What is a pyramid scheme

What is a pyramid scheme?

Pyramid companies earn almost all of their profits from new hires, and they often try to hide entry fees as fees for compulsory education, computer services, or product inventory purchases. Pyramid plans aren't just illegal; they are a waste of money and time.

A pyramid plan is a sketchy and unsustainable business model in which several top members recruit new members in the chain, who pay upfront cost to those who enroll them. As new members recruit their subordinates in turn, some of their subsequent wages are thrown into the chain. Often referred to as "pyramid scams," these transactions are illegal in some countries.


  • A pyramid scheme transfers earnings from those at the lower levels of an organization to the top and is often associated with fraudulent transactions.
  • The vast majority of pyramid plans are based on profiting from recruitment fees and rarely involve the sale of real goods or services of real value.
  • Multi-Level Marketing operations (MLMs) are similar in nature to pyramid plans, but differ in that they involve the sale of tangible goods.
  • In 2008, Canada was captured by a comprehensive pyramid scheme and a class action lawsuit was filed against the operation, forcing it to close and return funds to victim members.

How Pyramid Schemes Work

Pyramid schemes are so named because they resemble a pyramid structure starting at a single point at the top and expanding downward (see diagram below).

How Pyramid Schemes Work

Suppose that: Founder Mike sits alone at the top of the stack represented by the number "one". Suppose Mike hires 10 second-tier people to his level just below, and each novice has to pay him in cash for the privilege to participate. These purchase fees not only flow directly into Mike's pocket, but each of the 10 new members must recruit their own 10 tier three members (100 in total), who must pay second-tier recruiters. Send back a percentage of your withdrawals to Mike.

According to the difficult sales pitches at recruitment events, those brave enough to do the pyramid plunge will theoretically receive a substantial amount of money from the recruits below them. In practice, however, possible pools of members tend to dry out over time. And when a pyramid scheme is invariably closed, top agents walk away with loads of cash, while most lower-level members leave empty-handed.

It should be noted that the vast majority do not involve the sale of real products or services with any intrinsic value, as pyramid plans are largely based on new hires.

Pyramid Chart Types

There are different pyramid schemes that can be broadly classified as follows:

Multilevel Marketing Pyramid Chart

Multi-level marketing (MLM) is a legitimate business practice, but unlike traditional pyramid plans, this model involves the sale of real goods or services. However, participants do not have to close any sales in order to generate income by recruiting members below them.

Some MLMs are virtually indistinguishable from pyramid schemes because they involve the sale of printed material of no real value such as training courses. These MLM programs thrive by forcing recruiters to buy such value-free products at high cost and by having them sell the same products to the next generation of members.

Chain Emails

Chain emails entice inexperienced buyers to donate large sums of money to everyone listed in the email. After making the donations, the donor is invited to delete the first name in the list and change their name before forwarding the chain to their link group in the hope that one or more people will send cash on their way. In theory, recipients continue to collect donations until their names are removed from the list.

Ponzi Schematics

Ponzi's plans are investment cons that run under the leadership of "Rob Peter to pay Paul". They may not necessarily adopt the hierarchical structure of a pyramid layout, but by taking investment money from new blood, they promise high returns to existing investors. Often tempted by the prospect of unrealistically good returns, most Ponzi attendees lose everything.

Investment consultant Bernard Madoff, arguably the most notorious pyramid artist, was sentenced to 150 years in prison for running an illegal operation worth billions of dollars.1

An Example of a Real Pyramid Diagram

In 2008, a massive pyramid scheme in Canada promised citizens the chance to get rich by selling low-cost travel club membership plans. To qualify, the applicant "sellers" had to first purchase memberships at a price tag of $ 3,200 for themselves.2 More than 2,000 people pulled out their checkbooks as $ 5,000 was promised for each similar membership they sold. However, the profit could only be realized if the applicant members had accumulated $ 100,000 in sales that required the sale of at least 20 membership plans. But that proved almost impossible in a downward economy where people cling strongly to their money. As a result, the victim investors filed a class action suit that resulted in their money refund and the plan being lifted.

How Pyramid Tumbles

Pyramid schemes can be applied as long as the lowest levels remain wider than the upper levels. However, when the lowest levels shrink, the whole structure collapses. Due to the nature of exponential mathematics, pyramids are absolutely impossible to survive forever, and somewhere in the chain people will always lose their money. Interestingly, even senior early adopters can lose money as they approach the end due to conditions that often require waiting times, delaying payments from lower groups.


Pyramid plans are illegal in many countries. The model of making profits using the network effect often traps individuals to recruiting their acquaintances, which can feel slimy for everyone involved and ultimately strain relationships. Investors should be careful with such plans or avoid them altogether.

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"Multi-level" or "network" marketing is a form of business that uses independent representatives to sell products or services to family, friends and acquaintances. A representative earns commissions on his retail sales as well as on retail sales by other hires. Examples of well-known multi-level marketing companies include Amway and Mary Kay Cosmetics.

Some companies call themselves multi-level marketing when they implement pyramid schemes that actually violate Michigan's Pyramid Incentives Act. Even if a multi-level plan does not violate Michigan's Pyramid Incentives Act, if the actions, methods or practices are unfair, unreasonable or deceptive, marketing the plan may violate the Michigan Consumer Protection Act.

It is understandable that consumers often have difficulty telling the difference between an illegal pyramid scheme and a legitimate multi-level marketing opportunity. State regulators and industry continue to debate where the legal lines are drawn. Multi-level marketing is a legal and legitimate business method that uses a network of independent agents to sell consumer products. Compensation should be based primarily on the sale of products and services to the final consumer.

