I was in St. Louis last April visiting relatives. As any native St. Louisan will tell you, it is a civic duty to go to at least one Cardinal baseball game if you are in town during a home series. After all, St. Louis is a baseball town, and to miss a game is akin to denying your heritage. Not wanting to reject my birthright, I found myself in the bleachers at Busch Stadium for the first game in a series against Houston. I was anxious to see how the Red Birds looked as spring training had recently ended and it was time for the players to earn their diminutive seven figure salaries.A few minutes before the game started, an old college classmate whom I had not seen for at least 20 years sat down next to me. It was good to see him and to catch up on old times. The topic of conversation was as would be expected for people who have not seen one another for some time - baseball, old friends, baseball, who is doing what, where are they now, baseball, all standard fare. Then came the seventh inning stretch.
As the teams left the field, my old classmate said to me - "You know, I have always respected your business judgment. I'm working my own business, and I'd like to run some ideas by you and get your opinion." I quickly flagged the beer vendor.
"Have you ever heard of multi-level marketing?" he asked. "I'm vaguely familiar with it" I responded (as I always enjoy hearing distributors pitch companies and their products, this door wide-open answer has become only slightly less automatic than breathing). He then broke into a frenetic discourse on the evils of corporate America, job insecurity, and how anyone who does not own his or her own business is doomed to indentured servitude for the rest of their lives. But he had the answer.
"This program is unlike all the rest!" he exclaimed. "You buy your products, enroll people as distributors, and get a commission off of what they buy and sell." "Novel and provoking concept" I replied. "Yeah, but that's just the tip of the iceberg. You see, in this program, not only do you get a commission from your downline's purchases, you can also sign them up to take the company's $500.00 training course. The training is a separate fee, and you get a commission for each person you train, and also get an override bonus for every training course sold to your downline through five levels." He then spent the next inning describing the importance and details of getting people enrolled in the training program.
When he stopped for air, I asked what products or services the company was selling, as this had not been mentioned (just a minor marketing oversight). "Widgets" he replied. "Tell me about the widgets, are they any good?" I asked. His response was predictable: "They're just widgets, don't get hung up on them. I focus on promoting the training program, not on the widgets, because that is where the money is." You mean you are getting paid for selling training programs that train people how to sell widgets, but the sale of widgets is of secondary importance to the sale of training programs?" EXACTLY! he exclaimed, as though I had just received a divine revelation. I stated that seemed backwards to me. After all, baseball players don't command mega-buck salaries for their efforts in training camp. They earn their salaries based on their results during the playing season. "Shouldn't you get paid based on your sales results rather than your efforts simply to enroll people in a training program?" I asked. "This isn't baseball - this is multilevel marketing. The training is the product!" he proclaimed.
Several very visible companies have successfully incorporated training bonus programs into their plans. They are typically presented as a second compensation structure dedicated to training. As a result of these few companies' success with training bonus programs, the MLM industry is seeing a proliferation of training programs overlaid on traditional marketing plans. I frequently hear clients say - "Well, ABC company does it, and they are such a big company it must be legal." This raises a timely topic - what legal problems are associated with override bonuses on training programs? Training programs have not been the central focus of regulators' attacks on MLM companies, but that does not mean a training-based compensation plan is without risks. In the March 1997 permanent injunction that a California court entered against Destiny Telecomm, the court specifically enjoined Destiny from paying commissions based on training programs. The injunctions expressly states:
Defendants are hereby permanently restrained and enjoined from directly or indirectly paying commissions on sales aids, such as video tapes, flip charts, sales kits, magazines or other items or materials which can be used to recruit or train distributors or for the purchase of training classes.
The injunction prohibiting Destiny from paying commissions on sales has largely been lost by the public because the 1.6 million dollar civil penalty provisions have captured the media and public attention. Nevertheless, it is a significant aspect of the court's order, and one which the MLM industry should take note. This is particularly true since, as training-based compensation is becoming increasingly popular, the likelihood that the industry will see an increase in regulatory action is a very safe bet.
