Abstract: In this paper, a model of distribution-based social E-commerce is established, and used to summarize the business model of distribution-based social E-commerce. Then, proceeding from the characteristics of such E-commerce business models, an analysis is made on the MLM-related status quo and risks of distribution-based social E-commerce based on certain market supervision practices. Finally, suggestions are given for optimizing the business environment and unifying law enforcement standards.

Keywords: distribution-based social E-commerce; MLM; disguised payment of entry fees; multi-level; team remuneration; illegal benefits; optimization of business environment.

Social E-commerce generally applies social elements such as attention, evaluation, interaction, discussion, sharing, and recommendation to E-commerce through Internet social tools or the social functions of E-commerce platforms, so as to promote or complete transactions. The social elements used by distribution-based (or buying-based) social E-commerce are more specific, that is, the distribution entity shares and recommends product information through online social tools, and uses the social network (or private domain traffic) to promote and sell goods.

In recent years, distribution-based social E-commerce companies have been subject to controversy due to repeated suspected “MLM”. Some people even assert that it is difficult for the business model of distribution-based social E-commerce companies to be completely cut from MLM. On the other hand, distribution-based social E-commerce platform operators often wander between reporting, investigation, response, and even between “crime and punishment”, and are in worries and hesitation.

In order to avoid suspected white washing, the author first abstracts the business model of distribution-based social E-commerce, and then carry out the analysis and discussion from the abstract model. At the same time, in order to highlight the core points of this paper, the discussion of pseudo-social E-commerce that is “not for the purpose of selling” is also excluded. In the author’s abstract model, the E-commerce platform aims to digest the brands’ inventory, out-of-season or out-of-code products, and guide groups like “young mothers” to open their own virtual stores with a one-click shop model, and use their own social networks to sell goods and develop down line.

I. Abstract business model

 

(I) The formal characteristics of platform operation

As shown in the figure above, the distribution-based social E-commerce platform analyzed and discussed herein does have the characteristics of “formation of levels in a certain order” [1] (i.e: forming an upper and down line) in the distribution link. If the E-commerce platform in the figure “calculates and pays on-line remuneration based on online sales performance” [2], it seems that it will steadily fall into the quagmire of “multi-level” and “team remuneration”. If further, the E-commerce platform also sets a threshold for distribution qualifications. For example, you need to purchase 299 yuan of goods on the platform to be eligible for offline development and distribution, which in turn complies with the negative list of “disguised payment of fees” [3] under the Regulations on the Prohibition of MLM [3]. In this way, the E-commerce platform shown above has become a distribution-based social E-commerce platform that “pays entry fees in disguise”, “multi-level”, and “team remuneration” with all three characters.

(II) The source of profit of the platform

 As shown in the figure above, let’s assume that the E-commerce platform in the figure has signed an agreement with each brand party (including: Brand 1, brand 2...brand n), which stipulates that each brand party sells goods through the E-commerce platform, and the E-commerce platform will charge service fees (including: technical service fees, commissions, etc., the same below) at 30% of sales. At the same time, let’s also assume that the E-commerce platform in the picture, in addition to charging service fees from the brand in accordance with the aforementioned agreement, will no longer charge any fees to distributors at all levels such as Tom,Dick and Harry and their down line in the entire operation process. In this way, the source of profit of the E-commerce platform in the figure is identified as: the service fee charged from the brand party that has settled on the platform. Moreover, this will also be the only source of benefit for the E-commerce platform in the figure.

(III) Calculation of distribution remuneration

According to the order and level of the plan in the figure above, we set the following remuneration model: for goods directly sold by any first-level distributor store, the distributor (e.g. Zhang Jia n) can get paid at 20% of the sales (i.e.: get paid 20 yuan for selling 100 yuan of goods); the distributor’s direct upline (e.g. Zhang Jia Yi) gets 20% of the distributor’s remuneration (i.e.: if the downline gets 20 yuan, you can get paid 4 yuan), and so on. Each direct upline can get 20% of the remuneration for its downline, regardless of the number of layers in the middle. It is calculated until the direct distributor of the platform (e.g. Zhang's), as shown in the table below:

 According to the calculation in the table above, let’s assume that the brand has sold 100 yuan of products on the E-commerce platform, and the products were directly sold by the store of the n-level distributor of the E-commerce platform. Even if n tends to be infinite, then according to the remuneration model set above, in the entire distributor system, the total remuneration received by all distributors is the largest: 20+20×20%+20×20%2+......+20×20% n-3+20×20% n-2+20×20%n-1≈25 yuan.

