Chapter One: How is network marketing different from other methods of distribution
In this chapter, we will discuss some important issues that you might not think would affect the commission plan, but they do. I refer to the pricing methodologies a company adopts, the method a company chooses for doing business internationally, and whether it adopts an open-enrollment or barriers-to-signup strategy of recruiting distributors.
The pricing of a company’s product line has a lot to do with its commission plan. There are a lot of issues that have to be considered, and everything about the commission plan flows from these decisions. Who are the distributors going to market the product to? This is important because network marketing is peer-to-peer marketing, so the plan must be attractive to the target audience. Does the product take a long time to train people to use? Is it consumable? Is the answer yes for some products and no for other products the company sells? These are the questions to which you must know the answers. As a general rule, the harder it is to train consumers to use a product, the higher the commission percentage you should anticipate on the sale of the product. A higher commission should also be paid on a more expensive product. On consumable or easy-to-understand products, commissions can be less.
As we discussed earlier, most companies pay total commissions of between thirty-five and fifty percent of the “distributor price” of the product. If a company pays less than that, it’s difficult to be competitive. If a company pays more than that, it’s difficult to have a good quality product and afford to stay in business and be competitive.
Most successful companies ultimately publish a price list that looks like this:
Many distributors and company executives do not like this price list because it’s too complex; however, let’s look at why so many companies end up using it.
Commission Value (CV) is the price that commissions are calculated from. In many companies, the CV price is the same as the price that distributors pay for the product. And this is certainly what most distributors want companies to do; it’s simple and easy to understand. However, it makes sense to list CV separately on the price list because it gives the company flexibility in the products it can sell. This is because even if the CV price is the same on nine out of ten products, a company needs flexibility to be able to show that tenth item correctly on the price list.
Qualifying Points (QP) This is how much a product counts towards the qualification requirements of a commission plan. Here again, it’s often the same amount as the price of the product. However, if a company is doing business in multiple countries, and they allow distributors to sponsor downline distributors in multiple countries, then qualifications can’t be expressed in dollars because other countries don’t use dollars. The qualifications must be expressed in points. If a company is planning on doing business in more that one country, it should use qualifying points. Another advantage is that a company can increase or decrease QP independently from the price as a separate part of their marketing strategy.
Companies don’t always use the terms CV and QP. They may use terms like SV, QV, PV or others. But the concept is still the same. As you can see, this type of pricing mechanism allows for the flexibility that any long-term company needs.
Now let’s talk about the challenges of using this type of a pricing system.
Reduced commission value products
One of the great conveniences of this pricing method is that it allows companies to lower the commission value of a product, but leave the price the same. This means that the company will pay less commission on the product but sell it for the same price. In some cases, this is perfectly legitimate. Sometimes, in order to fill out its product line, a company wants to sell a product that doesn’t have enough of a margin to pay full commission. It therefore has a lower CV on that one product. But in other cases, companies lower the CV on an entire range of products, or in some cases the entire product line. This action frustrates and confuses distributors because they feel that the rules are being changed in the middle of the game.
A second variation of the CV system occurs when all products have commission value that is significantly less than the price the distributor pays. One method that has been tried several times over the last twenty years is to make the commission percentages of the commission plan add up to 100 percent, while the CV on the price list is about thirty-five to fifty percent of the distributor price. There’s nothing technically wrong with this idea. In the end, the money paid out ends up being the same as if the CV were 100 percent and the commission percentages were thirty-five to fifty percent. However, in my experience it’s very confusing to distributors because it’s so different from the traditional method of operation. In addition, so many companies have lowered CV as a method to reduce commissions that it immediately makes distributors suspicious.
Many companies end up needing to lower CV on a few products to fill out the product line. While distributors may be a little wary of it, this first method has worked But a second method of lowering CV across the board causes companies to deal with a lot of confused and frustrated distributors for a long time, so I would not recommend doing this.
Some companies have a ten-year plan to move into other countries. That’s fine, but distributors will push their company to implement their plans much sooner. The reasons are quite simple.
