cooperative in agribusiness

7/31/2019 Cooperative in Agribusiness

1/79


2/79

This publication is written for audiences at the secondary and postsec-ondary levels, or for anyone interested in agricultural cooperatives. It pro-vides a description and brief history of cooperatives, and discusses theirrelationship with agribusiness. This material describes the different types of

cooperatives as well as their structural and organizational characteristics,and explains how they are governed and nanced. It discusses careeropportunities in the cooperative eld, and explores the future of coopera-tives in a constantly changing business environment. Chapters 1-9 areeach followed by brief chapter review questions.

Keywords: cooperatives, agribusiness, principles, practices, organization,structure, nance, careers.

Cooperatives in Agribusiness

Katherine L. HansonEducation SpecialistEducation and Member RelationsRural Business-Cooperative ServiceU.S. Department of Agriculture

Cooperative Information Report 5

March 2002

This report was originally written by Irwin Rust in 1968 and published asEducation Circular 33. It was later superseded by Cooperative InformationReport 5 in 1978, written by Gene Ingalsbe, and has since been revisedseveral times.

USDA's Cooperative Services program is now contained in USDA's RuralDevelopment mission area and housed in Rural Business-CooperativeService (RBS). For a catalog of related publications, please ask forCooperative Information Report 4 and write to USDA/RBS, 1400Independence Ave. SW, Stop 0705, Washington, DC 20250-0705 (phone:202-720-8381 or FAX 202-690-4083). Publications and information arealso available on the Internet. The RBS Web site is:http://www.rurdev.usda.gov/rbs/index.html

Abstract


3/79

CHAPTER 1. HOW AGRIBUSINESS AFFECTS OUR LIVES . . . . . . . . .1

CHAPTER 2. WAYS OF DOING BUSINESS . . . . . . . . . . . . . . . . . . . . . .5

Individually Owned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Investor-owned Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Cooperative Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Limited Liability Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11

CHAPTER 3. WHAT IS A COOPERATIVE? . . . . . . . . . . . . . . . . . . . . . .12

Why Is a Cooperative Started? . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

What Is a Cooperative's Purpose? . . . . . . . . . . . . . . . . . . . . . . . . .13

How Is a Cooperative Different? . . . . . . . . . . . . . . . . . . . . . . . . . . .14

User-owned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

User-controlled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

User-benets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

Limited Return on Equity Capital . . . . . . . . . . . . . . . . . . . . . .16

Important Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Open Membership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Continuing Member Education . . . . . . . . . . . . . . . . . . . . . . . .17

Cooperation Among Cooperatives . . . . . . . . . . . . . . . . . . . . .18

i

Contents


4/79

CHAPTER 4. HOW COOPERATIVES ARE ORGANIZED . . . . . . . . . . .19

Articles of Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

Bylaws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Marketing Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

Membership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

CHAPTER 5. COOPERATIVE STRUCTURES . . . . . . . . . . . . . . . . . . . .22

Local Cooperative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..22

Regional Cooperative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22

CHAPTER 6. WHO RUNS THE COOPERATIVE BUSINESS? . . . . . . .25

Members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25

Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Manager and Staff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27

CHAPTER 7. HOW COOPERATIVES ARE FINANCED . . . . . . . . . . . .29

Capital Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

Capital Needs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

Member Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30

Facility Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

Operating Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

Commodity Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

Special Services Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

ii

Contents


5/79

Revolving Capital Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

CHAPTER 8. TYPES OF COOPERATIVES . . . . . . . . . . . . . . . . . . . . . .36

Marketing Cooperatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37

Bargaining Cooperatives . . . . . . . . . . . . . . . . . . . . . . . . . . . .40

Purchasing Cooperatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41

Related Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

CHAPTER 9. FARM AND HOME SERVICE COOPERATIVES . . . . . . .46

Electric and Telephone Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

Rural Utilities Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47

Rural Telephone Service . . . . . . . . . . . . . . . . . . . . . . . . . . . .49

Farm Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50

Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Housing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

CHAPTER 10. COOPERATIVE CREDIT SERVICES . . . . . . . . . . . . . . .54

Farm Credit System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54

Credit Unions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Organizations Serving Cooperatives . . . . . . . . . . . . . . . . . . . . . . . .57

iii

Contents


6/79

CHAPTER 11. CANVASSING COOPERATIVES IN YOUR AREA . . . . .59

CHAPTER 12. A COOPERATIVE FOR YOUR GROUP . . . . . . . . . . . . .62

CHAPTER 13. CAREERS IN AGRIBUSINESS . . . . . . . . . . . . . . . . . . . .64

Variety of Careers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65

Education Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65

CHAPTER 14. COOPERATIVES IN THE YEARS AHEAD . . . . . . . . . . .67

iv

Contents


7/79

How Agribusiness Affects O ur Lives

You might not be familiar with the terms "cooperative" or "agribusi-ness," but chances are you benefit on a daily basis from the prod-ucts and services they provide.

We all reap the benefits of agribusiness, from the food we eat to theclothes we wear. Whether you are a student, executive, technologyexpert, or farmer, you are first and foremost a consumer. America reliesupon agribusiness to feed, clothe, and house her 284 million citizens. Theefficient production, processing, and marketing of food and fiber is whatagribusiness is all about.

1

CHAPTER 1

Some of the many branded food and beverage items produced by agriculturalcooperatives.


8/79

Agribusiness is just what the name impliesagriculture in business.When you buy chicken, beef, pork, vegetables, fruit, juice, eggs, milk, orsimilar products at your supermarket, you depend on agribusiness. Inaddition to supplying us with these basic necessities, agribusiness also

provides jobs and income for nearly one-fifth of America's workforce. Inone way or another, we all depend upon agribusiness to fulfill our needs.Because of this interdependence, agribusiness is our business.

Cooperatives provide many services and products. Did you drink anyFlorida's Natural orange juice or Ocean Spray cranberry juice today? Youmight have spread Land O' Lakes butter or Welch's grape jelly on yourtoast. Maybe you ate some Sun-Maid raisins or a Sunkist orange as asnack, or packed Tillamook or Cabot cheese or Snyder's potato chips inyour lunch. Your dinner tonight might include Farmland ham andBirdseye vegetables. These well-known foods and beverages all have onething in common: they are all produced by farmer cooperatives. Youmight be surprised to discover how many of the brand-name items thatyou use or consume every day come from cooperatives.

What makes these products unique is that the farmers who producedthem are also the owners of the company that helped to bring them toyour table. A cooperative is simply a type of business that is owned andcontrolled by the people who use its services.

But cooperatives don't simply provide food and drinks for our tables.Many cooperatives provide goods or services such as utilities, savingsand loan services, insurance, and farm supplies to rural and urban resi-dents. You might recognize some of these cooperatives by name, such asCoBank, Central Electric Power Cooperative, CHS Cooperatives, orSouthern States. They are just a few of the nearly 48,000 cooperatives inthe United States that generate more than $120 billion in annual economicactivity for about 100 million members.

Cooperatives have a significant impact on the employment situations ofrural Americans as well. Although the number of farmer cooperatives hasdeclined in recent years to about 3,346, they still accounted for 254,658full-time, part-time, and seasonal employees in 2000. The decline in theoverall number of cooperatives reflects the ongoing trend of mergers,consolidations, and acquisitions. However, there are more members (3.09

2


9/79

million) of farm cooperatives in the United States than there are farmers(more than 2 million), because many farmers belong to more than onecooperative. So even though the number of cooperatives has decreased,farmers still depend on them. Twenty-seven percent of total farm market-

ings in 1999 was attributed to cooperatives.

Consider that almost 11 million people in rural areas relied on rural elec-tric cooperatives for their power in 2000, while 569 rural credit unionshelped their 3.8 million members save more than $18 billion. Likewise,1.4 million subscriber/members received their telephone service from 220rural telephone cooperatives. Thousands of isolated homes access theInternet in this age of technology, thanks in large part to the service pro-vided by these utility cooperatives.

