Direct Selling Under Scrutiny

Jan 25, 2021
By DSJ Staff

Academic Task Force Rebuts Misguided Assumptions About Direct Selling

When DSEF Fellow Dr. Robert Peterson, the John T. Stuart Chair in Business Administration at The University of Texas at Austin (UTA), reviewed the white paper “Alchemy of a Pyramid Scheme: Transmutating Business Opportunity into a Negative Wealth Transfer,” he found it deeply flawed. In his view the paper, authored by Andrew Stivers, Douglas Smith, and Ginger Zhe Jin, all current and former Federal Trade Commission (FTC) economists, contained myriad errors in analytic modeling.

“As a professor, I have followed the academic research streams and associated literature on direct selling for more than four decades,” Dr. Peterson said. “So, when the Stivers, Smith, and Jin (SSJ) working paper came to my attention, I thought I would give it a cursory review. Because the paper was not peer-reviewed and was not a published article, I did not expect to devote much time or effort to it.

“After I read the first sentence in the paper, however— ‘Multi-level marketing (MLM) is a distribution and incentive mechanism that has seen extensive scrutiny by law enforcement over the last 50 years, but by comparison relatively little in the economics and marketing literature,’—I was, to put it mildly, aghast,” Dr. Peterson continued. “Based on my knowledge of direct selling, the opposite is true. Literally hundreds of economics- and marketing-related articles have been published on direct selling in the past half-century, whereas only a relatively few (but well-publicized) court cases have been reported.”

Consequently, Dr. Peterson sought opinions on the paper from several of his colleagues—all DSEF Fellows—who had extensively published research in prestigious academic journals, were experienced in reviewing research submitted to such journals, and possessed a deep understanding of the direct selling channel.

Ultimately this group, along with Dr. Peterson, formed an independent task force that formally evaluated the SSJ paper: Dr. Patrick Brockett, UTA; Dr. Anne Coughlan, NU; Dr. O.C. Ferrell, AU; Dr. Linda Ferrell, AU; Dr. Linda Golden, UTA; Dr. Charles Ingene, OU; and Dr. Lou Pelton, UNT. Co-author Dr. Anne Coughlan believes direct selling companies are rightly troubled by the ramifications of the SSJ paper. “What’s concerning here is that this paper exhibits many errors of bad modeling,” she said. “But the fact that it does so is problematic because the paper will have an impact if, and when, it gets published. It will not only have an effect in the academic community, but it will affect the perception of direct selling in the public eye, potentially among policymakers and in the legal and litigation realm.”

SSJ provides insight into the thinking of the FTC when it comes to their understanding of the direct selling business model, and Dr. Coughlan says the task force co-authors set out to evaluate the paper’s assumptions. “Since three of the authors bear the FTC moniker, we wanted to put some special scrutiny on this paper, particularly given its conclusions, to make sure that it is backed up by good analysis.”

In December 2020, the co-authors publicly released their working paper: “Direct Selling Under Scrutiny: Assessing Analytic Direct Selling Models,” on SSRN, a platform for the dissemination of early-stage research. (The working paper was not funded by any entity and the co-authors have no financial conflicts of interest). The paper examines the SSJ model and other research that develops economics-based analytic models that are sometimes used to assess the legitimacy of direct selling companies as well as the business model.

“It is critically important to the direct selling channel that policymakers be able to distinguish legitimate direct selling companies from illegal pyramid schemes,” said Marjorie Fine, Director of Shaklee Corporation. “The formulation of laws, their enforcement by regulators, decisions by judges, and the perception of the public all depend upon understanding this distinction. This paper by leading academics constitutes a significant contribution to that effort. It completely debunks the model proposed in ‘The Alchemy of a Pyramid: Transmutating Business Opportunity into a Negative Wealth Transfer’ by exposing the fallacies upon which the model is constructed and the errors in the authors’ analysis.”