First, network marketing is popular in many countries around the world. In fact, it’s more popular elsewhere than in the United States, and several companies we’ve dealt with have established sales of popular products quickly and inexpensively. Obviously, international growth is profitable for a distributor’s bottom line.
Second, one of the traditional major marketplaces for direct sales and network marketing is first- and second-generation immigrants who are ignored by mainstream corporate America. The reason is that these groups, even though there may be a few million in a community, are too small for mass media advertising. So as a network marketing company sells product into these ethnic groups, it’s natural for those people to want share the product with their relatives. They send some to their home country for personal use, and then the pressure starts to build for a company to open business in that country.
It’s interesting that often one of the first questions asked of my company is, “Can you pay international commissions?” The answer is yes, we’ve been paying commissions internationally for more than fifteen years. This assurance is often followed by a great sigh of relief, after which the clients tell us they’re opening ten countries in the next year. Then we have to tell them that paying international commissions is the easy part of opening ten countries. Dealing with the international equivalents of the FDA and the IRS is the difficult and expensive part. Remember, these issues are complex and time-consuming, and this discussion is just an overview. A great deal of planning and preparation needs to go into any decision to move a company into the international market.
There are three major schools of thought on international commission plans. They are:
1. Single Worldwide Downline Unified Commission Plan: In this model, the plan is “seamless” worldwide. If I am a distributor in the United States and sign up a distributor in the United Kingdom, it should not make any difference in commissions. The plan is the same throughout the world, and a distributors downline sales volume counts exactly the same regardless of where it comes from.
2. Single Downline/Regionalized Plan: In the United States, the GDP is $35,000 per person, and in Vietnam, the GDP is $2,000 per person. Remember in Chapter Five, we talked about the importance of personal and group sales requirements. They should be based on the number of consumers needed to meet these requirements. Proponents of this theory argue that if sales volume requirements are the same, then it’s seventeen times as hard to meet them in Vietnam. These companies support a worldwide integrated downline, but argue that you can’t have the exact same plan for both of these countries; the commission plan has to have regional or country differences. A distributor must qualify in his or her home region, but get paid on the entire world.
3. Separate Downlines/Separate Commission Plans: People who favor this approach argue that the problems caused by the regionalized scenario are so great that the notion of a worldwide downline simply can’t work. They also contend that so few distributors actually build downlines outside of their home country that it’s simply too expensive to justify.
Which is the best approach? Up until about fifteen years ago, it was so expensive to do unified commission plans that it simply was not done. And even when companies first started opening foreign offices, they tended to be in very well-to-do, high-GDP countries, and so the unified commission seemed to be well on its way to becoming the universal standard international plan. However, with the rapid explosion of the Internet in the last five years, it has become cost-effective for companies to open smaller countries with low GDP per person. Many companies have had to think long and hard about what they want to do.
At first, distributors in large markets almost universally like the first approach, which works well if the GDP per person is relatively the same in all countries where the company does business. But inevitably, distributors pressure companies to start opening countries where there is a large disparity between the GDP per person. That tends to be a bit of a challenge. You may remember that we talked earlier about the fact that one of the most important things to take into account when designing a commission plan is the socio-economic profile of a distributor. If the profiles vary greatly from country to country, a company tends to lean more toward the second method; however, not many companies have used that model. Consequently, many details are still unknown.
Then there is another issue that must be considered and that is the legal environment in a country. For example in Korea, it’s against the law to pay more than percent in commissions. If a company’s plan pays more than thirty-five percent overall, then they cannot have a truly seamless worldwide plan. Most countries are going to have laws which a company will have to take into consideration, so a completely seamless plan is probably out of the question if the company is in more than a few countries.
The last concern involves computer costs. It’s more expensive to process worldwide commissions than to process each country locally. Relatively few distributors sponsor internationally, but those few distributors can be the reason a newly opened country has such rapid growth in sales. The question is, who bears the additional computer costs-the distributors who sponsor internationally, all distributors, the company home office, or the individual offices in each country? These are questions that every company must answer before it embarks on an international business policy, because to debate them after the company has started paying international commissions is extremely difficult.
