A startup founder approached me a few days ago with a multi-level marketing (MLM) idea. I’ve tended to stay away from MLM–when I was a little boy my mother became involved in distributing vitamins in a well-known American MLM company. They had a good product but I remember well how frustrated she became when friends refused to ‘see the light’ and buy into the pyramid.
But the world is a different place today–social networking makes it possible to reach out to a much wider group to find those interested in your product. But, at the end of the day, the end-user price can only afford so much margin, and that margin can be divided among a finite number of participants in the MLM pyramid. So I tend to remain a bit skeptical of MLM businesses.
Nevertheless, when this founder approached me I did my due diligence and found to my surprise that there has been a significant development in MLM jurisprudence, namely: The Federal Trade Commission v. Burnlounge Inc., in the U.S. Federal District Court for the Central District of California. This is a very significant decision for those of us outside of the U.S. because the U.S. tends to be in the forefront of MLM jurisprudence & analysis and the court chose to articulate with some care the considerations that will allow a MLM business to pass regulatory muster. I’m not saying that this decision is directly applicable to businesses in Asia and EMEA, but I’d suggest that it may be persuasive, or at least of interest, to regulators in those jurisdictions.
Burnlounge had a very interesting alternative to traditional e-sales of music: It would allow its members to set up storefronts of their own and sell to customers. And those customers could set up storefronts of their own. Commissions would then be shared up the chain as in any MLM structure. Significantly, the sales of the storefront packagess, rather than the music, made up the lion’s share of the revenue running through the system.
The Court applied the following test to determine the existence of an illegal pyramid scheme:
“[Such schemes] are characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users”
Here Burnlounge took in 28M USD during its two years of operation. Of that, almost 94% was for sales of the various storefront packages–only a little over 6% was for music sales of any kind. The court would have none of it: “Both as designed and in execution, the Burnlounge enterprise resulted in a large return for a small percentage of the [participants] which was funded by the substantial losses (i.e. the failure to recoup their initial investments) of the vast majority of the recruited participants.” And as you might guess, the Court found Burnlounge to be an illegal pyramid scheme.
The court provides quite a bit of economic and legal analysis in its opinion–this is a landmark case in U.S. MLM law. Anyone thinking about MLM as part of their business plan would be amply rewarded for a careful read of this decision.