Multi-level marketing (MLM) sometimes has an air of mystery. What is an MLM? How do MLM companies work? What makes them different? And the million-dollar question: How do MLMs make money? If you’re looking for the answers to these questions, you’re in luck. We’re about to solve the mystery of the MLM business model – in just a few paragraphs!
The best place to start is with an official definition. MLM companies sell products directly to consumers in a non-retail environment. Sales happen through an independent field sales organization that interacts directly with buyers through live-selling events, social media, and, prior to COVID-19 restrictions, at-home parties. The MLM model eliminates layers of middlemen often involved in product distribution.
Companies worldwide use an MLM model, also known as a direct selling strategy. From global giants like Kyani to domestic leaders like Paparazzi Accessories, the industry generated $35.2 billion in U.S. sales in 2019. The products and services delivered by MLM companies are wide-ranging across wellness, personal care, clothing, jewelry, home goods, leisure, insurance, energy, and educational categories. But, before we dive deeper into the business model’s appeal for entrepreneurs and business leaders, let’s take a brief look at the industry’s history.
In the beginning…
The origins of direct selling can be traced all the way back to early settlements, as peddlers began to travel from farm-to-farm and town-to-town selling their wares. However, the first official direct-selling company wasn’t established until 1855 when the Reverend James Robinson Graves founded a business based on a network of young door-to-door salesmen. (Fun fact: The direct-selling company the reverend founded is still operating today as the Southwestern Advantage Family of Companies.)
From its earliest days, the MLM business model had a significant impact on how sales happen – and who does the selling. In 1886, David McConnell made a bold move and began hiring women as sales representatives for his perfume company. (Fun fact: The company grew up to be Avon.)
From there, the MLM industry – and women – never looked back. In the late 19th and early 20th centuries, MLMs offered women new opportunities to make an impact in business and achieve financial independence. Today, 74 percent of MLM representatives are women who continue to define network sales success.
Through the years, the MLM model has proven to be highly resilient, effectively adapting and innovating from door-to-door to party-based approaches as times changed. The biggest game-changer has been evolving technology. Over the last 20 years, smartphones, apps, e-commerce, and social media have opened up new avenues for direct-selling representatives to reach and connect with their customers.
Emerging technology has also increased the MLM model’s appeal for entrepreneurs, salespeople, and customers alike.
The MLM advantage
No matter the era, starting a business involves taking a risk. Compared to traditional brick-and-mortar retail, a direct-selling model offers a cost-effective way to launch a business and get products and services to the market. Less capital, lower fixed costs, and simplified infrastructure add up to a faster ramp-up time from product idea to product sales.
An MLM company can typically launch the business with a strong product that meets customer demand, back-office MLM software, and a few independent sales representatives. The attainable initial investment creates an environment with very little friction compared to other business options, leaving the success of the business to be primarily determined by the investment of time, effort, and sweat equity.
The MLM company provides its field representatives with the resources needed to create and run their own business, including the products and services to sell, product and sales training, technology – including an e-commerce platform – and marketing tools. The sales representatives work on a 1099 basis, keeping employment costs low while driving revenue for both the field sales team and the company.
MLMs offer advantages for the entrepreneur who starts the company, the field representatives who market the products or services, and the customers who purchase the products.
- For the business: In addition to the cost-efficient reasons already cited, choosing a direct-selling model provides an MLM business owner with more control over how their products and services are presented and delivered to the market. By cutting out layers between the company and the consumer, customer feedback is more easily accessible, which can enable businesses to respond to customer input more quickly.
- For the sales representative: Direct selling offers a flexible option to traditional employment. Whether someone is looking for a full-time income or a way to supplement their current salary, MLMs provide a fulfilling opportunity for young parents, students, caregivers, and retirees. As of 2019, 6.8 million Americans are MLM representatives, with 87 percent doing so as a part-time gig to supplement their income. For the rest, nearly one million reps, MLM sales is a full-time career that’s focused on expansion by building their customer reach as well as a network of representatives.
Direct selling representatives are able to build their own business by taking the products and services straight to potential customers without worrying about securing retail distribution, paying slotting fees, or paying to receive premium placement on a store’s shelf. By leveraging the selling tools provided through the company’s MLM software, such as replicated websites, mobile app access, and reporting, they’re able to focus on building strong relationships with a community of people interested in their product’s benefits.
- For the customer: Buyers are able to build close relationships with their MLM sales representatives, engaging in a highly customized shopping experience that includes personalized demonstrations, recommendations, and convenient purchase options.
