Late last week, analyst Douglas Lane at Jeffries & Co. told investors that "direct selling companies" were going to be a good investment in the coming year. His rationale? The industry's ability to penetrate new consumer markets with disposable income, particularly in countries like China, Russia and India.The news report explained that the "direct selling" industry distributes products by demonstrating them in homes and with product parties.
What the news story left out is the fact that "direct selling" is really a misleading term for what is now more commonly known as multi-level marketing (MLM), or network marketing.
Here's the problem with MLM from a consumer standpoint: The MLM industry has been around for decades, and still fails to be a real player in the retail marketplace. The economy functions by real retail sales from real retailers online and in brick-and-mortar stores. MLM could completely go away and almost no retail consumers would even notice.
And while in raw dollars, the industry can collectively brag about the amount of money spent on products and services sold, all available evidence suggests that the bulk of those "sales" are really just purchases by associates/distributors who are merely meeting various "requirements." It's a fact that MLM companies require distributors to make certain minimum purchases in order to move up in the pyramid. And although the MLMs like to pretend that those purchases are sold to third-parties as ultimate end-users, available evidence shows that the bulk of those products are not resold to retail customers.
So the real purchasers of MLM products become those who have bought into the idea of owning their own business. They have little actual retail sales, and rely instead on recruiting new members to the scheme. Those new members are encouraged to make purchases of the products, are unable to retail much of the products for a profit, and so those people begin recruiting and the cycle continues.
The MLM industry has come under fire from Barry Minkow and his Fraud Discovery Institute. Minkow has investigated some of the bigger players, and has engaged in a public relations campaign to alert consumers and law enforcement authorities (specifically the SEC) about the realities of the industry. (Note: In the interest of full disclosure, I have worked with FDI on these investigations.)
Today, MLM is in a constant state of collapse, with distributors leaving the MLM plans almost as fast as they come in the door. Americans are becoming wiser to the schemes and many companies are finding it more difficult to grow the distributor base here. They are turning to overseas markets to fuel growth as those markets appear to have increasing disposable income and an apparent lack of education about MLMs.
How this industry can be seen as attractive is beyond me. U.S. consumers are becoming wiser to the scheme and if the FTC ever decides to really enforce the laws against pyramid schemes, these companies may be in big trouble. Overseas markets are attractive, but countries could take a tough stance against MLMs, like China has done. China prohibits selling via multiple levels, and instead only allows retailing of products (not that it matters to some U.S.-based MLMs).
Other industries have to be more attractive as the real numbers behind the growth are being exposed.
Forensic accountant Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations through her company, Sequence Inc. Forensic Accounting. The Association of Certified Fraud Examiners honored Tracy as the 2007 winner of the prestigious Hubbard Award and her first book, Essentials of Corporate Fraud, will be on bookshelves in March 2008.
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Reader Comments (Page 1 of 1)
12-13-2007 @ 1:40PM
Bob said...
This is not news, this is opinion and slander!
12-14-2007 @ 12:41AM
funfelt said...
Actually this is not true at all. Direct Sales is NOT the same as network marketing. In direct sales the primary exchange of money is for products which are demonstrated at home parties and vendor events or one on one sales. Network marketing relies more on sponsoring or signing others up for wholesale accounts. There is a difference! They do both have 'multi level' components to them but that is not the defining aspect.
12-14-2007 @ 6:19AM
Carol said...
You are completely wrong, direct sales is NOT the same as network marketing or MLM. Donald Trump & Robert Kiyosaki are promoting direct sales and there is a reason for this. There are no home parties involved either. More millionaires are being created by home businesses in direct sales than ever. You should do your homework before makings such wrong opinionated comments.
12-14-2007 @ 9:09AM
Tracy Coenen said...
Carol - Sadly, you have been sold a bill of goods. The line about millionaires from direct sales is just that - a line. Total urban legend with no proof to back it up. And for some insight about Kiyosaki and company, you should read these:
http://www.bloggingstocks.com/2007/02/23/note-to-yahoo-ditch-the-rich-dad/
http://www.bloggingstocks.com/2007/01/03/terrible-books-top-this-years-personal-finance-best-sellers/
Funfelt - Yes, there used to be a difference between direct sales and MLM. Unfortunately, all the MLMs now call themselves direct sales. But they're still MLMs and the name of the game is recruiting, not selling products. The home demo is really about finding new recruits to build the pyramid.
12-14-2007 @ 2:53PM
Amod said...
I totally agree with Tracy Coenen. i have not seen any true direct marketing company. They all start with saying that they are product selling company (direct marketing) but all end-up with MLM. Thier products are 3-4 times costlier then market price and hence they know that they can't sell to enduser. Thus they are interested in making only distributor. Can any company have sustainable buisness where there are only distributors and no end consumer? They are not doing a buisness but just concentrating money from a large no. of distributors to a handfull ditributors (top level), whcih are taken as success stories. Lacs of failed distributors are not talked about.
12-19-2007 @ 2:31PM
Roosevelt Cooper said...
I agree to a certain extent.
In my experience there are a lot of MLM companies that offer products that are overpriced compared to competing products in the marketplace for the sole purpose of funding their compensation plan. The only reason why these companies are still in business is through a process called "front-loading." This is where a distributor is encouraged to purchase large quantity of products to qualify for certain levels in the compensation plan. I do not consider this "real" retail sales and it's only a matter of time before the FTC realizes what is going on with these companies and shut them down. This cannot be sustained long term.
That being said there are also plenty of companies that offer a real product. In other words, a product that people would purchase without getting involved in the business opportunity. I have purchased a number of services from MLM distributors without ever becoming a distributor with the company. In fact, one of the companies I use to work for offered a service offered by a MLM company as an employee benefit for its employees. The employees had to pay for the service via payroll deduction and none of the employees were distributors with the company.
Every industry has its good companies and bad companies. A wise investor knows how to identify the difference and invest accordingly.