In the Netherlands, a famous slogan on TV is ‘Let op: geld lenen kost geld’ (watch out: borrowing money costs money). No money can be earned for free. With a pyramid scheme, however, people seem to defy these laws of finance and make money out of nothing. How does this work?
What is a pyramid scheme?
A pyramid scheme is a complex arrangement by which an organisation tries to raise investments solely by recruiting more members. These new members pay a fee to join and get rewarded for bringing in more investors, from whom they receive a share of their fee. The more members recruited, the larger the payment. The prospect of making a large amount of money for very little work draws people in. Quintessential for the pyramid scheme is that the source of income is almost never the sales of any goods or services and the emphasis is on recruiting more members. If every member recruits a number of people who take place in the layer beneath their recruiters, every new layer contains more people than the layer above it and it forms a likeness of a pyramid.
It’s a scam
This pyramid expands via exponential growth. That is, the pyramid gets larger at an accelerating rate. Say, for instance, that a group of five people start a scheme where they all recruit five new members. Then, the second layer contains twenty-five members, the third has 125 members, et cetera. When this is repeated ten times in total, the pyramid already comprises $5^10 = 9,765,625$ members. And after fifteen times it has exceeded the world population! Now it becomes quite clear that the scheme is not sustainable, because it will eventually become impossible to recruit any more members. Therefore, every pyramid scheme collapses in the end. For the people at the top, it can be very profitable, whilst the masses at the bottom lose everything.
Due to this very high risk of money loss and the fact that when you recruit people with promises that cannot be realised, therefore committing fraud, pyramid schemes are illegal almost all over the world. In the United States, recruiting people for a pyramid scheme is considered a felony crime and is punishable by a prison sentence of up to four years.
The Plane Game
One specific example occurred frequently in North America in the 1980’s. Here a scheme was devised where one paid to become one of eight passengers on board of an aeroplane. Also on the plane were four flight attendants, two co-pilots and a pilot, who receives the money from the passengers. When the money has been collected, the pilot ‘retires’ and everyone aboard moves up a step of the ladder and the plane ‘splits’ into two new planes: the passengers become flight attendants, the flight attendants become co-pilots and the co-pilots become pilots. Then the cycle continues.
With this scheme the more new people one brings in the sooner one can retire as a pilot and collect the money. Typical figures were 1,500 dollars to become a passenger and If one came all the way to be able to retire as a pilot one could earn 12,000 dollars. This is seemingly attractive but unless 14 members join one loses the entire payment. Versions of the airplane game were observed in four states in the US and later also in western Europe.
Multi-level marketing
Due to the illegality of pyramid schemes many disguises have been concocted. One commonly used disguise for a pyramid scheme is so called multi-level marketing. This is a method whereby salespeople are used to sell products instead of physical retail stores. These salespeople recruit and train more salespeople and earn a commission of their sales. This way multi-level marketing, like pyramid schemes, has a pyramidal structure. Due to this, many multi-level marketing firms are pyramid schemes as well.
Performing multi-level marketing is not illegal in and of itself but does get used often confused with pyramid schemes. The legal forms distinguish themselves from the illegal ones primarily if they do in fact have a source of income based on product sales instead of just recruitment. Many pyramid schemes pretend to produce or sell something, but this is normally just a cover for the pyramid scheme. The alarm bells should ring loudest when it seems a business relies chiefly on recruitment and not on a real product.
Watch out
So how does one spot a pyramid scheme? These are the most common identifiers one should be wary of:
Emphasis on recruiting: When a business focuses solely on recruiting others to join the program for an amount of money, there is a large chance that this may constitute a pyramid scheme. Take caution if there is a larger compensation for recruiting others than for product sales.
There is no real product being sold: Be cautious if what is being sold as part of the business is difficult to assign a certain value to. For instance, vague tech services or products such as mass-licensed e-books or online advertising on obscure websites. Some select fancy products to obscure the fact that it is a fraudulent pyramid scheme.
Easy (and much) money: Be wary if there are promises of money which can be obtained in large quantities and for very little work in return. It is quite possible that the returns are being financed through recruitments rather than turnover from product sales. If you are promised money only for placing advertisements or making obscure payments you could well play a part in a pyramid scheme.
Complex commission structure: Lastly, if there is a myriad of unclear rules and terms by which your commission is determined, make sure that you understand how and when you will be paid and whether the revenue comes from product sales. Pyramid schemes try there all to hide their illegal entity.
In the end, it is impossible for a business to function indefinitely without a fundamental source of income. However appealing and lucrative a pyramid scheme may appear, there is no such thing as a free lunch.