These numbers sound staggering, but the contribution of cooperativebusiness to rural America is immense, and cannot be measured by statis-tics or dollars alone. Farmers are not the only ones who reap the rewards

3

Agribusiness and membership in cooperatives is a way of life that is often passedfrom one generation to the next in rural families. Photo courtesy Farmland


10/79

of cooperative businesses. Cooperative housing helps people access bet-ter living conditions while connecting them with a support network ofothers with similar needs and interests. Both rural and urban residentsbelong to group medical, hospital, or health associations. Many use coop-

erative child-care services, read Associated Press news articles, andbelong to a state affiliate of the American Automobile Association orlocal credit union. These people are receiving the economic benefits of thecooperative, in proportion to their use of it. Cooperatives help bring peo-ple together to acquire goods or services not otherwise available to indi-viduals. By joining a cooperative and taking advantage of economies ofscale and combined buying power, members realize greater savings andgreater return on their investments. Moreover, members control thedirection and growth of their business, with a vested interest in eachbusiness decision made by that cooperative.

The cooperative form of business is useful to people regardless of wherethey live or how they earn their living. As these examples illustrate, thelife of every American is touched at some time or another by cooperativeenterprise. For these reasons, it is important for each of us to betterunderstand what cooperatives are, how they operate, and how they relateto agribusiness.

Chapter 1 Review

1. Name three cooperatives that produce brand name consumer goods.2. How many farmer-owned cooperatives are there in the United States?

How many cooperatives of all types are there in the United States?

4


11/79

W ays of Doing Business

Our private enterprise system

has three basic types of busi-ness organization: the indi-

vidually owned business, the part-nership, and the corporation. Anincreasingly popular type of businessownership is called a limited liabilitycompany (LLC). Cooperatives notonly have some things in commonwith each of these business types, butalso differ greatly in some respects.Each type of business organization

will be discussed in more detail later (table 1), but it is important to notethat although some cooperatives are operated informally, most are classi-fied as corporations.

Individually Owned

The individually owned business is more prevalent in farming than inany other segment of our economy. As owner-operators, farmers makemanagerial decisions and assume the risks. A farmer may choose to plant100 acres of wheat one season, but may also suffer the consequences if thecrop is damaged by drought. The farmer-entrepreneur is not only theemployer but also contributes much of the physical labor required.

Farms are achieving ever-higher levels of efficiency and production withimproved machinery and increasingly large acreage. Many other indus-tries typically benefit from additional employee resources and a divisionof labor uncharacteristic in farming. A farmer is a combined owner, man-ager, and laborer. Although some farms are family-owned corporations,most are still individual operations.

There are distinct advantages and disadvantages to an individuallyowned business that must be considered when weighing the businessstructure options:

5

CHAPTER 2

Cooperative member-owners are partnersin the business.


12/79

6

T a

b l

e

1

C o m p a r

i s o n

o f

M e t h

o d

s

o f

D o

i n g

B u s

i n e s s C o r p o r a t

i o n

C o r p o r a t

i o n

F e a t u r e s

C o m p a r e

d

I n d

i v

i d u a

l

P a r t n e r s

h i

p

L i

a b i l i

t y C o m p a n y

I n v e s t o r - O r

i e n t e

d

C o o p e r a t

i v e

W h

o u s e s t

h e

N o n - o w n e r

c u s t o m e r s

G e n e r a

l l

y n o n -

G e n e r a

l l

y n o n -

G e n e r a

l l

y n o n -

C h i

e

y t

h e o w n e r

s e r v

i c e s ?

c u s t o m e r s

c u s t o m e r s

c u s t o m e r s

p a t r o n s

W h

o o w n s t

h e

T h

e i

n d i

v i d

u a

l

T h

e p a r t n e r s

T h

e

m e m

b e r - o w n e r s

T h

e s t o c

k h

o l d

e r s

T h

e

m e m

b e r - p a t r o n s

b u s

i n e s s ?

W h

o

v o t e s ?

N o n e

n e c e

s s a r y

T h

e p a r t n e r s

T h

e

m e m

b e r - o w n e r s

C o m m o n

s t o c

k h

o l d

e r

s

T h

e

m e m


H o w

i s v o t

i n g

N o n e

n e c e

s s a r y

U s u a

l l y

b y p a r t n e r s '

U s u a

l l

y b

y m e m

b e r -

B y s

h a r e s o

f

U s u a

l l

y o n e m e m

b e r ,

d o n e ?

s h a r e

i n c a p i t a

l

o w n e r s s

h a r e

i n c a p

i t a

l

c o m m o n

s t o c

k

o n e - v o t e

W h

o d

e t e r m

i n e s

T h

e i

n d i

v i d

u a

l

T h

e p a r t n e r s

T h

e

m e m

b e r - o w n e r s

C o m m o n

s t o c

k h

o l d

e r

s

T h

e

m e m


p o l i

c i e s ?

a n

d d i

r e c t o r s

a n

d d i

r e c t o r s

A r e r e t u r n s o n

N o

N o

N o

N o

U s u a

l l

y 8

%

o w n e r s

h i

p

c a p i t a

l l i

m i t e

d ?

W h

o g e t s t

h e

T h

e i

n d i

v i d

u a

l

T h

e p a r t n e r s ,

b a s e

d o n

T h

e m e m

b e r - o w n e r s ,

T h

e s t o c

k h

o l d

e r s

i n

T h

e p a t r o n s o n a

o p e r a t

i n g

m u t u a

l a g r e e m e n t

b a s e

d o n m u t u a

l

p r o p o r t

i o n t o s t o c

k

p a t r o n a g e

b a s

i s

p r o c e e

d s ?

a g r e e m e n t

h e

l d


13/79

Pros Cons

1. It is easy to control 1. Any losses are borne bythe owner'sjudgement the ownerthey cannot be

is final shared.

2. Any profits belong solely 2. Capital is limited by what theto the owner and need . owner can provide or borrow.

This, in turn, can limit the sizeof the business.

Partnership

A partnership business is jointly owned and operated by two or morepeople. They provide or borrow the capital needed to start and operatethe business, make decisions by mutual agreement, and share the respon-sibility of repaying the debts. In essence, they divide the income andshare the losses.

Farming partnerships are common, especially between parents and theirchildren. When a child reaches a responsible age, the parent may furnishthe land and facilities and the son or daughter may provide much of themanual labor. Each partner might own livestock separately or purchasesupplies individually, and yet still share other operating expenses.

The partnership has major advantages and disadvantages compared withindividual proprietorship:

Pros Cons

1. The amount of available capital 1. Each partner is liable for anyis usually greater. all debts of the partnership

is known as limited liability).

2. Several partners may bring 2. If one of the partners dies orspecial skills and training wishes to leave theinto the business. organization, it must be dis

solved and a new partnershipformed.

7


14/79

Corporation

There are two kinds of corporations in the United States: investor-ownedfirms (IOFs) and cooperatives. Both business organizations are state-char-tered and are usually organized under the laws of the state in which theyhave their main office.

Investor-owned Firm

An investor-owned firm (IOF) is operated as a for-profit business. Capitalfunds are obtained by issuing shares of stock that can be purchased byinvestors for their profit-making potential. The price of such stocks canfluctuate from day to day, depending on the current stock exchangeactivity.

Stock shares of many IOFs are bought and sold daily, or "traded," onstock exchanges, such as the New York Stock Exchange. A stockexchange is actually a form of cooperative. Members are stockbrokers --people or businesses who buy and sell stock for their customers, whomay be corporations, partnerships, or individuals.

Because stock prices can climb or fall so rapidly, stockbrokers must close-ly monitor the activity of their customers' stock shares. In fact, most daily

8

Cooperatives often process their members crops and livestock into value- added products,as occurs at this sugarbeet processing facility in Minnesota. Photo courtesy AmericanCrystal Sugar


15/79

newspapers in major cities throughout the world publish stock marketshare prices and number of shares sold. Most television news channelsfeature a stock market segment in their daily programs and some contin-uous news programs such as CNN Headline News also display a constant

stock market "window" on their viewing screen.

IOFs supplement the capital they derive from the sale of stock shares byborrowingeither from banks or other financial institutions, or fromindividuals.

Corporations have several advantages over partnerships. They have per-petual existence, limited liability for individual shareholders, and trans-ferability of shares.

