Randall E. Torgerson, Deputy Administrator
USDA Rural Business-Cooperative Service
Editor's note: this article is based on the author's remarks at the annual Paciifc Coast/National Cooperative Bargaining Conference in Reno, Nev.
Taking a critical look at the concept of new-generation cooperatives is a topic where some have feared to tread. But in the wake of the recent bankruptcy of Tri Valley Growers, it is a subject that merits close attention.
Growers have two basic organizational strategies for achieving marketing power. One is by organizing horizontally to help establish farmgate prices. In addition to cooperative bargaining associations, guilds, alliances and farm organizations are variants that engage in the pricing of identity-preserved commodities.
The second strategy is vertical integration, by which producers seek to add value beyond the farmgate through cooperative marketing.All business organizations have three distinguishing features: ownership, control and who receives the benefits. The cooperative is owned and controlled by its users through democratic or proportional voting. It is capitalized by those using its services and returns to capital are limited. And it is obligated to return net margins (benefits) to
users on the basis of their patronage. We define a cooperative as a user-owned and user-controlled business in which benefits are received in proportion to use.What is different about new-generation cooperatives interms of structure and operations? A number of elements incorporated in these co-ops have been found in California for a number of years. But they were reborn on the high plains and prairies of North Dakota and Minnesota in the 1970s through the efforts of sugar beet growers. Based on the success of these organizations, a terrific resurgence of interest took place in the 1980s and 1990s by growers of durum wheat, corn, hard winter red wheat, bison, beef and (most recently) pork.
Factors driving this trend include: (1) Grower returns for raw commodities as a percent of the consumers' food dollar have been declining; (2) access to markets for growers has become more difficult as concentration among food processors and retailers has accelerated; (3) independent family farms feel threatened by the so-called "industrialization" of agriculture; (4) technological advances continue to result in increased production; (5) exports were curtailed by the downturn in Asian markets, by globalization of markets and by the strong dollar; and (6) growers have been looking for away to share in any increase in the value of their cooperative, especially when they approach retirement.The combination of these factors suggests that if farmers and ranchers are to survive as independent producers, they need to capture a larger share of the marketing profits generated between the farmgate and consumers.
One of the primary means of doing so is for farmers to form cooperatives that process their raw products into value-added products and then market them, thus bringing growers closer to the ultimate consumer. Farmer organizations - such as the National Wheat Growers, National Corn Growers and National Pork Producers Council - have become leading proponents urging their members to move in this direction.Based on these facts, many growers have pursued a vertical-integration strategy by organizing for marketing. Common characteristics of these new-generation cooperatives are that equity investment is a prerequisite to establishing delivery rights. These delivery rights are part of a producer marketing agreement (contract) that pools the delivery of products and links them to equity units purchased in the cooperative. If a grower is unable to deliver his agreed raw products, purchase of commodities is authorized by the cooperative for undelivered obligations. Delivery rights are allocated according to plant processing capacity. This closes membership at plant capacity.
Delivery rights are in the form of equity shares that canbe sold to other eligible producers at prices agreed to by the buyer and seller. The board of directors approves all stock transfers to assure that they are held only by eligible producers. This prevents ownership by outside investors. The value of delivery rights (shares) may appreciate or depreciate in value depending upon the performance of the cooperative. High levels of cash patronage refunds are issued annually to producers since they have substantial risk capital invested in the organization.
The advantage of the new-generation cooperative approach is that adequate equity capital is raised at the outset. The burden of capitalization is distributed equitably inproportion to future use of the marketing organization. Substantial up-front investment by members means that they want the business to succeed. And, assuming the business is performing adequately, exiting members can sell their invested equity at a value reflecting the cooperative's performance.
Like any business, future success depends upon a well-founded business strategy, identification of a ready market for the product, sound management, a strong role by the board of directors overseeing policy direction of the organization and protecting members' assets, and goodboard/management relations. The organization also has to follow sound cooperative practices. Deviation from these often spells trouble, often leading to poor performance or even the failure of the business.
Examples of new-generation cooperatives include: Dakota Growers Pasta Cooperative, Spring Wheat Bakers, South Dakota Soybean Processors, North American Bison Cooperative, Iowa Turkey Growers Cooperative, U.S. Premium Beef and Corn Plus ethanol cooperative. A number have started from scratch and built new facilities. Others, such as Pacific Coast Producers, have taken over ownership of processors that growers were formerly supplying.