So what are the risks associated with training programs? First and foremost, companies need to recognize that marketing plans must be driven by the sale of products or services rather than the sale of training programs. Paying commissions based on enrollments into a training program can easily be viewed as a head-hunting operation that compensates participants for signing up new participants. This is simply the operation of an illegal pyramid.
My baseball game experience perfectly illustrates how a training program can turn an otherwise legitimate MLM program into a pyramid. The emphasis is placed on signing people up into the training program and not on the sale of widgets to end consumers. A company can make the best widget in the world, but if its sales force emphasizes enrolling people into the training program rather than selling the product, the program will come under regulatory attack as a pyramid.
Commissions should be generated from the sale of goods and services to end consumers. A common regulatory approach defines "end consumers" as individuals who are not participants in the company's compensation plan, and who are not purchasing in order to participate in the compensation plan. What this boils down to is that retail sales, rather than sales to distributors, must constitute the foundation of an MLM program.(2)
Herein lies a second dilemma for compensation based training programs. Except in rare circumstances, the only individuals who will sign up for the training program are the company's own distributor force. There is simply no reason for someone who is not an ABC distributor to pay $500.00 to learn how to sell ABC widgets under the ABC marketing plan.
So where are the retail sales? I have heard companies proclaim that their training programs are so good that any sales person in any industry can use it. They claim that once word gets out about how good it is, non-distributors will flock to the training sessions. If in fact such predictions prove to be true, any regulator would be satisfied. If non-distributors are willing to shell out $500.00 for a superlative sales training course, it clearly has intrinsic value separate from the compensation structure. But guess what? That is not reality. When the sales figures are tallied, you will be hard pressed to find any non-ABC company distributors on the ABC company training program enrollment lists.
Any company that pays out more in commissions based on the sale of training programs rather than the sale of its goods and services needs to step back and analyze what it is really selling. If the sales force is emphasizing the training program over the company's products and services, the company is selling an income opportunity. If this is the case, the company must refocus its marketing strategy and compensation structure. The emphasis simply must be on the sale of products and services to the end user rather than the sale of training programs.
Some companies emphasize to their distributors that if they want to learn how to manage and operate their independent business, they must enroll in the "optional" training program. In reality, this is the only way for distributors to learn the program because companies taking this approach often lack a policy requiring upline distributors to work with their downline. This is a mistake, for if upline distributors take no role in managing and training their respective sales organizations, the risk that the program will be scrutinized as a security or lottery are greatly increased. If they do not work with their downline organizations, the upline are receiving income primarily from the efforts of others, or as a matter of simple luck. These are the cornerstone elements of a finding that a program constitutes an unregistered security or an illegal lottery. It is therefore critical that a training program does not usurp the training and management functions that should be performed by upline distributors.
My classmate was correct when he said baseball is different from multilevel marketing. In baseball it's three strikes and out. In MLM, one strike can get the company fined and ejected from the game. Therefore, companies must remember that they are in the business of selling goods and services to end consumers, not training programs. If the company insists on implementing a training bonus program, the products and services simply must be the star of the team. Training bonuses, on the other hand, should at the very most play the role of a pinch hitter.
1. Spencer Reese is a partner in the law firm of Reese, Poyfair, Richards PLLC. He is a graduate of the Washington University School of Law and is a member of the Idaho, Missouri and Colorado bars. He was formerly in-house counsel for Melaleuca, Inc., a multilevel marketing company with sales in excess of $260 million. Mr. Reese's current practice includes representing and advising multilevel marketing companies on all aspects of their business, including consumer protection, advertising law, litigation, contracts, marketing plan design, regulatory compliance, trademark law, FDA law, policy development and distributor compliance. Visit the firm's website at www.mlmlaw.com. Mr. Reese can be contacted at (801) 981-8281.
2. The retail sales debate is fiercely contested between regulatory authorities and MLM industry members. Most regulators recognize that while retail sales must drive the program, some degree of personal consumption by distributors is appropriate. The acceptable personal consumption levels, however, are often arbitrarily established and are typically far less than what most companies believe is necessary to protect against inventory loading.