A fellow Naija entrepreneur brought a business proposal to me, when he was told that the business proposed is a pyramid scheme he got offended. He defended the business as being legitimate because he has proof that it works! That incident gave birth to this post, “What is a Pyramid Scheme?”
What makes an investment a pyramid scheme? Why should you not join a pyramid scheme even though it seems to be running successfully and people are aggressively promoting it? Let’s start from the first question.
Definition of a Pyramid Scheme
Wikipedia defines pyramid scheme as follows “A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, without any product or service being delivered. Pyramid schemes are a form of fraud” Pyramid schemes are fraudulent investment. Several entrepreneurs all over the world have lost fortunes to such schemes thinking that they were getting into a lucrative investment program. A lot of Nigerian Entrepreneurs are being lured into such schemes because people are being deceived that they are legitimate investment plans. Ignorance is quite expensive.
Since you don’t want to lose your hard-earned income to any con-artist posing as an entrepreneur, you need to understand what a pyramid scheme is and why it is a no go area for any entrepreneurs that seeks to be successful.
Going by the definition given above, one can see that even though pyramid schemes appear as simple business opportunities, they are actual fraud in disguise. Pyramid schemes are presented to potential investors as a business opportunity with high rate of return with little or no effort after the initial contribution. This post seeks to explain what pyramid schemes are and how to distinguish them from genuine business opportunities.
Why is it called Pyramid Scheme?
This kind of investment fraud derives its name from the structure it has. Just like the name, pyramid schemes are usually structured like a pyramid. It starts with the originator who is on top, at the apex of the pyramid. This person recruits one or more people and ask them to pay some amount of money to join the scheme.
The amount requested can be as little as $5. The total money paid by the first set of recruits goes to the originator of the scheme. The recruits are then instructed to recruit other people under them. The new set of recruits will now pay the same $5. These payment will in turn go to the first set of recruits who paid the originator. In some cases, the entire amount will be paid to the recruiter while in some, only a percentage pre-determined by the originator will be paid to the recruiter while the rest is paid to the originator. In order words, the recruiter will only get his initial investment back and get some profit by recruiting people into the scheme.
Lets use a very simple example to illustrate the point I’m trying to make (in real life it is never this simple, it is usually complex). Let’s assume the originator recruited 1 person, Mr A, who paid him $5. That person he recruited will be asked to recruit another person under him who will pay $5 also. That means the originator recruits A who paid $5 to join the scheme. Then A recruits B who also pay $5 to join the scheme. The payment from B goes to A, meaning that A has recouped his initial investment in the scheme. If A continues recruiting more people, he will be making more and more money without selling any product or service. He simply tells them his own “success story” and show them prove of payments he has received from the scheme! (In Nigeria, a copy of the cheque showing payment from the scheme is enough to convince many gullible entrepreneurs. But is payment received from an investment really sufficient prove that an investment plan is legitimate?) Well, let’s not digress. This is not just about Nigeria. Let’s continue with the illustration.
Each new recruit is in turn required to enlist additional people. Each new recruit is obligated to pay the person who recruited them. This sounds so exciting bearing in mind that each member only pay once to the person who recruited them but can continue to make more money by recruiting new people into the scheme!
The scheme will continue until the base of the pyramid is no longer strong enough to support the upper structure. That means, it will be successful until there are no more recruit. At that point, you will be having several recruits who are unable to recoup their money because nobody wants to join the scheme anymore! Why will people stop joining when there is so much success stories from those that have been rewarded by the system?
The World Population is Finite!
The reason why a pyramid scheme cannot be successful forever is because irrespective of how long it may take a day will eventually arrive when there will be no more new recruits! Let’s assume for instance that the entire population of the Nigeria decides to join a pyramid scheme. How long do you think it will take before everyone becomes a member and there is no more people to recruit! Since the population has a fixed figure we are about 150million for now, (new births not withstanding) it simply means that eventually there will be no more recruit, so the last set of recruits will be stuck as there will be nobody to pay them. That is how people become victims in pyramid schemes.