A variant of these new-generation marketing cooperatives are those organized for farm production purposes. Production cooperatives have been organized by corn and soybean growers to add value to their raw commodities by feeding them to poultry and livestock. New, large-scale production enterprises have been organized in the pork, egg and dairy sectors. Examples are ValAdCo pork producers, Golden Oval and Dakota Layers Cooperative, and some new dairy cooperatives in Kansas and North Dakota.
It is estimated that between 75 and 100 new-generation cooperatives have been organized to date. Many are still in the formative stages. But of those that are operating, we can identify some strengths and shortfalls, and lessons to learn.
How are they performing?
Four issues can be raised about the existence and performance of new-generation cooperatives: ability to control production, stock vs. non-stock form of business, exclusivity inthe farn-ting community and the business culture. New-generation cooperatives, in theory, are very market oriented - they find a market for their output and produce for it, expanding production of processed products only to meet increasing demand. Presumably, they do not expand production beyond the immediate market. Evidence to date on this score is mixed.
In their formative stages, new-generation cooperatives have done an excellent job of identifying markets for their processed products, i.e., not just producing something and then asking the market to take it. This has been accomplished through thorough market research as a part of their feasibility analyses and then activating a particular marketing strategy in a business plan. Clearly, this has been a plus.
Over the long term, however, it does not appear that they are immune from the trap of many isolated units making independent production decisions and then over-producing for the market. This is the exact same dilemma that faces individual growers and is the Achilles heel of independent growers, each making their own production decisions in isolation.
One current example is the dilemma found in the sugar industry (see related story, page 10). Like many other commodity sectors, refined sugar is being produced in sugarbeet country in excess of market needs, despite the fact that about one-half of the production is sourced from new-generation cooperatives in the Red River Valley, Idaho and Washington. Production expansion has occurred in recent years where cooperatives have believed that they have a strategic advantage.
Marketing cooperatives by themselves are not a mechanism for industry-wide production reduction and restraint. Indeed, this is one reason that they have been looked upon - in aggregate - as a competition-enhancing influence on markets.
Business form is a hot-button issue. Most states permit incorporation under either non-stock or capital stock cooperative statutes. At one time, there was a movement that suggested that the non-stock cooperative was a purer form of cooperative. This feeling was particularly strong in California in the 1920s. However, many U.S. cooperatives involved in value-added marketing are organized on a stock basis. The conversion of Tri Valley Growers to a stock plan raised this issue again.
Exclusivity is another key issue. Cooperatives have often had open membership policies under which growers could freely join, sometimes simply by walking in the doorand transacting business. This has been especially true in the farm supply business and many raw commodity marketing and bargaining associations. Larger numbers of producers often translate into larger volumes, greater operating efficiencies, more strength in the market and a feeling of community spirit.
To the extent that new-generation cooperatives are only open to those who can afford sometimes high, upfront capitalization investments, they are viewed as more restrictive in their membership. Rather than having a rising tidethat lifts all boats, only those that can afford to invest are benefactors. This criticism is heightened in those new-generation cooperatives that tie membership control to the number of delivery rights owned, instead of the more typical one-person, one-vote rule.
A fourth issue is the potential for new-generation cooperatives to take on more of an "investor" than a "cooperative" culture. Since access to delivery rights is linked to investment in shares and an internal market is created for these delivery rights, some critics feel there is a potential for the organization to become more driven by return-to-capital than by return-to-use as a guiding principle. This becomes exacerbated if the business is allowed to be organized as a limited liability company that has management or other outside investors. A trend can easily develop whereby the business is driven strictly by return-on-investment considerations. It then evolves culturally into just another business - not one dedicated solely to serving the interest of growers.
Co-op practices need scrutiny
In the United States, share of marketing activity represented by cooperatives has doubled since the 1950s. And there is a great deal of opportunity for future growth. When problems occur, it is generally due to faulty practices. These lead to under-performance of the business and, in some cases, to ultimate failure.
A few new-generation cooperatives have experienced problems, including:
- Purchase of delivery rights outside of a grower's production territory.
- Use of purchases "off the market" rather than a member's delivery as a predominant means of fulfilling delivery right obligations.
- Leasing of delivery rights as a way to hold on to appreciated value rather than having ownership in the hands of active producers.