How MLMs make money
Now, it’s time to answer the money question! Whether you’re the business owner, investor, or a representative in the MLM equation, it’s critical to understand sales, revenues, and profits in the context of a direct-selling model.
First, let’s define a few key accounting terms.
- Cost is anything related to expenses, and it’s not limited to the goods and services sold.
- Price is the amount customers are willing to pay for a product or service.
- Revenue is the income generated from the sale of products and services to customers.
For an MLM, revenue is a key performance indicator (KPI). How you manage revenue and optimize costs is directly linked to the profits you’re able to generate. To determine revenue, multiply the selling price of your product or service by the quantity sold. (Revenue = Selling Price x Quantity Sold)
To determine your profit (also called net profit or the bottom line), you need to determine the difference between the price paid by your customer and the costs incurred to produce, market, and sell the product or service. Subtracting expenses and taxes from revenue tells you your profit. (Profit = Revenue – [Expenses + Tax]
Another important metric to understand is the Cost of Goods Sold (COGS), which can also be called the cost of sales. This metric accounts for the direct costs required to deliver a finished product or service. The labor and materials needed to produce the end product are also included. In the MLM business, the costs associated with the distribution, sales, and marketing of the product are not included when calculating the COGS. (COGS = Sum of Expenses + Direct Labor + Direct Materials)
For MLMs, tracking profitability – or the gross margin – is a key indicator of success. Like all businesses, it comes down to the art and science of maximizing revenue while keeping costs down. Gross profit is your revenue after all discounts, returns, and costs of sales (COGS) have been deducted. Determine your gross profit by subtracting any discounts given, returns processed, and your COGS total from your revenue. (Gross profit = Revenue – Discounts – Returns – COGS)
A high gross profit indicates the business is healthy and running efficiently. A lower gross profit means the business is not efficiently converting revenue into profit. Successful MLM companies typically look for a multiplier of 5X from COGS to retail price to fully fund the payout of the organization’s compensation plan and remain profitable. With certain products, such as wine and food, a 5X multiplier would create a retail price point beyond reasonable customer expectations. For these types of products, a 3.5X or 4X multiplier is more suitable, which means MLM companies design the compensation plans to pay out less in order to balance the reduced multiplier.
When a business is starting up, initial order volumes may be low, and COGS may be higher. That’s okay, but the gross profit needs to be evaluated carefully with business owners determining whether they’ll be able to get to a 5x multiplier as the business grows. In the early days, when a company’s compensation plan is not mature and not at full payout levels, you can still be profitable at a lower multiplier. Think about the volume you need to order from suppliers to bring down your COGS. Can you get to 5X by ordering 5K, 10K, or 100K products at a time? Knowing the answers to these questions will help you determine if your product or service is a good fit for an MLM business model.
Tracking and analyzing MLM revenue
Tracking revenue is critical. For early-stage startups or smaller businesses, an Excel spreadsheet can typically handle the company’s tracking needs. There are even a variety of pre-built templates that can be downloaded online so you can set up a system that provides the data you need without building it from scratch.
As your business grows, so will your accounting needs. For example, if you start with a handful of products, it will be relatively easy to track and spot trends in both demand and costs. However, as you add products, product lines, seasonal collections, or different catalogs, you will need to track and evaluate revenue in multiple ways. You’ll want to know your overall revenue, as well as the revenue by each product, product line, and collection. Having these views into your revenue will reveal the products and services that are thriving – and the ones that need to be discontinued. There are a variety of systems, at a variety of price points, that can simplify and automate the process for you.
Along with the ability to track revenues, you’ll also want to analyze your revenue to truly understand the health of your MLM business. For MLM business owners, the most straightforward metric is to determine if the company is operating in the “green” – generating enough income to cover all costs incurred in running the business – or in the “red” – incurring more expenses than income.
Through analysis, you’ll be able to forecast both revenue and profit. In the early stages of your business, there may be a gap – known as a revenue variance – between your forecast and actual sales. As the business matures and more trend data becomes available, the gap will get smaller, and your forecasting will become more accurate. Understanding and tracking the variance is vital for making strategic decisions to maximize profitability.
History shows that the MLM business model delivers a viable option for sales success. With thoughtful attention to direct sales principles and thorough tracking of performance indicators, MLM owners and their field sales teams can create a thriving business. ByDesign specializes in providing MLM companies with a complete ecosystem of solutions and trusted partners to help them start, run, and grow. Learn more about our MLM software’s corporate backend and representative portal solutions at ByDesign.com or contact us to schedule a consultation today.