A “naked pyramid scheme” refers to a blatant pyramid scheme that is easy to detect because no products are offered, merely a participation fee or “investment.” Chain letters work on the same principle. A continuous chain of “participants” or “investors” is recruited, in which each pays a fee to participate and receives money by recruiting others into the system.

We may call them “participants,” rather than “distributors,” because no products are offered. Sometimes participants are referred to as “investors,” a misnomer because there is no title to property or legitimate securities.

A product-based pyramid scheme, or PPS, is exactly what the name implies. A PPS is similar to a pyramid scheme, except that products are purchased by distributors, primarily for resale—supposedly. Such product purchases, often combined with other incentives, qualifies distributors for commissions in ascending levels in the distributor hierarchy.

As this paper demonstrates, the negative consequences of PPS’s are far more severe than the most blatant naked pyramid schemes because they are harder to detect and can grow to mammoth proportions before they are detected or transmigrated to new pyramids with new products—or moved on to new countries. This is how some of the more durable MLM’s have survived. Some U.S.-based MLM’s expanded into vulnerable countries in Asia when regulatory agencies in this country began investigating them.

Some have considered any MLM program as exempt from laws against pyramid schemes, as long as the program offers legitimate products, which can be retailed through its distributor hierarchy. A moment’s reflection will reveal the fallacy behind this logic (though statutes in some states, such as Utah, are weakened by this distinction).

As suggested above, if such an exemption were allowed, a pyramid promoter could initiate a PPS distribution system that in all other respects was like a naked pyramid scheme and then introduce quality products to legitimize the pyramid scheme. All they would have to do is create the illusion that the emphasis is on retail sales, not recruiting (which is inherently an illusion in most programs, due to RVE-EHI, discussed later). This is precisely what many MLM companies have done in order to minimize regulatory scrutiny while they conduct pyramid distribution schemes.

In trying to identify what PPS’s have in common with chain letters and naked pyramid schemes, I found two major characteristics which the three of them have in common and which cause most of the problems inherent in all types of pyramid schemes. A third characteristic usually found in PPS’s—significant purchase quotas and/or recruiting incentives—adds leverage and power to the scheme.

In my opinion, the issue is not whether or not products are offered or whether the emphasis is on recruiting or retailing. The latter emphasis is merely the effect, not the cause, of the problem—which is the highly leveraged MLM compensation system.

While this may seem confusing to some, I will sometimes use the acronym “PPS” to refer to the more generic practice of product-based pyramid schemes. “MLM” will be used in most cases, however, when referring to accepted MLM programs. If it were more widely accepted I would use PPS in every case, simply because the MLM designation has evolved into “network marketing,” “consumer direct marketing,” etc. I suspect new terms will arise, but they could all eventually fall under the generic umbrella of PPS.