- Making fixed-term market obligations for final products when the market for a raw commodity is short, causing wide price disparity for producers and, losses for the business.
- Hiring of management from outside of the industry that doesn't know intricacies of the market or how to adapt their management style to a user-owned business.
- Sourcing equity outside of membership, thereby resulting in conflicting goals and fiduciary responsibilities.
- Attempts by board members to micro-manage the business.
- Engaging in large amounts of non-member business.
- Efforts by the board chairman to also serve as chief executive officer, creating lack of trust within the membership.
Ownership of delivery rights
One successful new-generation cooperative in Minnesota decided to expand operations in a state that was not even contiguous to it. Instead of selling delivery rights for supplying the new plant to producers surrounding it, many of the delivery rights were purchased by existing members in the distant state. Similarly, some producers subscribed to more delivery rights than they had the capacity to deliver from their own farms.
This practice violates basic tenets of operating on a cooperative basis, in which value is added to the production of one's own farming operation. Instead, it appears that return on investment was simply sought by processing someone else's raw commodities.
Off-market purchases
The provision for purchases "off the market" in new-generation cooperatives was put there because of the possibility of a drought, hail storm or disease that would make it impossible for a member to fulfill his or her contractual delivery obligation. To keep the plant running at capacity, the cooperative could make purchases on the open marketin the member's name.
Some new-generation cooperatives have made this a common practice, again losing the traceability of production from one's own farm through the cooperative. This practice again smacks of operating more like an investor-owned firm than a user-owned business. Some California cooperatives have even been processing non-member products (cash market) instead of using plant capacity to process members' products under marketing agreements. This has led to member dissatisfaction in several instances and criticism that members are being treated as residual claimants rather than primary beneficiaries.
Leasing of delivery rights
Cooperative control should be vested in the hands of active producers. The recent payment-in-kind (PIK) program for sugar beet growers disclosed that many sugar cooperative members - particularly older ones - had leased their delivery rights to other producers. This presented many administrative problems for USDA.
The sugar program notwithstanding, the fact that delivery rights were leased clearly shows a problem. Growers holding delivery rights, while not actively producing themselves, are doing so based on expected appreciation in value of those rights or for tax purposes regarding their estates. This is aproperty rights issue, not unlike production quotas, which requires active monitoring by boards of directors and the need for policy direction. Otherwise, ownership in the cooperative could end up in the hands of retirees rather than active producers.
The previous three practices are those particularly related to new-generation cooperatives. The following six are related to all types of cooperatives including the new-generation variety.
Fixed-term market obligations
A Minnesota new-generation cooperative ran into severe difficulty when its management entered into fixed-price contracts for sale of processed products at a time when a shortcrop led to skyrocketing raw commodity prices. Millions of dollars in losses occurred that threatened to wipe out a large part of the entire grower equity base.
In order to survive, the company had to seek an outside equity investor, in this case a major investor-owned firm that was in the same business. When it recovered from the debacle, members wanted to buy out the outside firm, but found resistance to liquidating the investment by the out-side company, which had been given some control over the cooperative's marketing operations as a condition of investment. In an era of fluctuating commodity prices associated with the global market, this shows that boards have to scrutinize management activities through policies that assure continuity of operations.
Hiring management from outside the industry
It is a necessity to secure top management that believes inthe cooperative method of doing business and understands basic cooperative principles and practices. Numerous examples can be found where outside management is hired that possesses little understanding of the cultural differences between user-owned and investor-owned businesses, and moreover are not predisposed to learning about them. As a result, both board and management experience a great deal of frustration that leads to under-performance. Similar situations can be found where a successful manager in one industry is brought in to another, but an understanding of the essential nuances of that industry is missing. This results in poor decisions and can lead to failure.
Outside Equity
A basic cooperative operating premise is that control follows investment. If farmers want to control their business, they have to invest in it. There simply is no substitute for grower equity in a cooperative. Some people like to promote outside ownership in cooperatives without realizing that this act changes the basic fiduciary relationship within the organization. Conflicting goals result between maximizing returns to investors and maximizing returns to grower owner-users. Basic methods of providing equity capital are through up-front subscription, retained annual earnings and per-unitcapital retains. One or a combination of these must be used to finance the value-added marketing business. Using outside sources of ownership dilutes the purpose and the direction of cooperatives - frequently making them more management than producer controlled. Ready sources of debt capital continue to be available to cooperatives that are credit worthy through the cooperative credit system and other sources.
