In 2004, the FTC attempted to clarify some concerns from the Direct Sales Association with respect to the issue of internal consumption. The letter is short and can be read in its entirety below. There’s one thing that’s noticeably absent from the letter: the basis upon which the FTC distinguishes the good companies from the bad ones. Still, there are some good nuggets to pull from the advisory letter.
Much Ado About Internal Consumption
In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme. The critical question for the FTC is whether the revenues that primarily support the commissions . . . are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture. A multi-level compensation system funded primarily by such non-incidental revenues does not depend on continual recruitment of new participants. . .
Translated in English, I read the above paragraph to mean that the “intent” behind the distributors’ consumption of the product is an important factor. If distributors are purchasing products merely to participate in the pay plan, there’s a serious problem. If distributors are purchasing items for the inherent value, it’s a different story. So how does the FTC measure intent? What’s the appropriate metric to use to read the collective minds of the sales force?
The FTC expresses its disdain for recruitment schemes when it further says, “A multi-level compensation system funded primarily by such non-incidental revenues does not depend on continual recruitment of new participants, and therefore, does not guarantee financial failure for the majority of participants.” Clearly, the FTC understands that programs that require endless recruitment in order for distributors to turn a profit are unsustainable and harmful. How does the FTC determine if a program is an endless chain that requires constant recruitment? In my view, the answer depends on the marketability of the product. If the product is unmarketable, then the only way to advance in the program is to focus on recruitment and exhaustive internal consumption, which brings us to our last and most important part of the letter.
Forced Inventory Requirements…a big no-no
On page 2, the FTC solidifies its position that “intent” is very important when distinguishing good companies from the pyramids when it writes:
The Commissions recent cases, however, demonstrate that the sale of goods and services alone does not necessarily render a multi-level system legitimate. Modern pyramid schemes generally do not blatantly base commissions on the outright payment of fees, but instead try to disguise those payments to appear as if they are based on the sale of goods or services. The most common means employed to achieve this goal is to require a certain level of monthly purchases to qualify for commissions. While the sale of goods and services nominally generates all commissions in a system primarily funded by such purchases, in fact, those commissions are funded by purchases made to obtain the right to participate in the scheme. Each individual who profits, therefore, does so primarily from the payments of others who are themselves making payments in order to obtain their own profit. As discussed above, such a plan is little more than a transfer scheme, dooming the vast majority of participants to financial failure.
Although it’s not explicitly written above, the word “intent” is there in spirit. If a company has a forced inventory requirement, it’s an immediate red flag because it’s an indicator that the product is serving as a subterfuge of the money transfer scheme. Additionally, it’s an indicator that the product lacks marketability and that the business depends upon constant recruitment of new participants to engage in the inventory requirements. Imagine a company that sold $1,000 bottles of lemonade and required its distributors to purchase a product a month. Clearly, the bottles of lemonade would be considered token products designed to conceal the money transfer scheme. Most companies are not foolish enough to have inventory requirements in order to participate. Additionally, most companies have some type of sales requirement to demonstrate that their products are in fact relevant for nonparticipants.
Measuring Intent…how do regulators do it?
So what are some common sense ways to measure the collective “intent” of the sales force?
- Is there a prerequisite of selling before the commissions are paid out? This is known as one of the “Amway Safeguards” where the distributors earn commissions from downline volume only after hitting their retail sales quota. It demonstrates that the products are truly marketable because they’re moving to people outside of the compensation plan.
- Do former distributors continue to buy the products? I know of several people that continue to purchase products from prior MLMs because they love the value of the product. If the answer is “no,” it would indicative that the distributors were purchasing the items largely to participate in the pay plan.
What do you think? What are some ways to measure the “intent” behind internal consumption?