A few days back Gauri was being persuaded to invest in a new company scheme by a few well-wishers. This company, which shall remain nameless to avoid unnecessary trouble for all concerned, is being heavily advertised on TV and in the print media and to all outward appearances it seems like a gold-mine, with unofficial promises to the tune of about four times return on investment, risk free, in the first year, and some absurd high percent year on year – and many investors who extoll the virtues of this company have apparently got those kind of returns, at least in the initial period. Now I am no economist nor do I claim to be any kind of financial expert but a guaranteed return of about 4X in the first year starts ringing many frantic alarm bells even in my lay-person mind, even if people claim to have received such returns. A wise man once said that if it looks too good to be true it probably is, and I have no reason to disbelieve him.
Now I will be the first to admit that I haven’t studied this model in detail but from what I have heard, prima facie, the following are the main things that concern me about it (I know that a lot of people who have already invested in it will not like this post, but hey, it will at least give them something to think about) -
Risk-free guaranteed returns
I mean, just stop for a bit to take off the blinders and think about it from first principles – 4X in the first year translates to roughly 400% return on investment. Forget 400%, lets talk only about one-tenth that, or 40%, for the sake of argument – now the most successful companies in the world struggle to make 40% profits year on year; the best stocks on the stock market cannot guarantee 40% year on year; gold does not appreciate at 40% year on year and nor does real-estate (except in some exceptional cases) - in fact, the only businesses I can think of that can guarantee those kind of returns are possibly the drug cartels (and even that is not risk-free!) – so how is it possible for this company to offer those returns?
Still there are huge numbers of educated, and presumably wise, people who are sold on these numbers and the only reason I can think of is that they want to believe the numbers are correct and that they will happen, at least for them. Be that as it may, the answer that is trotted out to the question of returns is that it is not just an investment but a work-from-home opportunity which pays the investor/user for the work they do – thus giving them the returns. This brings me to my second concern -
Requiring an investment to be a contractor
Which legitimate company wanting to get work done from external contractors in return for remuneration requires those people to first invest money in the company? In my mind, basically, work-for-hire is a simple concept
- Person A does work for Company B for an agreed upon rate of remuneration
- When the work is finished Company B gives appropriate remuneration as per agreement
It seems to me that at no point is there any reason for person A to give money to company B for either 1. or 2.
Oh, but you’ll say, in some cases companies do take a deposit from their vendors, or that franchisees do need to invest money to start a franchise, and I agree that in some cases this is valid – for example, when the company is providing the vendor with the raw material to convert to finished goods the company must take some deposit to cover their costs in case the vendor runs off with the raw material or something. Still, I haven’t heard of any company taking money from its contractors against an assurance of paid work in future. That brings me to the third concern -
The work itself
It appears that the company is paying these investors/users to take surveys, and they pay Rs 500/- per survey per user (or respondent). Apparently, they can afford to do so as they are themselves paid Rs 2,500/- per user per survey by the client companies that commission these surveys. Right – now lets do some simple math -
- Number of users taking a survey = 10,000 (which seems a reasonable sample size to get any kind of good market insight – right?)
- Cost to client company = 10,000 x 2,500 = 25,000,000 – 25 million Rs (for one survey!)
Now my facts and figures could be wrong, and so could my math (I once got 7 out of 100 in my 11th standard calculus exam) so potential investors can do their own, based on their own facts and figures.
What I do know is that when I did a few market research surveys back in the early 90s as a part-time job we were paid Rs 5 per respondent, and even allowing for inflation the figure of Rs 500 seems a bit excessive (and Rs 2500/- even more so!) – it is possible of course but it doesn’t seem probable, at least to me. So if not from client companies commissioning surveys where does this company get the money to pay the survey-takers at the rate they promise? Which brings me to my final concern -
The expanding pyramid scheme
I may be totally wrong (and I hope I am for the sake of approximately 13 lakh people who have invested in this already, if one is to go by the claims) but given all the above, this looks suspiciously like an expanding pyramid scheme to me. For example, when I was in college there was a scheme where you were required to buy a piece of paper (a right-to-sell) from someone for say, Rs 300/-, then you sell it to three friends for Rs 300/- each and you keep your Rs 300/- + some percent of the remaining Rs 600/- and pay the rest to whoever you bought the right-to-sell from (your upline or upstream) and this cascades up the pyramid. So in order to recover your Rs 300/- you were required to rope in at least 3 more gullible friends and they were required to do the same to recover their own money, and so on.