Board micro-management
A key to successful cooperatives is good board-management relations. This is a practice that is a two-way street and has to be worked on every day of the year. It requires constant education about the respective roles of each. Boards must hire qualified managers in whom they have confidence and then turn over the day-to-day managerial responsibilities to them. Boards set policies that guide managers and provide them adequate room with which to manage. Periodic evaluations determine if objectives are being met and whether corrective action is required. Managers have a responsibility for maintaining good board-management relationships. Boards that develop an adversarial attitude toward managers or attempt to second guess decisions by micro-managing are destructive.
As an example, the board of a commodity promotion organization in Wisconsin was spending board meeting time going over every check written by the association. A North Dakota sugar beet cooperative lost a very resourceful manager because a few board members were attempting to dictate hiring and other belt tightening measurers rather than letting the manager handle it. These are examples of actions that lead to mistrust that eventually can lead to the demise of a cooperative.
Non-member business
Engagement in large amounts of non-member business can lead to changing priorities in a cooperative. It is often justified on the basis of using tax-paid surplus as a cushion for losses. But it can also shift management's attention to maximizing profits at this end of the business rather than enhancing returns to member-users. Over time, the culture of the organization changes to operating more as an investor-owned rather than a user-owned business. Recent developments in Calavo exemplify this development.
Attempts to wear two hats
Periodically, we see a board chairman who thinks he should also wear the hat of the chief executive officer. This situation is closely related to the former issue of micro-managing, but is a special case. While there is no question that one of the primary responsibilities of a board of directors is to see that members' assets are protected and that the organization is being operated in the members' interests, attempts by board leaders to substitute their policy role with executive management responsibilities simply doesn't work in cooperatives.
Much progress, strong potential
Despite identifying certain practices that have been, or have the potential to be, problematic for new-generation cooperatives, there are many more success stories. The failure rate has not been high. We have to consider this new form of organization as a work in progress in which continual fine-tuning and adjustments will be made to enhance their potential for success on all operational fronts: governance, transfer of delivery rights, capitalization methods, pooling rules, expansion options and membership relations.
A number of these projects typify farmers' and ranchers' efforts to identify niche markets that they can fill without incurring the wrath of dominant players in the industry. As smaller businesses, they are more nimble and can adapt their marketing strategy within these market settings. In some cases, such as Dakota Growers Pasta Cooperative and sugarbeet cooperatives' marketing agencies in common, they may grow to become top players in the industry. In others, such as Spring Wheat Bakers and North American Bison Cooperative, they have identified niche markets that are not dominated by any major player.
The Iowa Turkey Growers Cooperative has found its mark in further processing of meats rather than selling whole birds, and is rapidly expanding its role in luncheon meats for delis and for private-label markets. U.S. Premium Beef has developed a quality grid that rewards members for delivering higher quality beef that meets consumer demand. As part owner of the rapidly growing Farmland Foods cooperative team, they are participating in retail markets through Walmart and other major outlets. A number of grain growers have seen their ethanol cooperatives experience improved margins with the rise in petroleum prices and the possible reduction in the use of MTBE as a gasoline additive. Dozens of others are up and running or on the launching pad.
Congress is supporting these efforts through loan guarantees for stock purchase in new value-added cooperatives, grant programs that provide assistance in studies and help defray some startup costs, establishment of a value-added market development resource center and establishment of cooperative centers that offer technical assistance. A proposal has even been introduced that would establish a government-sponsored equity capital venture fund to augment these developments. And USDA recently announced a program that rewards processors for using more grains in ethanol-producing facilities. Conversion of other forms of biomass to energy are also the subject of expanded program funding.
In short, there is a lot of momentum and energy in the value-added arena as farmers seek to strengthen income and keep themselves in the driver's seat at a time of rapid consolidation and concentration in the food industry. How will it all turn out? Are these efforts too late? Or, are they on the cutting edge of new institutional market development?
The outcome will be determined by the strength of leadership offered, careful development of business plans and marketing strategy, and proper capitalization. Ultimately, the assurance that these businesses are set up on a user-owned, user-controlled and user-benefitted basis will determine if members are the primary beneficiaries.
