Pyramiding vs. networking

The plight of First Quadrant and J.C. Martin, two of the leading multi-level marketing (MLM) networks in the country, illustrates the difficulty regulatory bodies have in distinguishing networking from pyramiding. The former is legal and is recognized worldwide as an effective marketing strategy. The latter is illegal and, in this country, has actually victimized a lot of people who would otherwise be considered sophisticated and not easily fooled by get-rich-quick or other fraudulent schemes.

The Department of Trade and Industry is closely investigating the two companies and will reportedly issue its findings very soon. The DTI’s determination will affect hundreds of thousands of Filipinos engaged in network or multi-level marketing, all of whom swear they are in a legitimate and highly productive economic activity which has lifted them from poverty.

First Quadrant and J.C. Martin sell Marikina shoes and assorted fashion items. There are more than 20 other outfits marketing such goods as food supplements, water purifiers, premium cookware, fashion jewelry and personal care products.

The action against First Quadrant and J.C. Martin is assailed as a purely political move against Department of Environment and Natural Resources Secretary Mike Defensor to derail his current drive against illegal loggers. His wife, whose family has been into shoe manufacturing in Marikina for decades, is the managing director of the company which is credited with being instrumental in reviving a moribund industry in that now progressive city. Indeed, City Mayor Marides Fernando, the wife of former Marikina Mayor and current Metro Manila Development Authority chairman Bayani Fernando, is one of First Quadrant’s most enthusiastic supporters.

At any rate, the motives of the DTI’s Anti-Pyramiding Task Force in investigating the two companies are not the main thrust of this piece. What we’d like to focus on are the distinctions between legal networking and illegal pyramiding, as explained by both the DTI and the Securities and Exchange Commission.

To begin with, there are no specific laws governing either pyramiding or multi-level marketing (MLM). The Consumer Act of the Philippines does state that "chain distribution plans or pyramid sales schemes shall not be employed in the sale of consumer products" (Article 53).

The Act defines "chain distribution plans" or "pyramid sales schemes" to mean "sales devises whereby a person, upon a condition that he makes an investment, is granted by the manufacturer or his representative a right to recruit for profit one or more additional persons who will also be granted such right to recruit upon condition of making similar investments: Provided, that the profits of the person employing such a plan are derived primarily from the recruitment of other persons into the plan rather than from the sale of consumer products, services and credit: Provided, further, that the limitation of the number of participants does not change the nature of the plan" (Article 4(k).

According to the DTI, the test to determine whether or not there is a violation is whether the scheme involves an investment (entry fee and purchase of goods, or purchase of goods alone) for the opportunity to receive earnings primarily from recruiting, rather that from sales. If so, then there is a violation of law.

Pyramiding, the DTI says, should not be confused with MLM which is a legitimate marketing strategy designed to generate increased business volume.

An SEC Advisory further clarifies that "multi-level marketing plans are legitimate types of pyramid operations whose primary purpose is to sell a product and not mainly to sell the distributorship itself." Income is earned from the sale of the products being sold.

Thus, the focus of an MLM network is the sale of tangible products not of distributorships. The reason pyramiding schemes are prohibited is that they collapse when no new distributors can be found. The profits of those at the upper level of the pyramid come from sales to people at lower levels.

Mathematically, however, the point will eventually be reached where no new distributors can be recruited. If the scheme does only selling of distributorships and not of products, those at the lower levels of the pyramid are certain to lose their money.

The regulators have stressed that the mere fact that products are sold does not make an alleged MLM operation legitimate. If a new recruit is required to buy products, but does not subsequently sell to consumers who are not themselves new recruits, then the company might be growing primarily by getting more recruits and distributors to buy their products. This is a no-no. The idea of a marketing plan is that products be sold to consumers, those who are members of the network and those who aren’t.

Pyramiding isn’t limited to those highly-publicized scams where people put in money on assurances of interest earnings well above market rates. It later turns out that the high interest is possible only because the money invested by subsequent recruits is used to pay off earlier investors senior to them in the pyramid. Invariably, the scheme collapses since there are never enough new gullible investors to recruit.

It is difficult to figure out why even intelligent and wealthy investors get drawn into these fraudulent schemes, unless they are driven by insatiable greed. Or, to paraphrase P.T. Barnum, there’s a sucker born every minute.

The MLM strategy, however, does seem to serve legitimate economic purposes. Many have made a good living from this unique system. In fact, I’ve seen people turn desperate, unproductive lives into lucrative careers. It is clear this isn’t just an elaborate con game.

But whether First Quadrant and J.C. Martin pass muster depends on the government’s own findings of how they conduct business. Hundreds of thousands of people depend on both companies for their livelihoods. Abangan.