In other words, the return on investment for each layer of the pyramid depends on a much larger lower layer being created, thus expanding the pyramid – i.e. more and more gullible people putting in a capital investment to serve the return on investment needs for those invested prior to them. In most, if not all, such cases when the bottom stops expanding the weight of expectation of the top layers makes the whole structure collapse on itself and leaves the lower layers brutally exposed. Now scientists estimate that not even the universe will continue expanding indefinitely, so what can we say of this pyramid? Forget the law of diminishing returns, if this pyramid collapses then it could well turn out to be a law of vanishing returns for a large section of investors.
Being just a mere mortal and no soothsayer I don’t know if this will actually happen, though. For all I know the pyramid will keep on expanding at the same rate as world population and thus never run out of people for the bottom layer – and maybe the meek will yet inherit the earth. I don’t want to predict either way, so I will only say this -
- good luck, but caveat emptor.
April 28, 2011 at 4:31 pm
Hi,
Pretty much agree with what you say. I think companies like Amway too work more or less on the same principles, though they are not exactly cheating people out of their money, but the further branching of your network happens, the more your returns and of those down that network.
One interesting observation: my mum bought pure silver (not gold since inflation has anyway kept gold prices high) as investment, and in less than four months, she has got more than 30% returns on it due to the escalating silver prices, so when speculation w.r.t. markets is involved, one can make money by being in the right place at the right time, or can lose a lot in some cases.
April 28, 2011 at 7:13 pm
There are tons of such schemes that are forever floating around in India..people burn their fingers, and rise up optimistically to join the next scam.
April 30, 2011 at 7:45 am
One would think US is an enlightened place.
Madoff happened – one of the biggest all-time ponzi schemes ever detected. Wonder how many more are lurking around. There was one store in NJ that sold gold thus – ‘buy gold bar: pay current rate: after a minimum of 1 month, you can collect the gold you paid for AND pocket the cash difference between purchase price that was paid and the price at minimum gold rate in the duration prior to collection. e.g. you buy x bars at price P. By the time you collect the same x bars may be priced at ( x * y ). So you pocket x*P – x*y. This went on fine for good long time, one fine day things got alarmingly messed up – the store owner died – could not keep pace with increasing gold prices and got crushed under demand for gold bars + difference money if applicable. Looks like at any given time he did not have the number of gold bars ( that he was paid for at old rates ). Yes, everyone sunk, owner and customers.
To make it simple, yes, if something seems too good to be true, it probably is.
I appreciate the scepticism put forward in the article.
April 30, 2011 at 7:49 am
PS: Forgot to add to the ponzi gold scheme described above. If the price y > P, you don’t have to pay the difference, you still collect your gold. If the price y < P, then you pocket the difference and the gold.
May 31, 2011 at 10:33 am
A very valid point is that to generate cash flow, the entity should be producing something of value. While here they did name the ‘surveys’ (while they never were transparent enough to name who were the companies who were paying so much to buy those surveys) as the product that was creating value, it was way overrated.
Reminds me of the quote, ‘Hope is a dangerous thing’ (from the movie Shawshank Redemption)
June 4, 2011 at 11:24 am
If you look at the model of recent schemes like these, it is about balancing the tree under you. This is even complex than the simple pyramid.
They say you have to just contact 2 people, so you have now a left-sub-tree and a right-sub-tree. These subtrees grow on their own. The trick is you can cash out when the subtrees are balanced. For it to happen they offer you “flexibility” to attach someone joining deep under you below any person in your tree.
Those who have a bit of comp-sci background will now that creating an AVL tree data structure is not as trivial as other assignments in Data structure course. However, this is a process that is controlled
In real world when you don’t know which node (who) will join when and where, it is almost impossible to ensure the tree getting balanced when it grows!
But having said this, I too know of otherwise seemingly sensible people falling for such schemes.