New Generation Cooperatives

Joan Fulton, Assistant Professor; Brian Jones, Graduate Student; and Lee Schrader, Professor Emeritus

The changing face of agriculture, often referred to as the industrialization of agriculture, is causing increased vertical coordination in virtually all sub sectors of the food system. Increased concentration and increased vertical coordination in agriculture are occur-ring because businesses are trying to increase efficiencies, relay information more quickly, and take advantage of profits at other stages of the food chain. Many agricultural producers are responding to these changes by investing in value-added agribusinesses. One particular business organizational structure that has received considerable attention with respect to vertical coordination is the New Generation Cooperative (NGC). The specific organizational aspects of the New Generation Cooperatives, involving production con-tracts and tradable delivery rights and shares, evolved in response to challenges with the traditional cooperative organizational structure. The following section presents an historical perspective of NGCs, along with a discussion of an Indiana NGC. We also discuss the strengths and weaknesses of this business organization structure.

Growth/Development

The origin of NGCs can be traced to the early 1970s, when the sugar beet producers in the Red River Valley region of North Dakota and Minnesota decided to buy a processing operation using the cooperative organizational model. NGCs have become very popular in the last few years and are currently in, or being explored in, many sectors (e.g., wet corn milling, hog production, pasta production, egg production, and beef processing) of agriculture throughout the United States and Canada. Recent references to this resurgence in cooperative development have been referred to as “cooperative fever,” “hype,” and “getting on the value-added bandwagon.” This hype has been concentrated in North Dakota and Minnesota. An article in Milling and Baking News in 1997 reported that over 50 cooperative projects had been created in Minnesota and North Dakota since 1990. In addition to the Minnesota and North Dakota expansion, producers in other regions of the country, including Indiana, are becoming increasingly interested in New Generation Cooperatives.

The first Indiana NGC is Indiana Family Farms Pork Marketing Copperative (IFF) established in 1997. IFF’s purpose is to operate a live hog marketing facility and a slaughtering and processing facility. The cooperative plans to reactivate the former Emge pork plant in Anderson, Indiana. IFF currently has pork products in retail markets under their own label, with member’s hogs slaughtered and processed under a contract arrangement with other firms. Members using the slaughter and processing track must purchase stock commensurate with their right and obligation to deliver hogs of acceptable quality to the cooperative. Membership is limited to Indiana producers, and Indiana Family Farms pork products are marketed under that name. Although IFF has experienced the challenge of obtaining adequate equity, that is common to many NGCs, they have been successful in placing Indiana Family Farms pork in grocery store meat sections.

Structure

The organizational features found in NGCs are not new. Many of the features can be found in traditional cooperatives. However, it was not until the development of the NGC that all the features came together in one organizational form of business.

Some distinct features of New Generation Cooperatives include:

1. Linking of producer equity contributions and product delivery rights,
2. Tradable equity shares and delivery rights,
3. One-member, one-vote,
4. Earnings distributed to members on the basis of their patronage,
5. Value-added processing of members’ commodities, and
6. Significant equity investment by members.

In general, NGCs are involved in value-added processing of commodities. Unlike traditional cooperatives, NGCs rely on strict delivery contracts to assure a match between product flow and processing capacity. This strict delivery contract is proportional to the shares of equity purchased by each member. Linking equity shares to product delivery rights has many advantages. The members of the cooperative are the patrons, and each of them has a substantial investment in the business. This ownership provides the incentive for the members to behave in a manner that promotes the success of the cooperatives, including meeting delivery requirements and monitoring how management is operating the business. Another important element is that the equity received from the members is available to the cooperative from the beginning. Members can exit the cooperative by selling shares at a price that reflects the value of the cooperative. These trad-able shares allow for a more secure capital base for the cooperative business and capital appreciation if the cooperative is successful in obtaining higher returns for members.

Why the Cooperative “Hype”?

There are many factors that have been cited as contributing to this cooperative “fever.” Some authors have argued that the reduction and phasing out of agricultural support programs is leading farmers to look for alternatives that will decrease the volatility of farm income. To reduce this volatility, many farmers are considering the contractual arrangements of NGCs.

Social and economic conditions in rural areas prompted rural development programs to aid in new business development in North Dakota in particular. However, throughout the country, federal, state, and local governments are becoming more receptive to rural development issues, and NGCs are viewed as an opportunity for continued rural development. Financial grants, to help in the development process, are becoming available from various government sources. In addition, many farmers feel that if they don’t participate in rural development projects, their rural communities will be in serious financial trouble.