Then it will dawn on them that even though they were deceived to believe that they will make money by joining the scheme, the fact that there was no product or service being sold means there is no wealth being created, so it is a matter of time before the entire system collapse . Why, simply because it is not sustainable! I get angry whenever I come across articles canvassing for Nigerians to join a pyramid scheme that is packaged to look like a lucrative investment opportunity.
Pyramid Schemes are Unsustainable!
The fact that a pyramid scheme cannot sustain itself as people are made to believe is a proof that it is a fraud in disguise! It is just a matter of time, somewhere down the line a group of people are bound to lose their money when the pyramid is no longer able to sustain itself. The victims are usually those at the bottom of the Pyramid. This kind of fraud is illegal in many developed nations, but in the third world countries, government rarely pay attention until it is too late and people have become victims.
Why Do People Join Pyramid Schemes?
It is all about getting rich quick. Too many people are attracted to the idea of making a quick buck with very little effort; many different forms of disguised pyramid schemes have succeeded in fooling people. Ignorance plays a major role. Often time, sincere people who are men and women of integrity actually promote such scheme thinking it is sustainable.
These armies of aggressive marketers are the one that go out to convince their relations, friends and colleague to embrace the scheme because they have proves in form of payments they have received from such scheme! The question a wise entrepreneur needs to ask is, can this scheme sustain itself forever, or there is a possibility of the whole system collapsing in the nearest future?
There are too many ways that con-artist can disguise pyramid scheme and present them as legitimate business opportunity. The onus lies on an entrepreneur to study and make research before committing into any investment opportunity. What is the business all about? What is the fund being invested in? What is the rate of returns? Answers must be provided to those questions before you commit yourself!
What about Multi-Level Marketing (MLM)?
Legitimate Multi-Level Marketing is not the same thing as pyramid schemes. Even though they have a form of resemblance, MLM involves being recruited in order to sell a product or service that actually has some inherent value. As a recruit, you can make a profit from the sales of the product or service, so you don’t necessarily have to recruit more salespeople below you before you can recoup your investment and make profit.
If it is impossible to recoup your investment in a Multi-Level Marketing program by just selling the product or service, unless you recruit new intakes, then it is not a legal MLM but a pyramid scheme in disguise. The simple difference between MLM and pyramid scheme is that MLM is about creating wealth by selling a product or service while pyramid schemes is about collecting money from recruits.
Pyramid Scheme MLM
A pyramid scheme MLM usually provide a product for sale. But such product will have no inherent or independent value of its own. Its value will be tied to the scheme and sales will only be possible to new recruits. For example, a report on activities of the scheme being sold to new recruit does not legalize a pyramid scheme. In this kind of pyramid scheme, you would be required to recruit new members into the MLM in order to make a profit from the product and keep the MLM alive. If joining the MLM is the only reason anyone would buy the products being sold, then it is not a legitimate MLM but a pyramid scheme being disguised as a legal MLM.
Chain Letters Pyramid Scheme
Chain letters pyramid scheme are letters sent via snail post or electronically soliciting that people contribute a small amount of money to the people on the list. The amount can be less than $1. The recipient is then asked to delete the first name on the list and then add his or her name before forwarding the letter to more people. The recipients are expected to repeat the process. If you ever do such, note that you are involving yourself in a pyramid scheme because you are asking people to give money with the promise of making money. Knowing too well that there will eventually be a time when some recipient of such letter will not be able to recoup their investment, it is a fraud!
Why You Shouldn’t Participate In Pyramid Schemes
Having seen how a pyramid scheme works, you will agree with me that irrespective of the way it is packaged and how successful it seems to be operating, it is a system built on lies and deception. People are made to believe that they can create wealth, get rich quickly, simply by joining an association that produces nothing! Wealth can only be created when you give out something that has value. The act of promising people money for recruiting others who are being giving the same promise is deceptive and illegal. It is obvious to one with a discerning mind that such promise cannot be kept. Some people along the line must become victims of the system.
As an entrepreneur, you should always ask question before parting with fund. Any business proposal must be researched and thoroughly examined. Not all that glitter is gold. It is not only the originator of a pyramid scheme that is engage in an illegal activity, all those that participate are equally liable and guilty of committing fraud. Are you participating in a pyramid scheme? If you’ve ever lost money in a pyramid scheme, kindly share your story in the comments section. Cheers.