How do MLM companies make money?

Like traditional business models,  MLM companies make money by selling products and services to the end consumer. This business model is unique because it leverages an organization of field sales and marketing representatives to sell its products to the end consumer.  In this article, we discuss the MLM business model and how revenue and profit are calculated.

MLM Business Model

MLM or direct selling is a distribution strategy that is used by companies worldwide, from global giants like Kyani to domestic leaders like Paparazzi Accessories and a variety of medium and small businesses.  These companies sell a wide range of goods and services, including health and wellness products, jewelry, clothing,  insurance, energy, and much more. 

The first direct selling company launched back in 1855, and it inspired a way of doing business that would change both the face and function of retailing forever.  The MLM business model created one of the first opportunities for women to own micro-businesses, and it provided them with new levels of confidence, independence, and freedom.   Nearly 165 years later, seventy-five percent of MLM representatives are women who continue to sell products by inspiring, motivating, and educating prospects and customers.

In 2018, the MLM industry contributed $34.5 billion to the United States economy.

The MLM business model has several unique advantages over traditional brick and mortar retail.  In addition to bringing exceptional products and services to market, direct selling is an attractive model for new startup companies as they can launch their business with less capital and infrastructure than a traditional retail model.   Similar to a franchise, an MLM company provides the “system” that is used to effectively run an independent business for their field representatives. This includes things such as the products and services being sold, training,  technology, e-commerce platform, and marketing resources.  

An MLM company can typically launch its business with the product, back-office software, and some representatives to sell and market the products.  This attainable initial investment creates an environment with very little friction, as compared to the alternative options.  A common denominator for success when launching any type of a new business is sweat equity, which includes the contributions to your business that come from labor — investing time, effort, and hard work.  

Direct selling representatives do not sell their products in a retail store. They never need to worry about securing retail distribution, paying slotting fees, or high fees for their product to receive premium placement on the shelf.   Instead, they build strong relationships with a community of people who have a common interest in the specific benefits their product or service provides. Representatives share their products and services digitally and in-personthrough face-to-face conversations and live product demonstrations.

In the United States, millions of Americans representing all 50 states, participate in a direct selling business opportunity.  In 2018, 10.4 million people became involved due to the unique benefits of the products and desired to purchase them at a reduced price.   Eighty-nine percent of MLM representatives work their business as a part-time gig for supplemental income.  The ability to own a business and work it part-time provides a highly desirable option for students,  busy caregivers, parents, retirees,  and others who desire to work when and where they want.   An additional one million representatives work their business full-time. These individuals are expanding their business by building a network of representatives.

MLM Revenue and Profit:

Whether you’re the business owner, an investor, or a representative – understanding the impact of both revenue and profit is critical for your success.  To get started, let’s review some standard accounting terms and their definition in the context of an MLM business.

 Cost is anything related to expenses and is not limited to goods and services that will be sold.   

Price is the amount a customer is willing to pay for a product or service.

Revenue is the income that is generated from the sale of goods and services to customers.   

MLM revenue is an essential key performance indicator (KPI) of gross sales.  The management of revenue and optimization of the costs of goods sold (COGS) is directly linked to the profit generated.    

Revenue = Selling Price x  Quantity Sold  

Profit, also known as the bottom line or net profit, is the difference between the price paid by the consumer and the costs incurred to produce, market, and sell its products and services. 

Profit = Revenue – [Expenses + Tax] 

Cost of Goods Sold (COGS), also known as the cost of sales, refers to the direct costs required to deliver a finished product or service.  The labor and materials needed to produce the end product or service are also included.  In an MLM business, the costs associated with the distribution, sales, and marketing of the product are not included.

COGS  = Sum [Expenses + Direct Labor + Direct Materials ]  

Net sales is Revenue less all discounts and returns (does NOT include cost of sales).   

Net Sales = Gross Sales – Discounts – Returns

Profitability,  also known as the gross margin, is the art and science of increasing revenue while reducing costs. As a percentage, tracking the profit margin helps the owners of MLM companies assess if the business is a success or failure.   

Gross Profit is revenue after all discounts, returns, and cost of sales (COGS) has been deducted.  

Gross Profit  =  Revenue  – Discounts – Returns – COGS   

A high gross profit indicates that the business is healthy and running efficiently.  A low gross profit means that the business is not efficient in converting revenue into profit.  In direct selling, companies look for a multiplier of 5X from cogs to retail price to fully fund the payout of the compensation plan and remain profitable.     

With certain products such as wine and food, a 3.5X – 4X multiplier is standard.  For these products, a 5X multiplier would create a retail price point beyond the reasonable expectations of consumers.  For companies selling these products, their compensation plans are designed to pay out less to balance the reduced multiplier.For new startups where ordering volume may initially be low, and cogs may be higher,  the question to ask is,  can you get to 5% as your business grows?  In the early days, your compensation plan is not mature, and you will not be at the full payout levels, so you can still be profitable at a lower multiplier.  Can you get to 5% with ordering 5K, 10K, 100K products at a time?  What type of volume do you need to order from your suppliers to get the lowest COGS prices?  These questions will help you determine if a product will be a good fit for an MLM business model. 

Tracking revenue is a necessity when trying to maximize the value of an MLM company.  Many systems can simplify and automate this process with varying price tags. Excel is an option that works well for a startup or a very small business. There are a wide variety of pre-built templates that can be downloaded online to quickly set up a system to provide the data that is essential for running your company.  

As your business grows, so will your accounting needs. For example, if you start with a single product, it is relatively easy to spot trends in product demand and costs. However, as you grow, you may add new product lines with seasonal collections or different catalogs, and you will want to be able to track revenue in multiple ways.  For example, you will want to know your overall revenue, as well as revenue by individual product, product line, and by collection. This level of transparency in your revenue tracking will reveal the products and services that are thriving, and the items that may need to be discontinued.

Analyzing Revenue

While tracking revenue provides valuable information regarding product performance,  analyzing your revenue will provide data that is essential for understanding your business’s health. 

A straightforward metric that MLM business owners measure is if the company is operating in the “green”, or generating enough income to cover all of the costs incurred in running the business, or operating in the “red”, incurring more expenses than income.

Based on your revenue analysis, you can begin forecasting both revenue and profit.  In the early stages, there may be a gap between your actual sales and your forecast. That gap is called a revenue variance. As your business matures and more trend line data is available, the gap will get smaller, and your forecasting will become more accurate. The variance is a vital percentage to track for making informed strategic decisions to maximize profitability

As you can see, the way MLM companies make money is very similar to how a traditional retailer makes money.  One key advantage that an MLM company has is its ability to have thousands of 1099 sales representatives that market its products through independent businesses and drive revenue for themselves and the company.

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