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by on June 6, 2011 Leave a Comment

Can startup MLMs sell positions to fund their businesses?

This is an important question and one I get asked often by startup entrepreneurs: Can I sell top positions in my prelaunch business to fund it? To quote my least favorite answer from law school, the answer is:

it depends

On multiple occasions, I’ve been asked about the legality of three different methods. The first method is the most common: the selling of top positions i.e. pay $50,000 in exchange for a master position in the pay plan. In a nutshell, this arrangement would be categorized as a security. See below for more info on what constitutes a “security.” If something is a “security” it needs to be registered or fit within some sort of exception. If it’s not registered, a regulator can pursue a company for selling unregistered securities.

The second method is a little more elaborate and involves selling “revenue shares” in the compensation plan for x dollars. As an example, suppose Company ABC wants to create a revenue sharing pool whereby 1% of all company revenue gets skimmed into a separate revenue pool. Company ABC thereby makes available 3 spots to share in the revenue at a $50,000 charge per spot. Do the simple math and Company ABC can conceivably “raise” $150,000 with this method. Again, this would be considered a security.

The third option is the least common. It involves the charging of enrollment fees to give users an early enrollment option and access to a “beta” version of the product or service. With a successful “prelaunch” phase, the company can generate early interest and adequate revenue to scale out the business. Unless the core product is actually sold in these early days, commissions should never be cut. However, true value can still be provided in exchange for the enrollment fee; thus, bolstering the argument that it’s not a security.

What is a “Security?”

In the Securities and Exchange Act, the term “security” is defined broadly. If you want the full definition, click here. Warning: it’s boring beyond belief. Basically, for purposes of this analysis, the important question should be: what’s an investment contract? The U.S. Supreme Court addressed this issue a long time ago in 1946. The Court held an investment contract to be:

“A contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party.”

In the SEC’s case against MLM great, Glenn Turner, the court ignored the plain meaning of the word “solely” and held, “We adopt a more realistic test, whether the efforts made by people in the organization other than the investor are the undeniably significant ones, those essentially managerial efforts which affect the failure or success of the enterprise.”

Confused yet? But wait, there’s more!

Although the Howey Test represents the position of the Supreme Court and the Securities and Exchange Commission as well as a majority of the states, there are some states that apply an additional test. This is known as the “risk capital” test set forth by the California Supreme Court. There are only a few states that use this test; however, according to a colleague of mine, it’s worth knowing. The Hawaiian state supreme court provided the following factors to help clarify this test. Those factors are:

(1) An offeree furnishes money; and (2) a portion of this money is subjected to the risks of the enterprise (i.e. we’ll take this money and build the business with it); and, (3) the investor is promised a return on the investment as a result of the the enterprise (i.e. the investment will grow without the investor doing anything); and (4) the offeree does not receive the right to exercise practical and actual control over the decisions of the business.

Using the risk capital test, a classic example of a “security” would be the “sale” of membership dues for the development of a country club. If the club is simply an idea, the collection of membership fees on the promise of having a country club eventually might be considered a security. However, as pointed out in an American Bar Association article, timing is everything as to when the funds are collected. The article states,

Start quote The risk capital test looks at whether the money being put to work in a given venture will be used to develop or acquire the business or enterprise in which the interest is offered. If that test is satisfied, then such interest is deemed to be a security. Thus, a key factor under the risk capital test in determining whether what is offered and sold constitutes a security can be the extent of the development of the business at the time the interest is purchased.. . . [W]hen analyzing the purchase of a country club membership, it is possible that otherwise identical club memberships may be a security in the hands of one member and not in the hands of another member depending on the time the member acquired the membership and the maturity of the club itself at such time.” End quote

Again, the risk capital test is not used by the SEC and is only used in a few states. But when it’s a factor, it’s a factor when people collect funds in anticipation of fleshing out a concept. If there’s a little development behind the business, it might be a different outcome. In the MLM world, it could potentially be an issue if a company collected fees from participants (in the few states that actually use the test) without providing any value in return.

Translated in English

Can a company hypothetically sell top positions for $50,000 to help fund development?

Yes, but it would likely be illegal (unless they registered the security). Applying the Howey test (developed by the Supreme Court) referenced above, ask the following question: Is there a transaction where the person expects a return based on the efforts of other people? Using the looser standard published in the Glenn Turner case, the answer would undoubtedly be an emphatic “yes.” With a $50,000 payment, even if the investor intended on building the business, the payment would be considered a security assuming the business owner promised a lucrative return on the value of the position.

