The following is a Marketwave letter from Len Clements regarding Burnlounge:
Early last week the Federal Trade Commission
announced that they had filed a complaint in
a U.S. District Court of California against
BurnLounge, Inc. (actually filed on June
6th), a multilevel reseller of downloadable
music via "online music stores". The FTC
alleges that BurnLounge is an illegal pyramid
scheme and is seeking a permanent injunction
against the company (halting it’s business).
According to the FTC, the BurnLounge sales
pitch "represented that participants in
BurnLounge were likely to make substantial
income." BurnLounge recruited participants,
says the FTC, by selling them tiered priced
"product packages" that are offered for as
much as $429.95 per year. The higher priced
packages provided BurnLounge distributors
with a higher paying status in the BurnLounge
compensation plan.
The FTC asserts that the BurnLounge
compensation plan "primarily provided
payments to participants for recruiting of
new participants, not on the retail sale of
products or services".
The FTC has asked the court to halt the
"deceptive practices and misrepresentations"
and to freeze the defendant’s assets (to
preserve them for eventual consumer redress).
On June 8th the FTC attempted to get the
court to issue a temporary restraining order
against BurnLounge, which was denied. The
Judge ordered that a hearing on the FTC’s
request for a preliminary injunction and
asset freeze would be held this Tuesday (June
19).
In addition to naming BurnLounge Inc., the
complaint also named Juan (Alex) Arnold,
their CEO and Chairman, as well as three high
level distributors. BurnLounge announced the
resignation of Mr. Arnold today, June 18th.
The FTC also acknowledged in their Press
Release the "invaluable assistance of the
Office of the Attorney General of South
Carolina." BurnLounge is a Delaware
corporation based in New York City.
You can view the FTC’s Press Release here: http://www.ftc.gov/opa/2007/06/burnlounge.shtm
The actual complaint can be viewed here: http://www.ftc.gov/os/caselist/0623201/061207complaint.pdf
BurnLounge has responded that "We are
absolutely certain that our model will stand
up to the most rigorous scrutiny", and that,
"If there are changes to our operating
structure that are warranted and appropriate,
we’ll consider them."
BurnLounge’s public response can be viewed here:
http://corp.burnlounge.com/default/press_articles/ftcFaq.html
Commentary:
In the vast majority of service based MLM
programs (long distance calling, legal
assistance, medical discount programs,
travel, etc.) the actual product or service
sold is of such low margin, or low overall
cost, that no substantial multilevel income
can be derived from it. For example, if an
online shopping mall company were to receive
an optimistic 15% affiliate fee for all sales
made via the malls of each rep, they would
likely need to keep 10% (67% of the affiliate
fee) to run their business leaving only 5% to
pay out in the pay plan. So even if the plan
paid 10% down eight levels, this generous
appearing plan would actually be
paying out
80% of 5% of the sales made through the mall
itself (that’s a total 4% pay out). Same with
a long distance reseller, which maybe gets 1¢
of every 6¢ charged per minute, which is what
they would have to run their company on and,
with what’s left over, pay out in their pay plan.
So how does a company that’s paying 5-25% on
a $10-$50 monthly sale compete with the
"pills & potions" companies that typically
pay 40-55% on $75-$150 in monthly sales? They
add a "training fee" or some other one time,
upfront fee that usually ranges from $100 to
the legally mandated limit (for non-franchise
opportunities) of $499.99. Then bonuses are
paid from this fee which is where the most
substantial income is derived.
The challenge with this is that, based on
many years of legal precedent, paying
compensation for the act of recruiting new
distributors is indicative of an illegal
pyramid scheme. When this compensation is
paid from a purchase that only a
distributor would make, even if it’s for
a genuine product of value, that is still
a reward for recruiting since there is no
other way to earn the bonus other than to
recruit. For example, Equinox
actually had fine products. But they were
closed down by the FTC (mid-90s) because most
of the income was being earned by new
distributors "buying in" for $5,000 to over
$20,000 in product, which obviously is sales
volume only a new recruit would generate. A
better example is FutureNet,
which sold $195 WebTVs. Since they only got a
small piece of the margin on each unit sold,
and only part of that went into the pay plan,
no significant income could be made by just
selling Web TVs. So they added a $495
"internet training" package that new
distributors could purchase. That’s where the
real money was being made – until the FTC
shut them down for being an illegal pyramid.
Does BurnLounge do this? Unfortunately yes,
it appears they do.
Remember those $29.95 to $429.95 "product
packages" offered to new enrollees?
BurnLounge not only pays one time bonuses to
the sponsor on these packages, they pay
monthly commissions upline on them through a
binary pay plan. In their own FTC response
they claim:
"Our free business model is based on revenue
from music and movie downloads. For users who
want more features and products, we offer
other fee-based packages with extra products
such as BurnLounge Presents, BurnLounge
University and BurnLounge EventPass."
The FTC seems to be eyeing these music
downloading "stores" the same way they viewed
the online malls in the cases of BigSmart,
2by2.net,
and several others. These web sites are
essentially sales aids – and MLM companies are
not suppose to pay commissions on sales aids
(because only distributors would buy them,
thus you must recruit to earn money on them).
The only way BurnLounge will be able to
justify paying commissions on these packages
is to convince the judge that a very
significant number of people are buying these
packages who have no interest in the business
opportunity. That is, they will have to sell
the judge on the idea that money can be made
by selling these packages without the act of
recruiting a new distributor. That’s going to
be a very tough sell.
It’s amusing how BurnLounge, in direct
response to the FTC’s action, describes their
willingness to "consider" making changes that
they feel are "warranted and appropriate".
That’s not how it really works with the FTC.
Most likely, here’s what I think will
happen: 1) BurnLounge will have to remove the
"product packages" from their compensation
plan, and by doing so will avoid a permanent
injunction; 2) The remaining income potential
will not be sufficient to maintain a viable
network marketing opportunity; 3) BurnLounge
will either add many more tangible products
to their program or, most likely, will
abandon the MLM model and go direct sales
(those licenses they possess are far too
valuable to just give up).
We should know soon. I’ll let you know what
happens after the Tuesday hearing.
Len Clements
MarketWave,
Inc.
