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How Tariffs Affect Small Businesses

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Tariffs are duties charged on imports, and U.S. buyers pay the costs. Small businesses that bring in imported products can either absorb the expense or pass it along to their customers. When tariffs increase, as they have on certain goods imported from China, as well as the import of steel and aluminum products, countries often retaliate by increasing their own tariffs on American goods arriving on international shores.

Small businesses bear the brunt of tariff hikes and the resulting trade wars. “Small businesses are especially hard-pressed because they don’t have the reserves to tap into to wait for more stable circumstances,” said Davidson College economics professor Shyam Gouri Suresh.

We’ll help you understand how tariffs affect small businesses and what you can do to protect your firm when unexpected costs threaten growth.

What is a tariff?

A tariff is a tax that a country levies on imported goods and services. Tariffs increase the price of imports, potentially making them less competitive or desirable compared to domestic goods and services. 

A tariff is typically charged as a percentage of the value of the product that a buyer must pay a foreign exporter. In the U.S., importers must pay tariffs at 328 ports of entry, which the U.S. Customs and Border Protection controls. Companies that pay the tariffs to bring goods into the country likely pass that cost on to customers. The paid tariff goes to the Department of Treasury and makes up a portion of the federal government’s revenue.

Tariff increases

A country may introduce a new tariff or increase existing ones in order to restrict trade from particular countries or reduce imports of specific types of products, which is what the U.S. Trade Representative decided to do to combat unfair trade practices with China. The U.S. Chamber of Commerce implemented tariffs of its own on certain imports of aluminum and steel for national security reasons. Trade talks continue between the United States and China as of press time, but at least $300 billion worth of Chinese imports face tariffs, some as high as 25%.

The effects tariffs have on small business

These increased tariffs and resulting trade wars have cost American businesses big and small $38 billion, according to Tariffs Hurt the Heartland, a coalition of businesses and trade groups that oppose the tariffs. Automakers, tech companies and agricultural producers have been especially hard hit, but the National Retail Federation has also compiled profiles of affected small business owners from music teachers to gift shop owners.

“They have to either swallow this increase in price, or they have to pass that price increase on to the end consumer,” Gouri Suresh said.

Passing on the costs of tariffs: A closer look

Big businesses are in a better position to absorb higher costs than small businesses. Large companies can operate on smaller margins, while small businesses don’t have as much of a cushion and eventually must raise prices.

“As they increase prices, they may start losing their customer base,” Gouri Suresh said. “It’s a really difficult bind to be in. It favors bigger businesses that have deeper pockets who can ride out this trade war.”

Some firms may not be able to pass costs onto customers if they compete with businesses unaffected by high tariffs, said Katheryn Russ, an economics professor at the University of California, Davis. Small businesses likely have to take a blow to their profit margins if competitors don’t have to make similar price increases because of tariffs.

“If all businesses are having to raise their prices in a particular product space, then that’s different,” Russ said. “And this does seem to be a broad-based cost increase for U.S. firms.”

U.S. producers facing Chinese tariffs conversely have had to drop prices to remain competitive in China. For instance, soy farmers in the U.S. significantly reduced prices to avoid passing on cost increases to Chinese consumers.

Businesses that stand to benefit from tariffs

Tariffs on foreign goods should benefit domestic producers making similar products, as their products would be less expensive than those taxed at a high rate. Those producers may be able to raise their prices knowing the demand is higher, Gouri Suresh said.

For instance, American steelmakers are reportedly seeing bigger profits from higher demand, increased prices and a boost in production. But the rush to production may backfire as it meets a global economic slowdown.

How to prepare your business for economic changes

The U.S. government’s actions have been unpredictable, which makes it challenging to plan and prepare for increased tariffs, Gouri Suresh said. Tariffs have historically been implemented slowly, but the recent increases have not reflected the gradual nature of past rate hikes.

“The problem with what’s happening with the most recent trade war is the numbers are flying every day,” he said.

Tariffs have also affected industries differently, making it difficult to compare the impact across companies, Russ said. “It’s hard to offer specific advice. We just don’t know right now what’s going to happen,” she said. “I guess…just be ready for anything.”

Despite the unpredictability of the trade war, there are steps you could take to better position your business for economic changes.

Cut back where you can.

