Diary Co-ops

What they are andwhat they do

By Charles Ling, Ag Economist
Co-op Programs/ USDA Rural Development
e-mail: charles.ling@wdc.usda.gov

Editor’s note: Two previous articles in Rural Cooperatives —
“What Cooperatives Are (and Aren’t)” (Nov./Dec. 2009) and
“What Cooperatives Do,” (March/April 2010) — explain the
economic structure of cooperatives and their role in the
marketplace. Together, these two narratives examine the
economic theory of cooperation as advanced, respectively, by
Ivan V. Emelianoff and Edwin G. Nourse. These writings
constitute a comprehensive framework for understanding
cooperatives (summarized in tables 1 and 2, left column). This
third article examines dairy cooperative practices to illustrate
how well the theory fits the reality, and vice versa. It is
excerpted from the author’s forthcoming research report: “Coop
Theory, Practice and Financing,” which will be available
from USDA.

airy cooperatives, as a group, represent the most prominent of all agricultural marketing co-op sectors. Co-op milk and dairy product sales represented 42 percent of total commodity marketing by all U.S. agricultural cooperatives in 2007 (Deville, et al.). Dairy cooperatives account for a majority of milk sold in the United States, especially at the first-handler level and in the manufacture of “hard” dairy products (butter, cheese and milk powders).

In 2007, there were 155 dairy cooperatives in the nation owned by 49,675 member-producers, or 84 percent of the nation’s licensed dairy farms. They delivered 152.5 billion pounds of milk, or 83 percent of all milk marketed (Ling).

Cooperatives marketed 71 percent of the nation’s butter, 96 percent of nonfat and skim milk powders, 26 percent of natural cheese and 42 percent of dry whey products. Their shares of “soft” and cultured products were less significant: 4 percent of ice cream, 13 percent of ice cream mix, 11 percent of yogurt and 14 percent of sour cream. Co-ops processed 7 percent of the nation’s packaged fluid milk products in 2007.

Mission and functions
There is no mystery as to why so many dairy farmers organize in cooperatives: they seek to jointly and efficiently market their milk far better than they could as individuals. Milk is a “flow” product (cows are milked twice or thrice daily) and is highly perishable; it must be picked up from the farm and delivered to the market (milk plants) soon after it is produced. By working together through their cooperatives, farmers strive for better control over the movement of the milk through the marketing channel and to attain higher value for their milk.

The functions and services the farmers demand of their respective cooperatives vary, depending on the specific market situation the members of a cooperative face and their particular needs. Dairy cooperatives may be charged by members with the responsibility of performing one or more (or all) of the following marketing functions: In addition, dairy farmers may ask their cooperative to leverage its group strength to procure various other services to help sustain their farming operations and farm life. Some of the services may include providing: Organization
Dairy cooperatives can be of any size (and can be local, regional or national in scope), depending on whatever scale the membership considers to be the most appropriate for marketing their milk.

A small local cooperative may have a few member-farms and market less than 1 million pounds of milk a year. A regional co-op may have hundreds or thousands of members in more than one state and handle millions, or even billions, of pounds of milk. The nation’s largest dairy cooperative has about 10,000 member-farms in all of the 48 contiguous states who deliver tens of billions of pounds of milk annually to their co-op.

All dairy cooperatives are known to be centralized organizations with direct membership. A limited number may have other dairy cooperatives as association members, but the practice is usually for accommodating the fact that the cooperative is the marketing agent of all or part of the milk, dairy products or services of these association members.

Dairy cooperatives operating in the same market may form marketing agencies in-common to rationalize milk hauling and shipment for reducing transportation costs, to share market information, or to collectively bargain with buyers for higher prices for milk or dairy products marketed.

Governance
Members of dairy cooperatives exercise ownership and business controls through a board of directors that is elected from among member-farmers. Candidates for the board are typically nominated by a committee of elected members who are not directors. Elections of the directors are usually done at the annual membership meeting.

If a cooperative is large, in terms of membership or geographical area, members may be grouped into districts (or areas/regions/divisions/locals). Directors then may be nominated from the district and elected at the cooperative’s annual meeting. Districts are usually drawn such that members in the same district are more or less homogeneous. Voting at the district level is typically by one member/one vote. The number of directors each district is entitled to may be different due to proportionality considerations based on milk volume. Some boards may have at-large members.