An IOF is a legal entityan artificial person created when the state issuesthe corporation a charter to do business. Therefore, if one or more of theinvestors wants to withdraw from the business, it can still exist and oper-ate. This is called "perpetual existence." Because stockholders have limit-ed liability, if the corporation fails, they only lose the amount of theirinvestment.

Shares of a business can be bought and sold or transferred. Any individ-ual or business can buy or sell shares of an IOF without approval fromother investors. The capital base of a corporation can be very broad.Thousands of stockholders may have invested in the corporation by pur-chasing shares of stock.

Cooperative Corporation

A cooperative corporation is also a state-chartered business, like an IOF.It closely resembles any other firm that does the same type of things orperforms similar services. Structurally, the cooperative corporation looksabout the same as any other corporation. It employs the same kind of per-sonnel in similar jobs. It usually charges the same price for productionsupplies, and may pay the same price for products marketed through itsuch as grain, dairy products, cotton, fruit, vegetables, honey, or live-stock.

9


16/79

However, unlike an IOF, cooperatives exist to provide economic servicesto their member-users, rather than just to generate a return on invest-ment. Cooperatives, like other businesses, rely on profits to sustain theorganization and ensure that it is able to provide necessary programs and

services to its members. Part or all of its capital comes from membersrather than from outside investors. This capital is obtained in one of threeways: (1) through membership fees or sale of stock, (2) by agreementwith members to withhold a portion of net income based on patronage,or (3) through assessments such as per-unit of product sold or purchased,per-acre, per-cow, and so on.

Cooperative stock is not created for speculative gain purposes, and there-fore is not generally traded on stock exchanges. In typical open-member-ship cooperatives, there is little or no prospect for an increase in the mar-ket value of cooperative stock as a reflection of corporate earnings. This isbecause net income is distributed on the basis of patronage, rather thanon the amount of stock owned. Although cooperative stock signifies own-ership, it usually only represents one vote per member, regardless of theamount of stock that owner holds. Further, the stock usually carries afixed rate of return not to exceed 8 percent.

The stock purchases of new generation cooperative members are associat-ed with delivery rights that represent a commitment to deliver raw prod-ucts to the cooperative. These cooperatives often have an internal marketfor trading of these shares which may appreciate or depreciate in valuedepending upon performance in value-added activity.

Member-owners in both open and closed membership cooperatives arealso the patrons or users of the cooperative, and are largely responsiblefor financing their business. However, like other businesses, cooperativesalso rely on various forms of borrowed capital in addition to the capitalobtained from the member-patrons. The Farm Credit System is a majorsource of that outside capital.

Like IOFs, cooperatives are mostly incorporated to provide their mem-ber-patrons the shelter of limited liability if the business should fail. Inrare instances, small cooperatives that provide a limited number of ser-vices may choose to operate as an unincorporated business. Under suchcircumstances, the cooperative's legal status is similar to a partnership.

10


17/79

Liability is unlimited, and the death, entry, or withdrawal of a membermakes it necessary to restate (usually in writing) the nature of the rela-tionship between members.

Limited Liability Company

The limited liability company (LLC) is a hybrid business structure thatcombines characteristics of both a partnership and a corporation. It com-bines the single-tax treatment of a partnership with the limited personalliability of a corporation. As in a cooperative, LLC owners are calledmembers.

It takes at least two members to form an LLC. Its owners have no restric-tions concerning their role in the business. Contrary to common coopera-tive practice, they are free to become involved in the management of thecompany. They usually provide the equity capital, but their voting rightsare determined by an operating agreement, and not necessarily based onpatronage.

In an LLC, members share the profits and losses according to the estab-lished operating agreement. However, this percentage of responsibility isusually based on the amount of capital invested and the nature of thework performed by each member. The operating agreement also affordsmembers the freedom to determine how the income is to be divided.Perhaps one disadvantage of an LLC is the significant expense incurredat startup. A substantial amount of legal work, including the filing of twodocuments with the Secretary of State, is required to get an LLC estab-lished and operating. These required documents consist of the articles oforganization and the operating agreement.

Chapter 2 Review

1. Discuss the four ways of doing business in the United States.2. Where do cooperatives most often fit and for what reasons?

11


18/79

What Is A Cooperative?

Cooperatives are a

different approachto reaching a com-

mon goal. Members worktogether to achieve goalsthat they would not beable to achieve individual-ly. Some of the differencesof cooperatives are inoverall purpose, how theyoperate, in their gover-nance, and how they arecontrolled.

There are other differ-ences and distinctive characteristics that set cooperatives apart fromother types of businesses. These differences become apparent whenattempting to define a cooperative.

Any definition of a cooperative requires two key ingredients: it must bebroadly applicable and yet sufficiently concise to be easily understoodand remembered by the typical cooperative member. A simple, workabledefinition is:

"A cooperative is a user-owned and democratically controlled business inwhich benefits are received in proportion to use."

Such a definition captures the essence of what a cooperative is, but eventhis widely accepted definition requires elaboration to meet a wide arrayof legal requirements, while still describing the diversity of cooperatives.This basic definition, for example, does not answer three fundamentalquestions: (1) why is a cooperative started; (2) what is its purpose; and (3)how is it different from other forms of business?

12

CHAPTER 3

Cooperative board members conduct regular meetings.


19/79

Why Is a Cooperative Started?

Every cooperative has been started for one or more of the following rea-sons:

1. to improve bargaining power when dealing with otherbusinesses;

2. to reduce costs;3. to obtain products or services not otherwise attainable as an

individual;4. to gain market access or enhance marketing opportunities;5. to improve product or service quality; and6. to increase income.

Of course, the underlying rationale for a farmers use of cooperatives is toincrease income. Initially, cooperatives sought to increase farmers bar-gaining power with the much larger businesses that sold them suppliesand marketed their products. More recently, cooperatives have expandedtheir activities to fulfill the needs of a changing agricultural environment,and are trying to help their members take advantage of additional oppor-tunities to increase their income.

What Is a Cooperatives Purpose?

A cooperatives sole purpose is to serve members needs. Whether thoseneeds reflect some or all six reasons, cooperative member-owners havethe freedom to tailor their business to fit those needs. This requires a con-tinuing, fluid dialog between members and management, and flexibilityin the functions and operations of the cooperative. Just as in any busi-ness, member needs and requirements change based on both externalmarket factors and personal choices.

Although the purpose allows for a certain amount of flexibility in direc-tion, it does not permit a cooperative to strike off "on its own," seeking toperpetuate itself as a business entity or to fulfill the personal ambitions ofits management. Members must understand the cooperative's purpose ofmeeting their needs cannot be in conflict with serving in the public inter-est. To do so would go against the cooperative's basic mission. The coop-erative's purpose must remain compatible with the characteristics thatmake it a unique business.

13


20/79

How Is a Cooperative Different?

Understanding a cooperative requires one to clearly distinguish betweenthe principles that create its uniqueness and other characteristics that

may be desired "principles," but are based on common sense. For exam-ple, "give full weight and measure" and "duty to educate" have beendescribed as cooperative principles, because honesty and education areso critical to success. But these principles (better called practices) don'tdistinguish cooperatives from other businesses.

Discussion of cooperative principles and practices, therefore, should beprefaced with a definition of terms. Understanding comes easiest bydefining a cooperative principle:

"A cooperative principle is an underlying doctrine or tenet that defines oridentifies a distinctive characteristic."

Various writers over the last century or so have observed and analyzedthe application of cooperative principles. Three key principles emerge asbeing recognized and widely practiced for more than 150 years. Theseprinciples are more than good practices, policies, or common sense. Theydistinguish a cooperative from another kind of business. More important-ly, they are recognized in federal and state statutes as criteria for a busi-ness to qualify as a cooperative.

The three contemporary cooperative principles are:G user-owned;G user-controlled; andG user-benefits.

User-owned

The people who use the cooperatives own it, and are responsible for pro-viding the necessary financial backing to keep it operating.

User-controlled

The first principle characterizes how a cooperative fulfills its purpose.User-controlled is a governance principle, an important distinction.