To minimize the price increases that you’d have to pass on to customers, consider cutting back your operating costs as much as possible. This could allow you to run the business on a tight budget when needed.

Consider an industry change.

If you can easily alter your business concept, you may find that an adjacent industry is less affected by tariffs than the one in which you currently operate.

“Being nimble is going to be a really big boon for businesses if they can turn on a dime and reconsider what they’re buying and what they’re selling,” Gouri Suresh said.

Apply for a tariff exemption

Several categories of goods are exempt from tariffs, such as items that are necessary for health and safety. Goods are exempt on an industry-wide basis, and large groups of lobbyists and business owners must typically work together to seek exemptions.

Companies affected by recent tariffs may request to be excluded from Section 301 tariffs on Chinese goods and Section 232 steel and aluminum tariffs. Thousands of companies have filed exemption requests with the Office of U.S. Trade Representative, claiming they are unable to find comparable goods outside of China or that it would be extremely costly to do so. Approvals for these requests, so far, have been low.

The bottom line on how tariffs affect small businesses

U.S. tariffs on Chinese goods are hurting some American firms more than the intended target, Gouri Suresh said. The widespread impact on U.S. businesses and consumers may not be sustainable and tariffs could soon decrease. But if not, high prices on imported goods may become the new normal.

“In the long run, either the tariffs end and the trade war ends…or everybody learns to live in this new world,” he said.

In the meantime, small businesses will likely continue to feel the effects of tariff increases. It may be best for entrepreneurs to hunker down and operate as efficiently as possible until stable conditions return, Gouri Suresh said.

“When things go bad, they’re the ones who are going to suffer first,” he said. “But they are also the ones who will benefit the most when things turn for the better.”

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How to Avoid Pyramid Schemes

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Direct selling can provide a flexible way for you to run your own sales business from home or online, but it’s important to distinguish legitimate companies from pyramid schemes. The red flag is when such a system depends on recruiting an ever-increasing number of “investors” than the selling of a product. We’ll help you avoid pyramid schemes and identify legal direct selling companies worthy of your research.

Direct selling vs. pyramid schemes

Direct selling is a legal business practice conducted through single-level sales (think door-to-door salesperson), host or party-plan sales and multilevel marketing companies, which depend on individual distributors to sell products to the public, often in a group, party-like setting or through catalogs or online stores. Distributors often have the opportunity to earn commission on their sales and those of the salespeople they recruit.

A pyramid scheme may be disguised as a multilevel marketing business, but it is actually an illegal scam that emphasizes recruitment rather than the sale of actual products. Instead of earning most of their income through selling, distributors are heavily rewarded for bringing on new sellers, who may have to pay an entry fee.

“It’s going to take some healthy skepticism and research for someone to recognize that difference,” said Stacie Bosley, associate economics professor at Hamline University in St. Paul, Minn.

As of 2018, direct selling represents $35.4 billion in retail sales in the U.S. and 6.2 million people work full-time or part-time in the industry, according to the Direct Selling Association. Continue reading to find out how to avoid a pyramid scheme if you’re thinking about pursuing a multilevel marketing opportunity.

What is a pyramid scheme?

A pyramid scheme can be defined as a company that requires participants to make an investment in the business in exchange for the opportunity to sell products to consumers. Oftentimes, sellers are highly rewarded for recruiting newcomers, who then make a similar investment in the company.

Many types of businesses provide rewards for referrals, giving customers a small incentive to suggest a product or service to others, Bosley said. But if the recruitment model is the central feature of the company, it may be a pyramid scheme.

“Look for a really strong pay-and-recruit structure,” Bosley said. “If that’s there, I would worry about its legality.”

How pyramid schemes work

Here’s an example of a formula that a pyramid scheme could follow. Let’s say a seller makes a $500 investment to join the business. She is told she would be rewarded $150 per person if she recruits three more sellers, who would also make a $500 investment in the business.

From there, she would earn $30 for each new member that her recruits bring on. All of her recruits are given the same offer.

The original seller stands to make an increasing profit on her $500 investment, depending on how many people her recruits bring into the company. But each new member would make $450 at the first level, $50 short of their break-even point if they only recruit three more people. If they can’t pass the first level, they won’t get a return on their investment. Meanwhile, the company would continue to collect $500 from every new recruit, although it would have to pay commission to those who recruit more new members.

