How to Recognize a Pyramid Scheme

How to recognize a pyramid scheme

Image from

And Why to Run if You Do!

Some time ago a friend called me, terribly excited about a new scheme she had become involve in. Actually, she was so excited about it, and so keen that I should also get involved, that she had signed me up and paid the entrance fee on my behalf! (Something which made it so much harder when I had to tell her, “This scheme is a scam. I don’t want to be involved, and I urge you to get out of it as quickly as possible.”)

It sounded great. For a measly $200 you got entered on the lowest level. You only had to recruit two people under you (though you were welcome to recruit more if you wanted), and when you had cycled through a certain number of levels, you walked away with $6000. Then, you went back to the bottom and (without any extra input of cash) started cycling again.

Unfortunately my friend was very upset with me when I told her it was a pyramid scheme. She pointed out that the web site stated that it complied with all the government requirements. She pointed out that there were lots of testimonials of people who had made the way to the top level, collected their $6000, and done all sorts of wonderful, altruistic things with it. And she simply couldn’t – or didn’t want to – follow the math when I tried to show her how it would inevitably collapse.

My friend was naive (some unkind souls would say, gullible) but more than that she was desperate. And naive, desperate people fall for these schemes in their droves – if they didn’t, the schemes would not exist.

So how do you recognize a pyramid scheme? Firstly, it helps to have a basic understanding of how things work. Short of winning the lottery or Great-Uncle-Fred-Whom-You-Never-Knew-Existed dying and leaving you his millions (neither of which rates very highly on the probability list), there are basically three ways you can earn money:

1. You can work for it.

2. You can get someone else to work for you, and benefit from their labor. Some examples would be if you run an agency of some kind, or if you have an internet business and have affiliate marketers.

3. You can get your money to work for you, and bring in more money.

The first is the obvious, tried and true method: you give your time and labor in exchange for money. It works, and despite the jibes about “job” meaning “just over broke”, it has put bread and butter on the tables of many generations before us. Unfortunately, many people have developed the mentality that when they move away from the “job”, they will also move away from work. Nothing could be less true. Sadly, the free lunch is sold out. No matter what other means you use to earn money, it will still involve work.

Getting someone else (or lots of someone elses) to work for you does not mean you don’t work. What it does mean is that you are able to multiply the volume of work. Even though this inevitably means that you earn less per unit of work, there are vastly more units performed, therefore more money in your pocket. I once worked for a babysitting agency. Had the proprietor done the babysitting herself, she could have earned maybe $10 per hour. However, with a hundred sitters on the books, each earning $10 per hour, from which she received $1 per hour, she was vastly better off.

This works, however, only if the people under you actually work. If all they ever do is recruit more people, who also only recruit others, and so on down the line, no income is being generated. That means no dollars in your pocket or in anyone else’s. You will end up broke, but with a big organization.

That leaves getting your money to work. Dollars are not rabbits: they will not multiply if you leave them alone in a dark corner. The only way they can make more dollars is by working.

You can put your dollars to work in several ways:

1. You can use them to buy something which you are later able to sell at a profit.

2. You can use them to buy the raw materials to manufacture something you are later able to sell at a profit.

3. You can use them to pay someone else to do work from which you will profit.

4. You can use them to buy something that someone else will pay you to use.

5. You can lend the dollars to someone who will pay you interest while they have the use of them, and eventually return the original amount to you.

So how does all that relate to pyramid schemes? Very simply, in a pyramid scheme, people do not work other than to recruit new members to the scheme, and money does not work. The only money generated into the scheme is what is paid as an entrance fee by each member. Since that entrance fee does not generate any other money along the way, the only thing that each person can take out without destabilizing the whole structure is what they put in.

Let’s look at a very simple pyramid. Let’s say each person has to put one egg into the basket, and to recruit two new people for his next level. When his fourth level is complete, he can withdraw eight eggs and make an omelette. Here’s how it would work:

Level 1. You. One egg in the basket. Average 1 egg per person in the scheme.

Level 2. You plus 2.  Three eggs in the basket. Average 1 egg per person.

Level 3: You + 2 + 4. Seven eggs in the basket. Average 1 egg per person.

Level 4: You + 2 + 4 + 8. Fifteen eggs in the basket.

At this point your four levels are complete. You take your eight eggs and trot off to enjoy breakfast. However, now there begins to be a problem. By taking your 8 eggs, you leave only 7. Divided by the 14 people left in the scheme after you go, this means the basket now contains only an average of half an egg per person, instead of one.

As each successive level comes to the top, grabs their eggs and heads for the frypan, the average number of eggs for each person remaining in the system decreases. In this particular matrix, it takes only 12 generations before the average is 0 eggs per person! And that is assuming that it all works perfectly, with every person recruiting the required two others. If even a small percentage fail to recruit, or if people recycle to the beginning without any further input of cash, the whole thing falls in a heap even more quickly. Remember also that the “reward to investment” ratio in this simple example is much less than that offered by most pyramid schemes, thus they would collapse even more easily.

It doesn’t matter what kind of matrix, or what format you use. Sooner or later, the results will be the same. This happens for one simple reason: the only money coming in is the entrance fee for each participant. That money is not working. It has not generated any other money along the way. There are only two possible outcomes: either each person walks away with the money he put in (which kinda defeats the purpose of having a scheme in the first place); or a few people walk away with the money that lots of other people put in, and a lot of people walk away with nothing.

So, how do you recognize a pyramid scheme? Basically, ask two questions: (1) What income is being generated into the scheme? If the answer is, “Only the member’s entry fees” then don’t walk, RUN away. (2) What do the members do to make the scheme work? If the answer is “Only recruit more members”, run.

Often, in an attempt to overcome government regulations, schemes will claim that members are “buying” something when they join – often a bunch of e-books that have been around since the dinosaurs and can be downloaded for free with a bit of searching on the Net. In this case ask, “Is this an ongoing income generation, or is it a one-off that is really an entrance fee in disguise?”

Don’t believe the blurb on a web site or in a letter. Just because someone says that they “meet all government requirements” doesn’t mean that they do. Likewise, testimonials can easily be faked. And if a scheme finds it necessary to proclaim loudly and often that “This is not a pyramid scheme,” then there is a pretty good chance that it is! Above all, the old rule of thumb still applies: if it sounds too good to be true, you can bet it is!

Why do you care? Apart from the fact that you stand an excellent chance of losing your hard-earned, and that if you don’t other people will (which may or may not bother you, depending on your ethical standards), in many countries pyramid schemes are illegal. Here in Australia, it is not just illegal to promote a pyramid scheme, it is illegal even to belong to one. That means that if (when) the one you are part of crashes, you stand a good chance of prosecution and fines. It also leaves you open for civil action from those who have joined below you and lost everything, particularly if false representation was involved.

All of us want to earn more money. Most of us would like to do it the easy way, rather than the hard way. But, in the long run, pyramid schemes are just not worth the hassle.

Share with your friends
To report this post you need to login first.

Leave a Reply

Your email address will not be published. Required fields are marked *