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Power brokers: Multi-level marketing meets electricity sales

Baltimore-based entrepreneur Daniel Roche says the network marketing approach suits a culture in which people reach out to others through social media tools.

The pitch seems almost too good to be true: make unlimited income, work flexible hours and earn rewards for selling something everyone uses to your friends, family and acquaintances.

That something in this case is electricity, not knives, makeup or kitchen gadgets. And the business model, not without its detractors, is being applied to the deregulated electric industry.

It goes by various names — network marketing, direct selling or multi-level marketing — and it lets a company forgo hiring salespeople in favor of independent contractors rewarded with cash and perks like vacation stays for signing up customers and new salespeople.

Three such companies — Ambit Energy, Viridian Energy and North American Power and Gas — were licensed this year to operate in Maryland. A fourth, Utility Choice International, is waiting in line.

Paula Carmody, who heads the Office of the People’s Counsel, says that while her office does not feel there has been any wrongdoing, Maryland needs to be vigilant.

“These are issues that have not been on anyone’s radar until about six months ago,” Carmody said. “It’s a model that can be problematic.”

“There is a reason these services were regulated in the first place,” she added.

The Public Service Commission agrees and has already opened an inquiry into the role of power suppliers using independent contractors. The commission is considering whether contractors selling on behalf of a company, but not directly employed by the company, should be licensed individually. A hearing date has not been set.

How it works

Under deregulation, Maryland customers can choose a provider other than the incumbent utilities, such as Baltimore Gas & Electric or Pepco, because the supply and distribution functions have been separated.

A customer may choose any licensed supplier but will still pay the original utility. The electricity will still come in on the utility’s lines and the utility will be paid for distributing electricity regardless of the supplier.

Supporters of multi-level marketing say it is a perfect win-win situation where customers get lower prices for something they already use and the contractors get paid for guiding their customers to a better deal.

“It’s very simple: You tell people how they can save money, do something good for the environment, and make money at the same time,” said Joseph Cannavo, spokesman and independent representative with Viridian Energy. “God bless America.”

The network marketing energy suppliers pay their contractors to sign up new customers and pay more if they recruit other contractors who sign up even more customers. Those with more contractors and customers — “upstream” in industry lingo — get a cut of everything coming in below them.

According to the company’s literature, a hypothetical contractor for Texas-based Ambit Energy, one of the biggest companies using this model, with 729 contractors recruited by her and 7,290 qualified paying customers would earn $10,935 a month. A single contractor with no other contractors recruited and 20 paying customers would earn $1 a month.

Phenomenal growth

The stakes for gaining a foothold in deregulated markets are huge. Ambit has proven that by becoming major player in the alternative energy supplier field.

The company was named the fastest-growing private company in the U.S. by Inc. Magazine in September, with sales up 20,369 percent since 2006 — from $1.5 million to $325 million last year.

This growth rate has raised questions about how companies like Ambit can make these returns, especially with power prices trending downward.

“There is some concern by [The Office of the People’s Counsel] that the emphasis in these types of solicitation models can be as much, if not more, on recruiting and enrolling ‘representatives,’ as on the underlying energy supply services that are being provided to residential consumers,” Deputy People’s Counsel Theresa V. Czarski wrote in a Sept. 27 letter to the PSC.

The companies attribute their growth to their ability to beat the rate for electricity that customers pay if they do not choose an alternative supplier, which is called the standard offer service.

Even though the companies are buying power usually at market rate, with its inherent fluctuations, they say that is where the revenues really come from.

“We make money by building up a volume of customers and keeping them,” UCI founder and CEO Damon Mintz said. “If you keep churn down and keep the customers, it becomes very lucrative.”

Because of fluctuating prices, the companies do not guarantee specific dollar savings. Most will only guarantee a discount for an initial introductory period.

Ambit offers a 7 percent discount over the first two months, while Viridian offers a 10 percent discount for the first month. Ambit is the only one of the three to offer a guaranteed discount past an initial phase — but it is for a minimum of 1 percent less than the standard offer rate — the rate customers would pay if they didn’t choose a separate supplier.

Based on an average household monthly use of 750 kilowatt-hours and a default rate of 0.1003 cents per kilowatt-hour, this guaranteed savings would amount to $9.67 annually.