There could be instances where legitimate companies follow a similar model of rewarding recruitment. But if new member recruitment earns you more money than selling actual products or services, then the company would likely be a pyramid scheme.

Why are pyramid schemes illegal?

Pyramid schemes are illegal because they defraud investors who are promised their money back. In reality, money from bottom-level investors is used to pay other investors farther up the pyramid. And products in these schemes are often unsellable.

Pyramid schemes took off in the U.S. in the 1970s. One-on-one selling became popular for consumer items, such as cosmetics, kitchen tools and branded items like Tupperware, and pyramid schemes took advantage of the trend. The Federal Trade Commission began cracking down on scams that emphasized networking over selling actual goods, and the organization has continued to monitor the direct sales industry.

Another wave of pyramid schemes swept through the U.S. in the 1990s with the rise of email and internet access. Such scams still pop up today, though the FTC continues to bring cases against deceitful companies.

“Fraud goes in cycles, just like economies,” said Cheryl Jarvis, marketing professor and department head at Florida Atlantic University in Boca Raton, Fla.

The problem with pyramid schemes is the people at the top of the chain are the only ones who make money, Jarvis said. The majority of participants don’t see a return on their investment and ultimately lose money. Pyramid schemes are often short-lived because eventually, distributors run out of people to recruit and the operation stops growing.

“Mathematically, they’re unsustainable,” Jarvis said.

Report suspicious behavior. In addition to the FTC, state agencies investigate pyramid schemes. For instance, any fraudulent activity in New York should be reported to The New York State Attorney General’s Office. You could also file complaints with the Better Business Bureau.

How to avoid pyramid schemes

In addition to an emphasis on recruitment, here are other indicators that a direct sales opportunity may be a scam.

It’s sold as a passive income or easy money opportunity. As a recruitment strategy, distributors often emphasize how little effort is needed to make an income. In any business, selling enough product to turn a profit takes hard work, so be cautious if the company makes it sound simple.

Promise of unrealistic returns in a short amount of time. If you’re earning fast cash despite low sales, you’re likely receiving returns on people getting recruited to the company. Generating revenue too quickly could be a red flag.

No buy-back system. Pyramid schemes and legitimate multilevel marketing companies both typically require new members to purchase product to sell to consumers. However, reputable companies should offer a buy-back option if you want to leave the business. A company that doesn’t refund members for unsold product may be a part of a pyramid scheme.

High upfront fees. Be wary if the buy-in fee or initial investment seems high or exceeds the value of the products. High upfront fees combined with the lack of a buy-back program could indicate the business is a scam. Legitimate direct selling companies have a median startup fee of $99, according to the Direct Selling Association.

Abstract language. Take note if the company is unclear about processes or structures within the business. Product descriptions, prices and claims may also be vague or questionable. Recruiters could make inflated income claims as well to attract new sellers.

Do your own research rather than relying on what you hear from distributors, Bosley said. They are incentivized to recruit you and may not objectively present information.

“Of course, scheme operators aren’t going to make it easy for you,” she said. “There are layers of rhetoric and that makes it difficult to see the bones of the scheme.”

One way to quickly check a company’s legitimacy would be searching the Direct Selling Association’s database. Although not all existing direct sales companies are listed, a company that is a member of the DSA could be considered a reputable multilevel marketing business.

How to say ‘no’ to a direct sales recruiter

Social media has become a conduit for pyramid schemes. When people are approached about multilevel marketing opportunities, the sales pitch is often coming from someone they know, which can make it difficult to turn down, Bosley said.

“There’s feelings of obligation, allegiance, [of] not wanting to let someone down,” Bosley said. “We underestimate how powerful those kinds of emotions can be.”

The person asking you to join the company could be unknowingly participating in a pyramid scheme. If you’re skeptical about the operation, it’s best to reject them outright in a way you feel comfortable, Bosley said.

“If you give them any room, their incentives just keep coming,” she said.

First, you should be honest about your suspicions that there may be something illegal in the structure of the company. You could take a more thoughtful approach, communicating that you’re concerned about their involvement and well-being. You may want to point out that they could potentially harm others in the recruitment process.

“It doesn’t just affect you; it affects the person who recruited you and it affects the people you pass it on to,” Bosley said.

Request documentation. You could then ask for company documents, such as marketing plans or audited financial statements. The recruiter may not be able to provide this information, but if they can’t get such forms from someone else in the company, you could use that as a reason to reject their offer, Jarvis said.

