The Spread of Pyramid Schemes
I have been vaguely aware of pyramid schemes for a significant portion of my life- I’ve heard stories about them from friends, seen people’s posts on FaceBook trying to recruit new participants, and have even started to receive private messages from old peers pin attempts to recruit me. I always knew the concept of them was to scam people into believing they could make tons of money, but only after this class have I realized how much network effects, and specifically diffusion, explain the way in which these pyramid schemes exist.
To begin this discussion on the diffusion of these pyramid schemes through populations, we must start by explaining the basic definitions and mechanics of these organizations. This explanation starts with some information about Multilevel Marketing Companies, also known as MLMs. According to Merriam-Webster, multilevel marketing is defined as “a business structure or practice in which an individual seller earns commissions both from direct sales and from the sales of the seller’s recruits, of those recruited by the seller’s recruits, and so on”. Pyramid schemes are a type of MLM, specifically an illegal type, which almost always leaves the participants financially and emotionally worse off than before they agreed to join. There are five key characteristics, detailed in a report from the Consumer Awareness Institute, that distinguish a legal (albeit financially risky) MLM and an illegal, exploitative, and corrupt pyramid scheme. First, each participant is encouraged and incentivized (usually monetarily) to recruit others. Second, advancement in the organization cannot be accomplished by “merit” or the most common means of professional promotion, only by the amount of recruitment accomplished. Third, participants are encouraged and/or incentivized (by suggestion of increased future income) to continually “invest in”, or purchase, the company’s products. Fourth, the company pays participants based on the “level” of distributor they are (hence the name “pyramid scheme”) and there are more than five of these structural levels. In the market, distribution networks usually never have more than 4-5 supervisory levels, as it only drives prices up and profits of individuals down. Fifth, participants in the organization receive the majority of their income from downline recruitment (recruiting other participants) rather than simply selling the company’s products.
In researching this issue, I also found a recent Time Magazine article, detailing the effect of the pandemic on these pyramid scheme organizations. This article only strengthened my impression of these organizations as an immoral industry. It described how organizations of this type used the COVID-19 crisis to their advantage, appealing to recently unemployed people with promises of wealth and the ability to work remotely, claims that very much oversimplify and glorify the reality of pyramid schemes. Many people’s stories in this article dealt with the immense debt, financial loss, waste of time, and guilt over involving family members, all caused by the companies using pyramid schemes.
I noticed early on in learning about this phenomenon that it was an example of asymmetric information. The field of pyramid schemes is one built on deception and targeting the most financially vulnerable people in a population. These people would not intentionally put money into something that would cause them to lose money, but because of the immense deception present, the companies have much more information than the potential participants. The Time article mentioned that the Federal Trade Commission (FTC) does investigate MLMs that seem to display warning signs of employing a pyramid scheme, but because of the necessary time and resources needed to determine this, it is impossible to come to a verdict for each and every one. In addition, the report from the Consumer Awareness Institute states that “consumers… lack the sophistication to properly evaluate an MLM on their own”, meaning that if the FTC is not able to properly evaluate the company, it is practically impossible to know for sure whether or not the specific organization is running a pyramid scheme. Therefore, the people running the pyramid scheme know that new recruits will most likely have net financial loss by the end of their experience with the company, but the people looking for financial recovery have no way to know for sure, leading to a devastating case of asymmetric information.
Additionally, there are very clear connections between the spread of these pyramid scheme organizations and the spread of epidemics, using the SIR model. As several of the distinguishing characteristics above mentioned, recruiting others is a main requirement for people involved in one of these organizations if they wish to make any money. The main pool of people to recruit most often happens to be these people’s friends and family. However, this spread of the organization is not based on how many other neighbors are adopting the behavior- in fact that would actually be quite counterproductive. For example, if there is a group of 10 friends and one member becomes a recruiter, it most likely would not be a good idea for every person to also become a recruiter. This is because of the concept present in this field called market saturation- once there is a certain amount of distributors in a population, any additional distributors would not have enough of a client base, since all of the other distributors fulfill the demand of the clients. In friend groups, small towns, etc. people often have a lot of the same connections and would not all be able to successfully recruit people or sell items if too many people were recruiters/sellers. Therefore, current recruiters run out of people to recruit simply because the market would not be able to handle all of those people as distributors. Instead, this phenomenon looks more like the models of an epidemic spreading. The Susceptible (S) population are all nodes that are connected to someone who is a current recruiter for the organization, because the current recruiter will try and recruit the people around them. The Infected (I) population includes those who have joined the organization and will begin the process of recruiting others. The Removed (R) population is best described as those who either have had experience with pyramid schemes and will never consider joining a company that could harm them again or those that have no need/desire for this pitch (i.e. those who currently have a stable source of income or who know about the danger of these types of companies). Research has even attempted to model the probability of joining a MLM in a given period of time, which accounts for the p value of the epidemic spreading R0. The Bass Model models this probability as being equal to p + q(N(t)/m), where N(t) is the number of existing recruiters for the company at time t, m is the current market potential, p is a value representing innovation/external influence, and q is a value representing imitation/internal influence. This value p makes it seem that joining these organizations is less about the “choice” of joining or what people around you are doing, and instead more about the information you are receiving, a need for income, the state of the market, etc., and shows that this spread is more like a sickness and less like deciding whether to buy a new product. With this p, k being the number of people that a recruiter would try and reach out to, and the previously listed S, I, and R populations, the spread of these companies throughout a population looks more and more like the spreading of an epidemic.
Sources
- https://www.merriam-webster.com/dictionary/multilevel%20marketing
- https://www.ftc.gov/system/files/documents/public_comments/2006/07/522418-12585.pdf
- https://time.com/5864712/multilevel-marketing-schemes-coronavirus/