Sunday, September 28, 2014

MLMs and Reverse Business Models

Tonight, my roommate and I had an interesting discussion with a friend of his that was attempting to get him to join his community business model. The conversation was rather interesting and it also went on for a long time so I couldn't help but join. When I came in, the friend and her husband were being asked to identify within 10 words or less the problem that their business was attempting to solve. Her response was anything. We had either found Willy Wonka's golden ticket or the worst saleswoman I had ever met.

With such a wide response, my roommate replied by asking who their target market was to which the answer came, everyone. The product that can do anything for anyone. It must some sort of drug was my first thought. I was close. It was knowledge. Apparently, these witch doctors sold the secrets to fame, friendship, fortune, followers, fitness, and anything else that starts with the letter "f." It took a while for us to understand that this was some sort of life coaching company whose products came in the form of books, videos, DVDs, and live seminars. The reason why it took so long to understand that was because we didn't know the problem this service was supposed to solve. For the majority of the hour and half long conversation, this friend was trying to sell us on the passive income it would provide if we joined their "community."

One thing that doesn't take a brainiac to figure out is if you are going to sell something then that is what you are probably going to talk most about during your pitch. In this case, she wouldn't stop talking about residual income and passive income and how we should join their community. The whole pitch she was trying to convince us that the target market was the people using the services. No, the target market for MLMs is their communities of sales people. MLMs profit off of failure. In fact, we can use basic numbers from this company's example which are embellished at best.

The typical MLM will only have on average a 2-5% success rate for their sales people. Success being defined as someone who is generating more customers and more revenue. A business cannot be successful without customers but you have to remember that unlike traditional companies, a MLM employee is a MLM customer. This community is built in reverse. The pitch is that you are building a community where you are sharing profits with your friends and family and everyone is successful and is generating a passive income. It is fundamental truth that easy money is never good money... Easy in is easy out. Only things that have great value require a lot of work.

Here is a comparison that this friend made out of desperation: How many people drop out of your MBA program each year? Education is a business and only maybe 2 out of our class of 54 students dropped out or were kicked out. This equates to about a 4% failure rate which compared to the MLM in question is significantly less than what they shared to be a 75% failure rate. 75 of their 100 annual community members will fail within the same year. The cost of joining the community with the potential of making easy money is $100. The cost of attending our MBA program is in total $52K. The probable returns are also parallel.

The biggest issue I have is that these friends couldn't see how the MLM was stealing commission from right under their noses. If you are able to sell product or your community of friends sell product, then you are able to make commission. It is a pyramid structure. However when the sales pitch was about building a community, I wanted to also calculate the profits the MLM made off of failure. Let me repeat that. The MLM is making profits off of failure. Let's look at only 3 generations or levels within the community, which I am sure for how long it has been around is an extreme micro-approach to this problem.

Level No. People Description
1 100 People signed up for community
25 People that continue to sell
2 2500 People signed up for community
625 People that continue to sell
3 62500 People signed up for community
15625 People that continue to sell

So if we look at how much failure is present in only 3 levels of the community, there are 46,875 people who are not continuing to sell. And if subscription to the community is $100 for each member then that means the revenue generated for failure is $4,687,500. Each time a person signs up for the community, they share in each other's profits meaning that if they sell product then the people higher up in the level system also make commission. However, only 25% continue to sell product. The other aspect is that you don't make commission for the effort of getting a person to sign up. So what does this mean? For that revenue of $4.6M generated from the subscription itself, you make no commission. Even at a 5% commission rate, you should have made $500 on your first level alone. Say that at level 2 the commission rate decreases by 50% and so on. This would mean on subscriptions alone with a scaled commission rate, a representative should have made $500 + $6,250 + $78,125 = $84,875 in commission. Without that commission (which a good salesperson would have recognized), the MLM is profiting $4.6M off of failure.

This example only represents the effect for 3 generations from 1 successful community member.

The target market of a MLM is its own employees. MLMs will make money off of failure. MLMs sell okay products but drain money from its sales force through tiered commissions. The community is set up to fail the community on purpose. The MLM is designed for the failure of its sales force. This failure is the revenue model for the business. Easy money is not good money. This is why I feel like MLMs are ethically wrong and I would never work for one.

No comments:

Post a Comment