 Let’s further assume that the remuneration of all distributors at all levels calculated in accordance with the aforementioned remuneration system is directly paid to them by the E-commerce platform in the figure. Then the total cost paid by the E-commerce platform for every 100 yuan of goods sold is only 25 yuan. Compared with the 30 yuan it charges from the brand, the E-commerce platform obviously has residual benefits, and this profit model is obviously sustainable.

II. Risk of punishment

 As mentioned earlier, the aforementioned abstract business model is still aimed at selling goods, and generally does not rise to the point where it needs to be regulated by the Criminal Law. The relevant “MLM-related” provisions of the Criminal Law are systematically the “crime of organizing and leading MLM activities” added after the “crime of contract fraud”. The “criminal MLM” in the meaning of the Criminal Law is still characterized by “fraud”. This does not constitute the essential risk of our abstract business model, and will not be further discussed herein.

 However, in addition to the “criminal MLM” regulated by the Criminal Law, administrative organs often assume that the business model of E-commerce platforms falls under the circumstances stipulated in Article 7 of the Regulations on the Prohibition of MLM, determine that the relevant platforms are “illegal MLM”, and impose penalties on relevant E-commerce platforms on the grounds of “disguised payment of entry fees”, “multi-level”, and “team remuneration”.  The vast majority of E-commerce platforms also accept penalties and rectification as the so-called “positive response” to regulatory penalties. However, the author believes that in fact, for E-commerce platforms, this response is more out of avoidance of trouble. If they still want to continue operating, how can they rectify it? There does not seem to be a very clear and authoritative answer.

III. Plea to punishment

(I) The right to defend

 Articles 44 and 45 of the Administrative Penalties Law [4] clearly stipulate an administrative organ’s obligation to notify the party concerned of his rights to make a statement, the rights to make a statement and defend himself of the party concerned, and the administrative organ’s obligation to fully hear the party’s opinions. At the same time, it is also clearly stated that: “an administrative organ shall not impose a heavier penalty on a party for making a statement or defending himself”.

(II) Reasons for the defense

1.The relevant provisions of the Regulations on the Prohibition of MLM should be correctly understood.

 First of all, the “payment of entry fees in disguise”, “multi-level”, and “team remuneration” stipulated in Article 7 of the Regulations on the Prohibition of MLM are not sufficient conditions to constitute MLM; secondly, a necessary condition for constitution of MLM is “obtainment of illegal benefits”; therefore, according to the provisions of this clause, if there is no “obtainment of illegal benefits”, it should not be MLM described in the Regulations on the Prohibition of MLM.

2. “Illegal interests” should be understood correctly

 “Illegal interest” is not only manifested as the illegality and inappropriateness of the means of acquisition, but more importantly as the illegality of the interest itself. It also emphasizes more the illegality of the interest itself.

 “Illegal interests” should also be infringing, and should be judged from the perspective of whether there are other parties whose interests are harmed. Generally speaking, in the absence of a party whose interests are harmed, it is not appropriate to evaluate the relevant interests as “illegal interests.”

 Finally, the judgment of “illegal interests” should be uniform and predictable. The social E-commerce cannot be judged as “illegal interests” when it charges service fees from the brand as per the sales amount as Taobao, Meituan, and Ele which are legal.

3. Return to the abstract business model

 As mentioned earlier, in the abstract business model shown in the figure above, the brand party sells goods on the E-commerce platform, and forms a buying and selling relationship with the actual purchaser. The purchaser makes the payment directly to the brand party, and the E-commerce platform then charges the brand party a service fee in proportion to the payment (or sales); the brand party issues a sales invoice to the actual purchaser, and the E-commerce platform issues a service charge invoice to the brand party.

 The only benefit of the E-commerce platform in the figure comes from the service fees paid by the brand party, and the E-commerce platform will not charge any other fees from its distributors at all levels.