“Whenever you get strong-arm social pressure, I’d say that’s a red flag,” she said.

Pyramid schemes vs. multi-level marketing companies

If you’re considering getting into the direct sales industry, here’s how to spot a pyramid scheme compared to a multilevel marketing company.

MLM company

Pyramid scheme

Recruitment rewards may be offered, but product sales drive income.

Recruitment is the primary revenue driver.

Buy-back program and exit strategy available for sellers.

No repurchase plan for unused inventory.

Initial investment cost is relative to the value of products.

Steep fees to join the business and receive products.

There is an actual consumer demand for products.

Product descriptions and claims are vague or misleading.

When direct selling could pay off

Not all multilevel marketing companies are pyramid schemes in disguise. A direct sales business could have a lower startup risk and lower cost of entry compared to other business opportunities, like buying a franchise, said Joseph Aquilina, ethics and compliance counsel for the Direct Selling Association. Although the payoff could be miniscule — as low as 70 cents or less per hour — sellers are usually independent contractors and can work on their own schedule.

“This is a very low-cost and low-risk opportunity for people to build their own businesses,” he said.

People often fall prey to pyramid schemes because of a need to supplement their household income, Aquilina said. While direct selling could provide a solution, scams and illegitimate businesses could turn people off the entire industry.

“It can take only a few bad apples to present a reputation challenge for the whole bunch,” he said.

You could also start a hobby-based business to monetize a personal interest. You would be able to follow your entrepreneurial instincts without answering to a larger organization. But getting a business up and running — and reaching profitability — takes time and commitment, even more so than direct selling.

Keep in mind that multilevel marketing depends on sales, and you have to be willing to put in effort to become successful, Jarvis said. Chasing a quick-fix or easy way to make income would likely land you in a pyramid scheme rather than a legitimate company.

“You’re going to be spending a lot more time than you think to make sales,” she said. “Those who are successful are the ones who make it a full-time job.”

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Where Very Small Businesses Dominate

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Though it may seem like giant corporations like Amazon command the U.S. business landscape, small businesses continue to be the backbone of most local economies.

The U.S. Small Business Administration estimates that 99.9% of ventures, or 30.7 million companies, qualify as small businesses. However, the SBA’s definition of a small business is broad. To qualify, businesses must meet or fall below the maximum revenue and employee count that the SBA sets for each industry. Revenue limits span $750,000 to $38.5 million, while employee requirements range between 100 and 1,500 people.

But the vast majority of small businesses are much smaller — 89% have 20 or fewer employees. For this study, MagnifyMoney researchers only considered businesses with fewer than 10 paid employees, firms that may include younger companies and mom-and-pop operations with slim resources.

Researchers found that these extremely small companies come close to matching — and in one case exceeding — average payrolls of all businesses in their cities. We ranked the 50 largest U.S. metros by payroll relative to metro averages, growth among companies with fewer than 10 employees and the percentage of workers employed by these firms to see where they dominate.

Key Findings

  • Miami comes out on top with a large and growing number of small businesses: 84% of businesses here have fewer than 10 employees with 15% of the city’s total workforce employed by these extremely small companies.
  • Los Angeles takes second place, also with a large number of small-scale businesses, but what’s striking about these companies is that their payroll is 94% of the metro average, second only to Las Vegas where companies with fewer than 10 employees actually exceed the average payroll.
  • Louisville, Ky. is at the bottom of the list — just 7% of all workers are employed by companies with fewer than 10 employees. Additionally, the number of such small businesses in Louisville is dropping, which could be a bad sign for those still operating in the area.
  • Memphis, Tenn. comes in one spot above Louisville, Ky. This metro area had the lowest share of extremely small businesses on our list, as well as one of the lowest shares of all metro workers employed by these companies.
  • The average small business rate is 72% among all cities. In other words, roughly three quarters of businesses in the 50 largest metro areas have less than 10 employees on the payroll.
  • Generally, payroll per employee at these small businesses tends to be lower than the metro average. On average across all 50 metros, payroll per worker at companies with fewer than 10 employees is 79% of the metro average.

Metro areas where very small businesses dominate

Small businesses support the local economy in these high-ranking metros.

