximum available positions of a certain level.
An upline can again sign up to become downline of a downline by buying so-called business centers. Please do not get me wrong, I am not against binaries per se. I am against inventory loading. It would be great if binary companies will allow additional business centers without additional cost to the qualifying distributors.
- Low exit barrier — protection is given independent distributors who may want to get out of the direct selling distributorship business.
A test is to determine if the company offer a “buy back” policy at a pre-determined formula that the firm will repurchase, within a reasonable timeframe from last purchase, the unsold, unopened, unused, unexpired, undamaged inventory held by distributors resigning from the company.Case Study 4 — Closely linked to Case Study 3, when products cannot be returned within a reasonable time frame, wouldn’t that allow opportunity for irresponsible inventory loading? Wouldn’t that also suggest that the product may not have real value making it difficult to be sold in the marketplace?
What is being done about pyramiding?
- The most recent prosecution of several website companies by the SEC under Chairman Lilia Bautista shows that the SEC is serious and decisive in purging pyramid schemes hiding as network marketing companies. They have classified these companies as selling securities or investment contracts that need prior registration and approval by the SEC.
However, in the Philippines, since there is not much precedent, the interpretation of the Philippine Court will now serve as the backbone of the direct selling industry. A decision different to how the U.S. court treat pyramiding will open a flood gate of pyramiding companies in the future and put the legitimate direct selling industry at significant risk.
- The DSAP has in the past used the print media to regularly warn the public about pyramiding. To this day, it has made itself readily available to the Department of Trade and Industry (DTI) and the SEC for education, consultation or simply to provide a second opinion about companies suspected to be a pyramiding front.
- Individual companies like Amway and Waters have come up with their own anti-pyramiding campaign and brochures.
- At the De La Salle University, students who took a 3-unit full semester “Network marketing and direct selling” course decided to launch an anti-pyramiding website. (The essence of education after all, is in being able to apply what it learned inside the classroom and thereby become productive members of the society). They have decided to help protect consumers and fight pyramiding via the education route, supplementing the effort of the DSAP.
You will see that it only takes commitment to get anything done. Another group of students printed and distributed thousands of brochures while a third group saved their “baon” so that anti-pyramiding posters can be posted in the DTI and other government offices nationwide. The Junior Entrepreneurship Marketing Association (JEMA) of La Salle has adopted and institutionalized this anti-pyramiding project as a continuing social marketing project.
Effort will continue to be done to get rid of pyramiding companies disguising as network marketing companies. These wolves in sheep clothing are not a welcome element in the direct selling industry. There are plans and programs continuously being set up whether via media or education where the DSAP will definitely be more proactive in formulating a common stand to eradicate pyramiding. In the end, the DSAP and other concerned groups will continue to fight pyramiding because self regulation will always be better than government regulation.
Now, I turn to my second topic on proselytizing, which is a problem every direct selling company faces almost every year.
Proselytizing is the act of recruiting co-distributors to join other companies to the detriment of the upline and the network marketing company. In short, it’s about a distributor or distributors raiding a company’s sales force for another company for personal gain. The distributor can either be connected to or have departed from the original company.
Why is proselytizing unethical?
- There are over 75 million Filipinos, the market is so big out there, there is no need to get people from somebody else’s group. In a way, it’s like looking for a spouse, find someone single and not from among those who are already married.
- The raiding distributors have somehow been benefited when they were still connected with their original company, it is unthinkable that they now turn their backs and attack the company that enabled them to once support their families then.
- The upline spent so much time and effort to train and develop their own downlines. In the case of the raiding sales leaders, the predictable outcome is that downlines will most likely follow the uplines, therefore, a group reaction designed to affect the uplines as well as the company would naturally happen.
- There are universal laws against unfair competition. Would you like other people not only to raid your downlines but also to tell them to stop selling for your company?
- The downlines recruited will now be junkies. History has never been on the side of junkies who are affiliated with several direct selling companies. They will become mediocre in their career.
Why do some distributors do it despite having a big market for recruits?
- They are usually disgruntled. They may have been disqualified for a major promo and expect management to exempt them from the rule. They may not like management policy. They have grown sick of being number 2 or 3 to someone for a long time, or they have been terminated for cause.
- They believe that there exists a free market and they can do anything to improve their own interest, even if they will resort to short-cuts.
- They believe that they “own” their downlines (actually no one is owner, not even the company, the downlines own themselves).
- To the narrow minded, they actually believe that their market for downlines is limited.
How Can Companies Fight Proselytizing?
- There must be moral authority by the company of not encouraging their distributors to do so. Otherwise, a culture of proselytizing may unconsciously be developed.
- Institute a clear policy vs. proselytizing in your distributors business manuals. Proselytizing is not only detrimental to the company, it is also detrimental to the uplines. All distributors are entitled to protection of their recruits as they spent countless time and effort in helping their recruits start-up their business and become successful. Therefore, if the proselytizing issue is well defined in the distributors business manual, the uplines affected can file a complaint for violation against established ethical norm.
- Enforce confidentiality in using print-outs of genealogy report in recruiting. Make sure your business policy explicitly include a provision that family tree reports are a trade secret, also ensure that the actual printout indicate the same provision. You can then consider legal remedies if the case warrants it assuming the raiding distributors cannot get the report elsewhere easily.
- Balance everything, inaction or slow action on the part of management may not only position the company as easy target for future raiding, but may affect trust and confidence of uplines towards their company.
- Decide all issues based on facts, and not hearsay. Emotions always run quite high in direct selling companies, this is natural, as direct sales involves direct ego involvement. Sometimes however, facts get distorted when too much emotions come into the picture. Management should talk directly on those solicited and not to those saying their downlines have been solicited. When done properly, management may soon realize that there may be a big gap between what was claimed and what really happened.
- Lastly and most importantly, have periodic evaluation of the attractiveness of the company’s business opportunity. Impartiality is of course the key in assessing whether a company still provides in a competitive manner the 3 elements that are expected by any distributors: quality of their product value, quality of their company (training, management support, customer service, etc.) and quality of their compensation plan. If there is a need to redirect towards greater effectiveness, the company should not hesitate to move towards that direction, otherwise, it will not be able to solve the root cause of proselytizing.
In essence, business and government entities need to get their acts together by defining clear rules and commit to proper implementation. The direct selling industry must take the lead towards self-governance to protect the distributors and consumers against illegitimate practices and low quality products. Together, we can help improve a lot of lives with good business opportunities for many Filipinos. Let us help improve people make an intelligent choice by educating them.
Thank you for your attention.