Archive for March, 2012

Why MLM is a Bad Business: No Barriers to Entry

This post is part of a short series along with Why MLM is a Bad Business: Lack of Control.

I recently read The Millionaire Fastlane by DJ DeMarco and about a dozen pages of the 300+ page book dealt with MLM. (Full Book Review: Millionaire Fast Lane Reviewed)

DeMarco breaks down the key factors that all good business opportunities have. He presents these as "Commandments." In this post we'll look at the Commandment of Entry.

Commandment of Entry

DeMarco explains the Commandment of Entry as the following:

"As entry barriers to any business road fall, or lessen, the effectiveness of that road declines while competition in that field subsequently strengthens... Low-barrier-entry businesses are weak roads because easy entry creates high competition and high traffic, all of which share the same pie...

Network marketing, or multi-level marketing (MLM), always fails the Commandment of Entry—unless you own and create the MLM company yourself. If you’re in a room with 2,000 other people who do exactly what you do, you’re fighting stiff probabilities. Who is the innovator, the leader, and the one standing on a cliff parting the Red Sea? The guy on stage who founded the MLM company is the Fastlaner. And you? Sorry, but you’re just another soldier in his Fastlane army, a cog in his marketing strategy. The MLM founder doesn’t need to climb the pyramid, because he built the pyramid! You can be a pyramid builder or a pyramid climber. You can be the sheep or the sheepherder."

He writes a little later about how everyone flocked to Ebay to make millions when it was new. Then he writes about how everyone jumped on blogging to make millions. Everyone investing in tech stocks... well you get the picture. Underlying in DeMarco's advice here is that monetary wealth is a finite resource. We can't all be rich. He sums it up best with "If you want to live unlike everyone, you can't be like everyone."

DeMarco isn't the first person to note that barriers to entry are a good thing to have in business. If everyone could make an iPhone, Apple would be broke. The truth is that few companies can even make a phone that competes with it. Why? There are too many barriers to entry. For example a company has to have tremendous contracts with numerous parts makers and be able to negotiate millions of devices to get bulk pricing to compete with Apple. Then you need to create a music store to compete with iTunes, which means getting all the music contracts. Google is just starting to get there with this and we know how big that company is. In short, if you are Apple, you one have to worry about Google Android and maybe Microsoft Windows Phone competing with you. No one competing with you is a good thing in business.

In MLM, if someone else hit your town with any MLM opportunity, chances are you won't be able to recruit anyone. That's because just about every MLM uses the same recruiting techniques. Very few people enter MLM because they are truly excited about the product... they are pitched a business of financial freedom and that's what they are looking for. Since just about every MLM pitches it, it doesn't matter much if your selling juice and someone else is selling pre-paid legal services, you simply aren't very likely to recruit anyone.

Take a minute and imagine a world where a McDonalds franchise could be started for $100. That would be a low barrier to entry. We know today that a McDonalds franchise typically makes good money and it costs a lot more than that, but this is just a hypothetical. If McDonalds were $100 and presented any kind of real business opportunity there would 20,000 in every small city. McDonaldsville would have no one to sell hamburgers to except themselves. A McDonalds that doesn't sell hamburgers doesn't make money.

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MLM Business Opportunity

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Why MLM is a Bad Business: Lack of Control

I recently read The Millionaire Fastlane by DJ DeMarco and about a dozen pages of the 300+ page book dealt with MLM. (Full Book Review: Millionaire Fast Lane Reviewed)

DeMarco breaks down the key factors that all good business opportunities have. He presents these as "Commandments." In this post we'll look at the Commandment of Control.

The Commandment of Control says that the best business are ones where you have full control of the business. This makes sense because you should control your own companys destiny. If someone else can put you of business with the stroke of a pen, it is a problem. This is so basic that I feel I shouldn't even need to go further, however I will.