Can a company create a revenue pot to be divided between investors?

Same answer as above. In this scenario, there’s no fudging. When a top position is sold, there’s at least a tiny argument that the outcome of the investment will be largely influenced by the payor’s performance. In this scenario, the money is driven 100% by the performance of the company, not by the skill or talent of the investor. In this scenario, the business owner selling the hypothetical spots would undoubtedly show financial projections demonstrating the value of those spots i.e. “if we earn $15,000,000 in revenue, you would earn $x for your $50,000 payment” Clearly, this arrangement would be considered a security.

Can a company run a prelaunch and charge enrollment fees with the hopes of raising enough money to flesh out a business?

It depends. This is where the “risk capital” test might come into play. Again, the SEC does not use this, so if it’s a concern for someone, it should only be a concern at the state level (in the states that use it). Using the traditional Howey test, the answer would likely be “no, it’s not a security.” The Howey test involves an investment whereby the person expects a return based on the efforts of other people. Charging an enrollment fee would unlikely be considered an “investment contract” under Howey. Distributors would undoubtedly understand that the enrollment fee would not appreciate in value and entitle them to future earnings. However, if they live in a jurisdiction that goes a little farther and uses the risk capital test, the question then becomes: Is the enrollment fee being used to develop the business? If yes, what’s the stage of development at the time the enrollment fee was collected? If the business was in early stages at the time the fee was collected, was the payor induced by the business owner’s promise that a benefit of some kind, over and above the initial value, will accrue as a result of the enterprise? In my opinion, based on what I’ve read, the risk capital test is rarely a factor and when it is, the investments are usually substantial. The solution: be sure to offer something of value in exchange for the enrollment fee. Instead of treating it as an enrollment fee, treat it more like a sale. If there’s a beta version of the product or service, use the prelaunch phase to test it with early adopters. Throw in some free training, perhaps give them early access to future products or give them various discounts. And be sure to wait to pay commissions until the service is fleshed out. With this scenario, the moral of the story: do not sell the enrollment as an investment opportunity and add value in exchange for the money. And ideally, get the cash before you embark on the arduous journey.

Conclusion

It’s always a challenge for MLMs to get their businesses funded. Traditional angel investors are skeptical of the models and usually want a large chunk of equity in exchange of their investment. Due to these challenges to raise funds via traditional means, many executives rely on creative methods to get the cash they need. Some of these methods are legal, some are not. The methods discussed in this post are some of the most common that I see on a monthly basis. I hope you’ve found this article informative. I’d love to know your thoughts about all of this. What do you think?

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by on May 19, 2011 Leave a Comment

Old School Marketing vs. Relationship Marketing

The market rewards people that add value daily, helping others win. As the CEO of Coca Cola recently said at the Chick-Fil-A Leadercast, “Customers are increasingly basing their decisions on a number of factors that never existed five years ago. They want more empowerment and they want to know that the company is socially responsible.” I agree! Marketing is changing to a more relationships-driven environment fueled by permission. The direct sales has been ahead of this curve for decades. The space is growing substantially and it’s only going to get better.

What are your thoughts?

Photo courtesy of @Kathy Sierra

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by on May 17, 2011 4 Comments

Amazon White Paper: Why direct sales organizations should pay attention

There’s a rather lengthy white paper on the dominance of Amazon in the ecommerce space. It’s safe to say that Amazon is absolutely dominating e-commerce. In my opinion, Amazon’s dominance impacts direct sales organizations and the white paper below is worth studying. Due to Amazon’s amazing commerce platform, it’s easier than ever for a small business or an individual to create an online presence, market private labeled products to the public, house those products in one of Amazon’s warehouses, use Amazon’s shopping cart system to process orders and use Amazon’s logistics and fulfillment capabilities to ship those products. The moral of the story is simple: if a MLM is private labeling a product and does not have the exclusive rights to a formula, the time span between uniqueness and commodity is rapidly shrinking given the low barriers to entry. With MLMs today, it’s imperative to fortify operations with unique and proprietary offerings. When the MLM sales force no longer have unique offerings and instead have to compete on price against an individual leveraging Amazon’s service, Wal Mart or any other big box retailer, they’ll lose. Due to the speed at which people can knock-off products via private labeling, MLMs need to focus on proprietary.

