Co-op Conversions

Extent of commitment to co-op values
key factor in decisions to convert


By Julie A. Hogeland,Ag Economist
USDA Rural Development,
Cooperative Programs

Editor’s note: the author welcomes
feedback from readers on the topic of co-op
conversions; their thoughts may be used as
subject matter for forthcoming articles on
this topic. E-mail her at: julie.hogeland@
wdc.usda.gov.


ince the early decades of the 20th century, agricultural cooperatives have been associated with particular values that have influenced their marketing strategies. The traditional strength of cooperatives is that they help protect producers by creating a reliable and fair buyer for their products and enabling producers to control their destiny by providing a marketing channel that can extend from raw commodity to finished product.

Co-ops help establish orderly marketing channels and bring balance to markets where producers would have minimal bargaining power in highly concentrated industries. Likewise, they provide a reliable and fairly priced source of production supplies. Co-ops also help strengthen rural communities by keeping more dollars close to home.

What happens to these values when cooperatives convert to a publicly traded corporation? Will producers suffer from narrower marketing choices and/or lower returns? If so, could this create fertile ground for new cooperatives? Does the decreasing number of producers and changing market conditions lessen the need for cooperatives, or are they more vital than ever due to increasing concentration in the food processing and retailing industries?

Professor Michael Cook of the University of Missouri says, “The recent wave of demutualizations raises the question of whether the cooperative model can survive in an increasingly concentrated, deregulated, privatized and global business environment.” This article focuses on several recent co-op conversions (also called “demutualizations”) and some of the issues they raise for their former members, as well as a proposed co-op conversion that was defeated.

For Diamond Walnut Growers, the touchstone for conversion was the cooperative brand and the desire to use it to attract large amounts of outside capital to “grow the brand” and penetrate new markets. For Ocean Spray Cooperative, owner of a major consumer beverage brand, near-acquisition of its brand by PepsiCo became an opportunity to reaffirm that the 76-year-old cooperative was to be held in trust for future generations of growers as a sustainable, valueadded marketer of cranberries.

Within this increasingly concentrated, deregulated, privatized and global business environment, cooperatives have sometimes sought to become “just another business.” This can become a self-fulfilling prophecy. Cooperative values, and the extent to which producers hold them, may make the difference between conversion, acquisition or remaining under producer control.

Protecting farmers vs.
building the brand
Traditionally, marketing cooperatives are often seen as a “competitive yardstick,” providing competition to raise the prices received by producers. Formulated by economist Edwin Nourse, this role emphasized farmers’ collective power or strength in the marketplace. Cooperatives were the “small business Davids” that challenged the “Goliath of big business.” Competition provided through cooperatives kept other firms in the marketplace fair or honest. Even when cooperatives had improved market conditions, Nourse still felt farmer vigilance was required. Cooperatives should maintain on standby, ready to spring into action to protect farmers as needed.

At the core of traditional attitudes is a belief that cooperatives are fundamentally different from investor-owned or publicly- traded firms, hence the need for vigilance like that recently expressed by a manager of a large processing cooperative. Any entity that is not farmer owned and controlled is a competitor that makes it difficult for farmers to compete, he said. “If a corn grower’s crop fails, the processing firm doesn’t care as long as they can continue to get corn from somewhere to make cornflakes.”

Contemporary economic or strategic management discourse is, in contrast, highly optimistic, such that farmer victimization would seem to be a thing of the past. “For most global businesses, the days of flat-out predatory competition are over,” say Morgan and Hunt (1994:20). The new rules of market competition call for networking, partnering and trust. In this setting, the farmer protection provided by cooperatives and even cooperatives themselves can seem like an anachronism.

This market-oriented school of thought tries to minimize the difference between cooperatives and investor-owned firms by examining how well cooperatives perform according to some of the commonly used standards of investor owned firms (IOFs). These include: In contrast, the values encouraged by the competitive yardstick are: Capper-Volstead still vital?
Market-oriented values are in the ascendancy, shaping perceptions of the need for grower protection, or even collective marketing itself. To Mark Hansen, an attorney with Lindquist and Vennum and the architect of several cooperative conversions, the Capper- Volstead Act — which provides limited anti-trust exemption to farmer cooperatives engaged in marketing their products — reflects an era that no longer exists. For that reason, he questions the need for the Act itself.

“Why do farmers need Capper-Volstead?,” Hansen asks. “When do they need to collectively price a product compared with selling it individually to Cargill?” In 1921, farmers were not looking for processing facilities, just product marketing. In that period, the supply of farmers was essentially “endless” compared with today’s very low farm population. And some of them are seeking an exit strategy from farming. Capper-Volstead did not address capitalizing a significant branded product into the marketplace, says Hansen.

