Technical Appendix to: Consumer Harm from Voluntary Business Arrangements: What Conditions Are Necessary?
21 Pages Posted: 16 Nov 2019 Last revised: 19 Nov 2019
Date Written: November 15, 2019
The PDF "Consumer Harm from Voluntary Business Arrangements: What Conditions Are Necessary?" can be found here: https://ssrn.com/abstract=3488105.
Consumer participation in the entrepreneurial “gig economy” is now a common occurrence. The gig economy is characterized by flexible jobs, here called voluntary business arrangements (VBAs), filled by independent contractors and freelancers who work part-time or in temporary positions. The VBA participant enjoys job flexibility and control but does not typically enjoy the surety of full-time employment, health insurance, or other guarantees that accompany a full-time job.
These uncertainties suggest the possibility of ex post outcomes that fail to meet the participant’s ex ante expectations. This research analyzes when and whether such expectation divergences rise to the level of true harm to a consumer participant in a VBA. For example, in the context of one gig economy option – the multi-level marketing (MLM) business opportunity – litigation against some MLM firms has argued distributor harm because the firm has misled enrollees about the business opportunity, and/or because the business is a pyramid scheme.
This paper therefore uses the MLM context as the basis for definition and analysis of an economic model of distributor participation and true harm (here called “Avoidable Economic Loss,” or AEL). The analysis seeks both to define true harm and to examine the underlying conditions that suggest that true harm has occurred. This requires disentangling purposefully pernicious behavior by the MLM firm from other possible precursors to disappointing business outcomes – such as the inherent risk of entrepreneurial ventures, the dual roles of inherent skill and purposeful hard work, and the lack of full information about all elements of the business before a prospect commits to participate.
In order to most stringently test for the possibility of AEL in the MLM context, the analysis focuses on the distributors most likely to be at risk for harm: newer distributors who may personally consume the DS company’s products and may also sell them at retail, but who have not built a network of downline distributors that enable larger bonus payments from the MLM firm. Within this population are consumers of varying sales and business productivity, whose skill levels are unknown to the firm and likely also unknown to the participant. My analysis shows that: It is economically rational for a person to join the MLM as a personal-consumption-only distributor, without pursuing a retailing business; Distributors with full information do not suffer an AEL by joining an MLM, regardless of their skill level; Distributors who lack full information do not suffer an AEL unless the MLM firm or its sponsoring upline distributor purposefully misrepresent or suppress information that would have caused some to fail to join and thereby avoid unexpected negative outcomes; and an AEL can – but does not always – result from purposeful over-stating of the quality of the business opportunity by the MLM firm.
The model shows that an AEL occurs not because prospects are incompletely informed of all aspects of the MLM business, but rather when useful information that could have changed a prospect’s decision to join is known and is purposefully misrepresented or suppressed. The analysis therefore suggests a set of guidelines for assessing truly harmful behavior by an MLM firm, which help distinguish the key role of “fraud” in the identification of illegal pyramid schemes, above and beyond other characteristics such as the nature of the compensation plan and the commonality of personal consumption of the MLM’s products by its distributor participants.
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