As an economist who has devoted my academic career to the area of distribution channel design and management, there is no question the direct-selling industry has offered tremendous economic benefits to millions of Americans, consumers and entrepreneurs alike. At the same time, I’ve also seen firsthand the tremendous importance of protecting consumers — and legitimate business organizations — from the deceptive (and economically harmful) trade practices of a few bad actors.
Yet, while state laws defining and regulating illegal pyramid schemes have been in place for years, there has surprisingly been no federal statute on the books. But that may soon change this year.
The Anti-Pyramid Scheme Protection Act of 2017 (H.R. 3409), recently introduced by U.S. Reps. Marsha Blackburn (R-Tenn.) and Marc Veasey (D-Texas), offers a significant step forward in the area of consumer protection and business entrepreneurship by clearly and concisely defining illegal pyramid schemes and drawing a bright line between such illegal activities and the legitimate business operations of direct-selling organizations.
The hallmark of an illegal pyramid scheme is a plan that compensates participants for recruiting others into the plan. Compensation based on recruiting is what is therefore at the core of the pyramid definition.
The Blackburn-Veasey legislation addresses this ill through a clear prohibition against compensation based primarily on recruiting, combined with a provision that requires companies to repurchase inventory from distributors who leave the business. Together, these provisions will ensure that the purchase and personal consumption of products by plan participants in a DS business, for example, are voluntary, not forced as with illegal schemes, and provide strong protections for participants.
In this light, and contrary to the opinions held by some long-time critics of the DS industry, classification of a participant’s personal consumption as an “ultimate user” sale makes economic sense and aligns with the reality of the marketplace. Research confirms that many people who join DS companies as distributors do so after first trying and enjoying the products. Their purchase and consumption of products is no less an “ultimate sale” the day after becoming a distributor than it was the day before. From an economic and marketplace perspective, those are legitimate consumer purchases, and they should not brand a DS company as an illegal pyramid or eliminate the sponsoring distributor’s right to earn compensation on those continuing purchases, particularly when the DS company offers an inventory return provisions as outlined in the Blackburn bill.
This legislation is not just economically sound because of its clear and concise definition of an illegal pyramid scheme. It is also good public policy because it proactively recognizes direct selling for what it is: a legitimate distribution and go-to-market structure that provides individuals with a very low-cost option for running an entrepreneurial business. DS offers aspiring entrepreneurs with a business opportunity, but without the financial burden of product research and development, manufacturing, quality assurance, branding, website design and maintenance, real estate costs and IT or similar infrastructure costs — all of which characterize other entrepreneurial ventures like franchising, restaurants, Etsy businesses or other small retail ventures.
The distributor also has the support and assistance of the DS firm in other entrepreneurial tasks like promotional materials management, sales force training and motivation, sales tracking and back-end customer service. The distributor can choose her own hours and what she wants to sell, and change these decisions when she wants. She is paid for her productivity under a sales compensation plan equally open to all who join. Her enrollment cost is small, her risk is minimal and she can resign at will, without facing the costs of liquidating inventory.
These benefits are not available in other small-business ventures — even if the would-be entrepreneur has the financial resources to start one, which many may not. Those who end up shuttering their small retail outlets or restaurants do not recover the high costs they bore to open them in the first place, or the cost of liquidating inventory when they close.
In sum, this proposed legislation should, and does, leave the individual with the ability to choose DS as a legitimate entrepreneurial distribution channel. It imposes clear and economically reasonable obligations on the DS companies, and provides sensible protections for the consumer, while allowing the Federal Trade Commission to continue to enforce actions against illegal pyramid schemes.
Anne T. Coughlan holds the Polk Bros. Chair in Retailing and is a professor of marketing at the Kellogg School of Management at Northwestern University, where she has taught since 1985.