It has also been suggested that farmers are currently better off financially and can therefore afford the equity investment in NGCs. Finally, the success of the early sugar beet cooperatives in the Red River Valley region has undoubtedly supported the current wave of cooperative development. These early successes provided a positive, historical perspective as well as knowledge and experience of this new form of business organization.

Strengths of New Generation Cooperatives

NGCs have provided an opportunity for producers to become part of an integrated food system. By integrating, these producers receive a share of the earnings generated from the cooperatives’ processing operations. A second point relates to the issue of market power. Sexton’s research reveals that in food and tobacco processing, most industries have experienced increased concentration over time. Cooperatives provide farmers with a mechanism to integrate around the large processors and also serve as a competitive yardstick for the industry.

NGCs have also been able to over-come two key problems that traditional cooperatives have faced. The first problem is the free-rider problem. The free-rider problem exists because, traditionally, the benefits of a cooperative were based only on a person’s patronage, not actual ownership of the cooperative. This situation created a disincentive to make an equity investment in a cooperative, although investment was critical for the cooperative’s success. NGCs have overcome this problem by tightly linking delivery rights to equity contributions.

The second problem is the horizon problem. This problem refers to the investment perspective of cooperative members. In traditional cooperatives, decisions to make investments are often based on the timing of the expected returns. If an investment is expected to return profits at a future time when a patron is no longer a member, there is very little incentive for that patron to invest in the long-term project. NGCs have solved this problem by allowing tradable equity shares. These tradable shares allow members to capture the value of expected value of the business because the price the shares are traded at reflects the expected future returns of the cooperative (Harris et al.)

Weaknesses of New Generation Cooperatives

It is not surprising to find some weaknesses in the structure of these new business organizations. Since membership in NGCs requires significant up-front equity contribution, there may be many farmers who experience difficulty raising the capital to purchase shares. Inadequate capital can doom a cooperative project to failure. Often, members are required to hold a 40-50 percent equity position. Sometimes this capital requirement is too large, and there is not sufficient membership to support the investment. In these situations the cooperative is never successfully established, even though there is interest among producers.

Farmers who wish to purchase shares after the initial equity drive may have to pay more if the market price of the shares has increased since the initial equity drive. This disadvantage occurs because the market price of the shares (which the producer must buy if he wishes to be a member) reflects the present value of expected returns from future patronage. If the market price of the shares has increased since the initial equity drive, the potential members must not only pay more for the shares, but they are also placed at a disadvantage because they will not receive any gain except that beyond the expectations in place when the shares were purchased (Harris et al.). This disadvantage for prospective members is an advantage for the farmer members who joined the cooperative initially.

There may also be some financial risk implications for producer investment in NGCs. The decision to invest in an NGC from a portfolio perspective can be looked at in the following way. When the producer chooses to become part of the cooperative, a significant up-front equity investment is required. The producer’s investment portfolio, after investment in the cooperative, consists of the farm as well as the cooperative. Given, that in the long run, the same fundamental supply and demand drivers shape the profitability and margins in the entire production, processing, and distribution system, the margins from the NGC may be positively correlated with margins from the farm. If risk reduction was the primary objective, the farmer should find an investment where the margins are negatively correlated (and as close to perfectly negatively correlated as possible) with margins from the farm. Investment in a NGC may not provide the best risk reduction opportunities for producers. In addition, if producers use more debt to invest in valued-added activities, they are increasing their leverage position. This leveraged position increases the producer’s financial risk.

A final weakness is one that is not unique to NGCs but is a problem all cooperatives must deal with effectively if they want to be successful. Determining how best to align the goals of the cooperative organization with the goals of its owners can be very difficult. Sometimes traditional profit maximizing goals need to be reevaluated to determine the impact on the members of the cooperative.

Things to Watch for and Potential Pitfalls

Brent D. Bostrom, Chair of Doherty, Rumble & Butler, Cooperative Law Department, and Dennis A. Johnson, President, St. Paul Bank for Cooperatives, have worked extensively with groups of producers as they organized and established NGCs. They outline the following as potential pitfalls and difficulties most often encountered by New Generation Cooperatives*:

 

• Lack of a Clearly Identified Mission

The motives to form a cooperative must be made up of specific goals that seek to accomplish the mission of the cooperative. Careful analysis is essential if the cooperative is to be strategically competitive in the marketplace in which it operates.

• Inadequate Planning

In order to accomplish the specific goals of the cooperative, detailed plans must be developed to execute every phase of the cooperative’s development process. Knowing who will do what and when is very important to the success of a new cooperative. Poor planning will ultimately lead to the cooperative’s failure.

• Failure to Use Advisors and Consultants

The assistance of experienced con sultants and advisors is very important in overcoming the difficulties associated with starting a new cooperative. Utilizing people from the outside can pay huge dividends in the future. These advisors can provide a strong base of knowledge and information to identify opportunities and threats. Consultants often will provide an honest, unbiased assessment of the potential of the cooperative.

