Hodge-Podge of Agricultural Cooperative Topics: Including Business Form, Cooperative Law, and Marketing Agreements

Transcription

1 Hodge-Podge of Agricultural Cooperative Topics: Including Business Form, Cooperative Law, and Marketing Agreements Economics 535 Clarence Brewer October 1999

2 Hodge-Podge of Agricultural Cooperative Topics: Including Business Form, Cooperative Law, and Marketing Agreements Clarence Brewer Introduction The purpose of this paper is to investigate what makes the cooperative form of business unique, what laws support the cooperative form of business, and the use of marketing agreements within agricultural cooperatives. In the last ten years many general corporations and large cooperatives have been unifying through mergers, acquisitions and associations. The implications to the individual farmer many mean that he/she will need to become part of a cooperative to remain a farmer or associate with a corporation. Marketing agreements are commonplace in the agricultural marketing system and this paper is interested in the use of marketing agreements in agricultural cooperatives. Cooperative Business There are three basic types of business. They are essentially different from each other based on, who owns the business, who controls the business, who buys from the business, and who gets the profit. A proprietorship is owned by one person who operates, manages, and receives the profits. A partnership is owned by two or more people who share proportionally in the risks, management, and the profits. A corporation usually has multiple owners, offers goods and services, and uses sound financial practices (or so they should). Corporations are of two types, general and cooperative. Both operate under 2

3 State-granted articles of incorporation. Policy and management practices are set by a board of directors, and day-to-day business is the responsibility of a hired manager. Cooperatives are different than general corporations in their business purpose, ownership, control, and distribution of benefits. Three principles distinguish cooperatives from general corporations: user-owner, user-control, and user-benefits. The user-owner principle means the people who use the cooperative own the business. Cooperatives are financed by members purchasing stock, paying membership fees, or accepting self-imposed assessment on products purchased and/or sold or fees for services. User-control stems from the majority of the customers being members who are also responsible for selecting the members of the board of directors. As representatives of the members, the directors are responsible for setting policy and providing oversight on all the cooperative s business practices. User-benefits explain that the cooperative s primary purpose is to provide and distribute benefits to members. Distribution of these benefits is usually based on members use of the cooperative, not on the amount of capital they have invested. Benefits also include providing market access, providing needed services, or supplying products. A cooperative is thus a user-owned and user-controlled business in which benefits are distributed according to a member s use of the association. Regardless of the type, size, geographical location, or purpose, all agricultural cooperatives are organized for one of the following reasons 0 : 3

4 1. Improve bargaining power 2. Reduce costs 3. Obtain products or services otherwise unavailable 4. Expand new and existing market opportunities 5. Improve product or service quality 6. Increase income. The ten steps of starting a cooperative are 1 : 1. Hold an exploratory meeting with others who have a similar interest and determine whether you have common needs and desire to address those needs as a group. 2. Select a steering committee to guide the group through the formation process 3. Conduct a survey of potential members 4. Analyze markets for products, supplies, and services 5. Prepare a business plan 6. Incorporate the business 7. Adopt bylaws and select a board of directors 8. Find investment funds-including member investment needed to carry out the business plan. 9. Hire management and employees, and acquire facilities and equipment 10. Begin operations. Cooperative Law Agricultural cooperatives are granted special privileges by law compared to general corporations. The Capper-Volstead Act of 1922 is the key to these privileges. The Sherman Act (1890) was the first federal antitrust law. And most lawsuits against cooperatives allege violations of the Sherman Act, specifically sections 1 and 2 2. Section 1 makes it illegal for competitors to form a trust or other combination or conspiracy that restrains trade. Section 2 prohibits a single firm or a group of firms from becoming a monopoly, or even attempting to do so. The Sherman Act was a deterrent to cooperative operations. Many cooperatives found themselves at fault of the law. This was not the purpose of the Act. The Sherman Act 4

