Economic hardships have meant that a lot of people are looking for investments and opportunities that yield very high and quick returns. However, as a general rule in finance, high returns come with commensurately very high risks.
by Clive Mphambela
Some of the seemingly lucrative avenues for “investment” that many Zimbabweans today are falling for are actually “pyramid schemes” or versions of “Ponzi Schemes”, which promise investors very lucrative returns, for very little or no risk, over very short periods of time, and for very little or no effort on the part of the investor.
How can you identify a pyramid scheme? A pyramid scheme is a business venture that seeks to “recruit members” through the promise of very attractive payments or services as rewards for enrolling “new members” into the scheme.
They depend on new members joining, rather than supplying actual investments or selling tangible products or services.
New members “buy into the scheme” by paying contributions to existing ones who joined before them.
As new recruits grow and multiply, the recruiting of new members becomes quickly impossible, and most members are unable to get the initially promised profits.
As a result, the pyramid scheme collapses when new members can no longer be found to “join” the scheme.
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For these reasons, such pyramid schemes are unsustainable and in most countries, are illegal.
What is the basic concept of a pyramid scheme? In a typical pyramid scheme, the organistion entices individuals to join and make a payment to their recruiters or to other members in the scheme.
In exchange, the organisation promises those new members a share of the money paid in by additional members that they recruit.
The organisers or directors of the organisation, who typically are positioned at the top of the pyramid, will also receive a share of the payments from new recruits.
For this reason, pyramid schemes benefit early entrants and are potentially lucrative for early birds.
Such organisations are seldom involved in the sale of products or services with a real value.
Without creating any real goods or services, the only way for a pyramid scheme to generate revenue is to recruit more members or to solicit more money from the current members.
Some pyramid schemes are also referred to as franchise fraud or chain referral schemes and are essentially marketing and investment frauds, in which individuals are offered a distributorship or franchise to market a particular product.
The real profit is earned, not by the sale of the product, but by the sale of new distributorships, which is a form of recruitment. Emphasis, thus, is on selling new franchises, rather than the actual product or service and this eventually leads to a point where the supply of potential new franchisees or investors is exhausted and the pyramid scheme collapses.
Pyramid scheme fraud, therefore, often involves an unsustainable underlying business which rewards participants for enrolling others into a business scheme, which itself offers a non-existent or worthless product or service with no commercial value.
Pyramid scheme fraudsters will usually advertise a multi-level investment or social financing scheme that offers extra-ordinary profits/returns for very little or no risk to participants.
They also make it seem very easy to recruit new members and, in fact, in the early days, it may actually be easy for early entrants to recruit new participants, but this becomes increasingly difficult over a short period of time.
Most, if not all pyramid schemes, require a new recruit to pay some sort of joining fee to enter the investment scheme.
The fee is typically paid to the earlier recruiter or recruiters in the chain and occasionally, there is an administration charge that is paid to a central agent, or lead agent.
Money invested in a pyramid scheme is not actually invested in any product, but instead, it is simply passed up the chain of investors.
Because pyramid schemes are often illegal and make no profits, they do not have any assets and you are very unlikely to recover any lost investment. While the fraudsters at the top of the pyramid will collect most of the profits, those who entered the scheme later end up losing out.
Legitimate trading schemes rely on tangible goods and services, while pyramid schemes simply thrive on recruiting more and more new participants at the bottom of the pyramid.
Next week, we look at the characteristics of the Ponzi scheme, its similarities and differences with pyramid schemes and why they eventually collapse.
Clive Mphambela is a banker. He writes in his capacity as advocacy officer for the Bankers’ Association of Zimbabwe. BAZ expressly invites other stakeholders to give their valuable comments, feedback and questions related to this article to him on [email protected] or on numbers 04-744686/987, and Mobile number 0772206913. Readers can also visit the BAZ website www.baz.org.zw for similar articles and advice.