In summary, international sponsoring and commissioning has been the vehicle of success for some of the biggest network marketing companies in the industry today. It’s certainly a part of the future of the industry, but each company has to determine its own way because no consensus has been reached on these issues. A discussion of international issues should be part of the commission plan development so as not to limit a company’s options later.
Open Enrollment vs. Barriers-to-Signup
There are two basic methods for creating a network marketing company’s sales force. They are:
1. Open enrollment. This strategy makes it easy and inexpensive to become and remain a distributor. Almost all people who become regular consumers of the company’s product become “distributors” so that they can buy at “distributor wholesale.” In this type of company, all commissions are paid within the commission plan. Very little retail commission is ever earned because most people become distributors.
2. Barriers-to-signup. In this strategy, only people committed to becoming active salespeople sign up as distributors. The company maintains this strategy by creating such barriers as an expensive product demonstration kit, required ongoing training, and high monthly personal sales requirements. In these companies, retail consumers are a reality, and the distributors receive the retail markup from product sales.
Both of these strategies have worked well over the years, The trouble comes when a company tries to mix and match the methods. They pick one method and then try to copy elements from a company using the other method. The decision as to which of these two methods to use is one of the first a company will make as it starts to create its commission plan. This chapter is a discussion of the benefits of each method, what a company gets by choosing that method, and what they give up.
Let’s begin with the open-enrollment strategy. Open enrollment is the staple of modern network marketing companies that have been around since the early 1980s.
The first item to note is that very little product is sold at retail price in an open enrollment company. Since by definition it’s easy to become a distributor, if a person is going to become a regular consumer, they soon realize that it’s cheaper to purchase a sales kit and throw it away and get the “distributor wholesale price” than continue to pay retail price. Now, are these people still consumers? Absolutely, and they still need to be treated as consumers or, in many cases, they will ultimately leave. Companies must realize this, and make sure that they pay the actual salespeople enough sales commission within the commission plan to service these consumers, because they can’t rely on the retail markup.
There are certainly advantages to this strategy. One is that the consumers are dealing directly with the company. Therefore, the company knows who their consumers are. This can be a tremendous advantage over barrier-to-signup companies that often have no idea who their consumers are. In such a case, if a salesperson quits the business, the company loses all of that distributor’s consumers.
A second advantage is that the company can help share the burden of consumer service. Yet a third advantage that has appeared over the last seven years is Internet ordering. This method lowers a company’s costs and allows the company to provide better service to the customers.
In the open enrollment strategy, it’s important that the plan fairly compensate the salesperson inside the sales plan. Often, when a new distributor signs up, the company must recognize that he may never sponsor anyone and the only thing he plans to do is buy product for his own consumption. In the upline of this consumer is someone who must fulfill the role of salesperson. Sometimes, the sponsor is the salesperson, but often the sponsor is a product evangelist and the salesperson is further upline. This salesperson provides the consumer service, explains the product, and fulfills the role of the traditional salesperson. In the upline of the salesperson is someone who has to fulfill the role of sales leader, managing the salesperson. The plan must be designed to compensate the salespeople and sales leaders for the extra time they must spend to service the distributors who are actually consumers.
Another advantage of this method is that the recruiting distributor doesn’t have to try to determine what role someone is able to achieve with the company when signing that person up. For example, sometimes you recruit a distributor thinking he or she will be a sales leader, but instead that person ends up being a consumer. The reverse is also true; you think a new signup will only be a consumer, but instead that person ends up being one of your best sales leaders. In a properly designed open enrollment company, it doesn’t matter if the distributor remains a consumer; the upline is nevertheless paid sales commission. If at some point, this consumer starts building a business, a well-designed commission plan will automatically adjust and start splitting the commissions, ultimately giving the entire commission to this new salesperson.