5 was intended to combat the excesses of large and powerful corporations that had victimized the farmer. The Sherman Act was never meant to hinder agricultural cooperatives. An original amendment to the Sherman Act would have exempted any arrangements, agreements, associations, or combinations among persons engaged in horticulture or agriculture made with the view of enhancing the price of their agricultural or horticultural products. 3 However, the amendment was not included as part of the final law. In 1914, the Clayton Act was passed to exempt agricultural labor unions, but it fell short of protecting agricultural cooperatives as a form of business. The Capper-Volstead Act, section 1 provides: Persons engaged in the production of agricultural products as farmers, planters, ranchmen, dairymen, nut or fruit growers may act together in associations, corporate or otherwise, with or without capital stock, in collectively processing, preparing for market, handling and marketing in interstate and foreign commerce, such products of persons so engaged. Such associations may have marketing agencies in common; and such associations and their members may make the necessary contracts and agreements to effect such purposes. 4 Section 2 authorizes the Secretary of Agriculture to proceed against any cooperative that he believes monopolizes or restrains trade to such an extent that the price of any agricultural product is unduly enhanced. 5 The words may act together means that farmers can lawfully come together to act as one business unit. Without the Capper-Volstead Act, the courts could find that two corn producers could not join to agree to fix the price at which they would sell their corn. With the act in place, producers of agricultural products can form associations to have a common market place. Thereby, permitting for a legal reduction in competition among farmers. For an association to qualify for exemption as an agricultural cooperative, it must meet two conditions: 5

6 1. It must be operated for the mutual benefit of its members insofar as they are producers of agricultural products. 2. It must not deal in the products of nonmembers in an amount greater in value than such products that it handles for its members. An agricultural cooperative also has a choice of one or both of the following: 1. No member of an association is allowed more than one vote because of the amount of stock or membership capital owned. 2. The association does not pay dividends on stock or membership capital in excess of 8 percent per year. Under the law, an agricultural cooperative, aside from the above stated privileges, are held to the same degree of antitrust law. If an agricultural cooperative is found to be doing any of the following, it will be prosecuted, as would any other business entity: - Engaging in predatory practices - Engaging in price discrimination - Restricting members agricultural output - Coercing competitors or customers - Colluding with third parties to fix prices - Conspiring with third parties to fix prices - Combining with other firms to substantially lessen competition - Engaging in boycotts The primary weakness of the Capper-Volstead Act is in the lack of clarity for a few key definitions. The Act does not define agricultural producer, marketing, undue enhancement of price and does not even contain the word cooperative. 6 Many of the basic issues remain open for interpretation. For this reason, many questions are being raised concerning recent mergers, consolidations, and joint ventures involving agricultural cooperatives. 6

7 There are unique operational and structural issues that make an agricultural cooperative a unique form of business, most have been briefly mentioned above. However, one key cooperative activity that is tantamount to the role of cooperatives will now be discussed Marketing Coordination in Agricultural Cooperatives Agricultural cooperatives are integral parts of the agricultural marketing system. Their involvement is strongest in the dairy industry, moderate in fruits and vegetables, and grain, and limited in livestock. Bylaws describe member s responsibilities, and members and cooperative associations may agree on other conditions and agreements. Marketing agreements fall under such other conditions and agreements. Marketing agreements include different forms of commitment between members and cooperatives. A binding agreement between member and cooperative is required to establish a marketing agreement. Looking at a study conducted by the USDA in 1997, of marketing cooperatives with total sales of $15 million or more provides an indication of market agreement use. 7 The USDA study included more than half of the total marketing sales of all U.S. agricultural cooperatives. Under marketing agreements, members are required to market with a cooperative, which in turn provides marketing services. Cooperatives in the study were classified by four product classifications- (1) dairy, (2) fruits and vegetables, (3) grain and (4) other products such as cotton, livestock, poultry, tobacco, rice, and sugar. The largest number of cooperatives fall into the grain classification, with the smallest number in the fruit and vegetable classification (table 1). 7

