Multi-Level Marketing

11 Jun 1998 17:15

I recently had occasion to explain the notion of Amway to some foreign researchers here in Santa Fe. They were incredulous that such a thing could survive for more than a year, since it didn't seem at all different from a straight-forward application of the princples of the late Mr. Ponzi. And, in fact, when you think about it, it raises some interesting puzzles.

First, a little about how multi-level marketing works. Some central corporation provides a line of products or services. These are marketed through members of a network --- either they buy from the center, and then resell, or they simply act as salesmen, on some sort of commission scheme. The multiple levels, and the resemblence to pyramid schemes, comes in here. When you recruit someone else, not to buy the center's products, but to sell them, you get some kind of reward --- a percentage of their sales, or credit from the center, or something of that kind. You therefore have an incentive to get as many people as possible selling things under you. The center has a marketing force for free, or rather for very little.

The question, then, is why these things don't follow the usual life-cycle of pyramid schemes, growing exponentially until the supply of suckers is exhausted and crashing ignominously. We came up with a number of excuses for this shocking failure on reality's part to conform to our expectations.

  1. Money actually comes in. The problem with a pyramid scheme is that it's simple redistribution among those within the pyramid; no money enters from outside. This is not so with so-called legitimate multi-level marketing, where you can tap sources of money (customers) who are not part of the chain. (But it seems the incentives are almost never such as to encourage this, possibly useful, activity.)
  2. Slow growth. Maybe multi-level marketing schemes really will all crash and burn, only they grow so slowly we don't observe this, or they get stopped by some other cause before they reach their ecological limits.
  3. New one born every minute. A pyramid scheme could actually be kept going indefinitely if it grew slower than the rate of available suckers. (That's a technical term.) If the MLM grows slow enough, it could continue to add new, young members of the chain at the same rate as old ones drop out through death, getting real jobs, etc.

The next natural thought is that it should be possible to model this. One can imagine MLMs differing in their incentive mechanisms, all competing for the same population of customers and potential chain members. They're actually trying for a tricky piece of multi-objective optimization: first, the center wants to maximize its profits (discounted over time and risk); second, a chain which booms and crashes will go extinct, so it wants to have some sort of sustainable growth; and third, people in one chain can presumably switch to another if it offers them a better deal, so you need to optimize profit to chain members (discounted over time and risk). And then of course there are all sorts of issues about how competing MLMs respond to each other's successes and failures.

Now this starts to look like a very interesting interdisciplinary problem. We've got issues of institutional economics and mechanism design and market structure, small-world networks and dynamics on them, replicator dynamics, evolutionary search, game theory, even something like ecology (think of the marketers as predators and their customers as prey), bounded rationality (an all too realistic assumption in this case) involved in the decision to join an MLM or switch MLMs, probably in an evolving way (if one MLM collapses spectacularly, it will probably make people more leery of joining any other). In fact, it seems like the Santa Fe problem, lacking only a connection to rugged fitness landscapes and cellular automata.

I have no idea why multi-level marketing sustains itself.