New Generation Farmer Co-operatives (1997)

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This document has been made available in electronic format
by the International Co-operative Alliance (ICA)
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April, 1997
(Source: ICA Review, Vol.90 No.1, 1997, pp.32-38)




New Generation Farmer Co-ops
by Jerker Nilsson* 
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The "Co-op Fever"
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In 1989 two scholars studied the sparsely populated areas of the Great
Plains, concluding that farm programmes and other federal support to these
areas was an ineffective way of operating a regional welfare system. A few
years later a book with a similar message was published by another group
of academics (Egerstrom 1994a; Stefanson et al. 1995).

The region had for many years experienced an economic decline. "North
Dakota ended the 1980s with 634,000 people, down 18,000 from 1970 ...
Most of the loss occurred in rural areas, which lost 16,000 residents."
(Campbell 1995c) North Dakota is one of the US states with the lowest per
capita income. Agriculture is about the only type of business in the region,
and the farmers had for many years experienced declining prices when
selling their produce. Some farmers had even been excluded from the large
co-operatives for logistical reasons (Campbell 1995b).

In the early 1990s, these problems gave  birth to a new model of agricultural
co-operatives, the New Generation Farmer Co-operatives (NGC). This
model implies far-reaching vertical integration, giving the farmer larger
earnings through selling processed products instead of raw products.
Through production contracts, granting delivery rights and delivery
obligations, all business functions can be streamlined. The huge amounts of
money needed for constructing the production plants is attained through
direct investments from the members. In order to control the production the
co-operatives have closed memberships. As the shares (delivery contracts)
are tradable on the market, there is strong member involvement and control.
During the course of a few years, more than 50 new co-operatives have
started - there is good reason for labeling this process a "Co-op Fever"
(Campbell 1995a).

The NGC model has "had a substantial economic impact ... In North
Dakota alone, disposable income increased 11 percent between 1990 and
1994 - a period in which much of the NGC development occurred.
Population grew by 4,000 residents and 3,500 new jobs were created."
(Lawless 1996, citing Cropp at a NGC conference) The NGCs are about to
achieve the visions that some had when the Co-op Fever started: "reducing
the rate of out-migration, increasing the population, doubling the state's
manufacturing jobs, increasing the average per capita income of rural
residents to the national average, and diversifying agriculture and stopping
the decline in farm numbers" (Stefanson et al. 1995).

New Generation Model
----------------------------
The New Generation Co-operatives differ from traditional agricultural co
operatives in several respects, the most prominent being (Stefanson et al.
1995; Cropp 1996):

1.	Delivery contracts, stating the member's right to deliver products of
a specified quantity and quality as well as the member's obligation to deliver
these products, and 

2.	Closed or restricted membership, or even selected membership.

Some other characteristics follow from these two, all forming a coherent
body of business-oriented practices. 

Production
--------------
3.	The rationale behind exactly defined quantities and qualities of raw
product is that the co-operative is processing the products far downstream
the production chain.  While traditional co-operatives generally sell bulk
products, "value-added" is a keyword for NGCs. Thereby the farmers
increase their share of the consumer dollar - the raw product's share of the
consumer price is 30 percent on average, while the processing accounts for
31 percent (Egerstrom 1994b).

4.	The new generation co-operatives are market driven. The markets
they are aiming for are mainly the large cities in the East of the USA. There
are, however, also firms that operate all across the nation as well as a few
with international businesses.

5.	In order to reduce the costs or increase product quality, some co
operatives put extra demands on their members, such as demanding certain
grower practices, or requiring a certain proximity to a factory (Morris
1996). 

6.	Already in its startup phase the co-operative should be large enough
to be one of the most powerful players in its market (Lawless 1996).
Likewise, the production technology, both in the co-operative and among
the farmers, should be up-to-date, assuring efficient business. 

7.	If a member is unable to supply the contracted volume or products
of sufficient standards, the co-operative will buy these products at the
market rate and charge the member's account. 

Ownership
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8.	As the value-added strategy demands heavy investments in
production and marketing, the farmers have to pay large amounts for the
shares, amounting to between US$ 5,000 and US$ 15,000 per member.
This money must be paid up-front, thereby committing the member and
securing a solid capital base (Egerstrom 1994b).

9.	The shares are linked to one unit of production (a bushel of wheat, bison, etc.), 
and a member has to buy a number of shares, corresponding to
his deliveries. The value of each share is calculated as the quota between the
total investments and the volume of raw product to be processed. 

10.	The equity capital accounts for 40-50 percent of the total capital. The
rest is borrowed from local banks at market conditions. 

11.	Due to the closed membership, the shares (delivery contracts) are
tradable,  after approval from the board. Hence, there is a market for shares,
and their value could vary depending on expectations concerning the
performance of the co-operative. The share value could increase by 50
percent or more over a few years as an effect of the co-operative's ability to
raise the product prices. Dakota Growers Pasta Company succeeded to raise
the durum wheat price from $2.20 to $7.00 per bushel (Campbell 1995a).