As a MLM lawyer, I often encourage people to lock down proprietary rights early. This includes securing a patent or negotiating an exclusive arrangement from a vendor with a patent. The more fortified your business with exclusive rights, the better positioned your leaders will be in the marketplace. Enjoy the white paper below and tell me what you think..

Amazon White Paper

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by on April 28, 2011 1 Comment

The End of Class Action Litigation in MLM?

This is an enormous Supreme Court decision for MLM companies. In a 5-4 decision, the Supreme Court held that consumers (distributors) can waive their right to participate in a class action lawsuit. The full article can be found here. The lawsuit was a case between AT&T and Concepcion. In the original lawsuit, Concepcion served as a class representative for consumers against AT&T over a nominal sum of money per consumer: $30. Clearly, $30 is not worth suing over; hence, the purpose behind the class action. But in the fine print in AT&T’s agreement there was a clause where the consumers waived their right to participate in a class action lawsuit and instead were required to arbitrate their disputes. Clever. And apparently enforceable.

This is nothing entirely new for MLM companies. However, it bolsters the argument that all disputes should occur in arbitration instead of aggregating mass numbers and filing a class action lawsuit. There’s a little bit of healthy criticism over the fairness of arbitration proceedings. As stated in the article, “Modern arbitration practices have been the target of watchdog group
Public Citizen for several years. Bills to create an Arbitration Fairness Act were filed in Congress in 2007 and 2010. In a release supporting the 2007 bill, organization president Joan Claybrook blasted the “take it or leave it” forced nature of the clause, the lack of oversight of the process, and supposed bias: ‘…(A)rbitration companies are beholden to big corporate players for repeat business, which creates a bias. They do not bite the hand that feeds them. For example, public data show that in the portfolio of one California arbitrator who ruled in 532 cases, 526 were in favor of business – a mere 1.14 percent for the ordinary consumer.’”

Brian Fitzpatrick, law professor from Vanderbilt, said if the ruling went in favor of AT&T, it would “end class-action litigation in America as we know it.” Given this recent ruling, it just got a lot easier for companies to skim a little here and there from consumers without much threat of consequences aside from a PR backlash. There’s not going to be single agreement now where there’s no class action waiver, which really takes power out of the hands of an aggrieved community, also referred to as a “class.” I have mixed thoughts on this one. What are your thoughts?

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by on April 18, 2011 4 Comments

Ending the Hype: is it posible?

Travis Flaherty uncorked a great debate on his facebook page. Speaking of facebook, fan him up on the Travis Flaherty fan page here. In a facebook note, included below, he challenges people to end crazy hype when representing a network marketing opportunity. After reading his note, I immediately got flashbacks from when I was in the field several years ago. I’m guilty of making the same mistakes referenced by Travis in his article. In fact, I was WAAAAY worse! I never mentioned the company or its products. Instead, “I drove traffic to fortune 500 websites like Disney, Home Depot and Bass Pro Shops whereby they paid us for loyalty.” I left out the part that I only received a sliver of an affiliate kickback from those stores. When asked if selling was required, I said we simply built communities of people and drove revenue to product suppliers that paid us to transfer spend from our grocery budgets and buy products from our own business. I would say, “We’re a buyer’s club and they pay us for loyalty.”  Yep, I’m guilty of breaking the rules mentioned below. With the story I was weaving, you would’ve thought I was building the next Google. Instead, I was building Amway.

Note: I’m not suggesting how I promoted the Amway business was typical for all Amway distributors. I mention this illustration to make a point: I completely understand Travis’s call to end with hype. However, when there’s a focus on recruitment over product sales, or if the value proposition is out of line with comparables in the marketplace, it’s impossible to avoid hype and hyperbole because it takes a strong emotional pitch to overcome peoples’ gut instincts. When the value proposition is off, the glorified hype is inevitable.

The first impression when a prospect joins a business is crucial. It sets the framework for their entire experience. It’s the seed that influences their behavior going forward. When you’re in the field, education for the newbie is crucial. It’s important to inform them, at some point, they’re entering a sales and marketing business. Their function as a distributor is to move product volume, hence the word “distributor.” And companies, it’s important to publish and enforce standards designed to lead to proper positioning of your brand in the marketplace so you can properly educate and, if need be, weed out the people misrepresenting the particulars of your business. Yes, there are companies out there that are willfully (and blissfully) ignorant of how their product or service is being positioned in the marketplace. But in the end, when a business fails to deliver on some of the basic elements presented in the leaders’ presentations, it burns down quick.

