Pyramid Scheme – Definition

Cite this article as:"Pyramid Scheme – Definition," in The Business Professor, updated December 2, 2019, last accessed August 6, 2020, https://thebusinessprofessor.com/lesson/pyramid-scheme-definition/.

Back to: STRATEGY, ENTREPRENEURSHIP, & INNOVATION

Pyramid Scheme Definition

A pyramid scheme is a flawed and unsustainable model in which participants make money through the recruitment of new members. The new recruits are also promised to receive money if they recruit new people and provide some funds for the business. Pyramid schemes are regarded as investment scams in which participants only benefit based on their hierarchy.

Ponzi scheme is the most popular pyramid scheme that exists. In this type of business or investment, participants do not sell any products or render any services, they survive on the promise to receive money when they recruit more people into the business.

A Little More on What is a Pyramid Scheme

Just like an actual pyramid, there are people at the top and at the base of the pyramid. In a pyramid scheme, new recruits form the base of the pyramid. Pyramid schemes only rely on the enrollment of new members into the scheme and the constant inflow of money brought by the new members. In pyramid schemes, top-level members recruit new members who pay an upfront fee and are circulated as payments for people at different levels of the pyramid.

One of the attractive points for companies that are into pyramid schemes is that they offer high returns to participants based on how much people they can recruit into the scheme. Oftentimes, pyramid schemes are unsustainable, since they offer no products but only sustain on funds brought by new members of the scheme. Most pyramid collapse after the have outlied their assets or their liabilities more than the revenue they generate.

Basic Pyramid Scheme

Ponzi scheme is a popular example of a pyramid scheme, in this scheme, money is circulated between investors or participants as the inflow increase. New recruits are also promised high returns and circulation of money if they bring others. In most pyramid schemes, the earliest investors benefit the most, this is because money collected by investors below the pyramid goes back to those at the top. Pyramid schemes are purely investment scams and are deemed illegal in most countries.

The setup of a pyramid scheme is one in which one person recruits a second person, the second person also recruits other people and the downlines (recruits) of the second person also do the same. One typical thing about every pyramid is that the more people are at the top of the pyramid, the bigger the weight for those at the bottom of the pyramid, then, the pyramid collapses.

Business Pyramids (Multilevel Marketing Schemes)

Multilevel marketing schemes are not pyramid schemes, although, it is easy to confuse them for one. Multilevel marketing schemes have the structure of pyramids in the actual sense but they are not fraudulent in nature, neither do they rob Peter to pay Paul, they are also highly regulated. The distribution and sale of products are involved in multilevel marketing schemes and this is not present in pyramid schemes.

Multilevel marketing companies make their gain form the sale of products, however, a percentage of the investment and sale goes to those at the top of the hierarchy. Marketers at the top of the hierarchy take the majority of the profits and this is one of the criticisms of multilevel marketing schemes.

References for “Pyramid Scheme”

https://en.wikipedia.org/wiki/Pyramid_scheme

https://www.investopedia.com › Investing › Financial Analysis

https://www.thestreet.com › Personal Finance › Education

https://www.moneycrashers.com/how-to-spot-a-financial-scam/

https://financial-dictionary.thefreedictionary.com/Pyramid+schemes

Was this article helpful?