A scheme might be a scrappy and unreasonable plan of action, where several high-level individuals enlist more current individuals, who pay forthright expenses up the chain, to those that selected them. As newer members successively recruit underlings of their own, some of the next fees they receive are additionally kicked up the chain. Frequently called “pyramid scams,” these activities are unlawful in certain nations.
- A scheme funnels earnings from those on lower levels of a corporation to the highest, and are often related to fraudulent operations.
- The overwhelming majority of pyramid schemes believe in taking advantage of recruitment fees and rarely involve the sale of actual goods or services with intrinsic value.
- Multi-Level Marketing operations (MLMs) are similar in nature to pyramid schemes but differ therein they involve the sale of tangible goods.
- In 2008, Canada was overtaken by a sweeping pyramid scheme, resulting in a class-action lawsuit against the operation, which was forced to shut down and return funds back to aggrieved members.
How Pyramid Schemes Work
Pyramid schemes are so named because they resemble a pyramid structure, starting with one point on top, that becomes progressively wider toward rock bottom (see diagram below).
Let’s assume the following: Founder Mike sits alone at the top of the heap, represented by the number “one.” Expect Mike to initiate 10 second-level individuals to the level straightforwardly underneath him, where every beginner should give him a money installment for the advantage of joining. Not exclusively do those upfront investment expenses pipe straightforwardly into Mike’s pocket, but each of the 10 new members must then recruit 10 tier-three members of their own (totaling 100), who must pay fees to the tier-two recruiters, who must send a percentage of their takes back up to Mike.
As indicated by the hard-sell pitches made at enrollment occasions, those intense enough to take the pyramid plunge will hypothetically get significant money from the volunteers beneath them. But in practice, the potential member pools tend to dry up over time. And by the time a pyramid scheme invariably shuts down, the top-level operatives walk away with loads of cash, while the majority of lower-level members leave empty-handed.It should be noted that because pyramid schemes heavily rely on fees from new recruits, the vast majority do not involve the sale of actual products or services with any intrinsic value.
Types of Pyramid Schemes
Different sorts of pyramid schemes exist which may be broadly classified as follows:
Multi-Level Marketing Pyramid Scheme
Multi-Level Marketing (MLM) is a lawful business practice, however dissimilar to customary fraudulent business models, this model includes the offer of real products or administrations, in order to generate income by recruiting members below them.
Some MLMs are nearly indistinguishable from pyramid schemes because they involve the sale of printed materials that have no real value, such as educational courses. These MLM plans flourish by driving volunteers to look for such no-esteem items at significant expenses, and by making them offer these equivalent items to ensuing generational individuals.
Chain emails persuade naive recipients to donate chunks of cash to everyone listed within the e-mail. Subsequent to making the gifts, the contributor is welcome to erase the principal name on the rundown and supplant it with his own, prior to sending the chain along to his own gathering of contacts, with hopes that one or more of them will send cash his way. In principle, beneficiaries continue to gather gifts until their name is erased from the rundown.
Ponzi schemes are speculation cons that work on the reason of “Taking from one to give to another.” They may not really receive a fraudulent business model’s progressive construction, however, they do guarantee high returns to existing investors by taking investment money from new blood. Often lured by the prospect of too-good-to-be-true returns, most Ponzi participants find themselves losing everything.
Investment advisor Bernard Madoff, arguably the foremost notorious Ponzi scheme artist, was sentenced to 150 years in prison for operating a multibillion-dollar illegal operation.
An Example of a True Pyramid Scheme
In 2008, a huge scheme swept through Canada, promising citizens an opportunity to urge the rich by selling low-cost travel club membership plans. To qualify, candidate “dealers” were first needed to get enrollments for themselves, at an exorbitant $3,200 tag. More than 2,000 folks brought out their checkbooks, as they were promised $5,000 for each similar membership they sold. However, profits could only be realized when applicant members accumulated $100,000 in sales, which entailed selling a minimum of 20 membership plans. But this proved virtually impossible during a downward economy, where people fiercely clung to their money. Consequently, aggrieved investors filed a class-action lawsuit, resulting in the return of their money, and the dismantling of the scheme.
How the Pyramid Tumbles
Pyramid schemes are viable as long as the lowest levels remain wider than the upper ones. But once rock bottom levels shrink, the whole structure collapses. Naturally of outstanding math, it’s downright incomprehensible for pyramids to support always, and someplace inside the chain, individuals will perpetually lose their cash. Curiously, even elevated level early adopters may lose cash close to the end, because of conditions that postpone their installments from subordinates, which frequently require holding up periods.
The Bottom Line
Pyramid schemes are illegal in many countries. The model of profiting by using the network effect often traps individuals into recruiting their acquaintances, which can feel slimy for everyone involved and can ultimately strain relationships. Investors should exercise caution with such schemes or just avoid them altogether.