 At the same time, the remuneration of distributors at all levels is directly paid by the E-commerce platform, other than from the direct downline.  After any first-level distributor’s store in the figure sells goods, the remuneration received by the distributor at the same level (i.e.: the distributor who actually sells the goods, the same below) is fixed (i.e.: 20% of sales), and the indirect remuneration obtained by the superior distributor as per the aforementioned remuneration calculation will not harm or reduce the interests of the distributor at the same level. Therefore, the distributor at the same level has no sense of whether its superior distributor is actually paid.

 So in this case, can the regulatory agency directly give a negative evaluation of the distribution model of “multi-level” and “team remuneration” [5]? If you think that this model is the MLM stipulated in Article 7 of the Regulations on the Prohibition of MLM, and impose punishment against the E-commerce platform in this way, does it need to further check what illegal benefits the E-commerce platform has obtained? The E-commerce platform only charges service fees from the brand, and does not charge any fees from its distributors, but pays remuneration to its distributors. So how can there be profit-making behavior in paying remuneration? If it is believed that the payment of remuneration by E-commerce platforms to distributors is also to increase sales, and there is “indirect” profit-making, then how to define the “illegal” nature of this benefit and how to distinguish it from the traffic promotion of ordinary E-commerce?

 The business mode of the E-commerce platform in the figure is obviously sustainable. If the types of goods it sells are not fundamentally different from other E-commerce platforms, and the price of the goods sold is not higher than that of other E-commerce platforms, there is no need to completely negate its business model. In accordance with the provisions of the Administrative Penalties Law, regulatory agencies need to conduct a “review” of the facts and reasons for the defense proposed by the parties, and they should conduct analysis and demonstration to determine whether to “adopt” them. If a regulatory agency cannot effectively respond to these issues, but only recognize the “MLM” based on “payment of entry fees in disguise”, “multi-level”, and “team remuneration” and impose large penalties, it is difficult to produce an effective demonstration effect.

IV, Conclusion

The problem of “crime and punishment” in MLM is long existing. The business model and underlying logic of “distribution-based social E-commerce” described now are completely different from the model where “income mainly comes from the entry fees paid by new members or the profits of operators mainly come from the entry fees of participants” and “commodity prices are higher than reasonable market prices for huge profits” [6] in the 1990s. At present, the degree of market development, management methods, and consumer psychology of the masses in China [7] are no longer the same as they were more than 20 years ago. It is no longer necessary and urgent to treat the MLM-related issues of “distribution-based social E-commerce” with a terrifying attitude.

The State Council has stated that “the government and its relevant departments shall, in accordance with the principle of encouraging innovation, implement inclusive and prudent supervision of new technologies, new industries, new business forms, and new models, and formulate and implement corresponding regulatory rules and standards based on their nature and characteristic classification, so as to leave sufficient room for development while ensuring quality and safety. They shall not be simply prohibited or left unsupervised.” [8] This has been clearly written in the Regulations on Optimizing the Business Environment”. It is really undesirable to treat MLM-related problems of “distribution-based social E-commerce” simply and formally as a campaign.

It is true that for the issues of “multi-level” and “team remuneration”, in addition to encouraging innovation and being cautious and tolerant, it is indeed necessary to take into account leading a good social fashion and maintaining social public order and good customs. Will this business model lead to encouraging “reap without sowing”? It is indeed a question worth discussing.

However, in any case, the author believes that: in response to the Regulations on Optimizing the Business Environment to accelerate the construction of a modern economic system and promote the strategy of high-quality development, and also for the healthy development of “distribution-based social E-commerce”, regulatory agencies should indeed unify the scale nationwide, clear the original source of the Regulations on the Prohibition of MLM, further clarify the conditions that constitute MLM, and further explain the connotation of “illegal interest”, so as to guide “distribution-based social E-commerce” to completely separate from MLM. The business models and E-commerce companies that are originally sustainable cannot become the “Tang Priest” in the eyes of local regulations.

