Is Affiliate Marketing a Pyramid Scheme? Differences Explained (2024) - Shopify (2024)

Consider two scenarios. In the first, someone recommends a spatula on social media and shares a link to an online store. Each purchase made through the link earns the poster a commission. In the second, someone encourages you to pay for the right to sell a company’s spatulas, promising sky-high profit if you invest in the company’s sales network and recruit others to join.

What’s the difference between these two scenarios? Is one of them a scam?

The first is an example of affiliate marketing—a popular, legitimate, and effective tactic—while the second may be an illegal pyramid scheme. Here’s more on these two strategies, how they work, and how to tell the difference between them.

What is affiliate marketing?

Affiliate marketing is a performance-based marketing strategy where a brand pays an individual creator (a.k.a. the affiliate) for driving traffic to its website. Compensated actions often include conversions such as clicks to an ecommerce website, referrals, downloads, or purchases that the affiliate’s referral links generated. It’s a symbiotic relationship where the business leverages the affiliate’s audience and marketing skills to promote its offerings, and the affiliate gets paid when those marketing efforts are successful.

How affiliate marketing works

1. Establish an affiliate program
2. Develop affiliate relationships
3. Issue unique affiliate links
4. Have affiliates promote the brand
5. Pay affiliates for attributable actions

Businesses setting up an affiliate program often take the following five steps:

1. Establish an affiliate program

A business owner decides to start affiliate marketing and builds a program, specifying its goals, customer actions for which it will pay, and the compensation terms.

2. Develop affiliate relationships

The business advertises its program, joins one or several affiliate networks (platforms like Shopify Collabs that act as intermediaries connecting affiliates with brands), and invites individual creators and aspiring affiliates to join.

3. Issue unique affiliate links

The business onboards affiliate partners, providing applicable marketing materials and unique referral links or codes to each affiliate.

4. Have affiliates promote the brand

Affiliates use various marketing channels to distribute affiliate marketing links. Successful affiliates often use digital marketing strategies likesocial media marketing, content marketing, email marketing, and search engine optimization (SEO marketing) to promote products or services.

5. Pay affiliates for attributable actions

The business tracks customer actions resulting from the affiliate’s marketing efforts and rewards affiliates according to its compensation schedule.

Benefits of affiliate marketing

• Minimal start-up costs
• Low risk
• Flexible
• Targeted

Many reputable companies use affiliate marketing programs to boost brand awareness and increase revenue. Here are some key benefits:

Minimal start-up costs

Starting an affiliate marketing program is relatively inexpensive. Costs are typically limited to investments in performance-tracking software or payments to an affiliate manager or platform. There’s no need to develop campaign collateral, purchase ad space, or pay upfront for endorsem*nts of your products or brand.

Low risk

Affiliate marketing offers a low-risk way to promote your online business. You decide the payment terms and only pay affiliates when they deliver results. Many companies pay affiliates a percentage of attributable revenue, ensuring the program’s costs never exceed its profits.

Flexible

There are many ways to run an affiliate marketing program, and you can adjust your compensation model as your needs change. You might raise your commission to promote a newly launched item, for example, or add compensation for leads to get more customers into your sales funnel.

Targeted

Like many influencer marketing strategies, affiliate marketing lets you reach specific market segments by selecting affiliates popular with your target audiences. By leveraging individual creators, you can drive niche consumer groups to landing pages designed to encourage conversions.

John Murphy, an affiliate marketing expert and owner of The Cold Plunge Store, says that affiliate marketing is a good way of reaching customers who like to do research before making a purchase.

“If the buyer journey involves a lot of research upfront, that gives you the opportunity to write content that's geared toward educating people,” he says. “Then you can guide them to the website and put helpful content on those collection pages and product pages.”

What is a pyramid scheme?

A pyramid scheme—sometimes known as a pyramid scam—is a fraudulent business model in which individuals pay a company to sell its products or services based on promises of outsized profits. According to the US Federal Trade Commission (FTC), a business may be classified as an illegal pyramid scheme if it encourages recruiting new members and generates a large proportion of its profits from membership fees instead of from selling actual products or services. These businesses are called pyramid schemes because the organizers at the top typically receive all the profits while almost all of those lower down lose money when the venture fails.