• Lack of Member Leadership

Cooperative businesses are much stronger when the leadership comes from one its members rather than from someone outside the cooperative. A member-leader can provide better communication among advisors, consultants, and other members.

• Lack of Member Commitment

Cooperatives will only remain strong when they have support from a large percentage of their members. The use of delivery contracts pro-vides a formalization of member commitment in the case of NGCs. However, the strength of a cooperative business depends upon a greater level of commitment than is formalized in a contract.

• Inadequate Management

A strong, effective management team that effectively takes care of the ongoing business activities is essential to the success of every business. An important role of the Board of Directors is to choose the manager and outline goals for the cooperative. The team’s job is to follow through to ensure that the goals are executed.

• Failure to Identify and Minimize Risks

Because all business ventures involve risk, it is important to first identify and quantify the potential risks. Once the risks are known, steps can be taken to minimize their impact.

• Overly Optimistic Assumptions

The formation of a business plan requires making assumptions concerning market projections, operating costs, and government policy influences. It is important that these assumptions be realistic so that the business plan can effectively be followed as the cooperative moves forward.

• Not Enough Money and Excessive Debt/Equity Ratio

It often takes longer and more money to get a new venture started than originally thought. An important component of the planning process is to ensure that sufficient cash is available to meet the day-to-day financial obligations as well as maintain a debt/equity ratio that is acceptable to both investors and creditors.

• Inadequate Communication

 

Communication is critical throughout the entire cooperative development process to ensure that organization that evolves is consistent with the expectations of every-one involved. Effective communication must continue as the business begins operation to ensure that the business plan is successfully followed.

• Problems with the Physical Plant

 

The management and directors of the cooperative business must initially monitor the construction phase of the physical plant. The physical plant is a crucial component of the business because value-added processing is often a key objective of the NGC. Monitoring of the construction phase can catch problems like cost overruns, time delays, and building specifications before they become disastrous.

• Noncompetitve Business Location

NGCs must select a business location that will allow them to be a competitive player in the industry. The pressures that may come from producers to locate locally to enhance the rural community must be weighed against the need to be competitive with the other agribusinesses in the sector.

Conclusions

The success of NGCs began in North Dakota and Minnesota. This success has resulted in producers across the United States and parts of Canada becoming interested in this new business structure. NGCs provide an opportunity for farmers to increase efficiencies, relay information more quickly up and down the value chain, and take advantage of profits at other stages of the food chain. Unique characteristics of NGCs include tradable equity shares and producer delivery rights that are tightly linked to equity contributions. This has helped NGCs over-come the free-rider and horizon problems that have threatened the success of traditional cooperatives. However, it is important to remember that all business organizations represent uncertainty and risk. Bostrom and Johnson provide an excellent checklist of things to consider when forming a NGC.

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* The list included here is a summary. A full list of their comments can be found on the cited web pages.

References

Bostrom, Brent D. http://www.mncoop.org/publications-pitfalls.htm, July 7, 1998.

Cobia, David W. 1997. “New Generation Cooperatives: External Environment and Investor Characteristics.” in Cooperatives: Their Importance in the Future Food and Agricultural System. Michael Cook, Randall Torgerson, Tom Sporleder, Dan Padberg (Eds.) Publication of proceedings of Food and Agricultural Marketing Consortium January 1997, Las Vegas.

Johnson, Dennis A. http://www.mncoop.org/publications-financing.htm, July 7, 1998.

Hackman, Deanne L. and Michael L. Cook. 1997. “The Transition to New Cooperative Organizational Forms: Public Policy Issues.” in Cooperatives: Their Importance in the Future Food and Agricultural System. Michael Cook, Randall Torgerson, Tom Sporleder, Dan Padberg (Eds.) Publication of proceedings of Food and Agricultural Marketing Consortium January 1997, Las Vegas.

Harris, Andrea, Brenda Stefanson, and Murray Fulton. 1996. “New Generation Cooperatives and Cooperative Theory.” Journal of Cooperatives. 11, p. 15-28.

Milling and Banking News. 1997. “Industry Activities—Colloquium Speakers See Corn Sweetener Imbalance Into Future,” March 11, pp 16-18.

Sexton, Richard J. 1997. “The Role of Cooperatives in Increasingly Concentrated Markets.” in Cooperatives: Their Importance in the Future Food and Agricultural System. Michael Cook, Randall Torgerson, Tom Sporleder, Dan Padberg (Eds.) Publication of proceedings of Food and Agricultural Marketing Consortium January 1997, Las Vegas.