Even as India bans pyramid schemes under a statute called the Prize Chits and Money Circulation Schemes (Banning) Act, 1978, the country continues to be a happy hunting ground for pyramids because our legislation is deliberately unworkable

Each pyramid or a multi-level marketing (MLM) company has typical business plan. Get more into their scheme/plan and earn commission on it. The level of income, commission, attached to recruitment, rises as new members pour in. However, this technique, experts say is bound to collapse the plan, as it is mathematically unsustainable.

According to the Robert Fitzpatrick co-author of the book, False Profits, the first book-length analysis of pyramid schemes and multi-level marketing, such MLM enrolment technique is the root cause of the failure of these schemes.
On his blog, titled, “This is Not a Pyramid”, (http://www.falseprofits.com/files/6b364baa6fc2093ce159e272bbc423e5-34.html) he has presented a satirical explanation on the typical MLM enrolment plan. “Each one, just like you, gets the right to recruit as many as they can, and every time the person they sign up as a salesperson makes a purchase, they get paid, just like you do, on your recruits’ purchases. But, here’s the kicker! You’ll get a payment on the purchases of their recruits? Think about that! If you sign up five new salespeople and they each do the same, you have 25 more salespeople working for you, a total of 30.

Remember, you didn’t get money from the sign-up fees, only on the purchases made after the sign up fees are paid, and you didn’t get paid to recruit, but you got paid because you recruited. Is that perfectly clear?”

He adds, “When their recruits (the 25 additional salespeople) each recruit five more, you’ll get paid on their purchases to! That’s 125 more! Now, you’ve got155 salespeople, each one making purchases and you’re getting a commission from every one of them. How’s that sound? All you need to do is find five new salespeople.”

However, Mr FitzPatrick explains that, “it is obvious no one will actually make the promised profits, unless they recruit others to invest as ‘salespeople’ and the newly recruited salespeople, in turn, would have to do the same, ad infinitum. The presenter makes it obvious that it's all about recruiting, even as he insists it all about sales.  (No one is ever paid to recruit!)  Compounding rewards from recruiting are promoted as the main attraction of the scheme's ‘unique’ compensation plan.”  

Generally, such plans are divided in two categories—pyramid and MLM schemes.

Both have certain difference with pyramids being pure fraud. Their business is unsustainable—they promise payment for goods or services of dubious value. Often the products are notional, something like SpeakAsia, which claimed to sell e-zines (online magazines). MLMs claim to be serious businesses and have a product to sell. For instance, Amway, Tupperware, Herbalife, etc.

In case of MLMs, often people give up on selling the product. According to False Profits, 50-70% of the ‘distributors’ (members) quit in the first year and less than 1% of make money.

Take the case of Vivek Kumar (name changed) an engineering student, who in the lure of earning extra money invested in one such MLM scheme selling personal care products. Soon, he was unable to convince anyone to buy or invest. He eventually stopped chasing people and neither was his principal recovered, nor were the products sold.

More importantly, since most sensible countries have placed outright bans on pyramid marketing schemes, they tend to disguise their true nature by pretending to sell a product or a service, often of doubtful value. Most MLMs have attracted lawsuits due to high start-up costs, tiered sales and exploitation of personal relationships and cult-like sales techniques.

According to False Profits, the US courts often use the 70% test to analyze if the plan, based on building a downline, is legal or illegal. The test says that all the MLM must derive at least 70% of its income from retail sales to non-distributors. “If less than 70% of income comes from sales to these non-distributors, the courts have concluded the MLM company is in the business of endlessly recruiting distributors who recruit distributors. In short, they are pyramid schemes, not sales and distribution companies.”

But Mr Fitzpatrick says that even if the plans pass 70%, which also used by the Federal State Commission (FTC) test, the salespersons would still lose their money. “This is because a pyramid scheme is inherently deceptive and harmful. The fraud is in the design and the pay plan. Regardless of the minimal retailing that occurs per salesperson, under the scheme's compensation plan, recruiting a downline is still needed to recoup expenses.”

He adds, “By a pyramid's design, only a small minority can be in the upper ranks and have an adequate downline to achieve profitability. All the others are that downline! Like all MLMs, this scheme pays the recruiters more in commission, per sales of the entire downline, as their downline grows through recruiting.”

Interestingly, even as India bans pyramid schemes under a statute called the Prize Chits and Money Circulation Schemes (Banning) Act, 1978, the country continues to be a happy hunting ground for pyramids because our legislation is deliberately unworkable.