8 Grain cooperatives also had the lowest median sales. The other three classifications had much lower numbers of cooperatives but double to six times the median sales levels. The number of average members in the classes shows that the fruits and vegetables had the lowest number of members with the other class as having the most. Some livestock cooperatives have as many as 20,000 members, while the other classification also had cooperatives with as little as 100 members. Table 1: Use of Marketing Agreements and Cooperative Characteristics by Type Cooperative Type Number of Cooperatives Proportion with marketing agreements Average number of members Median sales Grain Fruit & Vegetable Dairy Other Included were cooperatives with $15 million or more in sales and individual producers as members. Marketing agreements included contracts and bylaw provisions that require member marketing. 2 Tobacco cooperatives were not included in average number of members. Source 8 Marketing agreements are formed through cooperative provisions or separate contracts that required the members to market with the cooperative. Bylaw provisions are enacted upon a member when the member enters the cooperative and market contracts are initiated apart from the bylaws. These two forms of marketing agreements are not mutually exclusive. Some cooperatives have both bylaw provisions and separate contracts. 9 The separate market contracts are more flexible and can be changed whenever a new agreement is reached. The bylaw provisions are more rigid and require a vote of the board to change. Under either type of market agreement, producers will have less marketing freedom but gain an assured market for their production. 8

9 Marketing Agreement by Classification of Cooperative Forty-four percent of the USDA surveyed cooperatives had marketing agreements with their members. Thirty-two percent used bylaw provisions, and 55% used only marketing contracts. Thirteen percent used both bylaw provision and market contracts. Producers and cooperatives have many reasons for using marketing agreements. 1. Conditions and requirements existing at the time of transfer. 2. Activities performed by cooperatives. 3. Marketing commitments extending from a cooperatives operations toward the end use of agricultural products. The producer makes marketing decisions beginning with obtaining services needed to move production past the farm and into the marketing system. Agreements specify conditions and needed services and offers the possibility of coordinated activities to solve marketing concerns. Assurance of product markets or product supplies are problems of producers and marketing organizations. When many marketing outlets and supply sources are available producers and marketing organizations have little need to make special efforts to operate. But when market outlets are few or when supply is highly variable, the need for coordination becomes greater, and market agreements become attractive. Table 2, details some characteristics that make market agreements attractive for each specific cooperative classification. Each type of agricultural commodity has unique characteristics that call for different market agreement specifications. For instance, Grain cooperatives typically provide grain storage and conditioning services in addition to year-round markets for grain. Cash and 9

10 short-term pricing are the usual method for grain cooperatives. Grain moves from local cooperatives to federated cooperatives, to processor, exporters, and other users. 10 Grain producers have large amounts of drying, storage, and transportation equipment that they personally own. In fact, private on-farm grain storage is greater then off-farm storage. 11 Table 2- Characteristics of transactions between producers and marketing cooperatives, by product 1 Product Characteristics Grain -Cash market, short-term contracts available all seasons -On-farm or grain elevator conditioning and storage available -Alternative marketing points available depending on area and producers storage and transportation capabilities -Specialty use products may require separate marketing channel. Fruits and vegetables Milk Other products -Perishable products and seasonal harvest -Range of products requires various services -Location, product, and resources of producer determine limited marketing alternatives. -Availability of cash markets depends On product -Very perishable product -On-farm pickup develops marketing relationship -Changes between marketing outlets possible, but require coordination Cotton- Range of services needed, ginning required near production Livestock- Auctions and contracts used, changing industry structure Poultry- Integrated production Sugarcane or beet- Relationship with processing or bargaining group needed 1 included were cooperatives with $15 million or more in total sales and individual producers as members. Marketing agreements included contracts and bylaw provisions that require member marketing. Source 12 Therefore, grain producers are the least likely to become part of a marketing agreement, long-term or short-term. The self-sufficiency of grain producers and the availability of year-round markets are the main reason grain cooperatives have the smallest proportion of marketing agreements. Some grain cooperatives also include livestock producers as members. The proportion of marketing agreements in grain cooperatives involved in specialty grains is much greater then basic commodity grain. But, by in large, grain 10

11 cooperatives remain the lowest for use of marketing agreements of the four classifications discussed. Fruits and vegetables are another story. The highly seasonal nature of production and the product perishability, along with the mix of products, create a situation where it is crucial for producers and cooperatives to have marketing agreements in place. Most fruit and vegetable cooperatives pool their producer s products. The pooling of products allows for economies of scale and market power compared to individual producers. Usually, products are commingled and producers share in the receipts based on delivered units. Fruits and vegetable producers lack the marketing flexibility of grain producers. Therefore, these cooperatives need an assured supply of raw product and members need and assured market. This provides great incentive for market agreements. Dairy marketing was the next classification investigated. The continuity of milk production and the perishability requires a safe and secure marketing system. Dairy cooperatives need a reliable constant supply and producers need a constant available market. Dairy cooperatives ranked second highest for proportion of marketing agreements. The other product classification was very broad and encompassed many types of agricultural commodities. Within this class, market agreements varied greatly from nonagreement auctions to long-term agreements. Sugarcane and sugarbeet producers ranked high in market agreement proportion compared to other producers within this category. Overall, 68% of cooperatives in this class had marketing agreements. 11

