Let me preface this by saying that I am not involved in any multi-level marketing (MLM) business, nor do I have an interest in joining one, whether at the top of the pyramid or somewhere in the downline. The very fact that I feel the need to include this disclaimer, though, is part of what I want to talk about in this essay. Why does MLM have such a bad reputation, what’s wrong with it, and can it be fixed?
If you’re a salesman, you’re already quite familiar with the challenge and opportunity of working on a commission basis. It’s easy: the more you sell, the more money you’re paid. If you’re selling $500 gizmos and you’re paid a 5% commission, selling 3 in a day nets you $75, not much at all. But sell 20 in four hours and you’re doing very well, earning $500, or a delightful $125/hour.
This business structure is so well established that many of the businesses with which I consult have “pure commission” salespeople on the team, people who are paid a very healthy fee for each closed sale, but who are paid zero if they can’t close. Since few businesses can afford to be philanthropic efforts, good intentions inevitably meet harsh reality at the sales desk, so it makes sense.
No sales = no income = no company.
Take a step up the food chain in a typical corporation and you’ll find that the sales manager gets a bonus based on the performance of their salespeople, and that the VP of Sales also gets a bonus based on the aggregate sales of the team. Indeed, the CEO of the company is also likely to get a bonus based on the growth of the company revenue year over year.
In essence, a pyramid system where that $500 product might well produce a $25 commission for the sales person, a $10 commission for the sales manager, a $10 commission for the VP of sales and (more likely than not) a $20 commission for the CEO. In other words, $65 (13%) of the $500 sale might well go to commissions in this sort of scenario.
Harvard Business School, for example, lists three basic ways to pay your sales force:
- Salary plans pay fixed rates of compensation and are appropriate when measurements of performance are difficult to ascertain.
- Commission plans pay salespeople in direct proportion to their sales and are appropriate for maximizing incentives or for predicting sales costs in direct relationship to sales volume.
- A combination plan includes all variations of salary plans plus other monetary incentive plans. This plan is more complex to administer; however, it allows for greater incentive and flexibility.
Even in that bastion of business capitalism, HBS, commission based sales is a recommended strategy.
Let’s go a bit further down this business scenario too. Now try to imagine the motivation for the sales manager when she (or he) is interviewing a potential hire. What’s their primary motivation? That they can sell the heck out of the product/service. In essence, the sales manager (and VP and everyone else in the company) is going to act based on enlightened self-interest and hire the candidate who seems most likely able to close on product sales.
Many large companies also offer a bonus or reward for new employee referrals too, which extends the incentive for finding good salespeople who can close deals down to the front lines. Now everyone in the sales loop is trying both to help sell product and find new salespeople who can maximize product sales.
(well, some salespeople might be concerned about new folks adversely impacting their own sales, but that’s typically addressed by sales territories, where each salesperson is assigned a different geographic or demographic customer group)
With a typical company, then, we have salespeople who are paid to sell their product and to find new salespeople, managers who are paid partially based upon the ability of their sales team to close sales and, through ESI (enlightened self-interest), also motivated to find new and better employees to continually maximize sales and revenue, and so on, up the chain to the CEO.
Now, tell me how Avon (NYSE:AVP) or Amway are different?
They also have a distributed sales team where each team member is paid on a commission-only basis and are also paid based on a percentage of the sales of their team (in the MLM space, they call this your “downline”). The sales manager has a similar structure and sits one rung higher up on the ladder, on and on, up to the Amway or Avon corporate team itself.
There are two core differences I see between a Fortune 500 sales team and the folks in my neighborhood who are selling an MLM product, though: first, traditional corporations don’t have an ever-growing org chart. Imagine if every few weeks another level of management was added to Kodak (NYSE: EK) or Starbucks (NASDAQ:SBUX). It’d produce chaos and, more importantly, would continually dilute the accountability chain. If sales drop, who is actually responsible when the sales team could be arbitrarily wide and deep?
The second difference, and this is the big one I think, is that in a traditional sales group, your incentive for bringing someone else on the team is a one-time bonus, not a percentage of their sales for a specified — or endless — period of time.
The first problem can be addressed by disciplined MLM organizations, of course. They can just say “after we’re four levels deep, we can’t go any deeper”. This makes intuitive sense if you think about each party taking a slice of the pie: even if each party only gets a 5% commission on a sale, eventually you’ll run out of base revenue and be paying more commission than the profit on a given product. That’s a recipe for bankruptcy.
Which leads us to what is the core problem with multi-level marketing companies: offering a percentage of transaction revenue from your downline or sales team without a specified duration.
The math is easy too. If I can earn 5% of every sale you make as part of my sales team or 10% of any sale I make, I’d rather just get you on board and take some leisure time while you do the hard work of closing the sale.
This is the core of where MLM breaks down, obviously, when members are incentivized by the very structure of multi-level marketing to find new team members rather than sell the individual products (and that’s times ten if there’s an “initiation fee” that’s split by the existing organizational members).
But what if there were an MLM business where both of these problems were addressed? Where it couldn’t grow arbitrarily deep (or wide, depending on your metaphor) and where people are paid a sales commission bonus for bringing new people on board, but only for a very finite amount of time?
As I said, I’m not involved with any MLM business, but when I do think about the fundamental business structure, I’m always intrigued by its extraordinary parallels to sales teams in traditional corporations along with its few core differences.
Seems to me that there should be hybrid MLMs that enjoy the benefits of a highly motivated, distributed affiliate-only sales team while avoiding the trap of motivating your team to the wrong end goal: finding more team members rather than selling products. Is there?
MLMs generally have a miserable reputation and even asking a question about MLM businesses structures on Twitter quickly elicited sarcastic and hostile responses. People don’t like ’em, but most of the commentary seems to be more about the people who are the most vocal proponents / salespeople rather than about the business itself. One way to look at that is that Avon, for example, sells a good line of products, has its own R&D team, etc.
Nonetheless, there is a stigma around MLM. Is it justified when you just look at the business structure?
For that matter, if I include an affiliate link to Amazon (NASDAQ:AMZN) or a redirect through something like Clickbank that pays me a commission because you decided to buy something through my link, is that really fundamentally different to me selling you some Avon skin lotion or a carton of Amway dishwasher soap?
What’s your take, dear reader?