Of necessity & invention
Conference shows diversity of responses
by co-ops to changing market conditions
By Kimberly Zeuli,
Assistant Professor
University of Wisconsin-Madison
Editor’s note: More highlights of the
2004 Farmer Cooperative Conference will
be included in the March-April issue of
Rural Cooperatives.
“Innovation is rarely rocket
science…in the past few decades,
most of the companies that have
created truly extraordinary
amounts of wealth have done so
by inventing great processes, not
great products.”
(The Economist, April 24, 2004)
usiness innovation can be
defined as any new activity
related to firm structure,
production and
output. Today, many
cooperatives are at the forefront of
agribusiness innovation. Cooperatives
are being created in new sectors, such
as renewable energy, to help farmers
capture the full rewards of technological
innovation. Established cooperatives
are modifying their financial and
ownership structures to seek strategic
advantage in today’s global marketplace
while continuing to meet the
needs of their diverse memberships.
Recent changes in state laws allow
unprecedented prospects for the evolution
of the cooperative model.
The seventh annual Farmer Cooperatives
Conference — Cooperative
Innovation — highlighted some unique
and successful examples of innovative
agricultural cooperatives. The annual
conference, most recently held Nov. 1-
2 in Kansas City, was established by
the University of Wisconsin Center for
Cooperatives (UWCC) in 1998, with
financial support from the Farm
Foundation, to provide an open forum
for critical thinking about the major
trends and issues affecting agricultural
cooperatives.
New energy for co-ops
It seems that everyone is talking
about ethanol these days, spurring
great expectations for corn and grain
producers. According to the
July/August 2004 issue of USDA’s
Rural Cooperatives magazine, 75 ethanol
plants operate in the Midwest and
Great Plains, with another dozen or
more under construction. Most of
these ethanol plants are farmer owned.
Raymond Defenbaugh, president and
CEO of Big River Resources Ethanol
pant, and John Eggleston, board president
of Northeast Missouri Grain
Processors LLC, provided insight into
how farmers can successfully secure
the returns ethanol promises.
They both agreed that farmers need
to commit to success and be willing to
sacrifice much for achievement. As legendary
football coach Vince Lombardi
once said, “winning is everything.”
Success also requires patience. Ten
years of planning went into the
Northeast Missouri ethanol plant.
Defenbaugh suggested that farmers
and co-ops might not be attacking the
right enemy: “The enemy in agriculture
is not other farmers and not other companies.
It is poor prices. Farmers need
to work together to combat this enemy.”
The statement that agricultural coops
needed to work together to succeed
was reiterated throughout the conference.
As Benjamin Franklin said, “We
must all hang together…or assuredly
we shall all hang separately!”
Practicing what they preach, Big
River Resources Ethanol members are
willing to share the lessons they learned
with other farmers interested in starting
an ethanol plant. As Defenbaugh
noted, his co-op has also certainly ben-
efited from the experiences of others
along the way. He also stressed the
importance of partnerships. Big River
has pursued several joint-venture
opportunities, with very positive
results. “Most people want to work
together, so don’t hesitate to look into
joint-venture options.”
Defenbaugh and Eggleston also
issued a perennial warning to all new
co-ops: make sure you raise sufficient
capital — the “life blood” of any organization.
If co-ops are not adequately
capitalized, they are not managing risk
well. However, those interested in
starting an ethanol co-op can’t assume
capital will flow to the co-op, even
with a good business idea.
With all the interest in ethanol, is
there a risk of producing excess supply?
Defenbaugh believes that this is a possibility,
but legislation and the increasing
popularity of ethanol fuel will balance
supply and demand. He compared
ethanol to the computer, which was
ahead of its time at first, but today is
used by most of the population.
Necessity: the mother of
cooperative innovation
“If necessity is the mother of invention,
then resourcefulness is the father.”
— Beulah L. Henry (The inventor of
a type of umbrella.)
CHS Inc. provides compelling evidence
that cooperatives can innovate
when it comes to changing traditional
structure. John McEnroe, vice president
of Country Operations for CHS,
provided one specific example of this
with his presentation on the CHS
“regionalization” concept.
Regionalization refers to the situation
when a local co-op is essentially
consolidated with CHS (the local
becomes a CHS business division), but
it may maintain its own name and
retains its local producer board and
considerable local control.
The CHS regionalization concept,
under which it has consolidated with
27 local co-ops, was born in 1993 in
North Dakota. At that time, a local coop
there in CHS’ trade territory was
struggling, but the board didn’t want
to sell the co-op or invest in new assets
because of the risk posed to its patron
equity. Eventually, it agreed to merge
with CHS to gain CHS’ oversight on
strategic management decisions at the
local co-op level.