Pyramid schemes claim to be in the business of selling products to consumers to look like a multi-level marketing company. However, little or no effort is made to actually market the product. Instead, money is earned in the typical pyramid fashion from hiring other people to market the program. Sometimes, when new "distributors" sign up, they are persuaded to buy inventory or over-priced items / services.

Pyramid companies earn almost all of their profits from new hires and often try to conceal admission fees as fees for compulsory education, computer services or product inventory purchases.

Pyramid plans aren't just illegal; they are a waste of money and time. Since pyramid plans are based on hiring new members to earn money, plans often collapse when the potential member pool dries up (market saturation). When the plan collapses, most people lose their money, except for a few people at the top of the pyramid.

Market Saturation

Although pyramid supporters claim that the probability of winning is infinite, this possibility cannot be realized due to the saturation of the market. For example, if a program starts with one person hiring two people, each hires two more people, and so on, at just 28 levels, almost the entire population of the United States - every man, woman, and child - get involved as shown below.

Number of New
Total Number of

When researching a multi-level marketing opportunity, you should inquire about market saturation and identify saturation levels in your distribution area. Legitimate companies do not have many distributors in one area.


Pyramid supporters are masters of group psychology. Recruiting meetings create a frenetic and enthusiastic atmosphere in which group pressure and promises of large sums of money play on people's greed and fear of missing a good deal. Promoters also clearly discourage careful consideration and questioning of the plan. Victims often find themselves tricked into participating. At a recruitment meeting, "this is an opportunity on the ground floor to change your life," "opportunities don't disappear, go to other people," and "if you take action now and work hard for three people, you can retire for up to five years and live off the remaining income." Another warning sign is. it is a confusing compensation scheme.

Allegations of a company that its plans are "approved" by the Michigan Attorney General must be bright red flags, and you should report any such claim to our office immediately. A company that misrepresents a fact will likely misrepresent others. While our office can tell you whether we have taken any legal action or not, we will not comment on any specific inquiries regarding multi-level marketing companies. In addition, we do not provide any form of prior approval for any company, and if you want legal advice on whether a multi-level marketing opportunity is truly an illegal pyramid, you should seek private legal counsel.


The simplest form of the pyramid scheme is a chain letter asking the buyer to pay $ 1.00 or more to each of the five names on the list, copy the letter and then send it to new contacts with the recipient's name added to the list. Most chain letters claim that they are legitimate as they offer a product. On closer inspection, the product is just an excuse. Often times the newsletter explains additional "get-rich-quick" plans and may be the only item new members "buy". Alternatively, the newsletter can be offered "free of charge" to every new paying member. Either way, if it pays distributors to hire new members rather than sell an actual product to a wider audience, the plan is just a pyramid. In recent years, pyramid plans have become more complex and many have surfaced on the internet.


It is not always easy to spot the pyramid scheme lurking as a multi-level marketing opportunity, but it is just as much a scam. Here are some tips to consider before joining a multi-level marketing program:

Avoid any program that focuses on hiring new people rather than selling a product or service to an end user consumer. If the revenue opportunity is primarily obtained by hiring more participants or salespeople rather than selling a product, the plan is likely illegal. Several courts are putting more pressure on members to sponsor new hires than to market corporate property as evidence of an illegal pyramid.

Be skeptical of any plans that claim to make money through the continued growth of your "downline", which are sales commissions made by new distributors you hire, rather than your own product sales.

Be wary of specific income or earning claims. Many programs boast incredibly high earnings ("thousands per week" or "six-figure income") from the few top performing firms. The truth is that most of the people recruited to the organization do not come close to these amounts and most are actually losing money.

Be careful when presented with "testimony" of other distributors. These "success" stories rarely reflect the truth.

Be careful about participating in any program that asks distributors to purchase expensive inventory. There are horror stories of people who have a basement or garage full of goods that no one can buy.

Make sure that the product or service the company offers is something you would buy without an income opportunity and that the product or service is competitively priced. Illegal pyramid schemes often sell products well above the retail price or sell difficult-to-value products such as health and beauty aids, new inventions, or "miracle" treatments.

Never sign a contract or pay any money to participate in a multi-level marketing program or any business opportunity, without taking your time and reading all the documentation. Discuss the opportunity with a spouse, knowledgeable friend, accountant or lawyer. If you feel like you have been subjected to high-pressure sales tactics or haven't been given enough time to review details, go elsewhere.

When asked about pyramids, comparisons can be made to companies with a top-paid person. What they don't say is that companies are not trying to hire an unlimited number of employees or pay employees based on hiring new employees.

Be careful when products or services are just recruitment tools. Products can be fraudulent and / or overpriced, but even high-quality products can act as a cover for recruiting activities.


If you decide to become a distributor, remember that you are legally responsible for any claims you make about the company, its product, and the business opportunities it offers. This applies even if you are repeating allegations you read in a company brochure or advertising brochure. If you decide to request new distributors, remember that you are responsible for any claims you make about a distributor's earning potential. Make sure you represent the opportunity honestly and avoid making unrealistic promises. Remember, you can be held accountable if these promises are followed.

If you join a disguised pyramid scheme as a multi-level marketing program, your decision will affect not only you, but everyone you include in the program. Many people devote a significant amount of time to marketing these worthless ventures. Ultimately, if a multi-level marketing opportunity sounds too good to be true, it probably isn't.

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