How technological aspects of marketing and procurement will affect traditional cooperative issues of equity, equality of opportunity, disproportionate market power or market access is not clear. Agricultural industrialization brought new values, such as “size and scale” and “being a low-cost producer,” to agricultural cooperatives. Consumerbranded products offered growth opportunities that did not exist for the minimally-processed products traditionally handled by cooperatives.

Now, cooperative managers ask, “How can I take the value of the brand, unlock it and make it liquid?” Others ask, “How can I get additional low-cost supply to increase product demand?” As cooperatives became “market-driven” and “value-added” businesses, some industry observers suggest a focus on profit has begun to diminish the other values provided by cooperatives. In documents filed with the Securities Exchange Commission (SEC), cooperatives pursuing conversion routinely state their commitment to market-oriented values such as growth, improving profitability and efficiency, and enhancing the return on the product brand.

The July 2005 conversion of Diamond Walnut Growers into Diamond Foods, a publicly traded firm, offers a commentary on changing cooperative values in some sectors. In 1912, the California Walnut Marketing Association, the precursor of Diamond Walnut Growers, initiated orderly marketing in the walnut industry through a federation of local walnut packing cooperatives. As the federated structure evolved into a centralized cooperative, Diamond Walnut’s strong marketing orientation emerged.

The cooperative became a leading domestic marketer and distributor of culinary nuts. In the late 1990s, Diamond Walnut focused on becoming a more competitive supplier to U.S. grocery chains and, in 2004, launched its Emerald brand of snack nuts. These objectives conflicted with the traditional cooperative values of “enhancing the raw-product price” and providing a home for growers’ product.

As a cooperative, Diamond Walnut’s pricing philosophy was, “A rising sea floats all boats.” Since 1965, Diamond Walnut’s average annual premium above the market has been 1.56 cents per pound (source, Diamond Foods). The Walnut Purchase Agreement accompanying conversion requires growers to deliver their entire crop to Diamond Foods for the duration of the contract: three, five or ten years. The contract offers no price protection or guarantees to pay market prices. Indeed, Diamond Foods has cautioned growers that payments could be reduced compared with the prior marketing agreement.

Producers more vulnerable?
University of California Economist Shermain Hardesty suggests these single-buyer (monopsonistic) conditions could make the contracting growers vulnerable to price manipulation.

“A lot of growers had in their minds that they would still be protected even through the conversion,” commented one former member. “But the company will have to decrease expenses.

Management will procure the cheapest product rather than maximize the price to a grower, as a co-op does. A cooperative would keep the industry from taking advantage of growers.”

At the time Capper-Volstead was enacted, the market power of each one of the “endless supply of farmers” was so limited that economics textbooks described the farmers as “atomistic” compared with the size of the businesses they were up against. Imbalance and disparity continue to describe agricultural markets. Consolidation of agricultural markets in recent decades means many farmers have only one buyer.

National Cooperative Business Association (NCBA) CEO Paul Hazen says the belief that predatory marketing no longer exists is shortsighted. “Cooperatives have made farmers into price setters, not price takers. By selling these businesses, we’ve lost this tool.” Hazen adds that if farmers’ only option is to sell to one huge agribusiness, “they are at the mercy” of that agribusiness.

The durability of the cooperative model — which has lasted for more than 150 years — is being threatened from the inside, many believe. An NCBA study found that most conversions are triggered by management. A small group of people motivated to change the business may present members with an ultimatum and only a very short period of time to vote. The absence of share ownership to compensate and motivate management can be an incentive within cooperatives, in particular for incumbent management to encourage conversion.

With conversion, select members, directors or management can cash-out at one moment in time the long-term value of a cooperative, painstakingly built up through the ups and downs of commodity cycles by (in many cases) several generations of producers. Total stock benefits received by a four-member management team at Diamond Foods could top $16 million, according to NCBA. To avoid short-circuiting members, Hazen recommends an open and transparent process, requiring high thresholds of member approval to approve conversion.

When brand becomes paramount
Another inside threat occurs when many cooperatives’ chief asset, the product brand, comes to drive the cooperative more than the needs of members for whom it was founded. In the mid-20th century, the Californiabased avocado cooperative Calavo mainly identified with and promoted Haas avocados (Stanford and Hogeland). This restricted its ability to grow by attracting members with other varieties. Calavo resolved this by aggressively promoting members’ fruit and establishing its own brand.

Getting full benefit of brand development required more and cheaper avocados than California members could supply, so the cooperative turned Chile and New Zealand. Calavo converted in 2001. Outside investment — e.g., product, equity or foreign-direct investment — may be needed to derive maximum benefit from the market development behind a cooperative’s brand name.

