Note: The author is a former chairman of the Direct Selling Association of the Philippines and is the first professorial lecturer on network marketing in the Philippines and in Asia. He is recipient of The Outstanding Young Men (TOYM) award in 2001 for business education.
- What is a Binary Plan?
- Why is the Binary Plan Attractive?
- What are Limitations of the Binary Plan?
- What is the Problem with Binary Plans?
- What are Remedies to Defective Binary Plans?
Since the entry of several multinational network or multilevel marketing companies in the Philippines starting the mid 1990s, many local companies have also taken advantage of the popularity of network marketing schemes by adopting it as their preferred distribution method of their products or services. Unfortunately, many have also abused the relative newness of the concept by introducing schemes that not only deviates from the original intent of network marketing, i.e. legal distribution of products and services that are priced fairly, but also dangerously borders on illegal pyramiding schemes. Already, government agencies have filed cases against highly publicized companies promoting internet-based services charging exhorbitant fees.
Among the newer network marketing compensation plans being used (and abused) nowadays is the binary plan. An ordinary housewife or employee would most likely encounter people selling them anything from gold coins, web-based products, prepaid cards, training services, and lately pre-need plans from companies using binary plans. There is no law that states that a binary compensation plan is illegal or is a pyramiding scheme, however, binary plans, being one of the 5 more popular types of network or multilevel marketing compensation plans, operate under the same laws that govern other multilevel marketing schemes, specifically the provision that disallow the practice of pyramiding schemes. Article 53 of R.A. 7394 of the Consumer Code of the Philippines state “Chain distribution plans or pyramid sales schemes shall not be employed in the sale of consumer products.” Network / multilevel marketing companies, including those using binary plans, must therefore clearly distinguish themselves from those operating pyramiding schemes.
What is a Binary Plan?
A binary plan is a network or multilevel marketing compensation plan, which allows distributors to have only two direct or first-level distributors. Any additional distributors sponsored have a “spillover” effect, meaning; they are placed at levels below the sponsoring distributors’ first-level.
Why is the Binary Plan Attractive?
There are 3 common reasons why the binary plans are quite attractive to both distributors and companies:
- The “spillover” concept attracts new distributors because technically, they can receive commissions by sponsoring only two distributors and let uplines (those who signed up earlier) do the “spillover” for them.
- Binary plans are quite simple to understand. This allows distributors to duplicate their effort easier, a necessary tool to succeed in network/multilevel marketing.
- Binary plan offers fast-paced growth opportunities, which attract the segment of our population who wish to “get-rich-quick”.
It is said that there are only two types of motivation — greed or service to humanity. Binary offers a potentially quick way to make money while providing a “service” that allows recruits to earn from the same method. Given the above, it is understandable that more and more companies have adopted the binary compensation method to attract new distributors.
What are Limitations of the Binary Plan?
The primary limitation of the binary plan is that distributors must “balance” sales from their two first-level legs to receive commissions. This typically means that the number of sales from the right first-level leg (example: 5 pre-need plans) must balance with that of the left first-level leg (example: 5 pre-need plans too). In some companies, exact balancing of the two first-level legs is not required but sales from one leg must not be greater than a specified percentage of the distributor’s total sales, for instance, one leg must at least account for 1/3 of the total sales.
What is the Problem with Binary Plans?
Legitimate network/multilevel marketing companies have been grouped together with the bad eggs of the industry. The worst scenario in the late 1990s was the realization that China banned all direct selling or network marketing operations because of the presence of many unscrupulous individuals and companies that gypped consumers of their money into investing in pyramiding operations. Government of other countries have also been more vigilant in protecting consumer interest.
Since binary plans are quite new and do not have any precedent in the Philippines, a look at the abuses of binary plans in the United States reveals potential huge penalties not only to the companies operating binary schemes wrongly but also to the independent distributors promoting them, to wit (source: Spenser Reese, 1997):
- On February 4, 1997 the Arizona Attorney General entered into a settlement agreement with Tele-Sales, Inc. wherein the company was required to pay a $25,000 settlement fee. More importantly, however, the Arizona Attorney General also sent letters to the company’s top distributors in the state, accusing them of violating the state’s pyramid law. The letters demanded that the distributors enter into a settlement agreement and that each individual distributor pay a $25,000.00 fine, otherwise, the Attorney General would sue them individually.
- On February 28, 1997, the Alameda County Prosecutor and the California Attorney General entered the offices of Destiny Telecom and seized business records to be used in actions against the company. The same day, they filed a $20,000,000.00 civil suit against the company, alleging it was promoting an illegal pyramid. Two weeks after the suit was filed, Destiny settled the case for $1.6 million.
- In 1996, Strategic Telecom Systems, Inc. was investigated by the states of Pennsylvania and Florida, which resulted in fines against the company, and the imposition of sales requirements, which required the company to dramatically change the way it conducted and promoted its business.
So why have government regulators in other countries been increasingly paying attention to companies utilizing binary plans than the more traditional compensation plans like stair step/breakaway plans adopted by the most members of the Direct Selling Association?
- The stair step/breakaway plans popularized by Amway have been ruled legal in a landmark decision by the U.S. Federal Trade Commission in 1978.