14


21/79

Because they own the cooperative, members also control its activitiesthrough voting privileges. In most instances, cooperatives have a "onemember, one vote" policy, regardless of how much equity members ownor how much they patronize the organization. Assigning each member

only one vote ensures the democratic control of the cooperative, althoughthere are exceptions to this policy that still allow for equitable voting. Afew cooperatives have experienced such a shift to heterogeneous mem-bership and resulting disparity of use that voting proportional to use hasbeen adopted with established limits. The number of additional votes isusually limited, for example, thus protecting the interests of the member-ship as a whole. Such a departure from equal voting rights recognizesthat the glue binding members to the concept of unity remains mutuallybeneficial. Voting according to volume at the secondary (regional) coop-erative level is often necessary to support equitable service at the primarylevel.

User-benets

Members unite in a cooperative to get services otherwise not available, toget quality supplies on a timely basis, to have access to markets, or forother mutually beneficial reasons. Acting together gives members theadvantages of economies of size and bargaining power, and allows themto share the cooperative's earnings on a basis proportionate to their use.These profits are returned in the form of patronage refunds. The coopera-tive attempts to fulfill member needs at the least possible cost. However,determining true costs at the point of transaction is practically impossi-ble. Like other businesses, cooperatives charge competitive market pricesand seek to generate sufficient income to cover costs and meet continuingoperating capital needs. Year-end profits are distributed to members aspatronage returns (cash and stock).

Members gain both directly and indirectly from belonging to a coopera-tive. They get an assured source of supplies and market for their prod-ucts, which can directly increase their income. They also get a less tangi-ble benefit because cooperatives serve as competitive yardsticks in themarket by which the performances of other businesses are measured.Some members gain valuable leadership experience, business knowledge,and social recognition by serving on the board of directors. All of these

15


22/79

benefits accrue in proportion to how much members take advantage ofwhat their cooperative offers. It is logical, therefore, that members areobligated to provide financing in proportion to the use of the cooperativethat produced those benefits. As a business, the cooperative has ordinary

costs that member-owners are obligated to pay.

All of these principles focus on the user-member and set cooperativesapart from other types of businesses. Another aspect unique to coopera-tives that defines how the member-owners (investors) receive returns ontheir capital investments is referred to as "limited return on equity capi-tal."

Limited Return on Equity Capital

Members form a cooperative to get a service such as a source of produc-tion supplies, a market for their products, or a specialized service.Regardless of the service provided by the cooperative, members seek toget service and not a monetary return on their capital investment.Limiting the payment, if any, for members' capital used to operate thecooperative supports the principle of distributing benefits proportional touse. Returns to capital are subservient to the value of services received.

Cooperatives limiting returns on capital is recognized in both federal andstate laws. They specify the maximum returns that may be paid oninvested capital. Cooperatives may choose to pay any amount less thanthe maximum. In most state statutes, the limit on capital returns is fixedat 8 percent. The basic federal cooperative law, the Capper-Volstead Act,recognizes this principle by setting a maximum dividend rate of 8 percentper year if members vote on any basis other than one-member, one-vote.

A cooperative generally does not retain the surplus of gross income overexpensescalled "profit" in an IOF. Instead, organization papers estab-lish the obligation of the cooperative to return net margins to its patrons.With this obligation or legally binding contract in effect before any trans-action with patrons takes place, the amounts involved never become cor-porate income. The net income, instead, belongs to patrons. This reducesthe cooperative's operations to an at-cost basis. With no corporate

16


23/79

income, the cooperative has no corporate income tax liability. However,federal income tax laws set up criteria a cooperative must follow so thattax obligations are met at either the cooperative or patron level.

Some cooperatives may distribute patronage refunds only to members. Inthis case, the earnings generated from nonmembers are treated as corpo-rate income by the cooperative and are subject to corporate income tax.

The Internal Revenue Code requires that 20 percent of the patronagerefund be paid in cash, and that patrons consent to the cooperative treat-ing the noncash portion as ordinary income. Under certain circum-stances, some patrons are unwilling to recognize noncash allocations aspart of their current income. In these cases, the cooperative pays the taxesat the corporate rate but can recover the tax payments when it laterredeems its noncash allocations.

Important Practices

Beyond the three basic principles, cooperatives adhere to many otherimportant generic practices that are also followed by other businessesand organizations. Among these are:

Open Membership

This policy is considered a key practice of food, health, housing, andother types of consumer cooperatives. Yet, this practice alone does notdistinguish cooperatives from public stock corporations that allow any-one to buy stock. Agricultural cooperatives are limited to bona fide farm-ers or producers. Some of these have closed membership. The type andpurpose of a cooperative will largely determine whether it can practiceopen membership.

Continuing Member Education

Keeping owners educated and informed about their business is an impor-tant practice for any organization, but it is particularly vital to a coopera-tive for at least three reasons:

17


24/79

1. The democratic control principle, exercised through majorityrule, requires that the entire membership be well informed toassure enlightened decisions;

2. The cooperative can be responsive to members' needs only if the

members express those needs and recognize that they must bearthe financial burden to fulfill those needs; and

3. Our public education system doesn't give much instruction oncooperatives in business and economic courses, so cooperativesmust become their own educational institutions.

Cooperation Among Cooperatives

The statement "Cooperation Among Cooperatives" was adopted by theInternational Cooperative Alliance in 1966, updated in 1995, and is stillemphasized today as a "principle" that cooperatives should pursue toadvance the concept of cooperation worldwide. In reality, it is also agood policy wherever members' resources can be used more effectivelyand the public interest served more efficiently.

It can be solidly argued that other generic principles, practices, and "goodideas" are necessary guiding forces for cooperatives. These recognizedguidelines will undoubtedly change over time, reflecting efforts to adaptthe cooperative structure to an ever-changing business environment.

Chapter 3 Review

1. Cite three reasons why cooperatives are started.2. What are the three contemporary cooperative principles?

18


25/79

How Cooperatives Are Organized

Cooperative businesses are

usually incorporated. Thefirm prepares a set of

papers called Articles ofIncorporation. These papers arethen sent to the appropriate stateoffice (usually the Secretary ofState) for review, approval, and fil-ing.

Articles of Incorporation

The articles specify the name of theorganization, its purpose, the scopeof its authority, its place of businessor headquarters, the number ofdirectors, and whether the corpora-tion's capital is stock or nonstock.

The articles define what the cooperative is going to do and how it isstructured and governed.

An incorporated cooperative possesses the legal characteristics of aninvestor-oriented corporation. It differs primarily in the nature of therelationship between the organization and its owners and in how benefitsare distributed.

Bylaws

All corporations, including cooperatives, must also have a set of bylawsthat tell how the corporation is going to operate. They are normally pre-pared concurrently with the articles of incorporation, because the twolegal documents are interrelated. Both are prepared by an attorney orother legal counsel.

Bylaws are more descriptive and detailed than the articles of incorpora-tion. They typically contain provisions for membership eligibility, elec-

19

CHAPTER 4


26/79

tion of directors, annual meetings, officers' duties, voting rights, dues andassessments, and rate of dividends (if any) to be paid on member capitalinvested.

The exact nature of services to be provided by the cooperative for itsmembers is not generally spelled out in the bylaws. Periodic changes maybe made to accommodate altering needs. Some flexibility in bylaw provi-sions is needed because amending them is a lengthy, time-consumingprocess.

Marketing Agreements

In a marketing cooperative, a marketing or membership agreement maybe referred to in the bylaws as a separate document or included in a spe-cial section. A marketing agreement is a contract between the cooperative

20

Co-op board members must carefully review all new and revised bylaws, and shouldenlist the guidance of an attorney or qualified expert to help draft or review them.


27/79

and a member. It may require the member to deliver and market all pro-duction through the cooperative, produce a specific commodity on spe-cific blocks of land, and follow production provisions.

The marketing agreement might also stipulate that the cooperative isobligated to receive and market the entire commodity delivered by themember under the terms of the contract.

Membership

The relationship between a cooperative and its members often dependson the type of service performed.

Marketing associations, for instance, require a formal application andissue a membership certificate. In some instances, the application must beaccompanied by payment of a membership fee, usually refundable if themember withdraws. In purchasing cooperatives, for instance, member-ship is identified with patronage. A patron making a purchase becomeseligible for membership by qualifying as a producer. A nonmemberpatron ordinarily is not affected by a cooperative's bylaws.