Pyramid schemes use a strategy known as multi-level marketing (MLM), a sales and marketing approach that involves promoting products or services through a network of independent participants. Although MLM participants rarely earn money, network marketing can be part of a legitimate business model, and MLM companies are legal, including well-known businesses like Avon Products and Primerica.

How pyramid schemes work

1. Parent company recruits independent distributors
2. Company charges participation fee
3. Company incentivizes recruiting new participants
4. Distributors recruit new participants
5. New distributors recruit additional distributors
6. The pyramid scheme collapses

Pyramid schemes tend to follow six stages:

1. Parent company recruits independent distributors

Business representatives encourage individuals to join the company. Participants are often called independent distributors, sales representatives, affiliates, associates, or independent business owners.

2. Company charges participation fees

New recruits pay for the right to represent the business, and a portion of their payment goes to those who recruited them. Some pyramid schemes also charge recurring membership fees and many require distributors to purchase inventory upfront.

3. Company incentivizes recruiting new participants

The business instructs distributors to sell its products or services, but emphasizes the need to recruit new participants, providing a stream of returns to earlier investors.

4. Distributors recruit new participants

The distributor encourages others to join, and new members pay the business for the right to participate in the program. Distributors earn a percentage of the new participants’ initiation fees or a portion of any successful sales their recruits make.

5. New distributors recruit more distributors

The business and older distributors encourage new members to recruit still more people in an effort to generate revenue from participation fees.

6. The pyramid scheme collapses

Because the pool of potential recruits is finite, it eventually runs dry. Without an influx of new members, the scheme is unsustainable and collapses. This often leaves distributors with expensive inventory they can’t sell, leading to significant financial losses for most participants—particularly newer members at the bottom of the pyramid.

Is affiliate marketing a pyramid scheme?

No, affiliate marketing is not a pyramid scheme. Affiliate marketing is a legitimate business activity that leverages an individual creator’s network to generate sales.

Although both pyramid schemes and affiliate marketing programs involve partnerships with individuals, only pyramid schemes charge participants for the right to sell products or services. Participants in pyramid schemes make significant investments in the company or its products but often lose money because they can’t sell enough of the products they bought. For this reason, pyramid schemes are considered a type of investment scam and are illegal under US state and federal law.

Affiliate marketing vs. pyramid scheme: key differences

• Investment
• Revenue
• Recruiting
• Promises
• Growth

Here are some key differences between affiliate marketing and pyramid schemes:

Investment

Unlike pyramid schemes, legitimate affiliate marketing programs do not require individuals to spend money to promote a business. Affiliate marketers might spend money to build their social following or take out ads, but any outlay is discretionary on the part of the affiliate, and no investment is required by the company.

Revenue

One of the defining characteristics of a pyramid scheme is that the business generates at least some of its revenue from membership fees. Legitimate affiliate programs center on genuine product promotion and only generate money from customer sales.

Recruiting

Although some affiliate marketing programs encourage affiliates to recruit new participants and offer referral bonuses, they place less emphasis on this tactic than do pyramid schemes. Instead, affiliate programs encourage product-focused promotional efforts. Because pyramid schemes often generate revenue by charging affiliates recurring fees to participate in the program, many exert a lot of pressure on participants to recruit others into their network.

Promises

Pyramid schemes often promise participants a quick path to wealth in exchange for minimal effort, and many paint glowing pictures of a life of luxury. Affiliate marketing programs rarely promise instant riches; instead, they clearly outline exactly what affiliates can expect to earn for specific customer actions resulting from their efforts.

Growth

Because pyramid schemes rely on the continuous recruiting of new participants, they inevitably collapse once they exhaust the supply of new recruits. Affiliate marketing programs don’t rely on recruiting, so they can continue to generate profits for businesses and affiliates as long as the products they promote are in demand.