Why do Pyramid Schemes Fail?
Pyramid schemes are inherently injurious to consumers because as a mathematical
certainty, they are doomed to collapse. As in the case of chain letters that require a
payment, only the people at the very top make any money.
The only way anybody can make money through a pyramid scheme or chain letter is if
participants in levels below them are defrauded into giving money based upon a rapidly
diminishing promise of eventually getting something in return.
Eventually they must break down because the pool of possible recruits becomes
exhausted and recruitment stops. Those at the bottom of the pyramid, the vast majority of
the participants, lose money because there is no one below them.
They won't get their money back or earn their promised fortune because no one is
beneath them in the pyramid adding new money to the pot. All pyramid schemes will
begin to die when later recruits don't sign on in numbers large enough to pay off the
earlier recruits.
An infinite number of people is the weak link in the required "endless chain" of new
participants. In order for a pyramid scheme to profit, there would have to be a neverending supply of potential, and willing, participants. In reality, however, the supply of
participants is limited, and each new level of participants has less chance of recruiting
others and a greater chance of losing money.
The diminishing odds of making money with a pyramid scheme make it a losing
proposition because each time a new level rises to the top, a new level must be added to
the bottom, each one at least twice as large as the one before.
Pyramid schemes are based on simple mathematics: many losers pay a few winners. A
nine-level pyramid, which is built when each participant gets six "friends" to join, would
involve over ten million people!
6
36
216
1,296
7,776
46,656
279,936
1,679,616
10,077,696
Who are the Victims?
Most pyramid schemes seem intent on exploiting people with limited means and limited
knowledge of business such as individuals who have little experience in direct sales,
distributorships, or franchise enterprises or who have limited money or credit with which
to establish their own businesses.
They rely on widespread ignorance of basic mathematics. Participants are promised large
rewards for putting up a certain amount of money and then recruiting the next level of
members. But the schemes always collapse because the supply of potential recruits
quickly runs out, making many participants both victims and perpetrators.
Many victims of these scams sell first to their friends. When the supposed moneymaking
opportunity goes belly up, most lose not only their money — but also their friends.
Why Would Anyone Pay to Join a Pyramid?
They're sold to investors with the assurance that they are perfectly legal, approved by the
IRS or a CPA, and that they are definitely "not" a pyramid scheme. Promoters may even
flaunt the fact that they are illegal and are therefore secret and exclusive. This adds to the
allure and mystery of this larcenous, but seemingly harmless, act.
Pyramid promoters are masters of group psychology. At recruiting meetings they create
a frenzied, enthusiastic atmosphere where group pressure and promises of easy money
play upon people's greed and fear of missing out on a good deal. It is difficult to resist
this kind of appeal unless you recognize that the scheme is rigged against you.
When the expected wealth does not materialize, participants often blame their own lack
of recruiting skills for the failure, rather than the original promoters who have benefited
most, and almost exclusively, from their deception.
The pyramid promoter is likely to persuade the investor that he is "getting in early" and
that he should consider himself at the top of the matrix. Most participants don't envision
themselves anywhere near the bottom layer of the pyramid.
Even the greediest person on the planet would probably see that if one is near the bottom
layer it will be very hard to get new recruits. They have to see themselves near the top in
order to envision the immense wealth, from minimal effort, that is going to come their
way.
The con artist at the top views each new investor as a predicable set of revenues and
expenses, with the revenues flowing directly to him. He happily pays out commissions
for the recruitment efforts of others.
Investigators say pyramid schemes come in waves of three to six years and rise during
times of economic boom by playing upon the greed and envy among those who are eager
to participate in moneymaking ventures.
As the losers rarely advertise the truth of their folly, the myth of their success resurfaces
with each new outbreak.
Modeling Growth
Have you ever received a chain letter offering you great financial rewards'? Typical letters might offer you
thousands of CD's, golf balls, or recipes if you would just follow the simple instructions. They ask that you
not break the chain. Actually, chain letter schemes are illegal, even though they have been quite common
(especially during the 1980s). Carefully read the following letter.
Pyramid Investment Plan
Dear Investor:
Become a millionaire!' Join the Pyramid Investment Plan (PIP). Send only $20 and return
this letter to PIP. PIP will send $5 to the name at the top of the list below. You will receive
a new letter, with your name added to the bottom of the list, and a set of 200 names and
addresses. Make 200 copies of the letter, send them, and wait to get rich. Each time a
recipient of one of your letters joins PIP your name advances toward the top of the list.
When PIP receives letters with your name at the top, we will start sending you money! A
conservative marketing return of 6% projects that you will earn over $1.2 million.
Here is an example of how this works: When we receive your check, we will send $5 to
Chris. Then Katie will be #1, and your name will be in position #6. Each time this process
is repeated, the names move up on the list. When your name reaches the top, each of
the thousands of people who receive that letter will be sending money to PIP, and you
will receive your share.
1. Chris
1.
2. Katie
3. Josh 4. Kana
5. Dave
6. Mira
If you send copies of this letter to 200 people, the list of names now reads:
1. Katie 2, Josh, 3. Kanako, 4. Dave, S. Miranda, 6. Your Name. According to the
conservative marketing return of 6%, how many of the 200 people receiving the letter will
join the plan?
Round
1
2
3
4
5
6
number
Letters sent
Responses
2.
If each new PIP investor mails 200 copies of the letter, and 6% of those receiving the letter join
PIP, how many people will there be in the second round?
3.
Continue this process for the third, fourth, fifth, and sixth rounds.
4.
Those investors in the sixth round receive a list that may look like this:
1. Your name 2. Moira, 3. Elizabeth, 4. Kiku, 5. Bill, 6. Clara. If you receive $5 from each
person responding in the sixth round, will you make over $1.2 million? How will you make?
5.
The letter is sent to 200 households in the first round. How many households receive letters in the
second round?
6.
What is the total number of households that receive a letter by the sixth round?'
7.
Assume that the quotes on the back of the letter arc from people who have participated in the plan
and are no longer on the list. Receiving this letter places you in at least the seventh round of the
plan. How many households will receive the letter by the time it reaches the thirteenth round?
8.
According to the 1996 census of Canada how many households were there in Canada?
Name
Canada †
Population
2001
1996
% change
Total private
dwellings, 2001
30,007,094
28,846,761
4.0
12,548,588
Newfoundland and
Labrador
512,930
551,792
-7.0
227,570
Prince Edward Island
135,294
134,557
0.5
55,992
Nova Scotia
908,007
909,282
-0.1
403,819
New Brunswick
729,498
738,133
-1.2
313,609
Quebec †
7,237,479
7,138,795
1.4
3,230,196
Ontario †
11,410,046
10,753,573
6.1
4,556,240
1,119,583
1,113,898
0.5
477,085
978,933
990,237
-1.1
431,628
Alberta †
2,974,807
2,696,826
10.3
1,171,841
British Columbia †
3,907,738
3,724,500
4.9
1,643,969
Yukon Territory
28,674
30,766
-6.8
13,793
Northwest Territories
37,360
39,672 A
-5.8
14,669
Nunavut
26,745
24,730 A
8.1
8,177
Manitoba †
Saskatchewan †
9.
What are your conclusions? Why are chain letter and pyramid schemes illegal?