17 April 2006

Network Marketing

Network Marketing is a unique way of marketing goods, where the manufacturer does not rely on the traditional channels of marketing like distributors, wholesalers, retailers etc but uses the end-users themselves to market goods. This concept of distribution channel, has so far been successfully implemented by Amway, Herbalife etc. A lot many of us hate networking marketing, probably becoz it somehow beats our logic of earning money and some of us becoz we are usually not comfortable building networks or just plain selling. But there are quite a number of people who jump at the opportunity to make a quick buck. How many of us realize the economics behind this and the earning potential is highly debatable.

The general process in any networking is roughly the same. Take the case of company producing, say belts, each belt costing $1. In the usual marketing world, each belt would be marked a retail price of $10, where the difference of $9 goes into the pockets of manufacturers, distributors, wholesalers, retailers, advertisers etc. In this case, each one of them continuously works in order to earn the buck. And the difference of $9 you pay goes for the service rendered by each one of them to bring the belt to your door.

In the networking world, this equation changes drastically. Lets say, a person X, in the marketing chain (lets call him an Associate), purchases the product at $20. It is his choice to either sell it to a 3rd party or use it for this own. For each purchase he gets 25% cut. So, for every product of worth $20, he gets $5 back. Not much money, right? Especially, when you pay more money than what you would in the usual market. The difference here is that, X can appoint or refer or recruit some more persons to do the same buying and selling, and each one of the associates he refers can further refer some more people to buy and sell the product. In this way, X builds up his own network or chain. The benefit for X in referring people below him is that for ever sale made by an associate under his chain, he gets a cut of it. Lets suppose he gets 20% of the sales made by associates under his chain. The more people he has under him, the more he earns. If an associate under him fails to refer anyone else, then X suffers the loss of income from that chain. Lets see who benefits from this and how much.

I'll take a simple example of a company, which produces items each worth $1 and labels for $20. Each associate sells $20 per month and refers 2 more people. where he gets a cut of 25% for each sale made. Suppose one particular Associate X sold goods worth $20 in that month and has refered 2 more associates Y and Z and each one of his reference sold $20. Together they have raised $40, out of which Y will get $5 as his share and Z will get $5 as his share. The remaining $30 moves up the chain. X will get $5 for the sales he has made and 20% of the $30 which has come up the chain, i.e $5+$6 = $11. Total amount sold for $20*3 = $60, out of which $21 is distributed to X,Y and Z. The remaining goes to the company, i.e $39. In this case 3 items were sold, one by each person, so for each item the company got $13. The company got a huge margin of $12 per item, Y and Z get only $5 back after spending $20 for a product which would be avlb in open market for $10. X meanwhile would get $11 back.

The crucial questions are: Why should the company charge $20 which is double the market price and what is the actual benefit of X, Y and Z, if they are overspending.

For the first question on why the company charges $20:
The example above only shows for 2 levels of associates. X at the top level and Y & Z are the next level. If the number of levels increases, i.e Y and Z too start refering associates, then the profitability of the company falls drastically. Hence it forced to price products very high.
See the same example for 5 levels.

The first column shows no. of person in each level, if each person refers 2 more people below him. If each such person sells goods worth $20 each, then lowest in the chain get $5 per sale, while
the top in the chain get $682.19, if every person below him sells $20.
The company has sold a total of 1023 units, each for $20 and gets back $2723.78, i.e each item
fetches $2.7. Not so much as compared to $13 when only 2 levels of associates where present.
So, the company earns less and less as the number of levels increase. In fact, it is better for the company to have a flat hierarchy than a long one. If the company would have charged only $10 for the product, then it would have earned only $1.3 per item, after distributing all the sale proceeds. This is one more reason the company is forced to charge very high prices. Not necessarily becos the quality of the product is good.

The biggest looser is the end-user, who buys a product worth $10 for $20, just to keep the 10 levels alive. The last level (i.e person who have not referred anybody) are the next biggest loosers. If they buy the products for themselves then they loose as much as $5 per item. If they sell it to others who are not in this chain, then they make $5 per item (almost as much as any retailer would make).

The biggest gainer here is the person highest in the chain. He makes cash of everybody's effort down the chain.

Now the second biggest question: Why do X,Y and Z overspend or force others to overspend? The answer is closely related to why someone chooses to do Network Marketing. Some of the prime reasons are:
1. Unconventional Income (or, Side-Income)
2. Getting into Business
3. Improving our network
4. To avoid over-dependence or become independent of the regular channels of income.
5. To work for few years and reap the high rewards.
6. High returns for meagre effort and investment (both economic and technical).

Points 1-4 are equally valid for any other kind of work and not only to Network marketing. The real reasons that work in favour of Network Marketing are reasons 5 and 6. The thought process for Reason 5 is: "Its OK if someone is taking advantage of my work today, but if I work hard enough and build a strong enough network, I can retire early and simply keep earning money becoz my network would then be working for me." Its not that vile to expect to ENJOY-THE-UNEARNED, but what is gross is to expect to BENEFIT-FROM-SOMEONE-ELSE'S-EFFORT. And, that is the biggest selling point of Network Marketing. No matter what sugar coating each one would give for their reason, it is this BENEFIT-FROM-SOMEONE-ELSE'S-EFFORT view that really drives the last nail in. Ofcourse meagre effort and investment in terms of technology or finances addes fuel to fire. This reason though a deciding factor in many cases, does not equal the GREED-OF-UNEARNED.

Some of the people who are into Network Markting were offended when I offered them the above reason. The immediate examples which they offered as an argument were:
1. In a corporate world, the top management is usually richly rewarded and despite their minimal effort enjoys the benefit of the effort of the working class.
2. In any traditional marketing 80% of the cost is paid to the middlemen and network marketing does nothing but distribute this 80% amount within the network which is (somehow) noble.

In any industry, each person's work is different and is dependent on his/her ability. The CEO of the company has different task than the watchman at the gate. We cannot replace one with the other and expect the same work to be done. Without the CEO's direction, the company would fall like a deck of cards and the large working class would be left without anything to earn. But, in a Network Marketing each associate is essentially the same with respect to the work each one undertakes, with only their personal ability to differentiate them of one another. The only reason why person X would earn better than person Y, if both of them put in the same effort is becoz X was in the Network much earlier than Y. In a traditional industry too, there would be such instances, but the difference would be very dismal. But in a Network, the earning potential would vary many times over. In the above example a 10th rung associate would earn approx 30times less than the top associate !!!.

In traditional marketing, there are lot of people involved at various levels like dealers, wholesalers and retailers. Each person's work is different and at a different cost structure. Each person earns for the sales he makes in that particular month. There are no free lunches anywhere in the chain. In Networking, each associate picks up goods to be delivered. Neither goods nor money flows thru the chain, but the chain earns the commission just because it exists. In other words, the structure comes free of cost in the traditional marketing, only the effort is paid for. But, in network marketing the structure is a cost centre, and the end-user pays for maintaining the structure,i.e in addition to the cost of effort put in by the structure.

The final question Does Network Marketing Work?
IT DOES.. for the first few. In a network marketing,
1. The company gains, if the hierarchy is flat, so that it can price its products low and earn profit on volume. The company stands to gain if lot of associates join, but few are able to build deep hierarchies below them.
2. The individual associate earns more if the hierarchy below him is deep, so that the numbers below him are huge and hence his cut.
The company and the associate benefit at different structures. Its anybody's guess who'll benefit best.

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