Let's apply the same Commandment of Control to MLM. The MLM company dictates all the rules. Distributor agreements will vary from MLM to MLM, but most of them have these rules that give the company the power:

  1. They allow the company to terminate your business at any time for any reason at their discretion. The result is that you can't rely on that income as 100% of it could be gone tomorrow through no fault of your own.
  2. They limit your opportunities to join other businesses, even if they don't compete in any way. For example, one person from Numis coin sales tried to recruit me and two weeks later was telling me that he was out of the coin selling business and into selling LifeVantage Protandim pills.
  3. They have the ability to change pricing and compensation structure whenever they want

In addition to the above there is also the control that you give up outside of the distributor agreement. For example, while you generally have the ability to price the product at whatever you want, they dictate the wholesale price that you can buy it for to be much more than it costs. LifeVantage Protandim filed with the SEC that it paid $1.20 per bottle of 30 pills including packaging (buying in bulk a million bottles). It sells the bottle to distributors for $40 and recommends that distributors sell them at $50. A distributor can choose to sell them at $80 if they want, but other distributors are selling at $50 and there are people on Ebay selling it in the $40-$45 range. So while you have the ability to charge more, you aren't likely to make many sales that way; you'll just make enemies when those people found out that over-charged them.

It isn't difficult to recognize where the real money is in Protandim. The company pays another company to create it for $1.20 and sells it to the distributor for $40. That's a gain of over 3,300% for being a middleman. The distributor making the sale gets 25% profit for his/her effort. If you really owned the business, you'd have the product made for perhaps $3 a bottle (you would have to pay more because you wouldn't be able to order a million bottles like LifeVantage did). Then you'd sell them at $35 a piece. Every LifeVantage consumer would flock to your business because you saved the customer anywhere from $5 to $15 per bottle. You'd make $32 per bottle ($35 minus your $3 costs) on all those customers. Instantly control gave you a multi-million dollar business. However, since you don't have it and LifeVantage does, you are just one in a sea of distributors with no competitive advantage.

Finally, there's another layer of lack of control. The MLM company itself has its own set of business risks. It could have problems producing product supply. It could have issues with declining product quality. It could go out of business due to poor business decisions from management. If it is one of the exotic juices like MonaVie or a pill like LifeVantage Protandim, it could be shut down by the FDA for the illegal claims made by the company. In fact, MonaVie CEO, Dallin Larsen's last company Royal Tongan Limu Juice was shut down for that very reason. It could be shut down by the FTC for being an illegal pyramid scheme ("Not all multilevel marketing plans are legitimate. Some are pyramid schemes.").

MJ DeMarco writes of a friend who lost his business when the MLM company changed the product line and compensation plan, "He never had the keys to his business, and his empire was nothing but a mirage founded on false foundations governed by a political party in which he had no voice." Further on he does it one better:

"I was involved in four MLM companies. Not once do I remember dictating product decisions, research and marketing, marketing restriction, rules, cost analysis or any other activity fundamental to owning a business. As a network marketer, you don’t own a business—you own a job managing and creating a sales organization... MLM distributors are commissioned employees disguised as entrepreneurs..."

He's right. A MLM distributor is not an entrepreneur and doesn't own a business. It is a commissioned sales job in a business where the distributor has no control.

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MLM Mind Game: Real Life Experience vs. External Perspective

Many MLM distributors will try to reject someone's well-formed logical argument due to the fact that they have no real life experience in MLM. This is an attempt to avoid the well-formed logical argument with a red herring, which is defined as "a piece of information which is intended to be misleading, or distracting from the actual issue."

There are many, many real world cases where we rely on external perspective instead of real life experience. If someone were say that the ramifications of jumping off a bridge generally involve serious injury or death, would you ask that person if they have real life experience of jumping off a bridge? No, you would use common sense from an external perspective and evaluate the ramifications before being a part of it.