12 Use of marketing agreements was much lower for grain cooperatives than other types. They had 6% where other classifications had 60% or more. Grain producers have more marketing options because their product is easily stored and many producers are selfsufficient in storage, transportation and conditioning. Cooperatives handling perishable products of products requiring special services were very organized and had high proportion of marketing agreements. Activities performed by a cooperative determine the amount and types of resources that must be controlled. The low end of cooperative investment is in the simple bargaining cooperatives. The high end of cooperative investment is in processing cooperatives. An organizations financial risks increase as their level of capital assets increase. Fixed investments in assets have been identified in economic theory as having a significant role in determining organizational structure. 13 We assume that cooperatives with greater fixed assets, all else held constant, would organize in ways that would decrease risk, such as using marketing agreements. Member equity provides a financial base for agricultural cooperatives. And member-marketing agreements are also a form of member support. If a cooperative is more capital-intensive then it is expected that the cooperative will have a relatively high proportion of marketing agreements. 12

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15 Figures 1 through 4 show the level of various cooperative attributes for those cooperatives within a classification with marketing agreements and those without marketing agreements. Cooperative groups can be compared by this graphical method to ascertain whether the theory holds. Grain cooperatives without marketing agreements have the largest share of all the attributes. However, within the grain classification we see that those cooperatives with marketing agreements have disproportionately more fixed assets. In fact, the 6% with marketing agreements have 20% of the fixed assets. Fruit and vegetable cooperatives (figure 2) is a different scenario, as in, those cooperatives with market agreements represent over 85% of each attribute. Within the fruits and vegetables classification, those with marketing agreements have disproportionately more fixed assets. Dairy cooperatives (figure 3) shows that within this classification most of the cooperatives have marketing agreements. However, as compared to the grain and fruit and vegetable cooperatives there is an opposite effect of fixed assets. The 76% with marketing agreements have only 68% of the fixed assets. This can be explained by the composition of dairy cooperatives. Dairy cooperatives can be further subcategorized: 1. Bargaining Cooperatives-Operate as bargaining associations and refrain from product processing/manufacturing. 2. Bargaining-Balancing Cooperatives-Bargain for milk with processors/buyers and manufacture surplus milk supply into commodity dairy products. 15

16 3. Processing/Manufacturing Cooperatives-Process fluid milk or manufacture dairy products. 4. Diversified Cooperatives-Perform a combination of the bargaining, processing/manufacturing, and supply balancing functions. Table 3 details the characteristics of these subsections. The bargaining/balancing group had the highest proportion of marketing agreements. With the simple bargaining groups having the lowest relative proportion. Groups that only conduct bargaining activities have the lowest amount of assets per cooperative with the groups performing processing, manufacturing, bargaining, and balancing having the highest. Figure 5 breaks sales volume for dairy cooperatives by those with marketing agreements and those without. Those firms with marketing agreements have higher relative proportions of actives devoted to bargaining, balancing, and processing. Table 3, we also see that for the groups with higher ratio of assets to sales have the highest proportion of marketing agreements. Table 3: Characteristics of dairy cooperatives by marketing functions 1 Marketing functions Proportion with marketing agreement Average sales per cooperative (mill) Average assets per cooperative (mill) Average number of members Financial characteristics Bargaining 69% High sales to assets, very low or no fixed assets Bargaining/Balancing 92% ,035 High sales to assets, moderate fixed assets Processing/Manufacturing 78% Highest per member equity investment Diversified 76% ,900 Large cooperatives, range of functions 1 Included were cooperatives with $15 million or more in total sales and individual producers as members. Marketing agreements included contracts and bylaw provisions that require member marketing. Source 14 The dairy industry is somewhat unique in their marketing coordination activity. Most producers have long-term marketing relationships. Even in the absence of formal marketing agreements, producers and processors exhibit long-term marketing commitments. 16