Travis’s note is below.

I thought about abridging it but there’s too many good points. It’s included in full below. What are your thoughts? Do you think it’s realistic to expect hype to end?

You are entering a no Spin Zone…
Warning: This article is probably the most controversial article I have written. By continuing to read on, you run the risk of being offended. If this is you, then it is likely you need to hear this information! My intent in writing this is to raise some clarity on what it means to be a TRUE ‘Network Marketing Professional’. It’s important to point out much of what I will be talking about, the examples I will be giving, I HAVE DONE PERSONALLY! As leaders, we are eager to share our victories – but forget there is even more wisdom in sharing our mistakes and past failures. It is my hope that my trial and error can help you to avoid some of the same pitfalls I’ve fallen in over the years.

There is a serious issue running rampant in Network Marketing. In fact, I believe this issue is so big – it threatens the very livelihood of our industry. Unless we, as leaders, take a stand against this problem our profession will never be taken seriously. The issue I am referring to is “The Spin” that goes on in Network Marketing. Others might describe it as “Hype”. In other words, I am referring to saying or representing something in a manner, in which the intent is to have someone assume something, that otherwise would not be true.

Allow me to provide some specific examples of what I am referring to. (Again, picking on myself for a moment) I was recently traveling internationally with my good friend and mentor, Jef Welch. We were in a cab together on our way to a business briefing. As Networkers, we naturally sparked a conversation with the cab driver by asking the normal questions; “How long have you been driving a cab?” “Do you enjoy what you do?” etc. We had a very pleasant conversation, during the drive. When we were exiting the cab I was prompted to invite the cabby to the event we would be speaking at later that evening. (Here’s where my MLM training kicked in) I started with a quick look at my watch – to suggest I was in a hurry. I complimented the driver, I had already decided on an ‘indirect approach’ since I did not have a great report with the driver. “So let me ask you a question; WHO DO YOU KNOW that might be interested in a potential six figure income opportunity, working from home?” Of course it prompted the real question I was looking for from the driver, “What is it?” he replied. I grinned with confidence knowing that I had just gained posture in the conversation. (I thought to myself, Eric Worre would be so proud!) Then I made the invite, “If I were able to get you ticket, to a very special event on creating wealth, hosted by some very powerful people might I add – would you be able to attend?” And then I continued, “Now I’m not saying I can get you a ticket, as they are sold out. But IF I could get you a ticket, for free, would you be able to make it this evening?” Now, most reading this may not see an issue with my approach. In fact, I thought it was excellent at the time. I was doing exactly what I had been trained to do. My Mentors had always taught me when inviting to build huge audacious value.

The reality is, if you really break down what I said, I suggested that this was a ticketed event. I suggested there was a fee to attend and I implied not everyone could attend – that in some way this was exclusive. Now, I know you could argue what we were to speak on was of value, that it was exclusive or ‘invite only’ – which could justify the word “ticketed”. Believe me I tried, when I was called out on this. Later that evening, Jef and I had a discussion about leadership and how important it is to have integrity at the top. I agreed. He then surprisingly brought up my approach earlier in the day, as an example of the “Spinning” that goes on in NM.

At first I was defensive. “I did exactly what I had been taught”, I thought to myself. However, after spending 15 minutes trying to defend my position, I decided to really listen to what he was saying….And he was right! Jef Welch called me out on this and I want to thank him for doing it because it’s helped me raise my game to the next level.

“Spinning” and “Hype” have been around NM since its origination. The only difference today is it’s highly perpetuated and amplified by Social Media. Another example I often see is when people post things like “500 people just joined my business in the past 7 days”, etc. This often happens in a Binary compensation plan because it allows you to build hype around fear of loss. “Get in now or else you’re missing out!” The problem is the people who want you to THINK they’re making a fortune, aren’t! What they’re not telling you is they are part of a power leg that is growing (largely because of the people above and below them doing the same thing). More often than not, they only have a few people on their inside leg, dictating their actual pay.

How about this one: “I am looking for my next 3 people to teach how to make six figures this year.” I see this all the time on Facebook and Twitter. The sentence SUGGESTS that you have already done this in the past – when in fact 90% of the people posting things like this have not! When I started in MLM, some of the worst advice I was ever given was “Fake it till you make it”. This is still very prominent in the industry today.