Chapter 4 Review

1. What two legal documents are required to incorporate a cooperative?What is the purpose of each?

2. Describe two areas a marketing agreement covers.

21


28/79

Cooperative Structures

The geographic areas a coop-

erative serves and themakeup of its membership

are elements that contribute tohow it is classified by structure.For instance, they may be differ-entiated as local or regional coop-eratives.

Local Cooperative

A local association serves individ-ual members in a community,county, or even several counties.These associations usually per-form a limited number of the firststeps involved in marketing.Farm supply cooperatives salesare at the retail level. Local associ-ations often affiliate with otherlocals in a regional cooperative.

Regional Cooperative

A regional cooperative usuallyserves an area of multiple counties, an entire state, or a number of states.Two important classifications of regional cooperatives are based entirelyon the makeup of their membership: federated or centralized.

A federated regional serves smaller local cooperatives that are operated bylocal managers appointed by and responsible to local boards of directors.Each local is a separate corporate entity that owns a membership sharethat entitles it to vote on matters pertaining to the regional.

22

CHAPTER 5

Cooperatives operate sophisticated processingand handling facilities throughout the UnitedStates. Photo courtesy CHS


29/79

The federated cooperative (a federation) has its own chief executive offi-cer and staff, and a board of directors elected by and representing thelocal associations.

While autonomous, local cooperatives depend by varying degree on thefederation for a variety of services. In purchasing federations, the servicesmay include research, procurement, and manufacturing. In marketingfederations, the locals often want services such as federated advertisingand product promotion, marketing, processing, handling surpluses,maintenance of product standards, and overall market contracts. Localsoften look to their federations, for example, to arrange and coordinateshipments.

A regional centralized association is structurally similar to a small-scalelocal cooperative and has individual members. A centralized regionalserves patrons in a large geographic area, such as a major portion of astate, an entire state, or all or parts of several states. A centralized region-al has a central office, board of directors, and chief executive officer whosupervises the entire operation. It may even have several branch offices.However, a centralized cooperative usually serves patrons within the rel-atively restricted membership area of a single state or region.

Both centralized and local associations obtain much of their capital frommembers who are investing as individuals. The federation is financed inpart by its local member associations.

Federated cooperatives are often thought to be more practical for largermembership areas because of the distances involved. Problems of plantsupervision, decisionmaking, and communication are augmented whenlocations are widely scattered.

Usually the local cooperative is small enough to permit frequent directcontact and the exchange of ideas, impressions, and information betweenmembers and employees. However, definitions vary and it is difficult toassign any single appropriate label in reference to size. A local coopera-tive may serve as few as 5 or 10 members or as many as several thousand.

Regardless of size, federated, centralized, and local cooperatives sharethe premise of democratic control. For example, each of several locals in

23


30/79

an area may have a director who also serves on the federated board. Onthe other hand, a centralized cooperative may elect its board of directorsunder a districting arrangement that assures a broad representation.Other centralized associations may use advisory committees that provide

channels of communication to management directly or through branchoperations. No matter what governance structure is adopted, electedindividuals who are representative of the membership population repre-sent each cooperative democratically.

Classification of cooperatives into federated, centralized, and local cate-gories is largely for descriptive purposes. There are exceptions to theaccepted classifications. For example, some regionals may have "mixed"membership comprised of individuals as well as local associations. Inpractice, the federation may have so many responsibilities and activitiesthat it is essentially a centralized operation. Examples of these are man-agement contracts with local affiliates, credit arrangements, and systemsfor distributing supplies directly from the federation to the member. Inturn, branch associations in centralized cooperatives may have consider-able freedom in their operations.

Chapter 5 Review

1. Regional cooperatives can be classified according to the makeup oftheir membership. Discuss those two classifications.

3. Describe one characteristic regarding control that all cooperative struc-tures have in common.

24


31/79

Who Runs the Cooperative Business?

Cooperatives follow

accepted business proce-dures similar to those of

other firms. They strive for effi-ciency, aim to meet or exceedcompetition, seek innovations,and are acutely cost-conscious.

Furthermore, cooperativesendeavor to maximize netincome, minimize costs of acqui-sition and operation, and pro-vide their services economically.

All successful cooperatives stress quality of products marketed,processed, purchased, and manufactured (such as feeds and fertilizers),as well as service.

Three groups of people are involved in the operation of a cooperative:G members;G directors; andG managers and staff.

Members

Members are the backbone of a cooperative. They organized it to servetheir needs. Their support, through patronage and capital investment,keeps it economically healthy. Their expanding requirements shape thecooperative's future.

Because the cooperative is organized to provide for the needs of its mem-bers, channels must be established so that the cooperative can beinformed of those needs. Several communication channels exist in a coop-erative, the most important being the annual member meeting. This iswhere the members learn how their cooperative has performed duringthe year, via reports by the board chairman, the manager, and other key

25

CHAPTER 6

Successful cooperatives operate on soundbusiness principles, just like any successfulbusiness.


32/79

officials. Members have the opportunity to ask questions, make sugges-tions, and request changes or new services. Members also elect newdirectors to replace those whose terms of office have expired or may re-elect existing directors for another term.

In addition to their rights, member-patrons also have responsibilities.Because patronage keeps the cooperative alive, members must use its ser-vices. Growth can improve a cooperative's efficiency, so ideally membersencourage neighbors and friends to patronize the cooperative. Andbecause growth calls for new capital, members must provide at least partof it.

Members participate in the cooperative in other ways, such as choosingdirectors. While being selected as a director is an honor, it is also a seri-ous responsibility. Cooperatives own assets worth thousands, even mil-lions of dollars. Sales can even amount to millions of dollars each year.Those who serve as directors are responsible for administering fundsplaced in their care by the members who elected them to office.

Members participate in their cooperative in still other ways. They mayserve on committees, call on prospective new members, or represent thecooperative in various community activities. However small the role theyplay, it is essential that members get involved in their association.

Directors

Members elect directors at the annual member meeting. The board repre-sents the members in all matters, sets policy, and is responsible to themembers for the cooperative's efficiency.

Directors hire the manager, determine the salary, and outline the dutiesand authority of that position. The directors must also formally reviewthe performance of the manager at least annually.

Directors decide how the cooperative will accomplish the purpose(s) forwhich it was created, and how its operations will be financed. For exam-ple, directors approve borrowing for fixed capital projects such as con-struction and land acquisition as well as for day-to-day operating expens-es. Directors determine the patronage refund allocation, weighing legal

26


33/79

requirements against the need for reinvesting refunds to provide moneyfor retiring old equities and still meet current capital needs. Directorsensure the cooperative maintains its character and they develop andadopt long-range business strategies.

Typically, directors receive nominal compensation for serving on theboard, plus an allowance to cover out-of-pocket expenses incurred whileconducting those duties.

Manager and Staff

Directors decide the cooperative's general direction but the manager andimmediate staff carry it out. The manager and staff make decisions, sub-ject to board review, that realize the basic objective of serving memberseffectively.

As cooperatives grow in size, variety of services offered, and number ofpatrons served, they must expand their management team to include spe-cialists in various fields such as member relations, communications, gov-ernmental and public affairs, legal services, personnel relations, account-ing, and transportation. Cooperatives may hire employees with specialknowledge of the various commodities marketed, purchased, or providedfor members such as milk, butter, eggs, fruit, feed, seed, fertilizer, or elec-tricity. Under ideal conditions, the manager's principal tasks are plan-ning, reporting to the board of directors, conferring with key supervisors,maintaining good organizational relations, and controlling the coopera-tive's operations.

A major problem of large cooperatives is communication with members.Often in a large cooperative, the manager and key staff are known per-sonally by relatively few patrons. The only time management is seen bymany members is at the annual meeting. But this large affair allows littletime for conversation with members. In an effort to stay in more frequentcontact with members, these cooperatives often conduct regional or dis-trict meetings during the year.

In a relatively small or local cooperative, it can be fairly easy to maintaingood relations between the cooperative and its members. The manageroften maintains personal contact, keeping members informed of their

27


34/79

cooperative's progress and activities. The manager can personallyencourage members to communicate their problems, needs, and evalua-tion of the cooperative services they receive.