17 The cooperative classification of other shows a more mixed balance of attributes by marketing agreements and non-agreements. Figure 4, shows that the majority have marketing agreements and that the cooperatives with marketing agreements represent cooperatives with smaller numbers of members but disproportional larger share of sales. Please remember that the other category includes a wide range of agricultural products. Overall, cooperatives with marketing agreements have higher fixed assets and lower member numbers. Grain cooperatives with marketing agreements usually have a supplementary activity, such as livestock feeding. Fruit and vegetable cooperatives were similar in activities between those with and without marketing agreements. Dairy 17

18 cooperatives exhibit unusual attributes on the surface. However, by investigating the dairy subsections we see that this can be explained. The level of market coordination will be disused next. Specifically comparing long-term contracts, short-term contracts, open market sales, and other methods of marketing. Considering all cooperatives, those with marketing agreements made, on average, 19% of their marketing sales with marketing long-term contracts. Twenty-eight percent used short-term contracts, 50% used open market sales and 3% used other methods. Table 4: Proportion of cooperatives sales from different arrangements, by type and marketing agreement status1 Cooperative type Marketing agreements Long-term contracts Short-term contracts Open market sales Other methods Grain Required 0% 53% 39% 8% Not required 2% 43% 55% 0% Fruit and vegetable Required 14% 13% 69% 4% Not required 0% 8% 92% 0% Dairy Required 29% 32% 38% 1% Not required 1% 53% 41% 5% Other marketing Required 18% 27% 51% 4% Not required 5% 13% 75% 7% Total Required 19% 28% 50% 3% Not required 2% 40% 57% 1% 1 Included were cooperatives with $15 million or more in total sales and individual producers as members. Marketing agreements included contracts and bylaw provisions that require member marketing. 2 Percent of marketing sales is calculated as an unweighted average of percentage distributions. Source 15. Summary The subject matter in this paper gives an understanding of the marketing setting in which agricultural cooperatives operate. We see that members and cooperatives operate and 18

19 indicate when their decisions will lead to coordination. Factors such as physical characteristics influence the need for marketing agreements. Transaction complexity creates incentive to coordinate. Fixed asset structure creates incentive to coordinate. Producers facing a common problem may find cooperatives are an appropriate form. Marketing agreements allow both member and cooperatives to proceed with greater certainty. Entering into a market agreement reduces operating freedom but also reduces market risk This paper has presented material on what makes the cooperative form of business unique, the legality of cooperatives and the role of market agreements in cooperative coordination. We see that the government of the United States acts to allow agricultural producers special privileges. But producers usually only participate in cooperatives and market agreements when there is specific economic incentive. However, as unification of corporate America increases, cooperatives and marketing agreements are a way for the individual producer to gain market outlets and market power to sustain his/her farming operations into the future. 19

20 0 Cooperative Information Report 10, Revised March 1995, CIR 10, What Are Cooperatives? 1 U.S. Department of Agriculture, Rural Business and Cooperative Development Service Cooperative Information Report 50, March, U.S. Department of Agriculture, Agricultural Cooperative Service, ACS Research Report 130, March, Cong. Rec (1890). 4 7 U.S.C. sec U.S.C. sec Understanding Capper-Volstead, U.S. Department of Agriculture Rural Business and Cooperative Development Service, Cooperative Information Report 35, Reprinted April, Marketing Coordination in Agricultural Cooperatives, Roger A. Wissman, Rural Business-Cooperative Service, Research Report 159, September Id. 9 Id. 10 Hunley, Charles L., and David E. Cummins, Marketing and Transportation of Grain by Local Cooperatives, USDA, Agricultural Cooperative Service, Research Report 115, Grain Stocks, USDA, National Agricultural Statistics Service, Jan pp Marketing Coordination in Agricultural Cooperatives, Roger A. Wissman, Rural Business-Cooperative Service, Research Report 159, September Williamson, Oliver E. The Economics of Capitalism, New York: Free Press Marketing Coordination in Agricultural Cooperatives, Roger A. Wissman, Rural Business-Cooperative Service, Research Report 159, September Marketing Coordination in Agricultural Cooperatives, Roger A. Wissman, Rural Business-Cooperative Service, Research Report 159, September