DP13054 Multilevel Marketing: Pyramid-Shaped Schemes or Exploitative Scams?

Author(s): Yair Antler
Publication Date: July 2018
Keyword(s): analogy-based expectations, bounded rationality, coarse feedback, multilevel marketing, pyramid scams
JEL(s):
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13054

We identify the conditions on the tendency of agents to spread information by word of mouth, under which a principal can design a pyramid scam to exploit a network of boundedly rational agents whose beliefs are coarse. Our main result is that a pyramid scam is sustainable only if its underlying reward scheme compensates the participants based on multiple levels of their downlines (e.g., for recruiting new members to the pyramid and for recruitments made by these new members). Motivated by the growing discussion on the legitimacy of multilevel marketing schemes and their resemblance to pyramid scams, we use our model to compare the two phenomena based on their underlying compensation structure.