As the intermediary between staff and the board of directors, the manag-er must deliver reports at board meetings on the activities of the associa-tion, outlining any special problems, operational changes, and pertinentfinancial matters.

Each year, the manager presents an operating plan and budget for thecoming year. It is subject to approval by the board of directors and isoften a joint product of the manager and the board. Periodically, the man-ager reviews actual performance with the board against budget projec-tions, and explains variations in performance.

At staff meetings, the manager discusses operating procedures and prob-lems with key employees and helps familiarize them with cooperativepolicies and objectives, interdepartmental relationships, and individualresponsibilities.

Quite often, the only cooperative employee a member encounters over aperiod of months is a billing clerk, cashier, truck driver, field representa-tive, or a warehouse employee who loads supplies into the member'svehicle. Therefore, many cooperatives have regular training programs tohelp employees learn how their cooperative works as well as generalprinciples and practices. Actually, these workers are the employees ofmembers, because members own the cooperative. Through their efficien-cy and friendliness, well-trained employees attract patronage and buildfavorable attitudes toward the cooperative, both as a business and as adesirable institution.

Chapter 6 Review

1. Describe the three groups of people involved in a cooperative, and dis-cuss their respective roles.

2. When and how are directors selected?

28


35/79

How Cooperatives Are Financed

Cooperative owner-mem-

bers in the United Statesfinance these businesses

by using all the standard methodsemployed by other corporations,plus a few unique to coopera-tives.

Capital Structure

If the association is a capital stockorganization, members receive

stock certificates as evidence of their ownership interest. More than onetype of stock may be issued, but usually no more than two are necessary.Most stock cooperatives issue one share of common membership stockper member. Preferred stock may be issued to show additional capitalcontributions.

Common stock is usually the voting stock, while preferred stock is gener-ally nonvoting.

Noncapital stock associations issue some kind of certificate (sometimes acertificate of equity) to show capital contributions of members. Manynonstock cooperatives raise some or most of their original member capi-tal via a membership fee.

The capital structure is usually kept simple. If stock is issued, par value iskept low at $5, $10, or $20, for example. Shares of this size are easier tosell, transfer, or pay off than shares of higher value.

Capital Needs

The total amount of capital needed by a cooperative depends on manydifferent factors. Some influencing factors include: the business volume,services provided, physical facilities required, the nature of its competi-tion, seasonality of the commodities handled, and degree of risk required

29

CHAPTER 7

Credit Unions are cooperatives.


36/79

in the day-to-day business. Whether the total amount of capital requiredis minimal or substantial, it is normally related to the number of mem-bers and volume of business conducted.

Two kinds of capital are used to sustain a cooperativefixed and operat-ing. Fixed capital is money used to buy such things as land, buildings,and equipment (fixed, tangible assets). Operating capital keeps the busi-ness going on a daily basis. Some operating expenses may include:advancing members money on products marketed for them, buying farmproduction supplies, paying utility bills, paying employees, and buyingoperating supplies such as packing cartons and office supplies.

There are three important sources of obtaining capital:G Members, who invest in the cooperative to obtain needed ser-

vices.G Nonmember patrons, other cooperatives, marketing and supply

companies, and individuals that invest in the cooperative to earndividends or because they are interested in the welfare of thecooperative.

G Loans from such lending agencies as a CoBank (part of the FarmCredit System), a commercial bank, or one of a number of gov-ernment agencies.

Some cooperatives also obtain financing from their wholesale suppliersand other creditors, based on the amount of their purchases. Marketingcooperatives obtain interim financing that corresponds with the time lagbetween receipt of the commodity from member-patrons and actual set-tlement with them.

Member Capital

Cooperative members must realize that launching a business requiressubstantial startup money. Because they are the owners and expect toreap the benefits of the business, they are obligated to finance a majorportion of the startup costs. Hopefully once the cooperative is operating,it will generate sufficient funds to perpetuate itself. But occasionally,members may have to contribute additional capital because of unforeseencircumstances, such as a major disaster or a major expansion.

30


37/79

Initial capital is needed to buy land, buildings, equipment, and otherfacilities, as well as to operate the business the first year.

Investing initial capital is a basic member responsibility, and evidence of

good faith, or their "earnest money." The members' share of initial capitalshould be large enough to make them realize they have a financial stakein the business to protect. In the case of many closed-membership coop-eratives that require a greater amount of initial investment, the belief isthat the members' commitment to the cooperative increases in direct pro-portion to their level of investment.

Members' investments are used as a credit base when applying for a loan.It should be a sizable proportion of total need because no credit sourcewould likely take financial risks in a cooperative if its members dontdemonstrate a willingness to do so.

As a general rule, each member's share is proportionate to his or heranticipated use of the cooperative. This contribution is usually made inthe form of cash. Often a few members may contribute more than theirshare, but this wont entitle them to any special privileges.

Under certain conditions, if members of a cooperative do not haveenough funds or credit to subscribe their share of initial capital, the coop-erative may be eligible to obtain financial assistance (e.g., government-backed loans) from the U.S. Department of Agriculture, through theRural Business-Cooperative Service (RBS). (Additional information onthese financial programs is available from state Rural Developmentoffices or online at: http://www.rurdev.usda.gov/rbs/busp/bprogs.htm.)

Facility Loans

Cooperatives usually obtain long-term financing from CoBank or otheroutside sources to cover the cost of constructing new buildings and buy-ing equipment or plant sites. The main sources of facility loans areCoBank, commercial banks, and insurance companies.

Cooperatives serving rural patrons may also obtain facility loans jointlyfrom RBS and CoBank, under feasible conditions.

31


38/79

USDA's Rural Utilities Service (RUS), through rural electric cooperatives,may lend funds to a cooperative to purchase electrical equipment andrelated items.

Operating Loans

Operating capital loans generally are for short- or medium-term uses.The medium-term loans supplement the cooperative's own capital funds.Short-term loans are generally seasonal, and are used to finance suchexpenses as seasonal increases in inventory, or accounts receivable.Cooperatives may obtain operating loans from CoBank, USDAs RBS,commercial banks, and other lenders.

Commodity Loans

Marketing cooperatives must often store their products such as grain,cheeses, fruits, or frozen citrus concentrate for long and short periods oftime. In some cases, a commodity loan is necessary to pay an advance tothe member before a product is sold. Such loans come from CoBank,USDAs Commodity Credit Corporation (CCC), a commercial bank, orother sources, and are secured by warehouse receipts.

Special Services Loans

A number of Federal Government agencies lend money to cooperativesproviding special services. An important source for rural electric andtelephone cooperatives is USDAs Rural Utilities Service (RUS). Loans aremade to construct rural infrastructure for electric power distribution,transmission, and general capacity. Modern telecommunications servicesare financed by RUS for fiber optic cable, digital switching, and broad-band service to rural America.

National Rural Utilities Cooperative Finance Corporation (CFC) is anindependent, self-help credit institution created by its member rural elec-tric systems to provide supplemental financing for rural electric coopera-tives.

32


39/79

USDA's Rural Telephone Service was established as an agency by amend-ment to the Rural Electrification Act to provide supplemental financingfor rural telephone systems.

The National Cooperative Bank (NCB), although oriented largely to con-sumer cooperatives, also makes loans to producer cooperatives. NCBfinancing includes term loans for major capital expenditures, lines ofcredit, and construction and real estate loans.

In addition to these loan sources, several "special interest" organizationslend funds to certain groups. The Bureau of Fisheries in the Departmentof the Interior lends to fish marketing cooperatives; the Bureau of Indian

Affairs, to cooperatives of Native Americans, Eskimos, and Aleuts; andthe Bureau of Reclamation, to small cooperative reclamation projects, pri-marily for irrigation in 17 western states.

Revolving Capital Finance

Revolving-capital financing is widely used by and well suited to coopera-tive operations. Here is how it works.

As a member does business through a cooperative, he or she authorizes itto use a portion of the money accumulated or saved through patronage.Or, the member may furnish capital based on the dollar value or physicalvolume of products sold or bought through the cooperative. In eithercase, this money is identified as a capital investment of the member andis used for capital purposes only.

