Over the years I have written a number of articles on entrepreneurialism. I really support the idea of striking out on one’s own and starting a business. But honestly there are two types of businesses I honestly believe are a bad fit for most people. Today I am going to write a bit about Multi Level Marketing (MLM) and Franchises.
Multi Level Marketing (MLM)
We can start with the less controversial dislike of the two business types. In fact I am not sure you can even call most Multi Level Marketing (MLM) a business. What is Multi Level Marketing? Essentially MLM is where a large company uses unpaid sales people to sell it’s merchandise. The MLM sales people operate as independent “Businesses” from the company selling the merchandise.
Normal Commission Pay
The sales people are compensated in two ways. The first is commission based on sales. This is normally how sales people are compensated, a percentage of the sales they make. Unlike most sales compensation however, this is touted as a small portion of the income a MLM sales person would make. In fact it is usually quite small.
Paid to Recruit Other Salesmen
The second form of compensation for MLM sales is where things get shady. Essentially sales people are encouraged to recruit additional sales representatives. They then receives a commission for sales of the people they recruit, and so on. This aspect of the business is sold as the real power of MLMs. The push is that you can make huge profits via this setup.
A Pyramid of Income
The problem of course with the recruitment commission model is for these returns to be large for each new employee the number of employees must be ever growing. The last person who is hired would have no recruits from which to be compensated. In this case the actual salary from this recruitment scheme tends to favor a top down pyramid. The earlier you are in the chain of people the more money you make. Meanwhile those that join last make the least.
Initial Layout of Funds
The problems don’t end there for MLM. You see many of them require new recruits to buy the inventory they plan to sell to customers. So essentially the simple act of recruiting another person to sell the item is the sales that compensate the recruiter. This sets up some very bad motivation. New recruits are sold a bill of goods to dig themselves into debt buying inventory they may never be able to sell.
There are Only So Many Customers
Worse still, even if you are the best salesmen in the world and the produce is great the structure means eventually new sales will dry up. As the company hires more and more levels eventually the number of potentially customers is outnumbered by those selling the inventory. The parent company does not care since the sales person bought the inventory and is unpaid. As such the more sellers the more parent company profit with little to no extra cost. But as a seller eventually the statistics mean the majority of people in a MLM make no money from either selling or recruiting. Why? Because there will always be mathematically more people at the end of the recruiting chain then the beginning as it expands out.
MLMs are Mostly Unprofitable at Best, Scams at Worse
In other words, MLMs are largely unprofitable messes that mostly just give free sales labor to a large company. They also annoy me to no end since they pray on those who want to work from home like stay at home parents. What this means is:
1) Those parents get desperate when they receive no recruitment and low sales. As such they start to pitch to their friends. What a great way to lose a friend! Try to shovel most of the crap sold by a MLM on them.
2) Anyone who is a stay at home parent and has a legitimate business has to be very careful describing it. If my wife talks about her consulting business in semi vague terms then everyone thinks she is selling Amway or some other MLM. No… She has a business she has raised from scratch thank you very much.
Franchising and Buying a Job
So Full Time Finance is no fan of MLM. But what about Franchising? Well, Franchising is not as bad as MLM. A franchise is generally not a Panzi or Pyramid Scheme. That being said a derogatory description of a franchise owner might be someone who bought a job.
Initial Upfront Fees and Lack of Control
For most franchises you pay a sizable fee. For that fee your franchisor (the parent company selling the franchise) controls what you sell, how you sell it, and often, but not always, at what price. Essentially this dictation removes most of the levers a business person would have to grow a business. If your local customers would react better to a different price, slightly altered offering, or even different advertising you are out of luck unless you can convince the franchisor.
Fee Grows with Success of Franchise
Meanwhile that fee I mentioned grows with the more popular a franchise is. What this means is that most of the franchises that make money got in early when the fees were low. Once the franchise is a success the fee will be sky high making profits that much harder.
Potentially Too Much Competition
Worse still some franchisors do not limit the number of Franchises sufficiently. Like the MLM there is little incentive for the company to limit the number of franchises since they get paid franchise fees either way. So what if their sales are inefficiently spread across multiple sites, they don’t pay the overhead on those sites and still reap the overall sales. The problem of course is this can basically run the franchise owner into the ground.
More in Common with Employee then Employer
All this really adds up to one conclusion. A franchise owner has more in common with an employee who receives some portion of their compensation in equity then a true business owner. They just don’t have the control necessary to grow their business independently. Meanwhile the fee itself can be massive compared to sales. Ie. You’ve purchased all the headaches of a job running a business. Again not quite as bad as an MLM, but unless you truly believe in the business and it’s a newly minted franchise I can not see much reason for most people to dive into this business type.
Friends with Failed Franchises
Over the years I have known 2 friends who have started Franchises. One started a burger joint. Another did Pretzels. Both sold their businesses after a few years to reenter the corporate world. Both basically said it was too many hours work for too little pay. Anyway food for thought. I know there are exceptions out there and anecdotal evidence does not equal statistics. That being said I still doubt highly the odds are in your favor. After all if they were, instead of selling franchises the company would be opening stores.
Do you have an alternate take on franchising or MLM?