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Multilevel Marketing and Pyramid Schemes in the United States: An Historical Analysis | Multi Level Marketing | Sales

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Authors: William W. Keep, Dean and Professor of Marketing, The College of New Jersey Peter J. Vander Nat, Senior Economist, Bureau of Economics, Federal Trade Commission Pub. in: The Journal of Historical Research in Marketing, Volume 6, Issue 4 Abstract: Face-to-face retailing experienced two noticeable transitions during the 20th century. The first occurred when door-to-door selling, in an increasingly urban environment with rising household income, displaced the itinerant peddler. The second happened when a “business opportunity” via multilevel marketing (MLM) altered single-level, commission-based traditional direct selling. The success of traditional direct selling pre-WWII caused concerned store retailers to seek legal remedies. Post-WWII, an increase in women salespeople and the “party plan” sustained growth. By the 1980s, with more women in the workforce and improved store retailing, direct selling growth stalled. Beginning in the 1940s, multilevel marketing offered an alternative business model, lowering fixed costs and adding a “business opportunity.” No longer commission-based selling, the MLM model operates on a dual premise of retailing products through a network of independent contractors also responsible for recruiting new distributors. When distributor income primarily derives from purchases undertaken by downline recruits, the MLM model creates an opportunity to operate an illegal pyramid scheme. By the 1970s, product-based MLM/pyramid schemes became a significant form of consumer fraud, creating millions of victims losing hundreds of millions of dollars. This paper presents an historical analysis of the transition from an industry that began by retailing product to general consumers and evolved into an MLM model that is now apparently heavily reliant on selling to itself. We draw upon a wide range of primary and secondary source material, including: court decisions, company documents (e.g., annual reports), industry data, academic research in business and law, government documents, articles in the public press, and relevant books with an historic perspective. We structure the analysis in five sections. The first briefly examines the development of direct selling in the United States. The second looks at the transition from traditional direct selling to multilevel marketing. The third provides a detailed explanation of the multilevel compensation structure. The fourth highlights key legal decisions regarding the continuing problem of illegal pyramid schemes found to be operating under the guise of multilevel marketing. And the fifth examines MLM growth, stagnation and continuing concerns. We finish with conclusions and recommendations for future research.
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    Title: Multilevel Marketing and Pyramid Schemes in the United States: An Historical Analysis Authors: William W. Keep, Dean and Professor of Marketing, The College of New Jersey Peter J. Vander Nat, Senior Economist, Bureau of Economics, Federal Trade Commission  Disclaimer: The views expressed in this article are those of the authors and do not necessarily represent the views of the authors’ respective organizations. A determination of whether a given MLM is a pyramid scheme is intensely fact-specific and beyond the scope of this  paper. We focus on areas of concern that threaten to tar the reputation of even a legal MLM. Acknowledgements: The authors want to acknowledge the research assistance of Terrance Bennett and helpful comments from reviewers. Forthcoming in:    Journal of Historical Research in Marketing  , Vol 6, Issue 4 (November), 2014. Copyright held by: Emerald Publishing    Keep and Vander Nat  Journal of Historical Research in Marketing   (forthcoming)   Multilevel Marketing and Pyramid Schemes in the United States: An Historical Analysis Introduction and Overview Face-to-face retailing experienced two noticeable transitions during the 20 th  century. The first occurred when door-to-door selling, in an increasingly urban environment with rising household income, displaced the itinerant peddler. The second happened when a “business opportunity” via multilevel marketing (MLM) altered single-level, commission-based traditional direct selling. The success of traditional direct selling pre-WWII caused concerned store retailers to seek legal remedies. Post-WWII, an increase in women salespeople and the “party plan” sustained growth. By the 1980s, with more women in the workforce and improved store retailing, direct selling growth stalled. Beginning in the 1940s, multilevel marketing offered an alternative business model, lowering fixed costs and adding a “business opportunity.” No longer commission-based selling, the MLM model operates on a dual  premise of retailing products through a network of independent contractors also responsible for recruiting new distributors. When distributor income primarily derives from purchases undertaken by downline recruits, the MLM model creates an opportunity to operate an illegal pyramid scheme. By the 1970s, product-based MLM/pyramid schemes became a significant form of consumer fraud, creating millions of victims losing hundreds of millions of dollars. This paper presents an historical analysis of the transition from an industry that began by retailing product to general consumers and evolved into an MLM model that is now apparently heavily reliant on selling to itself. We draw upon a wide range of primary and secondary source material, including: court decisions, company documents (e.g., annual reports), industry data, academic research in business and law, government documents, articles in the public press, and relevant books with an historic perspective. We structure the analysis in five sections. The first briefly examines the development of direct selling in the United States. The second looks at the transition from traditional direct selling to multilevel marketing. The third provides a detailed explanation of the multilevel compensation structure. The fourth highlights key legal decisions regarding the continuing problem of illegal pyramid schemes found to be operating under the guise of multilevel marketing. And the fifth examines MLM growth, stagnation and continuing concerns. We finish with conclusions and recommendations for future research. The Direct Selling Model in the United States Early in the 20 th  century, direct selling bridged the selling tradition of the itinerant  peddler into a new era. Where peddlers traveled great distances to sell primarily unbranded products to customers, direct selling salesmen went “door-to-door” and “house-to-house” selling regionally and nationally branded products in an increasingly urbanized environment (Friedman, 2004, p. 15). Over a relatively short period of time direct selling companies offered household consumers: brushes, groceries, radios, sewing machines, phonographs, musical instruments, vacuums, cosmetics, apparel, chinaware, cooking utensils, books, televisions, furniture – even automobiles.    