Now I know many of you reading this are going to say, “Well technically what I am saying is the truth, if you really look at what I am saying”. And I hear you…The question I would ask is not, what are you saying,” technically”; it’s, what are you leading people to believe or assume? Building your business upon “SPIN” and “Hype” is likened to building a foundation on shaky ground. It won’t last! You will continue to attract the bottom feeders in your business, the people who are looking to ‘get rich quick’, or catch the next free ride. My friend Jef was right; you must have INTEGRITY AT THE TOP if you want to build something that lasts. And isn’t that why we all entered into this industry – To create a long term, residual income for our family?

In closing, if you want to be a part of raising the bar in this industry, if you want to proudly call yourself a Network Marketing Professional – then it’s time to step up and declare a “No Spin Zone!” The only true way to grow an organization is to focus on what you have to offer from a personal standpoint, a systematic standpoint and most importantly – A leadership standpoint! The moment people join your team because of what YOU have to offer, when you no longer have to rely on “Spinning” to recruit, YOU KNOW YOU’VE ARRIVED!

In the spirit of success,
Travis A. Flaherty

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by on March 29, 2011 15 Comments

Small Business Administration Prohibits Lending to MLMs

I was sent this document by a friend and professional in the MLM space yesterday. It’s a portion of a federal regulation that outlines the ineligible businesses for SBA loans. The bill prohibits lending to:

“Businesses Selling Through a Pyramid Plan.”

It further states, “Pyramid or multilevel sales distribution plans are not eligible for SBA assistance.” (see below)

This is another example of an organization, in this case the federal government, that associates legitimate network marketing with pyramid schemes. PayPal and Facebook are other organizations that come to mind. As I’ve written in the past, since there’s an ocean of gray in the networking space separating good companies from bad, it’s led to an increase of illegal exploitation of the model by opportunistic owners. Simply put, it’s difficult to distinguish the good companies from the pyramid schemes, which is leading the government and companies alike to associate all MLMs with pyramid schemes.

I’ve written an article in the past titled “Pyramid Schemes: Saving the network marketing industry by defining the gray.” The article has been viewed over 7,000 times. In an effort to help sanitize the negative perception created by pyramid schemes, the article calls for more clarity in the space. I’ve also attempt to pass an anti-pyramid scheme bill in Tennessee to create guideposts to distinguish good companies from bad ones. The DSA killed the bill. The DSA exists primarily as a lobbying organization committed to preserving the confusion in the space, which makes it easier for pyramid schemes to thrive, in my opinion. They act more like a labor union. They need more leadership, less “strength in numbers.” Given their influence, they can dramatically increase their impact if someone would step up, be honest with the issues and lead. If the DSA’s model legislation would pass, it would literally be legal for a company to sell $1,000 shots of lemonade (assuming there’s a return policy). It would be incredibly harmful for the space. But I digress.

Unfortunately, since it’s difficult to distinguish good companies from bad ones, more people are throwing in the towel and associating pyramid schemes with legitimate MLMs. In a conversation with Facebook’s compliance attorney a few months ago, he explained why they ban the promotion of MLMs in their Terms of Service. He said if they narrowed the provision and simply prohibited the promotion of “pyramid schemes,” they’d be required to prove if a company was a pyramid, which would be close to impossible. It all boiled down to the confusion. Have you ever tried to advertise a site on facebook with the words “MLM” or “network marketing” on the landing page? Did it get banned? Mine did. The gray needs to be clarified, not obfuscated, lest the negative perception grow in size and lead the FTC to step in and clarify it for us, which would be a disaster.

SBA loans and MLM

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by on March 17, 2011 Leave a Comment

Thanks to the MLM community

I wanted to thank you, the readers, for your encouragement and support over the past few years. As I reflect over the early days when I started my practice, I recall the stress, anxiety and uncertainty. It’s a similar position to what you’ve encountered, I’m sure. I remember my first question about google: “How does it work!?” I remember the first phone call. I remember the first check. I remember the first name I chose for my practice (which stunk). They were difficult days and at the same time, exhilarating. Through a series of goals and immersing myself in a constant feedback loop, I got better.