This point leads to the last advantage: the simplicity of the recruiting strategy. Many distributors like the fact that they have only one sales pitch and one form for people to fill out. With barriers-to-signup companies, distributors essentially have two sales pitches: one for consumers and a second for people they’re signing up as distributors.
Now let’s talk about some disadvantages of the open-enrollment strategy. First, it’s much harder to get the design right in an open enrollment plan, and if you get them wrong, it’s a much bigger problem. The plan must pay the salesperson to service the consumer. For example, if a plan pays only five percent for taking care of the consumers and the average product costs $30, a salesperson receives only $1.50 a month. Is someone going to adequately service a consumer for $1.50 per month? Many times the salespeople leave consumers to take care of themselves. Of course, consumers don’t take care of themselves. They expect to be taken care of. Neglected consumers tend to leave.
Companies adopting this strategy with the wrong plan tend to be like grass fires: very hot on the edge (newly sponsored “consumers” buying product) and cold in the middle (older consumers no longer buying product). Consumers get excited and enthusiastic about the product, but then grow cool. They don’t get their questions answered, they don’t have contact from the company, or they run out of product. As one person put it, when they run out of product, they’re really going to buy it the first day, they’re probably going to buy it the second day, they think about maybe buying it on the third day, and then, by the fourth day, they don’t remember it at all. People need to be sold. An open-enrollment strategy strongly depends on a strong sales commission strategy that compensates salespeople for taking care of their consumers. Many open-enrollment companies over the last few years have failed to provide such plans.
The second challenge of the open-enrollment strategy is the sheer numbers of distributors a company has to deal with, often three or four times as many as their barriers to signup cousins. These numbers can be overwhelming. My company had a client that had almost two million “distributors” on their computer. How do you deal with two million distributors? Companies need sophisticated computer systems and still have to spend a lot of time and energy to sort out the consumers, product evangelists, salespeople, sales leaders, and dream-builders. They need to create marketing campaigns targeted to these different types of distributors. Unfortunately, many times, companies lack the computer systems and/or the ability to do the research and create targeted campaigns for the different types of distributors.
Overall, the open-enrollment strategy is gaining market share due in large part to the Internet revolution. It allows companies to deal efficiently with the masses of people and share the burden of servicing the consumer with the salesperson. Barriers-to-signup is certainly not dead, however. In fact, some of the fastest growing network marketing companies of the last five years have been barriers-to-signup companies. So let’s talk about them.
Barriers to signup
What are barriers to signup? In a company where you want to keep consumers from becoming distributors and limit distributorships to those people who are actually going to sell your product, a company can create barriers that make it unattractive for a consumer to sign up as a distributor. Common barriers are:
1. Relatively expensive sales kits: for example, a several hundred dollar product demonstration kit that every distributor must purchase.
2. Required training: a consumer isn’t willing to spend the time and money to go through this training.
3. Monthly or quarterly retail sales requirements: A distributor is required to sell more products every month than a consumer could consume on his own. (Note that this is different from front-end loading or garage qualifying, which is much higher and is normally based on group volume)
Creating these barriers means that people who aren’t salespeople simply won’t sign up as distributors just to get the wholesale price, hence creating “barriers to signing up” as a distributor to the company. To get the product, they must buy it from authorized distributors, who can then make the markup between the distributor wholesale price and a reasonable retail price. This approach allows for legitimate retail markup that the distributor earns as soon as the product is sold, with no need to wait for a commission check from the company.
The big advantage of the barriers-to-entry strategy is that the retail margin is somewhat protected. Very few distributors sign up just to get the product at wholesale. Another advantage is that everyone listed on the company’s computer is a salesperson, sales leader, or dream-builder. This means that the research, the marketing, and the communications strategy with the distributors is much easier.