In addition to its fully autonomous
member co-ops, CHS currently
includes 27 “regionalized” local co-ops
(business units). All 27 pool their
patronage with CHS. The patronage
refunds are then distributed back to the
locals, based on local use. CHS works
closely with these units in terms of
major decision-making and marketing.
For example, the CHS board
decides the percentage of cash
patronage refunds and the level
of equity redemption. The local
co-op’s employees become CHS
employees, although the local
co-op retains daily authority.
One of five regional directors
for CHS attends the local board
meetings.
McEnroe acknowledged that
there are pros and cons to this
concept. On the positive side, it
brings financial stability to the
local co-ops, which are afforded
timely equity redemption and
protection. The local co-op still
maintains significant control and
direction at the local level, while
also achieving economies of
scale as part of CHS. On the
downside, members may perceive
that the co-op is “selling
out,” although in actuality members
retain considerable local
control, as well as the ongoing
economic benefits of being part of a
co-op.
Authority for a few decision-making
abilities — such as how equity is paid
out, which is decided by the CHS
Board — is also lost and, ultimately,
the local co-op’s fortunes are tied to
those of CHS.
In contrast, as CHS would be the
first to acknowledge, many local coops
are doing just fine on their own,
implementing their own innovative
strategies.
Jeff Nielsen, general manager of
United Farmers Cooperative (UFC),
presented such a case. UFC is a highly
diversified local cooperative. Risk management
and the desire to provide
“customer-driven solutions” guided its
pioneering effort to create a memberowned
alternative insurance company:
Parthenon Risk Partners. According to
Nielsen, “the cost of insuring our people,
property and assets had become
almost unbearable.”
Parthenon is a captive insurance
company; this means it is owned and
controlled by the insured parties. It is
similar in design and operations to a
cooperative business. In 2002, there
were over 4,500 captive insurance
companies operating in the United
States. This new insurance program
has helped UFC lower insurance premiums
and increase coverage for its
employees.
Nielsen believes that: (1) a proactive
and engaged membership and
(2) a pro-active and visionary board are
the two essential components for
cooperative innovation. “When making
a commitment to find a solution,
you need to decide whether to create a
quick fix or the correct fix.”
Market stress leads to
cooperative formation
In 1972, the Michigan factory that
local cherry farmers sold their crops to
was closed. One of those farmers was
Don Nugent, who — along with other
cherry growers — responded to the
closure by forming Graceland Fruit
Cooperative, which purchased the factory.
The dual problems of oversupply
and the short, 12-hour shelf life of ripe
cherries provided the momentum to
create an innovative food product:
infused dried cherries. Nugent, now
president and CFO of Graceland Fruit,
overcame food poisoning and a car
accident to close a marketing deal for
this product with Ocean Spray, vividly
illustrating the principle that persistence
pays off.
In 1998, the IRS ruled that
Graceland no longer qualified as a coop
because of its level of non-member
business, so it converted to a C-corporation.
The cherry growers created a
new co-op (still using the old name,
Graceland Fruit Cooperative), which
supplies all of the cherries to Graceland.
Nugent believes that growing an innovative
co-op depends upon a good strategic
plan, a solid management team that
can implement marketing strategies, as
well as alliances for inputs, manufacturing
and sales.
As the instigator of a new Wyoming
cooperative state law, the Mountain
States Lamb Cooperative (MSLC) is
often featured in co-op news. MSLC is
a Wyoming-based, vertically integrated
marketing cooperative for lamb and
wool. It has 125 members in 10 western
states.
By the turn of the last century, lamb
producers had suffered through 20
years of dismal prices. A core group of
producers decided to form a vertically
integrated marketing and processing
operation, but were confronted a
major road block: lack of capital. Nonproducers
who considered agriculture
vital to their rural communities wanted
to invest in such a venture, but they
could not if it was organized as a cooperative.
Some members also wanted to
invest more but did not want to have
to supply a proportionate amount of
product.
Brad Boner, board chairman of
MSLC, said the cooperative created a
separate co-op in 2001, the Mountain
States Lamb & Wool Cooperative
(MSL&W), which is organized under
the new Wyoming co-op statute. MSLC
is the sole member of MSL&W. The
latter was formed to provide marketing,
processing and other services to both
patron and possibly non-patron members.
This co-op’s structure (referred to
as “the Wyoming model” or the
“Patron Investor Cooperative”) is similar
to an LLC in that it allows outside
investment without a delivery requirement,
but the business also receives the
benefit of co-op tax laws while being
able to provide a return greater than
the standard co-op limit of 8 percent
on contributed capital. MSL&W now
sells its products on both coasts and
has a joint venture with a New York
lamb wholesaler. A cross-country supply
ensures year-round, consistentquality
products.