In a large cooperative, a delegate body elected by members may be needed to channel information and make decisions on behalf of the membership. The delegate body may be empowered to represent the membership in all decisions, except for matters that specifically require votes by the entire membership.

A limited number of dairy cooperatives have non-member directors, typically in the states where they are required by law. Non-member directors usually play an advisory, nonvoting role on the board.

An executive committee of elected officers and selected board members may be constituted to facilitate decisionmaking when the board is not in session. The board may also appoint several committees to carry out specific board functions, such as audit, finance, membership and marketing committees.

The board controls the cooperative’s business on behalf of members and makes major decisions; it also sets the policy and determines the overall direction of the cooperative. Management carries out the co-op’s day-to-day operations. Another very important function of cooperative board members is serving as a conduit of communication between the management and the rank-and-file members.

Operations
Dairy cooperatives perform various marketing functions to carry out the most important task of providing an assured market for members’ milk. They may engage in one or more of these activities: Of the 155 U.S. dairy cooperatives, 108 may be classified as bargaining cooperatives because bargaining is their only, or main, marketing activity. Four co-ops are fluid processing operations that do business primarily in processing and distributing fluid products. Another 19 of these businesses are niche marketing cooperatives. The remaining 24 may be called diversified cooperatives, having bargaining and one or more processing/manufacturing functions as their main operations.

Besides assuring a market for members’ milk, dairy cooperatives may also perform some or all of the other milk marketing functions listed in the mission and functions section above. In addition, they may procure farm supplies or provide other services for members.

Dairy cooperatives also provide services to milk buyers in accordance with the terms of trade negotiated, such as delivering milk on schedule, maintaining quality control and related laboratory services, preconditioning or standardizing milk and/or fulfilling full-supply contracts.

Market performance
A cooperative affords dairy farmers the organizational size that is necessary for exercising countervailing power to effectively bargain and deal with milk buyers and other market participants.

The dairy industry has evolved in a way that dairy cooperatives and processors have developed into what may be characterized as symbiotic relationships with a high degree of “division of labor.”

Because dairy cooperatives are organizations of farmers, they have the comparative advantages of working closely with members for assembling milk, providing field services and performing farm-related functions. It is these advantages that accord them the predominant market share at the firsthandler level.

In additon to this dominance in milk procurement, co-ops have the responsibility of balancing milk supply. Many dairy cooperatives maintain plant capacity to manufacture reserve and surplus milk into storable products such as butter, milk powders and cheese. Consequently, they have major market shares of these hard products. Like a reservoir, these cooperative plants absorb milk in excess of demand and provide supplemental milk to the market when it is needed.

Many processors rely on dairy cooperatives for milk supplies that are tailored to their requirements for volume, quality, composition and delivery schedule. They tend to enter into what are called “full-supply contracts” with co-ops so that they can focus their attention on the sectors where they are dominant: making fluid, cultured and soft products (and lately cheese) and further processing and packaging dairy products for the consumer market. These sectors tend to be capital-, technology- and service-intensive and are exposed to high product and market risks.

Farmers, who are generally risk-averse and have many demands on their financial resources on the farm, probably prefer to stay out of these sectors rather than compete headon with processors (their milk customers), as long as the market performs well and their farming business can be sustained.

Still, there are a substantial number of dairy cooperatives operating in these sectors, although as a whole their market share is not high. The upshot is that though dairy cooperatives are generally less active in these sectors, they have the size, organization and wherewithal to enter the market if the situation calls for it.

Financing
Based on the complete financial data of 94 dairy cooperatives for the fiscal year ending in 2007, total assets of these cooperatives were $12 billion (or $8.41 per hundredweight/cwt of milk). Current assets accounted for 60.4 percent ($7.3 billion or $5.08/cwt) and fixed and other assets accounted for the other 39.6 percent ($4.8 billion or $3.34/cwt). These 94 businesses represented 61 percent of all dairy cooperatives and marketed 142.9 billion pounds of milk, or 94 percent of cooperative milk volume (Ling, table 12).