Another advantage to this strategy is the integral part it plays in the party plan business model. Party plan companies were originally direct sales but not multi-level marketing. Many party plan companies now have multi-level commission plans, but most are still barrier-to-signup companies. The reason for this is that, as you work through the whole business model of “salesperson- hostess-attendees,”, it’s difficult to make the open-enrollment strategy work. Some companies have made open enrollment work, but the barriers-to-signup model tends to fit better with party-plan companies. The party-plan model is certainly a successful, effective direct sales-and now multi-level-business model, so either barriers to signup will be with us for a long time, or companies will figure out how to use open enrollment in a party plan.
Another pro to the barrier-to-signup model is that commission plans can be much simpler because a large portion of the sales commission is paid “outside the plan.” To a large degree, salespeople are taken care of, regardless of how the commission plan is put together. This takes a tremendous burden off of the designers of the commission plan.
There are disadvantages, however. One is that it forces the distributor to determine, up front, whether a potential distributor will become a salesperson or simply remain a consumer. Sometimes, sponsors err on the side of keeping people as consumers rather than as distributors. Or they can make the error the other way, and then they don’t earn any sales commission. So it forces distributors to make judgments about people rather than letting the people judge themselves.
Another disadvantage to this strategy is that it’s difficult to pay the product evangelists. The barriers-to-entry strategy typically does an excellent job of paying salespeople, sales leaders, and dream-builders. But In an open-enrollment strategy, it’s easier to design a plan that pays the product evangelists as well.
The last disadvantage is that often the barriers-to-signup companies don’t have the names and addresses of the end consumers. This can cause a problem because if a salesperson quits, all of those customers “quit” with him or her because the company doesn’t know how to contact them. I’ve discussed this problem with executives from several large barriers-to-signup companies, and it’s a frustrating problem to them. Companies are trying to create incentives to get the names of the consumers, or have the consumers order online-anything to keep from continually losing them when salespeople quit.
Barrier-to-signup has become almost the exclusive domain of party-plan companies. More and more party-plan companies have multi-level commission plans. It has been interesting to watch over the last ten years as party plans started to adopt MLM plans. Many people in the network marketing industry basically said, “See, we had the right model,” but the party-plan companies retained much of their essential nature, including barriers to signup. Over the last few years, several of the companies using multi-level party plans have been the fastest-growing companies in the direct sales industry. This has caused many people to take a closer look at what they’re doing right.
This scrutiny has created a new trend that has been evolving over the last few couple of years since the advent of the Internet, which is kind of a combination of open enrollment and barriers-to-signup. I call it a mini-barrier plan. In this plan, everyone signs up as a “preferred consumer” and purchases product at the preferred consumer price that is between the distributor price and the retail price. Then at some point, those who meet certain qualifications are allowed to start purchasing product at the distributor price, and they receive the retail profit of the preferred consumers they have recruited in a commission check from the company. It’s an interesting combination that is only now starting to see wider use, but I think is an indication of the kind of changes that are coming to companies and commission plans as a result of the Internet. I am often asked which of these methods I think is best. I can argue the pros and cons endlessly. In some cases, when you look at the product line of a company, the method to use is very clear, and, in other cases, it seems like either method could work. In the end, it depends on the company’s products, strategy, and mission.
Once a company picks a strategy, it’s of critical importance that it not deceive itself. If the plan is an open-enrollment strategy, the company must not promise distributors they will earn “retail markup.” If the plan is a barrier-to-signup strategy, the distributors can earn money outside the plan in the form of retail margin, and the company can count on it.
Most of all, once the strategy is in place, the company must move on and protect the strategy. So for example: if you are a barriers to signup company, don’t erode the barriers to sign up. This destroys your salespeople’s ability to earn commissions. If you are open enrollment, don’t continually talk about retail consumer programs, unless you can create truly compelling reasons for a consumer to join a retail program instead of becoming a distributor.
I think that over the next few years each of these business models will evolve rapidly, primarily because of the rapid penetration of the Internet in our Industry. For example in June 2002, the DSA surveyed over 1800 distributors of several direct sales companies. An amazing eighty-seven percent of those distributors used the Internet in their business, compared to a sixty percent nationwide usage.