An Economic Model of Multi-Level Marketing

Abstract

This paper offers an economic model of the operation of a multi-level marketing (MLM) firm in competitive and non-competitive markets. The model takes a recursive approach to analyse decision making at the distributor level. This model is used to understand basic issues in the MLM market and firm structure. Specifically, it is shown that under reasonable assumptions MLM firms will include not more than six to ten levels in equilibrium, a very limited “multi-level” structure. This implies that the revenues of the median distributor are mainly a result of direct sales and not a result of commissions. The model also predicts that only markets where marketing costs are substantial will include MLM firms and that mostly individuals with a small outside offer will choose to become distributors. Finally, the model provides a formula that predicts market prices for a monopoly MLM firm.

Keywords: multi-level marketing, economic model

JEL Classification: D21, J33, J54, L22, M31