According to Mark Hanson,
Attorney & Partner at Lindquist &
Vennum PLLP and the primary architect
of the new Wyoming cooperative
statute, “The changing demographics
of producers in the United States and
elsewhere and the consolidations in the
food industry generally will provide
opportunities, nudge and even force
changes in business structure.” From
his perspective, the traditional co-op
model was designed to enhance farmermember
income, not provide increased
returns to investment. Therefore, a
modified structure is necessary for
today’s value-added cooperatives.
Co-op conversion — is it worth it?
Gene Carbone, former CFO for
Calavo Growers, spoke previously at
the Farmer Cooperatives Conference
in 2000, when his California-based avocado-
growers’ co-op was in the midst
of converting to a C-Corporation.
With hindsight, has his perspective on
the conversion changed?
Carbone said he believes it was a
success, in the sense that it provided
much needed liquidity to members and
provided a market-driven firm valuation.
After conversion, shares were initially
offered at $5. Shares are currently
trading at $10.80 and there is a
healthy turnover rate.
“Today, Calavo members are driving
Lexuses and Mercedes,” he said. “The
shareholders are very happy.” Original
members have probably been selling
some of their stock to new investors,
but former members are also returning
to the company. This suggests that the
capitalization issue was an important
impediment to Calavo members.
Under the current corporate structure,
the company no longer has to
treat all growers equally. Carbone feels
this flexibility is another positive outcome
from the conversion. However,
Calavo has to offer competitive returns
for the fruit producers (dividends per
pound), otherwise it risks losing supplies.
This is a source of tension
between shareholders, who receive dividends
per share, and growers.
Carbone cautioned that converting
a company does not happen overnight.
The three-stage conversion process
was, in his words, “a long and painful
process.” It took almost nine-months
to complete. There are also downsides
to the process. At the top of his list
was the loss of heritage, or co-op culture.
A potential change in directors
and, therefore, company vision, was
another risk. Further, the registration
requirements for a public company can
be onerous and costly.
Sale means veggie growers
no longer control own destiny
William Harris, a long-time Pro-Fac Cooperative member and investor
in Birds Eye Foods, provided a growers’
assessment of his co-op’s sale of
the majority of Birds Eye stock. Over
70 percent of Harris’ gross farm
income depends on his sales to the
cooperative. Pro-Fac has always been
innovative, he noted. Like the cherry
growers in Michigan, the vegetable
growers established a “new age” co-op
in 1961 to buy failing processing companies
in the region.
In this case, however, a private
company — Curtice-Burns (which
eventually became Birds Eye Foods)
— leased and operated the processing
facilities and marketed the finished
product for the co-op. According to
Harris, the profit and losses were
shared equally between Pro-Fac and
Curtice-Burns through a series of
agreements. “The business model
worked extremely well and through
acquisitions the company grew.”
Perhaps it grew too quickly, or too
large. In 1994, Pro-Fac purchased
Curtice Burns. By 1999, Pro-Fac was
highly leveraged and poorly positioned
to take advantage of future
growth opportunities. In hindsight,
Harris acknowledged, Pro-Fac did not
retain enough of its earnings. It also
had issued a lot of preferred stock,
which led to a cumulative dividend
issue.
Even with “their backs against the
wall,” Harris said that the decision in
2002 to sell approximately 60 percent
of its processing company and brand,
Birds Eye, to Vestar Equity Investment
was only made “after a lot of soul
searching.”
Was it the right decision? Birds Eye
Foods is certainly more financially
viable today than it was in 1999, meaning
that Pro-Fac is also more stable
financially. However, as Harris somewhat
wistfully noted, Pro-Fac no
longer controls its own destiny.
If Vestar wants to sell Birds Eye, the
co-op can’t stop it. Grower-members
have limited input into the company’s
decisions. They now have a legal, contractual
relationship with their processor.
Pro-Fac members are left out of the
loop at the corporate level and decisions
are not as transparent as in the past due
to stronger confidentiality conditions.
As a result, Harris feels that “what
would have been small disputes between
growers and Birds Eye have now
become protracted disagreements.”
Dave Swanson, Partner at Dorsey
& Whitney LLP, counseled cooperatives
to exhaust other options before
committing to a business conversion.
“Identify your goals and examine the
options. Can you get additional capital
from your members or through
joint ventures?” Alternative options
include sale of preferred stock, joint
ventures and consolidation. Each coop’s
situation is unique. The potential
pitfalls and benefits of alternative capitalization
methods need to be kept in
mind in order to preserve the political
and social aspects of the co-op
involved.