As I fly back from a mission trip in Brazil, I’m overwhelmed with gratitude at the many blessings in my life. In the span of a few years, after taking a leap of faith, everything changed. As I reflect, I can think of 10 reasons to be grateful:

  • I’m privileged to work with fiercely competitive entrepreneurs.
  • I’m privileged to have made so many great friends in the network marketing arena.
  • I’m privileged to have a wonderful lifestyle that grants me time with friends and family.
  • I’m privileged to be able to travel to so many amazing places.
  • I’m privileged to have so many interesting conversations about new and exciting business models.
  • I’m privileged to serve dozens of hard working distributors.
  • I’m privileged to learn about new and emerging trends in communication and marketing.
  • I’m privileged to learn so many unique and innovate solutions to interesting problems.
  • I’m privileged to operate in a space that desperately needs strong leadership to thrive in the new economy.
  • I’m privileged to do what I love.

Thanks!

So thanks again. You’re awesome. And if I can encourage you to do one thing, be courageous. Give an honest assessment of your life and if you’re not where you want to be, change. We were all born to be brave. I’m stealing a phrase from my brother-in-law, Bob Dickie. On his website, he talks about the importance of taking “The Leap.” The Leap represents a monumental shift in your life that at first seems terrifying, yet eventually proves invaluable. Take the leap!

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by on February 15, 2011 12 Comments

5 Reasons Why More Disclosure Is A Bad Idea

To misquote Billy Shakespeare: “To disclose or not to disclose, that is the question.” Troy recently received an email from someone expressing concern about the practice of companies “buying leaders.” I’ve written in the past about the practice of companies offering special sweeteners for top performers. In the video below, Troy says the lack of transparency creates “an integrity issue” and cites a book on Integrity by Henry Cloud. Troy says when there’s a lack of information, the “integrity of the whole” is questioned, which threatens to undermine the reputation of the industry we all fight hard to protect.

Under the video, I list 5 reasons why Troy is wrong and why more disclosure IS A TERRIBLE IDEA!

(be prepared for sarcasm)

5 reasons why more disclosure IS A TERRIBLE IDEA!

1. It gives prospects an extra factor to consider when making a decision

When you need people to buy into the character of the leader before joining, opening the door for questions on motive is a non-starter.

2. Prospects will reach crazy conclusions

If there’s a “special deal” that’s available only to certain people on stage, prospects might say, “He’s not here for the product, he’s here for the money!” Prospects should never engage in this line of thought.

3. It casts a cloud

When the leader is talking about the amazing properties of product X, prospects might naturally be distracted with the fact of the “special deal” they’re never going to get.

4. It’s nobody’s business!

Leaders drive the numbers, build the communities and should be allowed to enjoy the fruits of their labor. So for all the whiners that want more transparency, go build a bigger business and negotiate your own deal!

5. It’s the law

And laws are boring.

SOLUTION

Take the “special” out of “special deal.” Instead, publish a unique reward whereby ANYONE can qualify if they hit certain metrics within a certain timeframe. As an example, create a bonus whereby someone that climbs the charts fast i.e. Diamond in two months, give them a continuing reward i.e. pay them an extra 2% on the gross revenue they generate. Make these rewards public. And since they’re available for everyone, and they’re fully disclosed, they’re no longer “special.” Once the company is seeded with enough talent, they can shut off the reward and honor the terms with their top leaders.

The word “Transparency” should be more than a buzzword designed to foster trust. Instead, it should be part of a broad commitment to excellence and integrity. When there’s trust in the marketplace, it creates synergy that benefits everyone. When there’s a flavor of distrust, the “integrity of the whole” is compromised, which affects everyone. Until we realize that we’re all playing in the same sandbox, we’ll never be in a position to improve the state of the industry.

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by on February 10, 2011 3 Comments

Published in Obtainer Magazine!

I had the pleasure of meeting Michael Sander at the Direct Selling Congress in Amsterdam. Michael is the Chairman for “Obtainer Media” and he’s one of the coolest guys I’ve ever met. Living in Dubai, he has some amazing stories. The Obtainer is a great publication that focuses on the direct sales space.

Michael was kind enough to invite me to write a guest post in the magazine. I wrote an article titled “Grace vs. Law: the challenges faced by companies when correcting behavior.” I’m excited to be sharing it with you, so please check it out and tell me what you think.

The article is on p. 110 (click the link below). It’s easy to locate by typing “Thompson” in the search bar and it’ll zip you right to it. Enjoy!