12.	As the shares are tradable the entire equity capital becomes
permanent, and so, the banks offer more favorable credit terms (Harris et al.
1995).

13.	The closed membership and the tradable shares mean that the
composition of the equity in allocated, and unallocated capital is of minor
importance. The unallocated funds are capitalized in the shares' market
price. Nevertheless, NGCs have little unallocated equity.
 
14.	If the business is to expand, more shares are sold, primarily to
existing members, otherwise to other farmers (Torgerson 1994b; Cropp
1996).

15.	If more capital is needed without expanding the business operations,
the members are asked to raise more equity, in proportion to their delivery
volumes. Such additional investments are rational for the farmers - if they
reject, their shares might decline (Harris et al 1995).

16.	In order to avoid one member dominating, some NGCs have a limit
on how many shares could be owned by one member (Lawless 1996).

17.	Profits are distributed to the members as patronage refunds. Due to
the proportionality between deliveries and member investments, the
dividends are also proportional to the member's investments. Nearly all
refunds are paid in cash, leaving only small amounts as reserves or none at
all (Lawless 1996).

18.	Preferred shares are sometimes sold to the community. As there is a
legal limit on 8 percent dividends and no voting rights are granted, the local
people may buy preferential shares to support the co-op. 

Management
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19.	The principle of one member-one vote is applied in the NGCs. This
might be surprising, as differentiated voting is usual among the business
oriented American co-operatives. However, the differences between the
largest and the smallest NGC members are not as substantial as they are
traditionally in agricultural co-operative memberships. Second, the
heterogeneity within the membership is reduced by the fact that the NGCs
operate within narrow business fields, while many other farmer co-operatives 
run diversified operations (Harris et al. 1995). 

20.	The board of directors is elected by the membership from among
their number. 

21.	The Chief Executive Officer is generally a person with managerial
talents of the highest order. The co-operative should be run absolutely
professionally, and with the latest technology (Harris et al. 1995; Fure
1996).

22.	The co-operatives are contingent upon the advice from highly
qualified consultants (Lawless 1996). Every establishment is conducted
after thorough feasibility studies.

New Generation Co-ops
-----------------------------
The NGC model has expanded rapidly. More than 50 NGCs have been
established, perhaps approaching 100. Experts expect that another 100-150
NGCs will come into being before this decade is over (Guebert 1996). Until
1994 the farmer-members have invested in the magnitude of 1 billion US
dollars, and this amount is expected to be the double within a few years
(Egerstrom 1994b). The investments per firm vary from US$ 235 million
(Northern Corn Processor's Co-op, 2,500 members) to US$ 50,000
(Dakota Rabbit Growers, 150 members) (Torgerson 1994a).

The NGCs are working within a wide range of products, all being value
added products based on the members' raw products (Cropp 1996):

*	alfalfa/biomass	 
*	aquaculture	 
*	bison slaughtering and processing
*	carrot processing	 
*	cattle feed lot	 
*	cattle slaughter and processing
*	corn processing (ethanol, etc.)	 
*	dry edible bean processing	
*	flour milling	 
*	frozen bread dough	 
*	organic dairy products	 
*	organic fruits and vegetables	 
*	ostriches	 
*	pasta production	 
*	poultry and egg production	 
*	soy processing	 
*	specialty cheeses	 
*	straw/base particle board	
*	sugar beet processing	 
*	swine production 	 
*	venison processing

The development of the New Generation Co-operatives has been
concentrated in North Dakota and Minnesota. Wisconsin also has some
NGCs and a few are found in California (Egerstrom 1994a). In 1996 the
first NGC was established in South Dakota (Fure 1996). The model has
also spread to Canada which has  a few new generation co-operatives.
Some NGCs (e.g., North American Bison Co-operative) have members
both in the USA and  Canada (Egerstrom 1994b; Stefanson et al. 1995). In
1996, Iowa introduced a law that is intended to stimulate the growth of
NGCs in this state (Guebert 1996).

The most prominent influence to the NGC concept is American Crystal
Sugar Co. (ACSC) - a former IOF that was bought by a group of farmers in
the early 1970s and transformed into a co-op. Due to the ACSC's history it
is understandable that the membership became closed, and as the
supplier/buyer relations did not function satisfactorily it is understandable
that the co-operative introduced delivery control. This co-operative turned
out to be a success for the farmers, and it served as a model for Minnesota
Corn Processors in the 1980s (Torgerson 1994a). After these two
pioneering co-operatives the road was paved for the "Co-op Fever". No
bankruptcy or other severe hardships have yet been reported. 

Evaluating the New Co-ops
---------------------------------
The NGC model is constructed in such a way that the agency theoretical
problems are not higher than in comparable IOFs but rather lower (Bergeron
& Lalancette 1993; Cook 1997):

*	Horizon problems do not exist, due to the tradable shares. The
members have reason to consider not only the short-term prices and
conditions but also the long-term effects of investments, price decisions,
etc. Their goal is to maximize the discounted cash-flow from the co-
operative over a long future.
 