Keep and Vander Nat  Journal of Historical Research in Marketing   (forthcoming)   # Once viewed as a short-term approach to reduce excess inventory, direct selling established a firm foothold as a retail channel (Biggart, 1989, p. 27). Data on industry growth vary widely. In the mid-1920s estimates of the volume of annual direct selling ranged from $300 - $500 million (Curtis, 1925; Botsford, 1926). The Fuller Brush Company, founded in 1906, reported sales in 1923 of $15M, that dropped to $10.3M in 1929 in the face of increased competition (Friedman, 2004, p. 206). That same year the California Perfume Company (i.e., Avon), founded in 1886, generated $2.5M in revenue (Friedman, 2004, p. 202). Commissions of as much as 40 percent provided part- and full-time career options for the direct selling sales force. Exclusive selling territories created measurable areas of  prospective customers, with expectations of a specific number of home demonstrations  per day (Friedman, 2004, p. 204). Consistent with the then popular Taylorism method of scientific management, “specialty salesmen” – no longer simply peddlers – educated the American housewife on the “science” of new consumer products (Botsford, 1926). From 1919 to 1929 the percentage of U.S. households with a washing machine increased more than three-fold; vacuum cleaners more than four-fold, and radio ownership increased by a multiple of 400, in part due to direct selling (Friedman 2004, p. 195). Direct selling firms sought salespeople for a variety of situations. College students were recruited as early as 1913 for summer selling and Fuller Brush recruited African-American male teachers from segregated high schools to sell in segregated markets (Friedman, 2004, p. 205). In the economically challenging 1930s, twenty-seven Eastern colleges - including Harvard, Dartmouth, Princeton, Yale, Williams, Brown, Columbia, and MIT - signed a statement discouraging “the practice of door-to-door salesmen trading upon their college connections to make sales,” a strategy also apparently adopted by some salesmen who did not attend college ( The New York Times , 1932). Branch managers recruited and trained new salespeople. Given the high turnover within the sales force, this was an ongoing responsibility. Companies worked hard to determine effective selling strategies and training programs, regularly communicating with the sales force. During the difficult years of the 1930s, top salespeople received prizes as managers tactically adjusted the product range, advertising strategies, and prices to sustain consumer interest (Friedman, 2004, p. 235). Though for many decades a minority in direct selling, women tended to work the beauty category, an approach proven successful by Avon. Post-WWII, the percent of women in direct selling climbed until they became the majority of the sales force. Some companies welcomed women more readily than others. Fuller Brush took sixty years to hire its first “Fullerette” (Nuccio, 1966). Three years earlier Mary Kay Ash, an experienced door-to-door saleswoman, founded the new direct selling company Mary Kay (Nemy, 2001). In the African-American market, women ownership started with Annie Turnbo Malone selling her hair treatments door-to-door as early as 1900 (Peiss, 1998). Madam C. J. Walker, one of Malone’s selling agents, adopted a similar approach to selling hair treatments and cosmetics to African-American women, a market segment largely ignored  by store retailers and manufacturers. Their “agent-operator” earned commissions on    Keep and Vander Nat  Journal of Historical Research in Marketing   (forthcoming)   $  product sales and recruited and trained others to do the same. Those successful at recruiting received recognitions and compensation in the form of cash prizes, diamonds and low-cost mortgages (Peiss, 1998). Walker became the first women and first African-American millionaire in the United States. Both Walker and Malone used their agent network and wealth to promote social issues. The growth of direct selling brought with it some complaints – the Federal Trade Commission (FTC) recorded 17 of them in 1920 (  Nation’s Business , 1920). Problems also developed with the popular use of “collect on delivery” (COD), which required an initial payment to the salesmen with the balance due when the product was delivered (Layne, 1946). To allay concerns, the modern door-to-door salesman was characterized  publicly as different from the peddler, “a shabby, furtive and seedy individual” (Botsford, 1926). Disreputable “door openers,” such as fake surveys and opinion polls, and the “box-top” approach - a bait and switch that substituted a lesser brand after opening with a known brand - caused the National Association of Direct Selling Companies, precursor to the Direct Selling Association (DSA), to work with the Better Business Bureau in 1949 on an industry code of conduct ( The New York Times,  1949). Two decades earlier, door-to-door hosiery salesmen were labeled “a real menace,” not for misrepresenting themselves or pocketing deposits but rather for their success at selling. The rise of direct selling in the 1920s brought with it what later would be called “channel conflict,” taking “millions of dollars worth of hosiery business out of your [retail] store” ( The New York Times,  1925). The consumer protection issue would be inevitably confounded by the loud complaints from store retailers. Urbanization, the electrification of households, economic growth, and the corresponding development of a wide range of consumer products fueled the rise of direct selling in the early decades of the 20 th  century. The industry responded by opening new branch offices and developing a professional sales force. At the time, most women did not work outside the home, creating a viable home market for direct selling companies successful enough to create at least the perception of a threat to traditional store retailing. In Florida store retailers produced full-page ads warning against “the Stranger Who Raps on Your Door” (Curtis, 1925). Chambers of Commerce found themselves in the uncomfortable position of established retail members now condemning new, direct selling members. With the support of store retailers, some communities adopted “Green River ordinances” that prevented direct sellers from making a home visit unless first invited to do so – a maneuver upheld by the U.S. Supreme Court. Store retailers felt sufficiently threatened as to help communities create legal defenses. Direct sellers felt differently, “If the retailers in a town where direct sellers are working feel that they have values which are superior, let them make it known fairly and squarely (Curtis, 1925).” Though the 1930s brought lower household income and a large pool of available labor, it also brought government policies (e.g., Social Security) that formalized the employer/employee relationship. As a result, direct selling firms clarified the role of the salesperson to be that of an independent contractor (Williams, 1948). The degree of their
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