Cooperatives exist to provide a secure market for their members. A coop manager facing heightened import competition brought by trade liberalization said this value represented a “huge incentive” for his processing cooperative not to convert. Perpetually on the lookout for cost advantage, any cooperative which converts could disenfranchise a portion of its former growermembers in rural areas where alternative income opportunities may be scarce.

Although the United States is the leading exporter of walnuts, Hardesty suggests that to fulfill its mission to maximize long-term shareholder value, Diamond Foods may import walnuts from China, the world’s largest producer. California-grown walnuts could then experience reduced demand and depressed prices as a result.

Trade liberalization allows vendors to source globally, to compare prices from many suppliers. This is a “low-cost supplier” model of competition. The economic norm of efficiency renders such competition impartial, even if the impact on raw product suppliers of such instability is in effect not much different from predatory (destructive) competition.

Welch’s, the grape products cooperative owned by National Grape Cooperative, is committed to using the domestic grapes of National Grape members as its “first supplier.” It buys all of the co-op members’ grapes — a reflection of the traditional cooperative value of finding a home for what is produced by members. This holds true whether grower-owners provide as few as five tons per acre or as much as nine tons per acre, as long as quality standards are met.

Supply variation has spurred cooperative growth. Welch’s, like many coops, markets globally. Through market segmentation, global sourcing may supplement domestic production to provide cost and profit advantages that define sustainable competitive advantage. But Welch’s commitment to receive all of the quality grapes produced by its grower-owners is the kind of approach that clearly protects domestic farmers.

Cooperatives ask more of themselves than competing business models and can risk over-extending themselves on behalf of their producers. Almost 20 years ago, economist V. James Rhodes declared, “one of the unique obligations of cooperatives is a commitment to the continuation of past and present member service that goes beyond that of the IOF” (1987:166). The consequences of how this line is drawn may have greater ramifications now than it did in the past. When cooperatives pay higher than the market price, they can tell farmers, “We took care of you; you got the money first, so the co-op didn’t make any money.” Farmers may like this, especially if they are not necessarily concerned about the future of the organization.

Before it can take care of farmers, the cooperative has to be a sound business. Overpaying market prices to members can lead to “capital starvation” within cooperatives. Members need a competitive return on both product marketed and investment. Making investment proportional to patronage is one way to achieve this objective.

Using relationships to build a brand
By seeing other firms as adversaries, the Nourse model of cooperation tended to segregate cooperatives from the rest of the business community. The expression “cooperatives as the Fourth Estate” captured this distinction. Exploiting the concept of the “cooperative difference,” cooperatives established their own version of the marketing or supply channels used by private industry.

Cooperatives tried to “do it all” by providing an integrated food system that took the raw product from “farm gate to plate.” Likewise, Ocean Spray tried to “do it all” by going from “bog to bottle,” managing and controlling every aspect of the supply chain.

In June 2004, Ocean Spray members rejected an offer from PepsiCo that would have given the corporation control of the Ocean Spray brand and juice business. The Nourse “mythology” — which prized cooperatives as “small Davids among Goliaths” — held no sway for those cranberry producers who favored the PepsiCo joint venture. They argued that Ocean Spray could not survive on its own in a world of giants. Too small to go it alone, the cooperative needed a partner, they felt.

The debate over the joint venture was a healthy experience for Ocean Spray. A much deeper dynamic than dollars was involved: at stake was the growers’ right to control their destiny and maintain a multi-generational way of life. Reflecting on the pre- and postdebate period, Ocean Spray spokesman Chris Phillips said, “You can have it both ways—maintain cooperative status and have a major worldwide brand. A lot of people have looked at cooperatives as outdated, but it’s a very bold business model. Cooperatives have to be different in how they partner with others, in distribution, in manufacturing, in how they go to market. A cooperative needs to maintain majority control over its brand so at the end of the day it’s still a cooperative.

“But staying a cooperative doesn’t mean going it alone. By partnering with others, you can still go global and set grower returns on a healthy growth curve. Our returns have more than tripled in the last four years. A cooperative has a different job than a publicly traded corporation, which lowers the price paid for inputs. Ocean Spray’s job is to deliver to members a competitive commodity price and a dividend for owning a major brand.” For approved, contracted acreage, Ocean Spray takes all the fruit grower-members produce.

Less ownership, more control
Within Nourse’s “yardstick” philosophy, farmer control was expressed — or objectified — through investments in tangible assets such as processing plants, grain elevators or marketing facilities. The mark of ownership was often exclusivity, for example, the ability to “drop in” on the manager at will or to conduct site tours that now may be precluded by health and safety restrictions (for example, among artificial insemination or pork cooperatives).