The money thus collected by the cooperative from patronage is creditedto the member on the cooperative's books. At the end of the fiscal year,the member is issued a statement of the total amount invested in coopera-tive capital for the year.

This capital may be treated as a revolving fund and used for repaymentof debt, expansion, or for such other capital purposes as authorized bythe board of directors. As such funds continue to accumulate, the boardauthorizes repayment to those members who contributed.

33


40/79

Repayment first goes to members whose contributions are the oldest inthe revolving fund. Normally, each year's contributions are issued in anumerical series. Thus, the oldest of the numbered series are repaid first.

As a general rule, the member's evidence of revolving fund contributionsdoes not have a specified repayment date (due date). Rather, the boardestablishes revolving fund periods after considering the association'sfinancial requirements. Some cooperatives revolve funds at intervals of 5,7, or 10 years. Others, such as local farm supply cooperatives, revolve ona lengthier schedule such as 20 years. These time periods are not legalrequirements but they are considered to be moral commitments by thecooperative.

The revolving-capital plan allows members to build up equity in theirassociation in proportion to the amount of business they transact. Itensures that current investment in the cooperative is largely in the handsof current patrons. It provides an orderly process for returning or with-drawing a member's investment without impairing the total capital struc-ture. Perhaps more importantly, the revolving-capital plan gives the busi-ness flexibility to meet changing conditions and accompanying financialneeds.

On the down side, the revolving-capital plan creates some membershipproblems. Under some circumstances, the revolving period may have tobe lengthened, thus postponing the member's return on investment. Thelonger period may place a financial burden on some members. In someinstances, a return on investment is not paid until the member dies, andthe benefits are distributed to the member's estate. Older individualsoften prefer to recoup their investment sooner.

In situations of merging cooperatives, members inevitably inherit someamount of accrued patronage refund debt that was not accumulated bytheir home cooperative. Repayment must begin with the "oldest" debt.This can foster resentment among member-owners who must wait fortheir own dividends, until the inherited dividends are paid. Only whenthe numerical series of the contributions in the revolving fund haveevened out can other dividends be paid.

34


41/79

Considering the intricacies of the revolving-capital plan, members mustfully understand and agree to their financial obligations for this plan tobe successful.

Reserves

Like any other business, a cooperative builds up two types of reserves,valuation and capital. Reserves for such items as depreciation are calledvaluation reserves and are accumulated by a charge to operations. Froman accounting standpoint, they are handled as an operating expense as away to charge a pro rata share of the initial cost of a fixed asset over theestimated life of the asset.

The second type is called a capital reserve, which is usually built up fromnet operating margins.

There are two general types of capital reserves: (1) those reserved to meetan unexpected crisis, such as a poor business year; and (2) those for alarge planned outlay.

The latter type of reserve might be a building fund for new or expandedfacilities, adding new services, or a modernization program where thecosts exceed the current financial capacity of the cooperative. When sucha need arises, the cooperative can use its reserves instead of borrowingmoney, curtailing its services, or impairing its capital.

Thus, reserves protect the capital investments of members. When a coop-erative operates on a strictly nonprofit basis, it allocates capital reservesto all of its patrons on the basis of their use of the cooperative's services.

Chapter 7 Review

1. What are three important sources of capital available to a cooperative?2. Explain the practice of revolving capital finance.

35


42/79

Types of Cooperatives

At one time, it was

fairly easy to catego-rize cooperatives

according to the service theyprovided. In todays morecomplex economic environ-ment, however, cooperativeshave had to evolve into orga-nizations that often performmyriad different servicesthat they would not havetraditionally offered. In fact,many cooperatives "overlap"traditional categories, andserve multiple functionscharacteristic of more thanone type of cooperative.

For example, marketing cooperatives no longer simply market theirmembers products. Now, most also purchase supplies for their mem-bers. Many cooperatives extend some kind of credit, and in some caseseven operate a credit corporation, for the convenience of members.

Cooperatives have been serving as economic tools providing a wide vari-ety of services since Colonial times. When early American settlers had alarge task to accomplish, they pooled their talents and resources to get itdone more quickly and efficiently. The time-honored threshing bee, theneighborly barn raising, and the "cheese rings" of the early 1800s are allexamples of informal but true cooperative activity. The same conceptholds true in many rural communities and school districts.

All cooperatives have the same objectives: to provide services not other-wise available (marketing, insurance, or electric power); to provide themat the lowest possible cost (cotton gins or grain elevators); or to upgrade

36

CHAPTER 8

Marketing cooperatives help ensure that members

receive the most competitive prices for their qualityproducts.


43/79

productivity (mutual irrigation companies and artificial breeding cooper-atives). In fact, early settlement in much of the arid Southwest UnitedStates was made possible, in large part, by mutual irrigation companies.

Many marketing and purchasing cooperatives are household names inrural communities. But aside from the services these organizations pro-vide, probably the most widely known are the three types of cooperativecredit made available through the Farm Credit System and rural electriccooperatives.

Cooperative leadership has been provided by specialists in severalfieldsexperts on marketing, farm supplies, insurance, dairy cattlebloodlines and breeding, or electric utilities. The availability of such tech-nical knowledge and expertise is valuable in itself.

Marketing Cooperatives

Over the years, American farmers have learned many new techniques forincreasing yields and reducing manual labor. At the same time, findingsatisfactory markets for their products has become an increasing prob-lem.

Most farmers are more effective in production than in marketing. Theyfocus their time and efforts on the efficient operation of their farm inorder to produce high-quality, high yields of their crops or products.Most frequently lack the time or resources necessary to determine thedemands of a constantly changing public market. Cooperatives help fillthat marketing void by providing members with the marketing tools theyneed to get the most return for their investment.

One way they do this is by furnishing a variety of off-farm marketing ser-vices. In response to the market demand for high-quality and standard-ized products, cooperatives can efficiently assemble products from manyproducers and carefully and accurately grade the products to meet buyerspecifications concerning size, quality, color, or other terms. One suchexample of differentiating products based on quality can be found in fruitcooperatives. If orange growers bring superior oranges to the cooperativefor storage and sale, they do not want their products mixed with orangesof a lesser quality, thus reducing the overall value of the oranges.

37


44/79

Additionally, separating the oranges according to established standardsof excellence ensures that consumers get the quality of orange that theyexpectin short, they get what they pay for.

By paying producers on the basis of grade and quality, cooperativesencourage farmers to produce the kind of quality of product most indemand, while fulfilling consumer demands for standardized products.

Another marketing improvement cooperatives offer involves the process-ing, or packing of members goods. Processing includes such activities ascanning, pasteurizing, concentrating, churning, cheese making, drying,extracting, freezing, and ginning. By putting products in a form accept-able to large-volume buyers, cooperatives add value to those products,which, in turn, increases the profit margin for their members. Many coop-eratives that provide these services are referred to as value-added, ornew generation cooperatives.

Cooperatives transport, store, advertise, and promote products for theirmembers. They explore and develop new domestic and foreign tradechannels. Through research they develop new products or find new usesfor what they produce.

In addition to these obvious marketing benefits, cooperatives havebecome a valuable bargaining tool for farmers. Agricultural producerstypically lack bargaining power, even though their crops and livestockare essential for the nations food chain. Individual farmers produce rela-tively small volumes and have little product differentiation (distinctivecharacteristics that can be emphasized in advertising and give specialdesirability for users who value them). They lack the bargaining powerassociated with those factors. The importance of their profession isunquestioned, yet they must combine forces to achieve strength andleverage in the marketing world.

Businesses that buy agricultural products have become larger and moreplentiful in recent years. For example, many food processors and packersare large corporations with great bargaining strength that supply whole-sale distributors and massive chain food retailers. Similarly, as demand

38


45/79

increases and these retailers buy in large amounts, their bargainingpower also increases. Cooperatives help farmers gain market power tomatch the bargaining strength of other firms.

Marketing cooperatives benefit both consumers and producers. Becausethey emphasize grade and quality, they have made producers more qual-ity and market-conscious. For instance, food products from cooperativesfollow industry trends toward standardized packaging that enable theconsumers to shop more efficiently.