The co-authors found many factual errors and misguided assumptions about how direct selling companies operate in the analytic model used by SSJ, described in their paper’s Executive Summary:

The SSJ Model Omits and/or Misrepresents Substantive Facts Applying to Direct Selling (DS) Firms, Making Its Conclusions Inapplicable to the Question of Whether a Firm Is or Is Not a Pyramid Scheme

The SSJ model omits or misrepresents many aspects and facts about DS firms’ operations and business models that substantively slant its analysis and conclusions toward a pyramid scheme determination and, therefore, render the model inapplicable to the determination of whether a DS firm does (or does not) operate a pyramid scheme. While not guaranteed to be a complete list, some such omissions and misrepresentations in the paper include:

  • Its omission of any income sources to a distributor other than bonuses awarded for mere recruitment without regard to sales (such as retail markup income or the economic benefit of personal consumption at wholesale prices);
  • Its misrepresentation of the basis on which a bonus/commission income is awarded by direct selling (DS) firms, by assuming they are only awarded for pure recruitment;
  • Its omission of products that have market value to consumers;
  • Its omission of consideration of distributor differences on substantive dimensions that matter for the research question at hand;
  • Its omission of active choices by distributors concerning what to sell, how hard to work, how to price products for retail sale, how much to invest in training, whether or not to seek to recruit other distributors, or how much to personally consume;
  • Its misrepresentation of the DS firm’s objective as the maximization of one-period profit, with no consideration of the legal implications of the fraud it implies; and
  • Its omission of consideration of standard consumer and distributor protections offered by legitimate DS firms.

Matt Dorny, Vice President and General Counsel, Nu Skin Enterprises, believes the co-authors’ in-depth understanding of the direct selling business model and how it operates provides them with an important perspective. “I appreciate the time and effort the authors of this paper spent assessing various economic-based analytical models that could be used to help assess whether a direct selling firm is an illegal pyramid scheme,” Dorny said. “They noted several deficiencies in these analytical models based on the failure to consider important conditions and facts prevalent in the industry. Hopefully, this paper will help others better understand the deficiencies in existing analytical models and develop better analytical models in the future.”

The next steps for the academic co-authors include refining the paper and submitting it for publication in a prominent academic journal, a process that can take time. However, Joseph N. Mariano, President of DSA, underscores the value of the working paper for use with a variety of audiences. “We look forward to policymakers’ reaction to the paper,” he said.

“Direct Selling Under Scrutiny: Assessing Analytic Direct Selling Models” is available at SSRN.com, the leading platform for online sharing of working academic papers. View at https://papers.ssrn. com/sol3/papers.cfm?abstract_id=3743816

“Direct Selling Under Scrutiny: Assessing Analytic Direct Selling Models” - ACADEMIC TASK FORCE MEMBERS

Patrick L. Brockett holds the Gus Wortham Memorial Chair in Risk Management and Insurance in the McCombs School of Business at The University of Texas at Austin.

Anne T. Coughlan is the Polk Bros. Chair in Retailing and Professor of Marketing, Emerita, in the Kellogg School of Management at Northwestern University.

Linda Ferrell is the Roth Family Professor of Marketing and Business Ethics and Associate Director, Center for Organizational Ethical Cultures, at Auburn University.

O. C. Ferrell is the James T. Pursell, Sr. Eminent Scholar in Ethics and Director, Center for Organizational Ethical Cultures, in the Harbert College of Business at Auburn University.

Linda Golden holds the Joseph H. Blades Professorship in Risk Management and Insurance in the McCombs School of Business at The University of Texas at Austin.

Charles A. Ingene is Professor of Marketing and Supply Chain Management in the Price College of Business at University of Oklahoma.

Lou E. Pelton is Associate Professor of Marketing in the Ryan College of Business at the University of North Texas.

Robert A. Peterson holds the John T. Stuart Chair in the McCombs School of Business at The University of Texas at Austin.

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