How to Analyze Compensation Plans
This content of this post contains excerpts from the writing of respected MLM Attorney, Jeff Babener.
There are four different types of compensation plans: Unilevel Plan, Stairstep Breakaway Plan, Matrix Plan and Binary Plan. But first, a little history…
MLM History
Before we go into the types of multilevel marketing plans, let’s first learn a bit about the history of multilevel marketing. MLM started decades ago as classic door-to-door direct sales by the Fuller Brush Man. In the 1950s and 60s, multilevel marketing plans rose in popularity with Amway, Mary Kay, and Shaklee. These plans allowed distributors the opportunity to earn money both on their own sales as well as on override commissions on the sales of salespeople they recruited, and the sales made by the recruiter’s recruits, and so forth.
Companies had a difficult time managing the downline information and payouts before the advancement of computers and internet technology. To make things easier, companies would only allow “direct distributors” to buy directly from the company. These distributors would then sell products to the distributors in their downlines, collect payments, and pay commissions, bonuses, and overrides.
Today, thanks to advancements in technology, there is no longer a need for direct distributors to act as middlemen. Most companies today allow all distributors to purchase directly from the company.
Choosing a Company to Join
The most important factor in choosing a company to join is not the compensation plan, but whether or not the plan is achieving its goals for the distributors. To determine the strength of the plan, it’s recommended to consider the following characteristics.
1) Is it easy to enter into the opportunity? (You should only have to buy a modestly-priced sales kit.)
2) Are you rewarded primarily for direct sales, rather than for override commissions?
3) Are you rewarded for personally sponsoring others?
4) Are you rewarded for recruiting multiple levels?
5) Is the focus on selling products to the end-consumer, rather than to your downline?
6) Are you rewarded for training and supporting your downline?
7) Are you rewarded for high personal volume?
8) Are you rewarded for high group volume?
9) Are you rewarded for maintaining a monthly volume?
10) Does the plan provide for recognition?
11) Does the plan offer non-monetary rewards and incentives, such as trips or cars?
12) Is the plan’s monthly maintenance requirement reasonable – not so high that you can never achieve it, and thus never receive compensation?
Conversely, here are some characteristics of the compensation plan in which to be skeptical:
1) A plan that does nothing to discourage deadweight distributors and nonproducers.
2) A plan that encourages inventory loading or large investments in products.
3) A plan that emphasizes gimmicks rather than product sales.
Four Common Types of Compensation Plans
There tends to be variations on four main types of compensation plans.
The Unilevel Plan
In the unilevel plan, recruits do not advance above basic distributors regardless of performance. The advantage of the unilevel is to make it easy for companies to implement and for distributors to explain to potential recruits.
The main disadvantage of the unilevel plan is its lack of flexibility in achieving some goals, as mentioned above. Unilevel plans are limited in depth of levels of payment which inhibits deep sales organizations. Front line width occurs, causing sponsors to be “thin.” Most companies that start with unilevel plans tend to adapt them into plans that look much more like the stairstep breakaway plan.
The Stairstep Breakaway Plan
As the oldest, most common type of compensation plan, the stairstep breakaway allows for distributors to advance in rank and “break away” from the original sponsor after meeting certain criteria. The original sponsor receives a percentage override on the sale of the entire breakaway organization. This plan has the flexibility to motivate distributors to perform and advance.
Its chief advantages are that it has a good track record, it’s easy to modify, it’s accepted by regulatory agencies, and is driven by volume and performance.
It’s a disadvantage in that it is sometimes too complicated to explain to new recruits. Distributors can also be at risk of inventory loading if the company doesn’t monitor them closely. Lastly, there’s often unreasonably high recurring monthly personal purchase volume requirements.
However, the stairstep remains the most tried and true types of plan in existence today, and most likely to survive in the long-term.
The Matrix Plan
This plan looks much like a grid in which distributors are limited to a certain number of recruits per level. For instance, a 3×5 matrix, each level down to five can only have three downline distributors.
This plan is considered to be more gimmicky than others because, due to the width limitations, new recruits could find themselves placed underneath upline distributors who didn’t directly recruit them.
The automatic filling of spots in the matrix can be attractive to novice distributors if they sign on with strong leaders who help to fill their grids. This type of plan also works well in companies where most products are used by distributors rather than sold to the end-customer.
A significant disadvantage includes attacks by regulatory agencies since they sometimes look like a “game”. In conclusion, it hasn’t had a successful record in the industry, it fosters nonproducers, and makes upline distributors resentful. Yet, the plan is still often used by major companies. It’s yet to be decided whether or not this plan type is here to stay for the long-term.
The Binary Plan
Binary plans are the newest. In the binary plan, distributors are allowed to occupy one or more “business centers,” each limited to two downline legs. Compensation is paid on the group volume of the downline legs rather than a percentage of sales. Therefore, payment is volume-driven rather than level-driven. Sales volume must be balanced on the two legs to be eligible for commissions. Distributors may occupy multiple positions and can re-enter or loop below other two leg matrices. There is no depth limit on payment but each matrix has a finite amount to be paid out.
Proponents of binary plans cite the weekly payout and its simple explanation. It promotes group cooperation because payout is on group volume and requires balancing of volume in each leg to be eligible for payout. It’s sometimes referred to as more democratic because of the limitation on payout in each matrix, the unlimited depth payout, and allowance of looping or re-entry.
Conversely, binaries are the most controversial plans. It has the unfortunate origins in the early 1990s in fraudulent gold coin programs and later use for other questionable high-ticket, one-time purchase products. Critics charge that binary plans have brought on legal and business problems. Companies and distributors tended to promote the plan, rather than product. Often plans had a one-time sale requirement, creating a something-for-nothing atmosphere and appearance of headhunting recruiting.
Multiple business centers were often presented as a “purchase of a business center,” an “investment,” or a “front-load” of product. The required balancing of sales volume between legs meant that hard work might yield no payoff and income would be forfeited, because personal production did not count if balanced sales volume did not occur. Finally, the multiple re-entry or looping created a “game-like” atmosphere in which an individual could end up in the downline of someone he or she had sponsored. For the distributor looking long-term at a distributorship that might be sold, this “looping” also made it virtually impossible to place a value on a distributorship because no continuous downline genealogy could exist.
How to Choose the Best Plan
To decide which compensation plan is best for you, be sure to consider the following factors:
Overall Payout
How much of the sales dollar does the plan pay out to distributors? Most plans pay 35%-45% of the company’s wholesale purchase volume, and roughly 30% of suggested retail volume. Look for a plan that divides the pie in your favor without going overboard.
Orphan Commissions
When distributors fail to qualify to earn the commissions or bonuses on their purchase volume in a given month (usually because they fall short of the minimum purchase qualifying amount), the commissions they would otherwise have earned are called “orphan” commissions. Avoid plans where orphan commissions are returned to the company. Plans should be structured where orphan commissions “roll up” to the next qualifying distributor that month. This is also called “compression.” Orphan commissions from terminated distributors should be handled the same way.
Lock-In
Look for a plan with a lock-in feature. For example, when you reach a certain level you “lock-in” and cannot be demoted due to temporary drop in monthly performance.
Other Perks
Lastly, most companies offer perks above and beyond commissions for top performance, such as company cars, health insurance, free training, etc. Some publicly-traded companies offer stock or stock options.
Regardless of the advantages of the plan, always ask yourself the question: Does it emphasize getting products or services into the hands of consumers; or does it emphasize making money by finding new recruits? If it falls into the latter category, run away — fast. In the end it’s the product — not the compensation plan — that drives success.