Cooperatives strive to minimize costs associated with marketing. Theseefforts have served to build cost-consciousness among all in the food andfiber market. In essence, cooperatives often serve as the benchmark bywhich others gauge their own operations. This awareness, in turn, helpsto hold down costs to consumers.

Marketing cooperatives teach producers about markets. Through cooper-ative meetings and publications, farmers gain valuable insight about suchmatters as marketing costs, consumer preferences, and the need foradvertising and brand promotion.

Through marketing cooperatives, farmers extend control over their prod-ucts beyond the farm gate as they travel to the consumer. As in the caseof new generation or value-added cooperatives, members retain more ofthe profits associated with product marketing than if they simply selltheir product as a bulk commodity. As long as the cooperative retainseither physical possession or legal title to a commodity, members have agreater voice in its distribution and sale.

This control may be limited to bargaining on grower price and terms ofdelivery, as in the case of a product to be canned. In some new generationcooperatives, facilities have been created and expanded to allow for suchprocessing by the cooperative, which can lead to a larger portion of theultimate profit. In the case of milk, for instance, the negotiations mayinclude the manufacture of dairy products and delivery of the packagedor cartoned products by the cooperative to consumer stores and super-markets.

39


46/79

40

Perhaps the most important contribution of these cooperatives is thatthey can develop broader markets for the producer in terms of geograph-ic dispersion as well as variety of uses. Consequently, in times of abun-dant supply, the price-depressing effect of small surpluses is diminished,

and prices stabilize.

Membership in most marketing cooperatives is open to all producerswho fully meet membership and production requirements. Exceptionsare cooperatives with seasonally limited capacity or outlets, and the newgeneration cooperatives discussed earlier, which use closed membershipsto control the amount of product being marketed at any given time.

A member may withdraw from membership, but only during specifieddates annually. Although some cooperatives require a minimum 2-yearinitial membership, some marketing cooperatives close their membershipfor a brief season each year to make a preliminary estimate of theapproaching crop volume. When that volume has been determined, thecooperative learns how many new members/producers it can support.

A corporation farm actually engaged in growing agricultural productsmay choose to become a member of a farm cooperative. Further, underspecial circumstances, a marketing cooperative may hold membership inanother larger cooperative handling the same commodity, and marketsome of its volume through that cooperative.

Bargaining Cooperatives

A cooperative bargaining association is a special type of marketing coop-erative. In instances where the number of agricultural product processorshas declined but survivors have grown in size, bargaining cooperativesserve as an effective marketing tool for farmers. They negotiate with can-ners, packers, or processors on matters such as price, quality, and time ofharvest or delivery.

Bargaining cooperatives generally do not take physical possession of theproduct, but rather establish the terms and conditions of the sale andtransfer of that product. The actual sale of the product may be madedirectly by the farmer to the buyer. Milk producers and fruit and veg-etable growers often use this type of marketing cooperative.


47/79

Purchasing Cooperatives

Traditionally, farmers have sold their commodities at wholesale prices,while paying retail prices for their production supplies. This imbalance

obviously decreased their profit margin, but they had little choice. Theygained little advantage from product differentiation. They purchased inrelatively small amounts and often paid extra for products with brandnames in feed, farm equipment, and petroleum.

To overcome these disadvantages, farmers turned to the cooperative asan economic tool. In some cases, entirely new cooperatives were orga-nized to manufacture ready-mixed feeds, fertilizer and fuels; to purchase,clean, and distribute high-quality seed; or to provide other production-related services. Thus, these cooperatives supplied farmers with superiorproducts, without the higher costs associated with brand-name purchas-es.

Initially, cooperative purchasing was quite informal. A group of farmerspooled their orders to gain the advantage of bulk-purchase prices onmajor farm production supplies such as feed and fertilizer. The demon-strated benefits to producers encouraged them to organize more formalor incorporated cooperatives. These cooperatives hired full-time man-agers and built warehouses to handle a variety of other production sup-plies.

Cooperative purchasing, initiated by farmer clubs in Wisconsin andIllinois, really began around 1850. After the Civil War, local and stateGranges acted as agents to pool orders and buy needed supplies fordirect shipment to farmers. By the early 1900s, the number of purchasingcooperatives was growing steadily, but the real expansion in cooperativepurchasing occurred after 1930. The Depression made it necessary for thefarmer to cut costs to survive. Subsequently, World War II created short-ages of needed materials.

This same period witnessed the rise of strong and progressive regionalcooperativesmostly federations of locals. The regionals had the volumeand the financial strength to own and operate such large-scale facilities asoil refineries, fertilizer manufacturing plants, and feed mills that couldgive members more assured supply sources.

41


48/79

Consequently, todays farmers can share via local supply cooperatives inthe ownership and benefits from such large-scale activities.

Farmers obtain membership in most purchasing cooperatives by acquir-

ing a share of common stock (the par value is often between $1 and $50)and by agreeing to abide by the cooperatives bylaws. In other purchas-ing cooperatives, patronage (by the producer) is the sole requirement formembership.

Purchasing cooperatives do not usually require members to sign a writ-ten agreement, so members are free to buy farm supplies whenever theychoose. However, a few purchasing cooperatives stipulate a minimumannual patronage requirement. Non-producers can be patrons, but notvoting members of farmer cooperatives.

Three major objectives of purchasing cooperatives are:

1. to effect savings for member-patrons through quantity purchasing andmanufacturing and efficient distribution methods;

2. to buy the type and quality of supplies best adapted to the membersfarms and farming needs; and

3. to provide the related services suited to the needs of member-patrons.

The savings generated by increased efficiency and reduced per-unit costsassociated with large-volume purchasing and manufacturing are passedon to the member-patrons at the end of the fiscal year in the form ofpatronage refunds. Refunds are distributed according to the amount ofbusiness members conducted with the cooperative either on a dollarbasis or on a per-ton, per-gallon, or some other unit basis. If the coopera-tive needs more capital, it may defer or retain some of the refunds for adetermined number of years, and then start redeeming or revolving theoldest amounts.

Purchasing cooperatives can usually adapt more easily to changes inenvironment and agriculture than marketing associations. For example,when rural Southern California areas with large concentrations of citrus

42


49/79

orchards were urbanized and replaced by housing developments andshopping malls, many citrus marketing cooperatives were forced to selltheir facilities and discontinue their operations.

Faced with similar changes, some purchasing cooperatives have expand-ed their product line to offer supplies to suburban customers on a patron-age basis such as lawn and garden seed and fertilizer, sprays, beddingplants, lawnmowers, hand tools, petroleum products, and auto supplies.Meanwhile, business with their farmer-members continues. This flexibili-ty has helped many purchasing cooperatives to prosper and flourish,even as the number of farmer-members declines.

Services provided by the typical purchasing or farm supply cooperativevary somewhat according to the area it serves. Some carry a relativelylimited line of supplies related to member needs. Petroleum cooperatives,for example, may purchase and distribute only petroleum and relatedsuppliesgasoline, heating oil, propane, lubricants, tires, batteries, andautomotive supplies.

However, most local purchasing cooperatives carry a wide variety ofsupplies and services related to farm commodity production. They maymix feed, blend fertilizer, clean and shell seed, supply automotive needssuch as gasoline or tires, and carry a full line of building supplies andtools. Many cooperatives have evolved and developed more adequatefarm service centersone-stop shopping for members.

One basic service provided by most purchasing cooperatives is on-farmdelivery. Feed is delivered in bulk to farmers bins and bulk tank trucksdeliver fuel oil directly to farm home storage tanks or refill propane fueltanks. The value and convenience of such a service are immeasurable.

Many cooperatives not only deliver bulk fertilizer but also offer customfertilizer spreading services using specialized equipment. Some petrole-um cooperatives even operate special trucks to deliver, repair, and mounttires on farmers field equipment. These services save members theexpense of buying or renting such specialized equipment and valuabletime for farm operations.

43


50/79

Related Services

Since the days of the earliest settlers, Americans have been using cooper-atives to solve mutual problems and to provide specialized services. The

early fire departments operated

cooperative in agribusiness

Documents