“Overall, choice has been sold on the promise of lower rates,” said Tyson Slocum, director of the energy program at Public Citizen, a Washington-based consumer advocacy group. “But, rarely are rates folks get really much of a discount from the standard offer rate.”

David Kolata, executive director of the Citizens Utility Board of Illinois, a consumer watchdog agency, said Ambit’s deals there have hewed close to the default rates offered by the incumbent utilities. He said the average consumer in Illinois has saved about $8 a month by going with Ambit.

“For the most part they haven’t really provided many great deals for people so far,” Kolata said. “The Ambit product replicates the utility price — it’s essentially the same. They’re making most of the money — it seems like — collecting money to sell it.

Driven by recruiting

At the heart of multi-level marketing is the drive to recruit — whether it is new customers or new contractors. Some say this is the model’s greatest strength; others say it’s the biggest flaw.

“Network marketing by its very nature is driven by recruiting,” Mintz said. “That is the business model — recruit people who get customers. You can’t live in network marketing if you don’t have recruiting.”

Supporters say that instead of just anyone selling the service, customers are speaking with someone they know.

“With us, it’s not simply a transaction — they can look at someone they know who can answer questions rather than a piece of mail,” Mintz said. “In the traditional sales model, a representative gets paid to get you to sign as a customer, not keep you.

“Our people are compensated to keep them as customers. They’re not getting paid just to get them to sign a piece of paper.”

The companies recommend reaching out at first to friends, relatives, neighbors and other acquaintances.

That approach can pose problems. Tim Morstad, associate state director of advocacy for AARP Texas, said that since deregulation took effect in that state in 2003, any AARP meeting or seminar is bound to include those angling for new customers or contractors.

Morstad said the marketing got so aggressive that Texas lawmakers had to pass laws to police how the companies’ representatives could act and what was acceptable behavior.

“Like any other multi-level marketing setup, like Amway or Tupperware or what have you, once they start up somewhere, people just come out of the woodwork to sell to friends, neighbors, at churches,” Morstad said. “You can see how, if you can have anyone selling electricity, this can go wrong so many ways.”

Do the numbers work?

Another problem with multi-level marketing comes from its shady past and less-than-flattering associations with fly-by-night and get-rich-quick schemes. Detractors say the model is little more than a legal pyramid-type scheme where the last ones in get the least.

“If you get in early enough and get on top of the pyramid, per se, you might do OK,” Kolata said. “But, at the end of the day, with these types of deals, a few people make money — most people, though, don’t.”

And, critics say, it is not a cheap option to jump into the world of network marketing as an independent consultant, which can cost hundreds of dollars in fees paid to the company. Ambit, for instance, charges a $399 startup fee that includes marketing materials, as well as a $25 monthly fee for a website and other online tools.

“The people who bought in at $400 — what happens to them when the wheels fall off this thing?” Morstad asked.

The companies admit that the fees and sales of websites and other products to contractors do generate revenue, but they say it is a small portion of the total.

Ambit CEO Jere Thompson Jr. told Inc. magazine that the fees amounted to 2.4 percent of the company’s revenues. The company now has more than 70,000 independent representatives.

Laurie Heacock, a Severna Park resident, has been an Ambit contractor since November 2009, moving up two levels in the company’s rankings with about three dozen consultants recruited. Heacock said the startup fee was not that much compared to what it would take to open a traditional franchise.

“I understand the importance of timing, and I was impressed by the founders and their Fortune 500 management team,” Heacock said. “I also realized this was the largest industry in the U.S. to ever deregulate. For me, it was a minimal investment and a huge opportunity to get in on the ground floor.”

Daniel Roche, an entrepreneur who sold his Baltimore-based Web design firm e.magination network LLC in July, has been an Ambit contractor less than a month. He said the network marketing approach has its detractors but is well-suited to a culture in which people reach out to throngs of friends and acquaintances via websites like LinkedIn.com and Facebook.

“People are a bit leery of the direct sales model. It has that Amway, Mary Kay stigma to it,” Roche said. “I looked at that and had the same thoughts, too, but when you’re combining different business models with the technology that’s available, I’m very curious to see if these things will work.”