MLM distributors dismiss those with external perspective to limit any opposing views to people who have real life experience in MLM. Those with real life experience in MLM either were successful in making some money (the less than 1%) or lost money (greater than 99%). The MLM proponents will then say that you shouldn't listen to those who "failed" to make money, because they didn't know what they were doing. This leaves only one set of people that the MLM proponents deem as having the right experience to listen to... the very few people who happened to make money in MLM because they were in early and at the top of the structure. Of course, these people are going to say great things about MLM, especially because they stand to benefit if more people are recruited into MLM. This is a common tactic of Tim Sales.

The reality is that the people who aren't in the MLM are the ones with the most valid opinion. They are the ones who are not biased. They don't stand to gain or lose any money if you decide to join or not. It is the MLM proponent that wants you to join - they stand to make money if you do.

Need another reason why not to listen to those in MLM? Look at the overly optimistic probability bias of sunk costs. That's a mouthful. However, it goes a little something like this:

"In 1968 Knox and Inkster, in what is perhaps the classic sunk cost experiment, approached 141 horse bettors: 72 of the people had just finished placing a $2.00 bet within the past 30 seconds, and 69 people were about to place a $2.00 bet in the next 30 seconds. Their hypothesis was that people who had just committed themselves to a course of action (betting $2.00) would reduce post-decision dissonance by believing more strongly than ever that they had picked a winner. Knox and Inkster asked the bettors to rate their horse's chances of winning on a 7-point scale. What they found was that people who were about to place a bet rated the chance that their horse would win at an average of 3.48 which corresponded to a "fair chance of winning" whereas people who had just finished betting gave an average rating of 4.81 which corresponded to a "good chance of winning". Their hypothesis was confirmed: after making a $2.00 commitment, people became more confident their bet would pay off. Knox and Inkster performed an ancillary test on the patrons of the horses themselves and managed (after normalization) to repeat their finding almost identically.

Additional evidence of inflated probability estimations can be found in Arkes and Blumer (1985) and Arkes & Hutzel (2000)."

Bottom Line: Once someone is invested in MLM, like betting on a horse, he/she is going to be more optimistic about the prospects of it. When you combine that with his/her financial incentive, the result is that the person is going to give the predictable positive response towards MLM. It is the external perspective that is free of financial bias and not clouded by their investment.

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MLM Mind Games: Poor Irrelevant Analogies

MLM distributors quite often make arguments for their products in public forums. Many times they'll use an analogy or comparison. If only given a quick glance the analogy seems logical. However, when you spend a little more time breaking them down, it becomes clear that they are trying to mislead you. Here are a few of the many poor analogies I've seen used over and over again:

Product Pricing Analogies

Many distributors claim that their product is priced competitively when compared to a product at another location. Popular examples include coffee at Starbucks, soda and popcorn at the movies, and beer at a ballgame. In all these cases, it is the location that raises the price of the products. Coffee, soda, popcorn, and beer are generally many, many times cheaper when bought at your grocery store freed from the overhead of locations needing to pay baristas, movie stars, and ballplayers.

Comparison to Other Business Models

Many distributors claim that MLM is similar to other trusted business models. Here are a couple of poor, highly flawed comparisons they make.

  • Real Estate Agents - They make a comparisons to being a real estate agent. I have bought several homes and I know dozens of people who have done the same. At no point did the real estate agent ever try to convince me to become a real estate agent. If he had, he wouldn’t have received bonuses related to my sales. As the FTC says in its guidelines of the MLM and pyramid schemes, the differences rely greatly on how much recruiting is being done and how many sales are made to the public who are NOT distributors.
  • Franchising - Many distributors claim that MLM is just like owning a franchise, similar to McDonalds or a Subway. I have been a customer of McDonalds and Subway many times and never has the owner of the franchise approached me about buying a franchise. Referring to the statement above they do zero recruiting and nearly 100% of sales to people who do own franchises in the same company. Owners of a franchise do not earn on-going commissions or percentages of sales of people they recruit.

Bottom Line: It is clear that the real estate agent and franchise comparisons aren't accurate. Anyone involved in the MLM industry using it is either trying to swindle you or doesn't know what they are talking about. In either case, you want to ignore what they say and distance yourself from them and the pitch they are making.

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