Managing Risk
Farmer Co-op Conference eyes strategies for doing business in volatile marketplace
Inside the Upstate Niagara Cooperative dairy plant in New York, created through a merger of two co-ops to provide strategic growth opportunities. Photo Courtesy Upstate Niagara
By Lynn Pitman,
University of Wisconsin Center for Co-ops
Editor’s note: Conference presentations are available on the
University of Wisconsin Center for Cooperatives website:
http://uwcc.wisc.edu/farmercoops08/program.
quity and capital management issues continue
to drive major strategic decisionmaking by
today’s farmer cooperatives. Against a
backdrop of volatile markets and global
competition, cooperatives must develop
strategies that balance growth imperatives against risk and
supply chain cost management. More than 170 cooperative
board members, CEOs and others doing business with
agricultural cooperatives gathered in St. Paul, Minn., in
November to discuss “Cooperative Strategy, Structure and
Finance” at the 11th annual Farmer Cooperatives
Conference, organized by the University of Wisconsin
Center for Cooperatives.
Elements of a successful merger
Upstate Farms Cooperative and Niagara Milk Producers
Cooperative Inc. had discussed a merger in the past. As
value-added marketers of raw milk, both shared a similar
orientation toward product and quality, and both co-ops
operated in the same geographic area. Both were
member/owners of O-AT-KA Milk Products Coooperative,
which was created to guarantee markets for member milk.
Their decision in 2006 to form Upstate Niagara
Cooperative Inc. was a win-win decision for both co-ops, said
Dan Wolf, president of the board of the new cooperative.
The merger provided an effective way to achieve operational
consolidations, and has provided strategic growth
opportunities that position the cooperative favorably for the
future.
Similar earnings and member benefits meant that there
was no need to adjust member equity shares in the merged
cooperative. A board representation proposal that integrated
the boards and the delegate structure from Upstate is in the
process of being phased in. The merger included 90 percent
ownership of O-AT-KA, which continues to provide market
security by guaranteeing markets and providing value-added
products.
Strategy formulation and risk
Michael Boland, a professor at Kansas State University,
reviewed the process that underlies any effective corporate
strategic plan. Strategies are not just ratified by the board,
but should be formulated in concert with a general manager
or CEO.
Boland differentiated strategic planning — which relies on
an analysis of the parts of business — from strategic thinking,
which is a synthetic process of seeing the big picture. A
strategic perspective can exist on multiple levels, from a
conceptual perspective of the business, to its pattern of
conducting business over time, to its position in the market,
to strategic action plans to achieve an objective.
Landmark Service Cooperative CEO Larry Swalheim and
Board Chairman John Blaska presented the strategic planning
and risk assessment process that allows Landmark to meet
short- and long-term goals. Key assignments made during
the co-op’s annual strategic planning retreat help focus
management on top strategic initiatives. Verity Resources, a
joint venture created with AgQuest to provide in-house
producer financing, is another result of the past year’s
strategic goal setting.
At Landmark, board committee meetings are effectively
used to push the strategic agenda forward, and are not simply
opportunities for division managers to “lobby for cash.” The
equity committee ensures that the program is synchronized
with the long-term capital needs of the cooperative.
An internal audit committee has been formed to ensure
the identification, reporting and management of risk. Regular
risk management reports in eight different areas are used to
assess risk exposure; these reports mean that the board knows
exactly what its exposure is.
This framework has allowed Landmark to move quickly
on new opportunities as they arise. The cooperative was able
to move quickly — in just three months last year — to forge
a merger with Grand River Cooperative. Both Blaska and
Swalheim agreed that it is strong and effective
communication between the board and management that
allows this framework to operate.
Strategies for maintaining co-op competiveness
Sunkist President and CEO Tim Lindgren and Board
Chairman Nicholas Bozick also discussed the need for good
communications between the board and management.
Lindgren noted that Sunkist uses committee work and places
emphasis on teamwork to avoid close, divisive votes.
Sunkist has undertaken a variety of strategic initiatives to
maintain its competitive position and to improve returns to
its members. Today, Sunkist’s extensive marketing network
supports a widely recognized brand.
The co-op’s global licensing program and other nonpatronage-
sourced business generate significant unallocated
retained earnings that supply the majority of Sunkist’s equity
needs. This allows the cooperative to revolve member equity
out on a 5-year plan.
Sunkist has undertaken several initiatives to meet buyer
demand and to achieve operating efficiencies with its
facilities. Sunkist Global LLC sources counter-seasonal,
complementary non-member fruit. Sunkist/Taylor markets
fresh, pre-cut fruits and vegetables. A freeze in 2007
provided an opportunity to consolidate processing operations
into two plants that can meet the changing product demands
of the Sunkist customer.
Bob Broekelman, vice president for recruitment and
selection at FCCServices Inc., pointed to the looming
retirement of the baby-boomer demographic as another risk
that cooperatives must develop strategies to manage. This
group will be difficult to replace, given the next generation’s
smaller number and the dwindling number of those with a
background in agriculture.