Total liabilities of these co-ops were $8.7 billion. Of this amount, 72.3 percent were current liabilities ($6.3 billion or $4.40/cwt) while 27.7 percent ($2.4 billion or $1.69/cwt) were long-term debts. Equities, the balance of assets and liabilities, were $3.3 billion ($2.32/cwt).

Dairy cooperatives typically pay members for their milk twice a month. A large proportion of the current assets and the current liabilities are for such pending periodic cash payments to members.

This is a unique characteristic of the balance sheet of dairy cooperatives. Therefore, it is important to focus on the ratio of long-term debts to equity in evaluating financial strength, which was 72.6 percent for the 94 cooperatives.

Equities can be grouped into four categories: common stock, preferred stock, retained earnings and allocated equities.

Common stock — In 2007, common stock only accounted for 0.1 percent of total equities. This is because common stock of cooperatives is usually issued for witnessing membership and carries minimal nominal value.

Preferred stock — Preferred stock, as reported, was 7 percent of total equities. A substantial portion of the preferred stock was issued by some cooperatives to members for witnessing retained patronage refunds or for witnessing members’ additional investment in the cooperative and may be considered as allocated equities. It is not clear who holds the remaining preferred stock (probably representing less than 5 percent of total equities); the holders could be nonmembers as well as members.

Retained earnings — Retained earnings could be earnings derived from non-member businesses, but may also include allocated equities that some cooperatives choose not to separately specify in the financial reports, retained net savings that are going to be allocated later, or earnings that are difficult to attribute to specific member transactions.

Therefore, retained earnings that are not likely to be subject to allocations (or considered by some to be “permanent” equity) should be less than the reported 10.8 percent of total equities. In any case, retained earnings belong to the cooperative and therefore are owned by members.

In most cases, non-member businesses of dairy cooperatives are incidental to the dairy operation. These may include: In a limited number of cases, retained earnings are profits from investment activities that may or may not be related to the core business of serving members’ marketing and farming needs.

Allocated equities — The 94 cooperatives reported that 82.1 percent of their equities ($1.91/cwt) were allocated to members. Allocated equities are members’ capital from one or more of these sources:

Retained patronage refunds — Retained patronage refunds are net savings that are allocated to members based on patronage but are retained to finance the cooperative’s operations after a cash portion has been paid to members. Members must treat the entire patronage refund (retained as well as cash payment) as income for tax purposes. Cooperatives usually revolve retained patronage back to members after a certain period of time.

Capital retains — Some cooperatives use capital retains to finance the operations or, more often, for special projects such as building new plants. Money is withheld from milk payment at a certain rate per hundredweight of milk. Members must treat capital retains as income for tax purposes. Capital retains are also revolved back to members after a certain period of time.

Base capital plan — Some larger diversified dairy cooperatives have adopted base capital plans to establish a more stable equity pool. Under such a plan, a target base capital level is established at a rate per hundredweight of milk marketed during a representative period. The base capital may be funded by retained patronage and/or capital retains, or by other means of member contribution. Once a member attains the prescribed base capital level, future patronage earnings allocated to the member are paid in cash.

Members provide almost all equity capital. Counting common stock, preferred stock (that are issued to members), retained earnings and allocated equities, almost all equities (probably more than 95 percent) of dairy cooperatives are supplied and owned by members.

Theory and reality fit
Considering all of the above, it is clear that the economic structure and market performance of dairy cooperatives are in full accord with the economic theory of cooperation as expounded by Emelianoff and Nourse. Dairy cooperatives’ mission, functions, organization, governance, operations, market performance, financing, etc., all conform to the theoretical prescriptions, as tables 1 and 2 show. Cooperation as practiced by dairy farmers in marketing milk is an enduring business model that is in full agreement with the economic theory of what cooperatives are and what cooperatives do.

The dairy market has seen some extreme highs and lows in the past few years. While co-ops tend to be a stabilizing influence on ag markets, they cannot prevent such market shifts. Still, the cooperative form of a business remains the overwhelming choice of dairy farmers for marketing, processing and many related services.

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March/April Table of Contents