Notes:

[1] Article 4 of the Seventh Amendment to the Criminal Law (effective from February 28, 2009): one article was added after Article 224 of the Criminal Law [Crime of Contract Fraud] as one point of Article 224 [Crime of Organizing and leading MLM Activities] Whoever organizes or leads the pyramid selling activities to cheat the participants of property and disturb the economic and social order, in which, in the name of marketing commodities, providing services or any other business operation, the participants are required to obtain the qualification for participation by paying fees, purchasing commodities or services or any other means, the participants are classified into different levels according to a certain order, the calculation of remunerations or kickbacks to participants is directly or indirectly dependent on the number of persons recruited, and the participants are induced to continue or coerced into continuing recruiting others to participate, shall be sentenced to fixed-term imprisonment not more than five years or criminal detention, and be fined; or if the circumstances are serious, shall be sentenced to fixed-term imprisonment not less than five years, and be fined.

[2] Article 7 of the Regulations on the Prohibition of MLM (effective from November 01, 2005): The following behaviors are MLM: ...(3) an organizer or operator seeks illegal benefits by recruiting personnel and requiring the recruited personnel to recruit other personnel so that an upline-downline relationship is formed, and calculating and paying remunerations to an upline personnel on the basis of the sales performance of his downline personnel.

[3] Article 7 of the Regulations on the Prohibition of MLM (effective from November 01, 2005): an organizer or operator seeks illegal benefits by recruiting personnel and requiring the recruited personnel to pay fees， or fees in disguised forms such as order of commodities， as a condition to being qualified for participation or recruiting other personnel to participate;…

[4] Administrative Penalties Law (effective from July 15, 2021) Article 44 Before making a decision on an administrative penalty, an administrative organ shall notify the party concerned of the content of the administrative penalty to be imposed, and the facts, reasons, and basis thereof, as well as his rights to make a statement, defend himself, and request a hearing and other rights he enjoys according to law. Article 45 A party to a case shall have the rights to make a statement and defend himself. An administrative organ must fully hear the party's opinions and review the facts, reasons and evidence put forward by the party; and it shall adopt the facts, reasons and evidence put forward by the party if they are established.

[5] Note: The other issue of “payment of the entry fee in disguise” is omitted.

[6] Notice of the State Administration for Industry and Commerce on Suppressing Illegal Acts in MLM Activities (implemented from August 10, 1994, and expired on December 3, 1998) V. If an operator conducts MLM activities and falls under any of the following circumstances, it shall be banned: 1. The business of a participant in a MLM activity is mainly to introduce others to participate, and the income mainly comes from the entry fees paid by the new members he introduces or the profit of the operator mainly comes from the entry fees of the participants; 2. Paying a high entry fee or paying a high entry fee in disguise by subscribing for commodities. Payment of fees are a condition for joining; 3. Making false or misleading publicity about the remuneration of participants in MLM activities or the quality, use, origin, etc. of the goods to entice them to join; 4. The price of the goods is higher than the reasonable market price for making huge profits; 5. Returns are not allowed or harsh return conditions are set.

[7] Notice of the State Council on Prohibiting MLM Business Activities (implemented from April 18, 1998) 1. MLM Business does not meet the current Chinese national conditions and has caused serious harm. As a business method, MLM has the characteristics of organizational closure, concealed transaction, and dispersion of MLM personnel. In addition, Chinese market development is low, with relatively backward management methods, and the consumer psychology of the masses is not yet mature. Criminals use MLM to carry out cults, gangs, superstitions, hooliganism and other activities, which seriously deviates from the requirements of ethical and cultural progress, affects the social stability; and use MLM to absorb party and government cadres, active-duty soldiers, full-time students, etc. to participate in business, which seriously damages the normal work and teaching order; use MLM to commit price fraud, defraud money, and promote counterfeit and shoddy products, smuggle products, make huge profits, evade taxes, which seriously harms the interests of consumers and interferes with the normal economic order. Therefore, MLM business activities must be resolutely prohibited.

[8] Regulations on Optimizing the Business Environment (effective from January 01, 2020) Article 55 The government and its relevant departments shall, in accordance with the principle of encouraging innovation, implement inclusive and prudent supervision of new technologies, new industries, new forms of business, new models, etc., formulate and implement corresponding regulatory rules and standards according to their nature and characteristic classification, so as to leave sufficient room for development while ensuring quality and safety. They shall not be simply prohibited or left unsupervised.