He discussed “Gen Y” the group now entering the
workforce for the first time, and how to recruit and retain
this future generation of workers.
Strategies for turbulent times
Amy Gales, central region president with CoBank,
outlined strategic guidelines that cooperatives might adopt in
these turbulent times. In her succinct review of the current
financial crisis leading up to the present situation, Gales
noted that the losses of $1 trillion have pulled $10 trillion
from the market, and the global de-leveraging has led to a
crisis of liquidity, capital and confidence.
Commercial banks have responded to current credit
market conditions by pricing to risk. There has been a flight
to quality and a reluctance to extend new credit, although the
first quarter of next year may see a freeing up of credit if the
market begins to settles down, she said.
Farm credit institutions are positioned with quality
portfolios oriented to longer-term growth instead of quicker,
higher — and more risky — returns. These institutions are
reserving their liquidity for core borrowers, Gales said.
As a government-sponsored entity (GSE), CoBank
continues to balance its mission with sound lending practices,
although it is not immune from the current situation, she
noted. As interest rates continue to rise, loan structures will
be more important. Increasing need for credit will make
market partners more difficult to find.
Gales offered a “Top 10” list of strategies that cooperatives
can adopt to cope with a volatile financial landscape. She
noted that “cash is king” in times like these, and it is
important to improve working capital and manage debt so
that resources are available for inevitable bumps in the road.
To maintain a strong emphasis on profit, there can be no
“sacred cows,” she stressed, and a cooperative must be willing
to act when margin objectives are met. Refining short-term
and long-term planning by understanding the cost of doing
business is another useful strategic focus.
Leverage is good, but only up to a point: the 1980s were
an example of what happens when highly leveraged farming
is faced with asset devaluation. Capital expenditures should
be made with an understanding of where they fit in on the
planning timeline, and preferably should be made without the
money to back them up.
Managing the day-to-day financial operations — cash flow
and accounts receivable — brings benefits as well, Gales said.
Risk management is an increasingly critical piece of
cooperative strategy, and new levels of procedures and
controls to manage price risk must be implemented.
Expertise is now more important than ever, and a CEO/CFO
strategic perspective, rather than a GM/Controller
operational perspective, can prepare a cooperative for future
challenges, Gales said. A board that really understands its
responsibilities and adds value to the organization can bring
another crucial perspective.
Effective communications with all stakeholders, both
internally and externally, makes strategic implementation
possible. While these are economically challenging times,
Gales reminded the conference that there would be many
opportunities for those that were watching for them.
Managing supply-chain risk
Bruce Vernon, vice president of marketing for MKC, and
Cheryl Schmura, vice president of crop nutrients for CHS
Inc., examined the substantial challenges of managing risk in
today’s fertilizer-supply chain. Vernon described the
sometimes discontinuous relationship between inputs and
corn, and the substantial fluctuations in both.
Former correlations in prices between inputs and natural
gas are not holding firm. The impact of global competition is
profound. Cooperatives now face volatile supply and demand
pricing, rather than one grounded in production costs, and a
more uncertain supply.
Regardless of recent price volatility, said Vernon, the
cooperative must assume some measure of risk to service its
customers. To mitigate the risk, MKC is stressing reciprocity
on the part of both cooperative and customer: the buying and
selling of grain is linked to the buying and selling of inputs.
Schmura described how a complex interplay of factors,
including equity market and dollar valuations, a decline in the
skyrocketing price for grain and fertilizer, foreign trade
tariffs, weather events, and collapsing freight rates, has
contributed to an overall market situation in which market
players have lost trust in one another.
Smoothing out the extreme ups and downs of the
fertilizer-supply chain is a challenge. Farmers are hesitant to
place orders in a volatile market, and cooperatives can’t
assume the risk by importing product without customer
orders in place.
The lack of demand has hampered movement in the
supply chain that would free up inventory space, allow dollar
averaging on the value of existing inventory, and support new
production and imports. Next spring may see stresses on the
system.
Cooperatives can address supply risk by finding partners
with multiple sourcing options, having a good relationship
with a bank, and planning based on “what-if” scenarios. Price
risk can be managed by locking in margin and not letting
greed take over the decisionmaking process. A good cash
position and reputable partners can support cooperative
performance.
Changes in cooperative business structures
Several case studies looked at the structural changes that
agricultural cooperatives have adopted to meet particular
challenges. Brian Henehan, senior extension associate at
Cornell University, and Kevin Murphy, Pro-Fac
Cooperative’s vice president of member relations, discussed
how Pro-Fac has strategically repositioned itself several times
in response to changing market conditions. Pro-Fac has used
innovations like transferable delivery rights, multicommodity
pools, and equity conversion to publicly traded
securities to create liquidity for member investment.
Murray Fulton, a professor at the University of
Saskatchewan, provided a cautionary tale about the need for
monitoring and oversight in his description of the events
leading up to the conversion of the Saskatchewan Wheat
Pool in 2005 to a business corporation. Overconfidence by
senior management and the lack of effective oversight by the
board of directors led to major investment strategies that
increased long-term debt five-fold over three years.
