Are MLMs deliberately constructed to avoid the law?

If MLMs are so bad, why aren’t they shut down? Find out why, according to an academic, the very structure of MLMs helps them to avoid laws and regulations, and hide behind their network.

In April and May this year, our founder took part in the world’s first global online MLM conference. The two-day virtual event brought together expertise from among regulators, prosecutors, former MLM distributors, social media consumer advocates, researchers, educators, and journalists to discuss ways to improve consumer protection and reduce consumer harm within the multi-level marketing (MLM) industry.

One talk that gave us a new perspective on the industry was by Dr Claudia Gross, an assistant professor at the Radboud University in Nijmegen, the Netherlands, at the department for Organizational Design and Development.

Claudia’s main interest is on how to design organizations that support ethical behaviour and how to ‘translate’ academic knowledge into better organizational practices. Since her PhD on the MLM industry in Germany, she has been interested in and concerned about the manifold and widespread unethical practices in the industry.

We thought Claudia’s insights into the MLM business structure were important and wanted to share them as part of our investigation into the industry, and why as many as 99.6% of people join join an MLM will lose money after business expenses are deducted.

Here’s our summary of Claudia’s presentation, with illustrations of her points from her slides.

Why the ethical problems of MLM persist 

So why, despite very clear issues with the MLM industry being known for many years, do so many distributors still lose instead of earn money? Why do distributors still make excessive and even illegal product claims? Why do that many MLM organisations have a culture that is cult-like

There are many different answers to these questions. And Robert FitzPatrick’s book Ponzinomics – the Untold Story of Multi-Level Marketing gives a great overview. Claudia’s presentation aimed to show what we can learn about the industry from an organizational theory perspective.

Who is responsible for misbehaviour?

Claudia’s presentation focused on MLMs that have consumer products. Looking at these companies, she asked what their organisational theory perspective is, and how that theory reflects on how these organisations are set up. She explored their:

  • Structure – Who does what? Who is responsible for recruiting new members? Who educates new members? Who teaches them how to work? Does management do that or do self-employed contractors?
  • Culture – What values are propagated? Are they ‘we offer great products and enjoy working here’ or ‘our products save the world and who does not join is a looser and quitter’?
  • HR/incentives – What are people paid for? For giving advice to customers OR for selling products?

The key issue Claudia wanted to resolve was: Who is responsible and accountable for misbehaviour in these organisations? 

How ‘traditional’ business organisations work

To understand how MLMs work, it helps to look at ‘traditional’ organisations. This can be a car manufacturer, a drugstore chain or a shoe retailer. 

In a traditional company, the organisation consists of managers and employees. If it is a big company, with many factories, stores etc, it may have a headquarters and other locations. But however small or big it is, it has managers and employees.

Let’s take a smaller company such as a drugstore as an example. In this business, if an employee tells customers that the nutritional supplement they sell heals cancer or protects from Covid-19, that employee would get into trouble with the manager of the store.

This is because the organisation is accountable for what its employees tell to consumers. So management/headquarters are responsible and accountable, and they are the ones that need to ensure their staff are doing and saying the right things. 

The implication for this set-up is: 

  • Misbehaviour, such as illegal product claims, can always occur but it is very clear who is responsible for correcting it and who is accountable if it persists.
  • Management/headquarters are also accountable for respecting labour laws. So employees also have rights, for example to receive an adequate salary. What is regarded as ‘adequate’ varies between countries, but it is highly unlikely that an employee would ever need to invest more than they earn in their job.
  • The implication for organisational cultures that are cult-like, is again, that management would be seen as the initiatior and responsible.

Here’s Claudia’s illustration of this set-up:

How MLM organisations work

Let’s compare that with how MLMs are set up. In an MLM, the core organisation only comprises a headquarters in each country (if that). The people actually selling products are independent contractors, also known as distributors.

These distributors somehow belong to the organisation but not really, because legally they are independent. So while consumers are still protected by consumer laws, what independent distributors do in their living rooms, on webinars, and on their private social media accounts is not that well protected.