Click here for article

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by on February 9, 2011 19 Comments

USA Today Reports on MLM: point for point response

Photo by @w3inc via Flickr

Over the past year, USA Today has taken a special interest with the MLM model. They’ve published a number of articles skeptical of the MLM model and usually reference examples from Fortune Hi Tech Marketing. Recently, they published an article titled “Many in multilevel marketing sales find it hard to earn much.” The article focuses on some legitimate concerns with the MLM model and I address them point for point below. However, it’s not entirely fair to focus on the challenges facing the model without mentioning the positives. When done right, direct sales offers people with an unmatched opportunity to change their finances. There’s a low-cost of entry, people can represent exciting brands and unique items, they can sell those products for profit and they can build large sales teams and earn override commissions on downline performance. If the product is marketable and the compensation plan fair, it gives the average person a chance to change their life. Is it tough to make it in the MLM space? Absolutely. It’s damn hard to make it in sales and it’s damn hard to achieve anything significant in life. Are there companies out there exploiting the model and harming people? Yep. It’s why I sued a company last year. But the fact of a few bad apples should not impugn the entire MLM space. In reality, it’s challenging to win in any endeavor, including business. In the MLM space, it takes strong sales skills (which can be developed) and a lot of work.

Comments about the article

The picture

In the image of the victims in the article, there’s a VHS tape. Who in the world still sells VHS tapes!? This initially made me wonder how recent the couple was involved with Amway. And then I continued to read and discovered that they quit the business in 2000! Seriously!? If the author was trying to make a point about Amway by talking about “victims,” it would have been a lot better to get some quotes from a more recent example.

Pokorny echo

The article reiterates some of the same points discussed in the past about the Pokorny class action lawsuit. Amway has already taken a beating on these very issues and most of the issues referenced in the article have already been addressed by Amway. The article references tool companies, which was the main point of contention in the Pokorny class action case. Gerald Nehra, another MLM attorney and one I hold in high esteem, was quoted in the article. The article states:

The sale of training materials has to be a “very small” part of distributors’ businesses, or “people will focus more on that aspect of the business than on the aspect of selling products to customers,” says Gerry Nehra, a Michigan attorney representing multilevel marketing companies and former director of the legal division of Amway from 1982-91. Nehra, who would not comment on Amway specifically, says that when selling training materials becomes the focus, the business becomes “overly dependent” on recruiting more representatives, which raises questions about whether a company is a pyramid scheme.

It was a good summary by Nehra. When the vast majority of funds are made via tool sales, the economic pressure forces people to focus almost exclusively on recruitment (who need more training), which lead to sustainability issues and cultural problems within the organization. It’s a large issue being dealt with by multiple companies in the space right now. But this is old news.

Likelihood of Success

The article states:

Even proponents of multilevel marketing say the cases and probes underscore one of the growing problems in the industry: It can be very difficult, if not impossible, for most individuals to make a lot of money through the direct sale of products to consumers. And big money is what recruiters often allude to in their pitches.

“Ease of earning an income” is never a factor when determining if a company is a pyramid scheme or not. One of the greatest things about the industry: ease of entry. One of the worst things about the industry: ease of entry. Because it’s so cheap and easy to join a MLM, the vast majority of participants do nothing and never earn an income. It’s not because the model is unfair, it’s largely because the vast majority of participants DO NOTHING, which skews the income averages down. The issue referenced in the article centers on one thing: managing the expectations of prospects before they join. This highlights the importance of using a good income disclosure to make sure the prospect is fully informed of the data before making a decision.

Price competitiveness

The article states:

With the growth of discounters including Walmart and retail websites, few people need to buy toiletries, detergent or vitamins from a friend or neighbor, especially with the higher prices charged so all the commissions can be paid. Making money by recruiting more people, selling them training materials and persuading them to buy products can become the only way to make much money at some of the companies.

I’ve written about this in the past. The above paragraph is absolutely true. And it’s why most MLMs avoid selling cheap, commodity products. I think it’s safe to say that the vitamins at Wal Mart are not the best in the market. They’re targeting a different demographic and offering a different value proposition. The MLM space is designed to introduce unique products and services into the marketplace. The keyword is VALUE. If there’s legitimate demand for the product being sold at the price requested, and the margin is sufficient for the company to support a MLM compensation plan, the above quote about big box stores is irrelevant. However, if the product is UNmarketable and UNcompetitive with alternative products in the marketplace, then the company is relying on “opportunity driven demand” (i.e. the compensation plan) and the distributors are forced to focus almost exclusively on recruitment and internal consumption. It happens. But just because it happens does not mean it’s representative of the entire space. The above quote paints the entire MLM space with a broad brush. Smart companies are NOT trying to compete with Wal Mart. When it comes to cheap goods, Wal Mart has that space covered. But when it comes to premium products with incredible health benefits, great MLMs shine. I’ve written about this concept a year ago about the importance for MLM companies to constantly innovate. In order to avoid the market catching up and offering comparable items at cheaper prices, the MLM executive team needs to stay one step ahead of the curve to keep their distributors armed with marketable items.

