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Pyramid scheme

From Academic Kids

A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, usually without any product or service being delivered. Pyramid schemes have been in existence for at least a century. In addition, other methods of conducting business known as multi-level marketing (MLM) and as "matrix schemes" often closely resemble pyramid schemes (although unlike pyramid schemes, which are almost always frauds, MLM and matrix schemes are in many cases regarded--at least legally--as legitimate business methods.)

Most pyramid schemes are attempts to confuse potential consumers into complicated but convincingly fool-proof money making scams. The essential idea behind each scam is that the individual only makes one payment, but somehow they are promised to receive exponential benefits from other people as a reward. A common example might be that a victim is enticed with an offer that, for a fee, allows them to sell the same offer to other people. Each sale includes a fee to the original seller. Clearly, the fundamental flaw is that there is no end benefit; the money simply travels up the chain, and only the originator wins in swindling his followers. Furthermore, the people in the worst situation are the ones at the bottom of the pyramid; those who subscribed to the plan, but were not able to accrue any followers themselves. To embellish the act, most such scams will have fake referrals, testimonials, and information.

Contents

History

Pyramid schemes come in many variations. The earliest schemes involved a chain letter distributed with a list of 5–10 names and addresses on it. The recipient was told to send a specified small sum of money (typically $1 to $5) to the first person of the list. The recipient was then to remove this first person from the list, move all of the remaining names up one place, and to add his own name and maybe more names to the bottom of the list. Then he was to copy the letter with new name list to the individuals listed. And hopefully this procedure was to be repeated and pass on and then he would be moved to the top of the list and receive money from the others.

Success in such ventures rested solely on the exponential growth of new members. Hence the name "pyramid", indicating the increasing population at each successive layer. Unfortunately, simple analysis will reveal that within a few iterations the entire global population would need to subscribe in order for pre-existing members to earn any income. This is impossible, and the mathematics of such schemes guarantees that the vast majority of people who participate in these schemes will lose their invested money.

Very large scale pyramid schemes were initiated in post-Soviet states, where people had little familiarity with stock market and were led to believe that returns in excess of 1000% are feasible. Particularly notorious were MMM (pyramid) in Russia and pyramid schemes in Albania.


Legal status

Although pyramid schemes have been declared illegal in many countries, they still persist in various forms. While schemes simply involving the blatant exchange of money have generally disappeared, many schemes persist that purportedly "sell" a product to mask the primary intention of simply enrolling new members; these are sometimes called "matrix schemes" or "multi-level marketing".

Identifying features

The distinguishing feature of these schemes is the fact that the product being sold has little to no intrinsic value of its own or is sold at a price out of line with its fair market value. Examples include "products" such as brochures, cassette tapes or systems which merely explain to the purchaser how to enroll new members, or the purchasing of name and address lists of future prospects. The costs for these "products" can range up into the hundreds or thousands of dollars. A common Internet version involves the sale of documents entitled "How to make $1 Million on the Internet" and the like. Another example is a product sold at higher than ordinary retail price for the same or similar products elsewhere. The result is that only a person enrolled in the scheme would buy it and the only way to make money is to recruit more and more people below that person also paying more than they should. This extra amount paid for the product is then used to fund the pyramid scheme. In effect, the scheme ends up paying for new recruits through their overpriced purchases rather than an initial "signup" fee.

The key identifiers of a pyramid scheme are:

  • A highly excited sales pitch
  • Vaguely phrased promises of limitless income potential
  • No product, or a product being sold at a price ridiculously in excess of its real market value.
  • An income stream that chiefly depends on the commissions earned by enrolling new members or the purchase by members of products for their own use rather than sales to customers who are not participants in the scheme.
  • A tendency for only the early investors/joiners to make any real income.
  • Assuring that it is perfectly legal to participate.

The key distinction between these schemes and legitimate MLM businesses is that in the latter cases a meaningful income can be earned solely from the sales of the associated product or service to customers who are not themselves enrolled in the scheme. While some of these MLM businesses also offer commissions from recruiting new members, this is not essential to successful operation of the business by any individual member. Nor does the absence of payment for recruiting mean that an MLM is not a cover for a pyramid scheme. The distinguishing characteristic is whether the money in the scheme comes primarily from the participants themselves (pyramid scheme) or from sales of products or services to customers who aren't participants in the scheme (legitimate MLM).

Examples of pyramid schemes

An example of a pyramid scheme is the business practices of Gratis Internet, Inc. — the creator of Freeipods, Freeflatscreens, and numerous similar websites which involve a single user signing up for an affiliate offer and then referring a set number of people, each of whom is also required to complete an offer. This is the only way the company can pay for the merchandise it gives away. As time progresses, people run out of friends to refer; only early program participants benefit.

Is the US Social Security system a pyramid scheme?

Economist Thomas Sowell argues:[1] (http://www.capmag.com/article.asp?id=1505)

Social Security has been a pyramid scheme from the beginning. Those who paid in first received money from those who paid in second — and so on, generation after generation. This was great so long as the small generation when Social Security began was being supported by larger generations resulting from the baby boom.

The issue is discussed in the section Are national retirement programs Ponzi schemes? of the Ponzi scheme article.

Financial pyramids in post-communist states

After the collapse of the Soviet Union and communist states in East Europe, population in many of these states fell victims to numerous financial pyramid schemes. It is safe to assume that a significant factor was lack of free market financial experience of population that was exposed primarily to planned economy before.

Notable examples are Albania (see Sali Berisha article), Romania (Caritas - in fact it is considered a Ponzi scheme) and MMM pyramid in Russia.

See also

External links

ja:無限連鎖講 lt:Piramidinė schema fi:Pyramidihuijaus sv:Pyramidspel

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