Exclusivity influenced the operating philosophy established for CF Industries, a fertilizer cooperative. It was started in 1946 as a fertilizer brokerage operation by a group of regional cooperatives seeking to pool their purchasing power. CF grew to be one of North America’s largest manufacturers and distributors of nitrogen and phosphate fertilizer products. It was owned by eight farmer cooperatives: CHS Inc., MFA Inc., Growmark Inc., Southern States Cooperative, Land O’Lakes, Tennessee Farmers Cooperative, Intermountain Farmers Association and Cooperative Federee de Quebec.

Through the end of 2002, CF operated as a traditional supply cooperative, focused on providing its cooperative owners an assured supply of fertilizer. SEC documents note that more than 80 percent of CF’s annual sales volume was to its cooperative owners. CF diversified into fertilizer manufacturing and expanded its distribution network, starting in the 1960s, by acquiring several existing plants and facilities. Further expansion occurred during the 1970s and 1990s.

Agricultural cooperatives differentiate themselves from other suppliers by their service orientation. The Middle East oil embargo of the 1970s led cooperative suppliers such as CF and Farmland Industries to make customer needs paramount.

They would not only provide a reliable source of fertilizer in time for spring planting, but would also have sufficient inventory to fill orders should a severe shortage arise.

Protecting members was a strong dimension of CF’s organizational culture and member-owners responded with loyalty. “We stayed in that alliance no matter what,” one co-op official commented.

Loss of flexibility is a drawback of the “ownership equals control” strategy. The commitment to protect members by providing assured domestic supplies reduced CF’s profitability.

High inventory carryovers resulted from the commitment to guarantee that members would not run out of fertilizer, raising CF’s cost of production over time.

Reluctance to source offshore
Regional cooperative ownership of domestic fertilizer assets minimized opportunities for CF to sell outside of the cooperative network. Farmer-members were also sometimes hesitant to see their cooperatives invest in offshore fertilizer assets. CF had an operating loss of $311.3 million in 2004 (Rural Cooperatives).

The geographic advantage of different regions for fertilizer production changes over time, depending on the price of natural gas, a primary feedstock for fertilizer. During the late 1990s through 2003, high U.S. natural gas prices triggered fertilizer import prices to fall below the U.S. cost of production. The energy crisis of the 1970s led to a cooperative norm of assuring supply “no matter what.” Yet, some 30 years had passed without another supply crisis.

Meanwhile, the fertilizer industry had globalized. U.S. or other North American companies were increasingly engaged in offshore production, bringing a degree of control and security to the U.S. industry through these investments. The growth of China and Brazil contributed to making the fertilizer trade international, further lowering the probability of supply restrictions.

Farmers once had resisted imported product because of texture or color. Over time, however, the quality of imports had improved to be commensurate with domestic product. Questioning supply reliability had become less necessary for cooperatives as their size and marketplace clout grew. As major customers, their needs would be met. Loyally making purchases from CF when a competitor was closer or cheaper ultimately created losses for CF’s owners.

These developments changed cooperative norms. In 2002, CF reassessed its corporate mission and chose to emphasize its financial performance over guaranteeing an assured supply to its owners. “Taking care of customers no matter what means you lose money,” one co-op manager said. Others commented: “Why am I competing for this business; if the other supplier has a $10 transportation rate, he should get the business.” “I can’t afford to service that last truckload,” is more important than, “I will never run out of product.”

The conversion of CF was an acknowledgement by its owners that ownership of fertilizer assets was not a prerequisite to securing fertilizer supplies. CF has begun to resemble the “hunter” cooperative described by Rhodes, seeking new customers and activities whenever a profit seems likely because retaining the organization’s original purposes and members will result in lack of growth, or even decline (Rhodes:161).

CEO’s key role
Cooperative conversion offers a commentary on a growing split between members and cooperatives that would have been unthinkable in the era when cooperatives were routinely regarded as an extension of the farm. Conversion represents an “arm’s length” relationship with former members that may begin in stages as the needs of the product brand — or the brand’s customers, such as retail chains — begin to relegate the farmer-owners of the cooperative to a secondary role. The farmer-owners of the cooperative can become non-competitive within their own organization because they don’t produce enough product (in the case of Calavo) or enough equity (Diamond Walnut) to support the growth of the product brand.

Just as conversion represents an internal threat to cooperative stability and coherence, the solution to creeping privatization is also internal. Protecting the market share of producer-members starts with the selection of a CEO who is willing to make this commitment.

Maintaining producer loyalty was a critical issue for cooperatives in the Nourse era of multiple cooperatives competing for the producers’ business. In the contemporary era, some cooperatives have tried to “think outside the box” of cooperative values and recruit CEOs from outside the cooperative sector. Maintaining the loyalty of the CEO to cooperative values in an era of globalization and supply-chain economics may be a new challenge for cooperative members, but it is one within their control.

References




May/June Table of Contents