by Tamara Scully

Cooperatives play a major role in the agricultural industry, and in rural areas in general. From electrical cooperatives to the local credit union, cooperative business organizations are familiar to farmers across the country.

What is the role cooperatives play in the market? Why are they formed, and what should members expect? To answer those questions, the National Farmers Union invited Dr. Frayne Olson, of North Dakota State University, to share his expertise at their recent Growing for the Future conference.

Market adjustments

Cooperatives are formed when the market isn’t functioning as it should, Dr. Olson said. If the market were delivering goods and services at reasonable prices, and businesses were making a reasonable profit, there would be no reason for cooperatives to exist. Unfortunately, in many situations there are no real competitive pressures to keep those profits in check, and that market becomes unbalanced. While most businesses are formed when there is a market opportunity, historically most cooperatives have been formed when there is an economic threat in a given market, typically due to lack of competition.

Cooperatives were developed to allow an alternative in such situations. By providing a means for groups of people to join together in a mutually beneficial business venture, which serves them both as customers and owners, a cooperative provides an option, and keeps pricing in check.

Cooperatives provide a business model based upon “democratic control by the people who use its services, and whose benefits are derived and distributed equitably based on use,” Dr. Olson said. While they are legal business entities, the definition of exactly how a cooperative meets these goals is somewhat fluid, and the real definition of what their roles and goals will be is found in each company’s by-laws.

Core concepts

Even with differences in the by-laws of cooperatives, they are all structured to do two things: pool the capital of their members, for collective purchasing or sales power; and provide users (member) specific benefits. Cooperatives must make a profit for their members, and provide services to those same members. Balancing profits and services through a democratically elected board of directors, all of whom are members, as well as not answering to outside investors, make cooperatives unique.

The conundrum arises from this dual purpose.

As an owner, cooperative members want the best return on their investment. But as a customer, those same members want affordable goods and services. This balancing act requires a lot of member input. Most cooperatives are run on a system of one member/one vote. Others base votes on each member’s equity. Members need to let the cooperative’s board know what they expect from their membership, and the board needs to be translucent in letting members know what decisions are being made.

“How does the cooperative access the financing it needs to maintain a strong, viable company, yet at the same time maintain some equity? How do we treat our members fairly as owners, but yet treat them fairly as customers,” is the core question all cooperatives must answer, Dr. Olson said.

Cooperatives utilize each member’s equity, through retained earnings, to reinvest in the company and remain profitable. At the end of a given period of time, the cooperative must return that equity back to the member. The concept of member equity is a key one. There is a misconception that all cooperative members must be treated equally.

“The more you use that company, the more you should benefit from that company,” and benefits are distributed proportionately to use, he explained. Equitably, not equally, is how cooperatives must treat members.

Benefits of cooperatives

Members of a cooperative receive multiple benefits. Cooperatives are formed to meet a market need, whether for better purchasing power, selling power, or both. Members, by definition, benefit both as owners and users of the cooperative. When members sell their product to a cooperative, they have a ready market, and are receiving a preferential price for their product. When a cooperative is buying products for their members, the members are receiving a better price than if the cooperative did not exist.

But either way, members are also receiving patronage services from the cooperative. These can be difficult to measure, as they include not only price differentials, but also values such as market information, internal strategy and planning, and other knowledge that can benefit the member’s own individual business planning. Cooperatives often provide services to members that otherwise would not be available in the region, even if those services are not profitable for the cooperative. For example, in some rural areas, a cooperative formed to purchase fuel for its members use may also provide an equipment repair shop, meaning that members don’t have to travel far to get their equipment serviced.

Cooperatives are not formed to generate a high rate of returns, as is a company with private investors, focused on quarterly earnings. Cooperatives are focused on the long-term strategy, not short-term income. They function by providing members with favorable contractual terms, to serve as a reliable source of needed inputs, or to secure a market for members’ products.

“Risk management becomes a little harder to try to quantify,” Dr. Olson said. “If a cooperative is the only company that’s selling products to you or you’re buying products from them, there’s this internal checks and balances. The cooperative has the checks and balances in that the members own the company. We kind of become complacent and don’t recognize the cooperative is providing these benefits.”

The existence of cooperatives can prevent spatial monopolies or monopsonies from taking advantage of markets where there are few buyers or sellers due to low business volume, which frequently happens in rural areas. Cooperatives provide much-needed competition. In the case of agricultural marketing cooperatives, it is legal for them to have a monopoly, under the Capper-Volstead Act.

One problem the cooperative business structure must contend with is free riders. The existence of the cooperative itself provides some benefits – by adding competition to the market – to those who are not members. This actually threatens the long-term existence of the cooperative itself.

Cooperatives require member participation to function as they were designed to do. Understanding why a cooperative was formed, why it is still in existence today, and how it can continue to operate to benefit and provide value to its members in the future is the challenge to keeping cooperatives viable.

“The economic motivation, either through an opportunity or a threat, has to be great enough to overcome the costs, or the resistance to forming the cooperative,” Dr. Olson said. “There is a lot of effort that has to go into not only starting the company, but also to maintaining the company.”