Substantial internal funds from the 1996 IPO meant that
new ventures were not subject to the more dispassionate
analysis of outside equity markets. SWP’s aggressive new
business strategies ultimately failed, which led to the loss of
its cooperative status.
Marvin Wiens, former board chairman of the
Saskatchewan Wheat Pool, provided his perspective as a
board member during that time. He resigned in 2004, when
both board and management agreed that SWP could not
longer survive as a cooperative. He cited these reasons for
this action: the board did not persist with hard questions and
exert financial control; the cooperative did not work to
maintain member loyalty during a competitive period; and
they lacked a shared vision.
Clarifying the objective of a strategic initiative — to
manage risk, share investment cost or provide market entry
— will aid in determining the structure to be used, said
Gregory McKee, professor at North Dakota State University.
The North American Bison Cooperative chose to form an
alliance with North Dakota Natural Beef LLC (NDNB)
after it declared bankruptcy in 2005, to re-establish itself in
the market. Dieter Pape, who is the CEO and general
manager of both firms, described how the cooperative,
formed in the 1990s, built a processing plant, but
encountered severe financial problems because the market for
bison had not been adequately developed.
The alliance with NDNB has provided the co-op with
needed marketing expertise as well as cost efficiencies. The
cooperative began paying patronage refunds for the first time
in 2007. A strategic alliance with North Dakota State
University has also provided NDNB with resources to
differentiate its products, a key advantage of a new market
entry.
Back to basics
David Barton, professor at Kansas State University,
provided a comprehensive review of the principles and
practices of cooperative finance. While profitability is
absolutely critical to success, a focus on services to
members and patrons is still required.
Barton recommended that cooperatives consider
replacing traditional, qualified patronage distributions with
nonqualified ones, and that they practice strict balancesheet
management and use a base-capital redemption
program.
Chris Peterson, professor at Michigan State
University, stressed that the goal of cooperative finance
decisions is to deliver the cooperative’s value
proposition and to ensure that the cooperative can
maintain operations, make investments and pay
members appropriate returns. The total profit in the
system, on both the cooperative level and member
level, must be considered when assessing cooperative
performance and making investment decisions.
Peterson noted that a recent National Council of
Farmer Cooperatives study showed that those cooperatives
that can respond to changes in the marketplace continue to
do well, and that the cooperative model had not prohibited
them from finding creative ways to raise capital.
Strategies for capital and equity
Central Valley Ag Cooperative (CVA) faced a complex set
of equity management issues that it assumed in a series of
mergers. Doug Derscheid, CEO of CVA, described how the
cooperative has worked to create a fair and equitable
approach for dividing the total redemption budget between
simplified equity classes.
CVA is moving toward a revolving equity fund by using
nonqualified retained patronage refunds to pay down equity
debt, and cautiously using unallocated retained earnings to
contribute to capital reserves.
The leveraged balance sheet of the recent past, with only
adequate working capital, will not work in today’s economic
climate, said Tom Houser, vice president of Agribusiness
Banking Group at CoBank. Higher levels of operating capital
will be needed to manage the risk associated with record
grain prices and crops’ input costs.
Cooperatives face several challenges in establishing
permanent capital. Many members see cooperative
profitability translating to member loss.
But permanently retaining more equity can position the
co-op to revolve the allocated equity more quickly. While
there is a common mindset that equates a tax on cooperative
income as a negative, a co-op tax liability may benefit the
member in the long run.
Legal perspectives on strategic planning and capital
management issues were provided by attorneys Mark
Hanson, Stoel Rives LLP, David Swanson, Dorsey &
Whitney LLP, and Michael Weaver, Lindquist and Vennum
PLLP. Swanson suggested that a long-term contractual
relationship is better than a transactional arrangement when
times are tough, but warned against assuming that a contract
party is solvent.
Hanson encouraged cooperatives to review their business
operations to minimize capital needs while adjusting equity
programs to build a permanent capital base to address capital
risks. Weaver discussed the need for cooperatives to
recapitalize, given the aging of both assets and patrons.
Former owners may be a source of outside capital.
Another approach to build equity was the use of an
unqualified per unit retain, which acts as a pretax
contribution to capital, as opposed to the nonqualified
allocation.
Michael Cook, professor at the University of Missouri,
provided an insightful wrap-up to the conference, noting that
the risk and volatility that characterizes the current economic
landscape was part of every presentation. He summarized the
questions that every strategic analysis should address: What is
the arena of business operations? What vehicles are used to
achieve success in that arena? How does the cooperative
differentiate itself with patrons and suppliers? What is the
timing and staging of business activities? Is there economic
logic to support these answers?
Strategic thinking must also take the behavior of others,
especially rivals, into account, he noted. Furthermore, the
structures used to carry out business strategies are not neutral
regarding benefits and distributions, and ownership and
control. The board has a critical role in considering all of
these questions.
