Direct sales companies such as Amway or Herbalife can function through two business models: single level marketing or multi-level marketing. Multi-level marketing is a strategy which involves promoting the existing distributors to bring more distributors into the fold and the incentive for the old distributors is a percentage of their recruit's sale. The recruited distributors are called down like for the recruiter.
In companies like Amway that utilise this business model, the participants buy the products from the company directly and sell them to the customers to earn commission on the sale while they also earn apart from the income of their downline. Since the MLM company's revenue is derived from the distributors, an MLM has the characteristic of being more focused on distributor recruitment than sales to customers.
This business model has earned some ill repute due to the fact that most of the MLM distributors, the ones doing most of the work, either earn no or nominal profits while the distributors at the higher levels earn significant profits, forming a pyramid scheme.
The earnings of the fortunate few are then highlighted to attract more people to the business while the people are kept ignorant about the fact that the majority of the participants provide revenue for the company -which is the earnings of the company and select few participants- by suffering financial loses themselves.
Promising quick and easy money is illegal
The question of the legality of these businesses is often raised as some people find the pyramid scheme questionable. However, it has been concluded that not all MLM companies are illegal while not all are legitimate either.
In 1979, a United States judgment by an Administrative law judge in the case accusing Amway of functioning as an illegal pyramid scheme ruled in favour of Amway. It has lead to the establishment of Amway Safeguard Rule which is now the legal standards for the courts and other regulatory authorities to judge the legality of an MLM.
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The rules state that the business plan must focus on earning through the sale of products rather than recruiting new members and the MLM needs to be upfront that to earn the member will have to learn new skills and work up to 7-8 hours rather than promising easy money quickly. Furthermore, illegitimacy can be gauged by whether the company asks its members to buy the products in bulk or claims that members can earn a significant amount of money without selling, then such companies are not legal. The products also need to be legitimate ones, that can be sold to people at retail price at the open market and don't claim to give miraculous cured to health issues without approval by the medical association.
However, in India, it was only in 2016 that any legislation regarding direct selling companies came into being. Prior to this, any legal actions arising against MLM companies were based only on Prize Chits and Money Circulation Schemes (Banning) Act of 1978. This Act banned schemes for making quick and easy money "applicable to the enrollment of members into the scheme". This, however, was unsatisfactory to be made applicable to direct selling companies.
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This confusion was solved by the release of Model Direct Selling Guidelines, 2016 by the Ministry of Food Affairs.
Must be a legal entity under the law, create contract and establish grievance redressal mechanism
Any MLM company in India must structure its business according to the 2016 guidelines and some of the requirements are given below:
- The MLM company must be registered under the Companies Act, 2013, must have acquired necessary licenses, must comply with statutory formalities like income tax etc.
- An undertaking must be submitted to the Department of Consumer Affairs within 90 days of the release of guidelines. Furthermore, a declaration of compliance must be submitted.
- The direct sellers cannot be forced to buy more products than they can sell or pay any monthly subscription and neither can they earn a commission for recruitment of new sellers. Their remuneration can only be extracted from the sale of products.
- There must exist a written contract between the company and the participant which must lay down the main terms including the repurchase policy, warranty policy, cooling off period etc. Also, the method of calculating remuneration should be explained properly.
- A grievance redressal mechanism for the customers must be established by the company details of which must be provided to the consumer by the direct seller. The company is liable for all grievances arising out of the sale of products or services.
- The state governments are also under orders to establish mechanisms to regulate and overview the functioning of these direct selling entities.
- It is mandated for the company to provide their potential direct sellers with accurate and honest information about all aspects of direct selling including realistic remuneration, opportunities, rights and responsibilities.
- The direct sellers cannot use unfair trade practices, claim unverifiable facts about the product or compel other direct sellers to buy an unreasonable amount of goods.
- The company must maintain a record of business deals, products, prices, the direct sellers employed etc.
1st Year, NLU Lucknow