*	Common property problems could be substantial in many traditional
co-operatives, i.e., the members can act opportunistically. In NGCs, the
free-rider behavior is limited as the unallocated capital is capitalized into the
market value of the share. In traditional co-operatives the market signals to
the members could be distorted by the existence of unallocated capital, while
NGCs operate under strict market conditions. The fact that interest is not
always paid by traditional co-operatives might lead to distorted market
signals to the members as well as disincentives to invest. These dangers do
not exist in a NGC (Harris et al. 1995).

*	Portfolio problems are minimal because NGCs operate within
narrowly defined businesses. There is little room for divergent opinions
about investments. Second, the membership is fairy homogeneous, hence
the risk for conflicts is reduced. Third, the project plan is thoroughly
scrutinized before the startup of the co-operative. 

The Upper Midwest faced a decline, schools and stores were being closed
and public support to the region was threatened. The farmers were selling
their produce to distant buyers at low prices. This resembles the classical
conditions for the establishment of co-operatives - the members faced high
transaction costs when trading on the markets (Staatz 1987).  Land value
was declining and family traditions were threatened, both expressing
transaction specific investments. Due to the remote location and relatively
small volumes produced in the area, intermediary firms in the production
chain also experience high transaction costs. Passing several commodity
markets and approaching profitable consumer markets, the farmers could
earn more money. ValAdCo - a hog breeding co-operative owned by grain
farmers  - "was able to turn $1 worth of grain into $3 worth of livestock"
(Lawless 1996).

The membership tends to consist of the best farmers (Campbell 1995b).
Less efficient members will find that the sales value of their shares exceeds
the profits they can make by remaining on as suppliers, while more efficient
farmers will find it profitable to pay a higher price for the same shares.

The New Generation Co-operatives represent a promising model. However,
the economic and social conditions in the Upper Midwest might have had
such a large impact that it is difficult (but still possible) to apply this model
elsewhere. 

Second, it might be tempting to copy just a few of the elements of the model
but such an attempt would be hazardous - all components hang together into
an integral whole. 

Sources
----------

Bergeron, M.Y. & S. Lalancette. 1993. "Caracteristiques des
principes co-operatifs au plan financier; une perspective d'agence" 
Annales de l'Economie Publique, Sociale et Co-operative  64/3.

Campbell, D. 1995a. "Temperature Rising. Co-op Fever is Still Sizzling
Across North Dakota, but will the First Failure Cause it to Dissipate?"
Farmer Co-operatives  62/5, 10-16. 

Campbell, D. 1995b. "The Carrot and Stick. A Conversation with Bill
Patrie, the Man Who Helped Spark Co-op Fever" Farmer Co-operatives 
62/5, 17-21. 

Campbell, D. 1995c. "Look in the Mirror Ignited Rural Development"
Farmer Co-operatives 62/5, 12-13.

Cook, M.L. 1997. "Organizational Structure and Globalization: The Case of
User Oriented Firms". Strategies and Structures in the Agro-Food Industry,
eds. J. Nilsson & G. van Dijk, van Gorcum, Assen. 

Cropp, R. 1966. "New Generation Co-operatives Defined" University of
Wisconsin Center for Co-operatives, Madison, WI.
 
Egerstrom, L. 1994a. Make No Small Plans. A Co-operative Revival for
Rural America. Lone Oak Press, Rochester, MN. 

Egerstrom, L. 1994b. "The New Wave. New Co-ops Help Growers Gain
Larger Share of Food Dollars" Farmer Co-operatives 61/7, 6-9. 

Fure, J. 1996. "Putting Their Ducks In A Row. South Dakota Groups
Builds Soybean Processing Plant" Year in Co-operation, Spring 2/2. 

Guebert, A. 1996. "Ny amerikansk samvirkebevegelse." Bondebladet, May
22nd, 1996.

Harris, A., B. Stefanson & M. Fulton. 1995. New Generation Co
operatives and Economic Theory. Centre for the Study of Co-operatives,
University of Saskatchewan, Saskatoon.

Lawless, G. 1996. 'New Generation' Farmer Co-operatives Conference: A
Summary" University of Wisconsin Center for Co-operatives, Madison, WI.

Morris, R.K. 1996. "Legal & Financial Aspects of New Generation Co
operatives: Legal Implications" University of Wisconsin Center for Co
operatives, Madison, WI.

Staatz, J. 1987. "The Structural Characteristics of Farmer Co-operatives
and their Behavioral Consequences"  Co-operative Theory. New
Approaches. USDA, Washington DC.

Stefanson, B., M. Fulton & A. Harris. 1995. New Generation Co
operatives; Rebuilding Rural Economies. Centre for the Study of Co
operatives, University of Saskatchewan, Saskatoon. 

Torgerson, R. 1994a. "Co-op Fever. Co-operative Renaissance Blooming
on Northern Plains" Farmer Co-operatives 61/6, 12-14. 

Torgerson, R. 1994b. "'New Wave' Co-operatives: Rethinking Some
Issues" Farmer Co-operatives 61/8, 2. 

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* 	Mr. Nilsson is Professor of Co-operative Business at the Swedish
University of Agricultural Sciences.