- The legal principles governing the network marketing industry have not been adhered to in many binary plans, leading to the belief that they are pyramiding schemes. These includes:
1. Emphasis on recruitment
Companies paying its distributors based on the recruitment of other distributors rather than for legitimate sales to end consumers are guilty of pyramiding. In this day and age, no company in their right mind would of course expose themselves to outright pyramiding. Most would sell some products or services to hide the scam but their products or services have no real world value and/or are overpriced such that only those interested to participate in the compensation will buy these products just to comply with their company’s requirements.
A good test is to ask, “Is there a direct one-to-one correlation between recruiting and distributors’ commissions?” If the answer is yes, it is a pyramiding case. An investigation of the many binary plans reveal that many companies classify the enrollment of a business centers as a sale, hence the problem.
Another good test is to ask is “If recruitment were to be stopped today, will distributors still make money?” if the answer is no, isn’t the principal source of commissions coming from recruiting and not from retail sales? hence, a pyramiding.
A 3rd test is to ask is “Will people buy without joining the compensation plans?” If the answer is no, the products being sold have no real world value and/or is overpriced, hence, a pyramiding. If a product is priced so high that no reasonable person would buy it, it is obvious that the main motivation for distributors to buy the product is to join in the company’s compensation plan, a pyramiding scam (profiting from recruiting) disguising as a legitimate network marketing operation.
2. Buying of multiple business centers
When a distributor enrolls, he is automatically assigned his first business center or a position within his own personal sales organization (PSO). To maximize earnings, the distributor are then strongly encouraged to purchase additional business centers and place as much as seven business centers at strategic locations within his PSO with each business center costing a few thousand pesos each for a total of a few hundred thousand pesos. Each of these business centers must independently meet their two recruits requirements with their corresponding purchase. However, the probability that a distributor will be able to use or resell these inventories is dubious.
Three important questions must be asked as far as purchasing multiple business centers are concerned:
- Isn’t the intent to sell “positions” more than to sell products to end consumers?
- Isn’t there existence of significant investment and inventory loading?
- Isn’t the focus to gain from recruiting rather than sale of products since upline distributors get commissions on the purchase of these business centers?
- Unregistered Investment
The Securities and Exchange Commission (SEC) regulates selling of investment instruments. The relatively big amount of investment required for buying multiple business centers may constitute selling an unregistered investment contract, a serious offense where both criminal and civil penalties can be imposed to the offender. Since binary plans are known for their “spillover” effect, the distributor-investor is led to anticipate profits primarily from the efforts of the others, constituting a passive investment.
The above are some of the more obvious violations of binary plans. Unfortunately, when pride and emotions get in the way, logic is seldom followed and the companies, as well as the plan originator, defend their defective binary plans instead of listening to potential remedies.
What are Remedies to Defective Binary Plans?
Binary plans can be designed to operate and be implemented legally as follows:
- Balance must be done between recruiting and retail sales of products, as evidenced by a significant number of non-plan participants who purchase products without signing up as a distributor. This can be done by allowing distributors to qualify for commissions or subsequent commission phases after they have complied with personal retail volume.
- Consumers must have a compelling reason to buy from a network marketing company. For example, given the wide availability of phone card retail store outlets nationwide, there is no compelling reason for a consumer to buy a phone card through a binary plan. The likelihood is to simply participate in a compensation plan.
- Retail prices must be fair to encourage retail sales opportunities. Fair market value means price determined in an open market system where consumers are willing to buy a product at its quoted price even without participating in the compensation plan.
- To avoid a direct one-on-one relationship between enrollment and commissions, payment of commissions must not be based on balancing the number of enrollments in each leg but in the sales volume in each of their legs.
- Income must not be primarily dependent on the efforts of others. Companies must require personal involvement by distributors. This they show by training and motivating their downlines continuously, as well as do personal retail sales.
- Never use the line “get 2 people and let the system work for you!”
- Limit the number of business center a distributor can buy to 3 instead of 7, and
- Initiate a buy-back of unwanted inventories program. This policy will at least discourage inventory loading which is disapproved by all members of the Direct Selling Association of the Philippines.
- Buying of additional business centers must be based on qualification, not investment. This can be done via removing all mandatory purchase requirements from the multiple business center program of binary plans. Qualification can be awarded after a distributor has shown personal involvement in downline management. For example, attaining a specific group sales volume (not number of people) in a specific number of months.
Binary plans are not illegal per se. It becomes illegal if the design is abused to create wealth from recruiting. Government regulators will take an increasing role in reviewing binary plans. Based on U.S. experience, a negative publicity alone from a government investigation is enough to make distributors and prospects of a binary company nervous, seriously impairing its ability to be a continuing concern.
To existing binary companies violating certain practices, there is still time to correct these deficiencies before government regulators catch up and force these changes through regulatory actions.
To prospective binary companies, the “Law of Foolish Fellowship” must be avoided — just because a competitor or many companies are joining the bandwagon does not mean you should jump into it quickly without reviewing the elements that make up a legitimate network/multilevel marketing operation.
A final warning — Beware of too much emphasis on speed. It may eventually cost you more!