1. Miami

The South Florida city boasts the highest percentage of businesses with fewer than 10 employees as well as the largest percentage of its workforce employed at such companies, despite a relatively small business rate increase in one year’s time, just a 0.2% change. Average payroll per employee is 86% of the relative metro average.

The economic development council in Miami-Dade County identifies and promotes industries that are poised for job and wage growth including aviation, banking and finance, creative design, hospitality and tourism, technology, life sciences and health care, and trade and logistics. Tourism has long been a lucrative sector for Miami. Small businesses in the industry can promote their services at the City of Miami Beach Visitors Center, which has more than 120,000 annual visitors.

2. Los Angeles

Los Angeles holds the No. 2 spot thanks to a strong average payroll, second only to Las Vegas among extremely small businesses. Business rate growth was flat in one year’s time but 12% of LA’s workforce is employed by small businesses with fewer than 10 employees.

Entertainment is unsurprisingly among the top industries in Los Angeles, alongside aerospace, bioscience, transportation and fashion. The City of Los Angeles offers several resources and incentives to support small businesses, such as the Restaurant and Hospitality Express Program, which streamlines the permit approval process for food service establishments. The cyber threat protection program also helps small business owners learn best practices to prevent cyber attacks or breaches.

3. Tampa, Fla.

Another Florida metro rounds out the top three. Though it tops No. 2 Los Angeles by small business rate, Tampa has lower employment numbers: 11% of its workforce is employed by a small business with fewer than 10 employees. The average payroll of those companies is 81% of the metro average. Tampa has seen a 0.1% one-year change in the small business rate.

The metro area’s key industries include financial and professional services, manufacturing, distribution and logistics, life sciences and health care, information technology and defense and security. Tampa Bay is also a popular location for corporate headquarters.

Areas with a lesser impact from very small businesses

These metro areas see less economic influence from local small businesses.

48. Nashville, Tenn.

Nashville has one of the lowest small business rates in our study at 67%. Just 8% of workers in the area are employed by a small business with fewer than 10 employees, which see an average payroll per employee at 79% of the metro average. Nashville has seen a -1.0% one-year drop in its small business rate.

Nashville once had a population growth rate of nearly 100 people per day. That growth slowed this year, according to a report from The Tennessean newspaper, but the area has felt the effects of a rapid influx of new residents, including high tourism, expensive housing and displacement of low-income residents. Large retail chains like Trader Joe’s also continue opening throughout the area.

49. Memphis, Tenn.

The other Tennessee metro near the bottom of our list has a small business rate of 62%, the lowest of all metros we ranked. In Memphis, 7% of all employees work for a small business with fewer than 10 employees with average payroll per employee at 79% of the metro average. During one year’s time, Memphis had a -0.8% drop in the small business rate.

Memphis is among the poorest metropolitan areas in America, and residents face economic barriers such as high poverty as well as segregated and devalued neighborhoods. The Memphis River Parks Partnership, a nonprofit focused on transforming the area of Memphis closest to the Mississippi River, is working to support local businesses. Part of the organization’s efforts include contractor development strategies that position minority- and women-owned businesses for success.

50. Louisville, Ky.

In last place, Louisville has a 66% small business rate and a significant drop of -1.2% in growth during a one-year period, tying with Milwaukee. Just 7% of Louisville employees work for a small business with fewer than 10 employees where payroll per employee is 78% of the local average.

Louisville is working to grow its tech workforce to become an emerging technology hub. The city has invested in job programs and initiatives such as Code Louisville and Bit502, according to The Lane Report. Louisville has also partnered with educational institutions, nonprofits and local businesses to boost the city’s tech output.

Methodology

To rank the places where very small businesses dominate, we looked at data for 50 of the largest metropolitan areas. Specifically, we evaluated these four metrics:

  • Small business rate. This is the percentage of businesses with fewer than 10 employees.
  • One-year change in small business rate. This is the change from 2015 to 2016 in the small business rate.
  • Percent of workforce employed at small businesses. This is the percentage of all paid employees who work in small businesses with fewer than 10 employees.
  • Relative pay of small business employees. This is average payroll per employee of these small businesses divided by the metro area average payroll per employee.

We then ranked each metro in each of these metrics. Each metro area was scored based on the average rank received across the four areas. Data for all metrics comes from the Census Bureau’s 2016 and 2015 Survey of Entrepreneurs.