When I joined my last in-house gig a little more than 9 years ago, I knew almost nothing about the legal side of multi-level marketing, or MLM. It turns out that I chose an auspicious decade in which to enter the field!
There is a lot of misinformation out there about MLM compensation (maybe someday I’ll take you down a long and winding road in an effort to correct those misunderstandings). For now, I’ll just say that MLM is a method of selling products through independent contractors who earn commissions. Traditionally contractors have purchased inventory from the MLM company and then resold those products to their own network of customers and downline contractors.
Pre-2016
Until 2016, when this and this happened, it was accepted practice within the industry to award commissions based on the product orders placed by contractors as long as the contractors were certifying both that at least 70% of their orders were being resold to their end-customers, and that they had at least ten such end-customers. This is known as the Amway rule. For decades this was deemed an acceptable protection against what we call “inventory loading,” which is where a contractor purchases more products than they can reasonably resell.
Inventory loading can be by choice (for example, to reach or maintain status in a compensation plan) or by accident (for example, by overestimating your talents as a salesperson). Either way, it’s not good for contractors because they are left to eat the cost of purchasing those products.
2016 & Beyond
When The FTC’s fists of fury slammed down in 2016, it wasn’t a complete surprise since certain commissioners and politicians had been very vocal in their criticism of the industry (and to be fair, I personally feel that some of that criticism was warranted). On the other hand, holy mackerel, what a sudden and jerky departure from years of legal precedent!
Since this is a blog post and not a law review article, I’m going to oversimplify a bit and say that almost overnight, the Amway rule was dead in the water and the FTC boldly declared that paying commissions on orders was inherently suspect (see the last two paragraphs of this FTC blog post for example). Rather, commissions should be paid on “profitable and verifiable” retail sales to non-contractor-end-consumers.
Alright, let’s break this down, starting with verifiable.
Verifiable
In principle, I actually think this requirement is great. Legitimate MLMs should and do have end-customers. For these companies, theoretically all they will need to do is figure out a way to track those sales. And for the rest? Well, this will weed out the poseurs and pyramids in disguise who use the veneer of MLM to mask truly shady behavior.
However, from an operational standpoint I shudder because of the corporate time, effort, and cost that is involved in making this shift. It’s not just a matter of updating a few websites and fliers; it’s a matter of replacing entire systems that calculate commissions and manage other contractor business matters.
There’s also the question of how to validate retail sales. The FTC has declined to set industry-wide requirements on this point and has instead indicated that each company will have to evaluate its own practices and make a judgment call.
Profitable
Now let’s deal with profitable. To be honest, I’m a little less sanguine about this one. Obviously everyone wants every contractor to have a profitable business. It’s good for contractors because they get to pay their bills. It’s good for MLM companies because it keeps contractors engaged in the business. It’s even good for customers because it keeps their contractors in business and able to continue to sell them products. Heck, it’s just all around good for America.
All that said, there is something unsettling about the FTC declaring that sales aren’t valid unless they’re profitable. Contractors are independent business owners and they have always been free to set their own prices as they see fit. Just as I can charge client A an hourly rate of X, client B an hourly rate of Y, and client C a fixed project fee of Z for my legal services, a contractor could do the same for products by offering coupons, discounts and other incentives in order to manage their inventory. In that regard, this is a massive shift and essentially turns the MSRP into a “Manufacturer’s Mandated Retail Price.”
The other unsettling part is that in the end, the contractor suffers if a profitable sale can’t be verified. Now, in addition to selling their product at a loss, they are denied any other multilevel compensation that would have otherwise been paid on the order. I’m not sure how this achieves the FTC’s goal of protecting contractors.
What’s an MLM to Do?
So what is an MLM to do? There’s always burying your head in the sand but I don’t recommend that. You can also go in the complete opposite direction and abandon MLM entirely but even that was too late to save the company from the wrath of the FTC.
I don’t think any company would choose to be the subject of an FTC order but the silver lining for them is that at least they have a clear set of rules to abide by. The rest of the industry is left to consult with lawyers like me as to what this patchwork of FTC orders means for them.
Here’s where I have to give you a disclaimer – I’m not your lawyer (unless you’re one of my clients, in which case I am your lawyer!). Without knowing the specifics of your company, I cannot assess where you are or tell you where I think you should go. If you engage me however, I’ll be happy to review your compensation plan and make some surgical suggestions for how you might maintain your core business model while adhering to FTC guidance.
But generally speaking, I think it makes sense for most companies to seriously consider shifting to an affiliate commission model with limited levels of compensation. An affiliate model kills multiple birds with one stone by:
· Eliminating the risk of inventory loading by eliminating the need for inventory at all. The contractor is no longer a distributor, buying inventory and holding it until it can be resold, but rather an affiliate earning a sales commission.
· Verifying every single sale that takes place. There’s no need for a contractor to certify to sales or submit receipts to the company because all sales occur from the company’s affiliate platform.
· Ensuring every single sale is profitable. The contractor doesn’t have to fret about profits or prices because they are set by the company and apply evenly across the board.
Don’t get me wrong; this is going to be a drastic and expensive change but I think it’s the safest move if you’re looking to protect your business from future FTC actions. And if you’re a new company looking to enter the MLM waters, it may be prudent to consider an affiliate model as an alternative.