Distribution system / Amway’s revenue increase

The article states:

Roland Whitsell, a former business professor who spent 40 years researching and teaching the pitfalls of multilevel marketing, says it’s little surprise Amway’s big growth is now outside of the U.S. He says the “direct selling” in multilevel marketing is needed in countries with “primitive distribution systems and limited choices in retail stores,” but its potential is “seriously limited” here.

Lieberman notes the company is “extremely successful in formerly communist countries and in developing countries.” Sales were also up last year in the U.S. by about 5%, he says.

Regarding Rolan Whitsell’s quote, he’s certainly entitled to his opinion. However, network marketing is not just about the physical distribution of product. Are there more efficient means of delivering goods in the market? Sure. It’s easy to place an order on Amazon.com and have it on your doorstep within a day. However, Rolan Whitsell is willfully ignoring one of the most valuable functions of a good MLM: engaged sales force telling the product story! Some products are so new, so far ahead of the curve, there needs to be a person-to-person interaction before a consumer will make a decision. I have a client that recently sold its product through Kohl’s, a popular retail outlet. They soon discovered that the product only sold well when it was demonstrated and sampled; hence, their entry into the direct sales space. Did they have a shipping problem before they started their MLM? No. They had a marketing problem, which is one of the benefits of leveraging the MLM model when selling unique products and services. Rolan’s quote completely ignores this important function. Wal Mart is not in the business of selling premium cookware, yet Pampered Chef is worth over $1,000,000,000. Selling is more important than shipping.

As for Amway’s report about a 5% increase in revenue, if they actually grew in 2010, they’ll be dramatically ahead of the curve. This is the first report I’ve seen about a company’s performance in 2010. I’ll report findings from the other companies as they’re published.

Cost of doing business

The article states:

Wittlich says he worked day and night on his Amway business and never made a profit. “Active” Amway distributors earn an average of just $115 a month, according to Amway’s latest disclosure statement. Just a quarter of 1% (0.26%) make more than $40,000 a year, which Amway attributes to the fact many work part time.

See my original comments about Wittlich. He quit the business 10 years ago! What insight could he possibly provide about Amway’s business model today? Also, see my comments about the greatest thing and the worst thing about direct selling companies: the ease of entry. The majority of people do nothing, which skews the numbers down.

More about tools

The article quotes Lou Abbott, author of MLM: the whole truth. The article states:

Abbott says nearly all multilevel marketing companies prohibit distributors from selling “tools.” When they are allowed, the products are supposed to be sold at cost. He notes $8 DVDs are a “profit center” when they cost “25 cents” to produce.

This is not entirely accurate, although I can see how Lou would reach this conclusion. It’s perfectly fine for tool companies to profit handsomely from the sale of tools. If there’s a market for the material, the creator can sell the items at whatever price the market will bear. The rub comes into play when there’s a financial opportunity associated with the selling of tools, which turns into a MLM on top of another MLM. And with the competing interests, the model with the stronger pay plan gets the most focus, which is usually tools.

Indicators for the future

The article states:

Stuart Singer, a partner at Boies Schiller & Flexner, one of the law firms that represent the class-action plaintiffs, hopes the Amway settlement, if approved by a judge, will have a beneficial effect on the industry.

“If Amway recognizes the need to transform their business, then I think the other companies that are involved in multilevel marketing will have to follow suit,” he says. “It’s just a matter of time.”

We can hope. The space will never “go mainstream” until the space gets serious about quality control. As an industry advocate once said, people are burying their faces in piles of money and they’re doing nothing to address the obvious problems. Until the bad companies are routinely weeded out, they’ll continue to burn through people at an alarming rate and create another generation of skeptical MLM participants. The solution lies in incentivizing on customer sales.

Conclusion

In order to genuinely improve the space, it’s important to honestly acknowledge some of the challenges. The negative truth always stings more than the negative lies. While the USA Today article was clearly biased, she raises some valid concerns that can be easily addressed. What do you think about USA Today’s article? Do you disagree with any of my points above?

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