Business, Legal & Accounting Glossary
A pyramid scheme is an illegal “investment” in which vested members are paid from the membership dues of new members. Ultimately when the number of new members is unable to support the payments due to existing members, the pyramid scheme collapses. Often when a pyramid scheme falls apart, the majority of members lose all or most of their investment. In order to entice a constant stream of new members to join a pyramid scheme, such schemes offer a very attractive rate of return for joining. Generally, there is no real product produced or service performed with a pyramid scheme. A pyramid scheme is also known as a Ponzi scheme. Many chain letters are also a form of a pyramid scheme.
A pyramid scheme is a business model that involves the exchange of money primarily for enrolling other people into the scheme, without any product or service being delivered. Pyramid schemes have been in existence for at least a century. The method of conducting business known as multi-level marketing (MLM), as well as matrix schemes, often closely resembles pyramid schemes.
Pyramid schemes come in many variations. The earliest schemes involved a chain letter distributed with a list of 5-10 names and addresses on it. The recipient was told to send a specified small sum of money (typically $1 to $5) to the first person of the list. The recipient was then to remove this first person from the list, move all of the remaining names up one place, and to add his/her own name and maybe more other names to the bottom of the list. Then he/she was to copy the letter with new name list to the individuals listed. And hopefully, this procedure was to be repeated and pass on and then he/she would be moved to the top of the list and receive money from the others.
Success in such ventures rested solely on the exponential growth of new members. Hence the name “pyramid”, indicating the increasing population at each successive layer. Unfortunately, a simple analysis will reveal that within a few iterations the entire global population would need to subscribe in order for all of the members to earn any income. This is impossible, and the vast majority of people who participate in these schemes simply lose their money.
Although pyramid schemes have been declared illegal, they still persist in many forms. While schemes simply involving the blatant exchange of money have generally disappeared, many schemes persist that purportedly “sell” a product to mask the primary intention of simply enrolling new members. One debatable example is Quixtar, a reincarnation of Amway. The distinguishing feature of these schemes is the fact that the product being sold has little to no intrinsic value of its own. Examples include “products” such as brochures, cassette tapes or systems which merely explain to the purchaser how to enrol new members or the purchasing of name and address lists of future prospects. The costs for these “products” can range up into the hundreds or thousands of dollars. A common Internet version involves the sale of documents entitled “How to make $1 Million on the Internet” and the like.
There are numerous pyramid schemes that sell such intrinsically worthless products which market themselves as “multi-level marketing” programs. This is unfortunate because there are in fact a number of perfectly legitimate businesses which use this MLM business model.
The key identifiers of a pyramid scheme are:
The key distinction between these schemes and “legitimate” MLM businesses (e.g. Excel Communications) is that in the latter cases a meaningful income can be earned solely from the sales of the associated product or service. While these MLM businesses also offer commissions from recruiting new members, this is not essential to the successful operation of the business by any individual member.
To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.
Definitions for Pyramid Scheme are sourced/syndicated and enhanced from:
This glossary post was last updated: 20th February, 2020