Multilevel marketing (MLM) is when a company uses a commission-based sales force who not only sell but also recruit new people to work in sales below them. That creates a pyramid where the people at the top make money, but it gets much harder further down the line. In such a scenario, the company makes money even if most of its sales are to its own reps and not the general public. These companies can sometimes be a scam and, in other cases, work out for people who are very good at sales.

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This video was recorded on May 14, 2019.

Dylan Lewis: Dan, I'm having you on today because I wanted to do a show on maybe a concept that some people are a little familiar with, the idea of a sin stock. This is something that is often applied to the tobacco, alcohol, gambling field where you have companies that are putting stuff out that people may have some moral objections to and they don't want to put their investing dollars behind. I want to enter a different category of company to the sin stock consideration. I have some objections to what is going on in the MLM, or multi-level marketing, space. You know a little bit about this, and I wanted to bring you on to talk about it.

Dan Kline: Yeah, absolutely! Multi-level marketing is something we've all probably been exposed to. If you've ever been to one of those parties where there's games and then at the end of it, they're trying to show you a bunch of merchandise and sell you stuff -- maybe it's Tupperware, sadly adult toys has been a popular one, maybe it's nutritional items. It's a business model that works based on commission salespeople, non-salaried salespeople, getting paid based on how much they sell and recruiting new people into the organization, to create a pyramid -- we'll delve deeper into the word pyramid later -- where the person at the top gets a cut from everyone from the bottom. You only make money if you're selling, but the company makes money in a variety of different ways. Sometimes you pay joining fees, sometimes you have to buy product, sometimes you have to buy kits for these parties. And it's really a very appealing idea to people because it's owning your own business; but there are a lot of caveats to that.

Lewis: Yeah. Importantly, you can also make money once you have people underneath you, aka downlines, who are buying product to sell to the general public theoretically. This is very often referred to as direct selling, social selling, network marketing. There are a lot of different names for it. They all broadly fall under the multi-level marketing umbrella, though.

One of the first things that you immediately hear people ask when you're talking to MLMs is, "Are MLMs a scam?"

Kline: Scam is a tough word. It can be a scam, but sometimes it isn't. It's really just, are you good at selling? If you're someone who's very comfortable starting with your friends and family, and not only having them over or going to their house and selling them stuff, stuff they may need and stuff they may not need, but also willing to recruit people into that, and then continually develop a new market -- let's pretend I'm selling nutritional supplements. I could call all my friends and have an event. Maybe the first week, I do really well. How long is it until I've exhausted not just my friends, but my friends of friends of friends? So it's not a scam, but it's often presented as the way it works for the top 1%. The videos show people on yachts, driving fancy cars, being flown into conventions, all sorts of exciting stuff, rah rah. The reality is, that is possible, but it's not likely for most people. And honestly, it's the same if you went to any sales job where you're being paid by commission. If you're a newspaper salesperson and you're not good at selling, you're probably not going to succeed in sales. Multi-level marketing companies, it's much more complicated because you're not getting leads, you have to do every piece of the business yourself, and in many cases, you have to explain a product that isn't necessarily something people want, even if it is something that would be useful to them.

Lewis: And there are some telltale signs of MLMs that are more in the scam category. I think ultimately, you want to look at the stuff that you're selling and its utility. There are some MLMs where you're truly selling a good product, it's something that is useful, it's something that people want; it's in the kitchenware space -- Tupperware is a great example of that. People legitimately want it. There are some other ones, where you're in the supplement game, nutritional stuff. And there are some dubious claims about what the product is capable of doing. I think that's a red flag.

Kline: Absolutely! You want to sell things that people would have bought otherwise, or that would replace other expenses for them; not things that you have to put a hard sell on. The other major red flag is: Do you have to fill your garage with a lot of inventory? If you constantly have to buy merchandise to maintain your discount or meet a status, that's not a great sign. You want to be in a situation where, if this is something for you, you have to order a minimal amount of product or test kits or samples, where you can show it to people and then take orders. That puts the risk back on the company; as opposed to, if you have to buy a whole bunch of stuff that's not returnable, all of a sudden, what does the company care if you sell it or not? You've already bought a bunch of stuff. You might continue to buy it just to meet your status level and stay where you are. So you really want to monitor how much money you have to put out in order to go into this type of business.

Lewis: Right. The common criticism of MLMs is that many of them operate seemingly like a closed system, which is an economic term that basically explains how the people that are the end customers of a product are within an organization, not the general population. Rather than products funneling from the company to the distributors out to John Q. Public, they wind up going from the company to the distributors and then sitting there. If the bulk of the sales are happening because of that, and the company doesn't really seem to care where the product goes once it goes to the distributor, another red flag.

Kline: Right. The biggest goal of the company should be growing its audience with the public, not growing its distributor base to continue selling to distributors, that you can't make money if this doesn't go beyond your immediate circle. One of the things you want to think about is, is the public aware of this product? Has there been some advertising or some marketing? Does the company have a robust social media that isn't just you? Or is the entire sales proposition for this recruiting new salespeople?