If an independent MLM distributor makes excessive or illegal health claims to consumers, it is still illegal. But the difference with MLMs is that distributors are not employees, which means that headquarters can far more easily distance themselves from what their distributors do.

So when illegal health claims are made public, for example by media reports, headquarters distance themselves by saying this is not in line with how they work – this is a single black sheep. Headquarters are not sufficiently held accountable for what distributors do.

At the same time, distributors, as independent contractors, are not protected by labour laws. So when most distributors invest more than they earn, they have no labour law to fall back on. And there’s no minimum wage protection for them.

Here’s Claudia’s illustration of this set-up:

MLMs outsource central tasks to their network

But there’s an extra layer to how MLMs work on top of this. Because MLMs do not simply work with single contractors or distributors. Instead they work with whole networks of distributors; they outsource central tasks to the upline/downline system.

The MLM distributor network is responsible for educating and socialising people. It is the distributor network telling distributors how to approach their friends and family members, how to sell, how to recruit, how much you can make and what the company values and ideals are. So upline members tell downline members what to do and what to believe; and all distributors in the network tell each other the same thing.

Three aspects are central here: 

  1. Many typical management tasks, such as recruiting, educating and socialising members, are outsourced to the distributor network.
  2. Headquarters are insufficiently accountable for what is going on in this distributor network.
  3. The relationships between uplines and downlines is not sufficiently regulated.

Again this might differ per country, but as all members are formally self-employed, traditional labour rules simply do not apply. 

Here’s Claudia’s illustration of this set-up:

The implications of this for cult-like culture

Within the distributor network/the upline/downline system, all kinds of beliefs are transported. Beliefs about products, about the income potential, how great the company is, etc. Beliefs like ‘you only need a positive mindset to succeed’, and ‘anyone who doesn’t support you or who fails is a loser and negative thinker’.  

And all this goes on without rules and regulations tackling the core relations: between uplines and and downlines, and between distributor networks and headquarters.

The last layer is what happens when problems gain public attention. When problems are made public, headquarters defend themselves by pointing out that their official website contains correct, ethical and legal statements. They point out the product descriptions which are made within the legal requirements of each country. And they remind you of their codes of ethics and distributor guidelines, all of which all sound wonderful.

In short, they make statements that show that headquarters is working in line with the legal and the ethical standards of a country. But this obscures the core problem – all the unregulated relationships. Relationships that are not covered by the laws that are made for ‘traditional’ companies. 

So while rules and regulations may differ between countries, and individual MLM companies may differ in the way they work, the core truths of MLMs are:

  • They are a unique organisational form that has little to do with ‘traditional’ business organisations. MLMs have a different structure, very particular culture, and an incentive system unknown to other organisations.
  • Responsibility for tasks such as recruiting, socialising etc, are outsourced to the distributor network/the upline/downline system, as is any accountability for misbehaviour. 
  • Government rules and regulations for ‘traditional’ organisations do not cover how non-traditional organisations work. This also holds for other non-traditional organisations, such as organisations in the gig economy that work with independent contractors. MLMs are very good at avoiding regulations – both by their set-up and extensive lobbying work (like this example by Amway).

‘Legal’ is not the same as ‘ethical’

The fact that most MLMs have not been prosecuted anywhere around the world, does not mean that they work in an ethical, socially acceptable way. The laws are simply insufficient. 

Far more specific rules and regulations are needed. Laws that regulate the specific way how MLMs are set up. From an organisational theory point of view, what is missing most is accountability by headquarters for what is happening in their distributor network 

From an organisational theory perspective, the situation is dire, but laws can change and organisations can also be put under public scrutiny so that they change to survive.

Want to learn more about the widespread legal and ethical problems in MLMs? You can read a free article on the Journal of Business Ethics by Claudia and colleague here.

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If you’d like to learn more about how MLMs work, and why most people who join apparently lose money, we recommend reading these articles:

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Photo by Bharat Patil