University of Wisconsin Center for Cooperatives
The Potential Role of Cooperatives in Wisconsin’s Aquaculture Industry
Prepared for the Wisconsin Aquaculture Advisory CouncilBy Greg Lawless and Will Hughes, UWCC
Cooperative Development Services,
30 West Mifflin St, Suite 401,
Madison, WI 53703
Tel: 608) 258-4396
University of Wisconsin Center for Cooperatives,
Rm 230 Taylor Hall, 427 Lorch St.,
Madison, WI 53706,
Tel: (608) 262-3981
The Potential Role for Cooperatives in Wisconsin Aquaculture
Part I: Introduction
This report is presented in response to the Wisconsin Aquaculture Advisory Council’s expressed interest in the potential role for cooperatives in the state’s aquaculture industry.
In recent years, farmers in North Dakota and Minnesota have rekindled an interest in cooperatives nationwide. Their investment-driven, market-oriented businesses called for a new kind of cooperative model and approach. At the same time, older, more traditional co-ops throughout the Upper Midwest continue to serve their members in many ways, particularly in agriculture.
This report will present a range of cooperative models or approaches that could possibly be applied in the Wisconsin aquaculture industry. As that industry continues to grow and change, its leaders must respond to new demands, they must create new opportunities, and they must work together toward the goals they share. Specifically, there is an on-going need for market expansion and infrastructure development, particularly with respect to emerging areas of aquaculture like farm-raised perch.
Cooperative enterprises offer one means of growing an industry and adjusting to change, but certainly not the only means. Non-profit associations, coalitions, strategic alliances, limited liability companies, and conventional corporations are among the many ways that individuals and businesses can cooperate. This report, however, is concerned only with the potential applications of the formal cooperative business model.
Part II: A Continuum of Cooperative Models
The various ways that the cooperative model may be applied in aquaculture occurs on a continuum. The continuum presented in Box 1 shows six types of cooperatives ranging from cooperative associations to the New Generation Cooperatives (NGCs).
Box 2 below presents some of the issues that reflect business involvement by cooperative members. In the pages below, each type of cooperative will be discussed in light of these differences issues. In addition, each section will suggest ways that each type of cooperative approach might be applied in Wisconsin’s aquaculture industry.
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The topic of capitalization, which is critical to the success of any new venture, will be discussed more thoroughly after the various co-op approaches have been presented.
Sometimes, farmers producing a common product will form cooperatives to ensure widespread education about production techniques, about market developments, about legislative activities, and about other issues that affect their industry. The cooperative associations they form to provide this member education may also do general product promotion and/or market research to encourage expansion of the industry.
A formal cooperative need not be established to perform these functions. Certainly, the Wisconsin Aquaculture Association, and the Wisconsin Agriculture Advisory Council have already made great strides in all of these areas without turning to the cooperative model.
Whether organized as cooperatives, as non-profits, or as informal coalitions, associations such as these provide services that offer roughly the same benefits to all who join. In other words, general benefits, like market research, producer education, and product promotion, are offered as opposed to individual or business benefits.
Perhaps the only reason to form a cooperative association to provide general benefits would be that the existing or developing organization is intending to provide business benefits in the future. In other words, if producers intend to cooperate eventually to acquire inputs and services, or to process and market products, then the process of forming a cooperative association may offer stepping stones to get there.
One of the key issues in forming a new cooperative is raising the capital necessary to begin operations, whatever those operations may be. A cooperative association, like non-profit organizations, would typically divide those capital responsibilities among prospective members, either equally or in proportion to an agreed upon basis, like farm size. The established fee, in the form of annual membership dues, may be either nominal or significant, depending on the extent of the general benefits offered by the association.
The dairy herd improvement (DHI) associations of Wisconsin provide a good example of service cooperatives. DHIs provide specialized information services, for farm management purposes, by helping record and evaluate member farms’ milk production. This is an example of a business benefit that can be measured for each farm member.
When the benefits an organization provides varies from farm to farm in a measurable way, the cooperative business model may provide an appropriate means of capitalizing and running that organization.
Service cooperatives are generally formed to meet a need that either the existing marketplace is not meeting adequately or can be met cooperatively at a lower price. Wisconsin’s aquaculture operators need to ask themselves whether there are goods and services that a cooperative could provide better or cheaper than existing providers?
If enough producers share common needs for specific business services (like record keeping, tax reporting, consulting work, etc.) and if a cooperative is a cost-effective delivery mechanism for these services, then the producers may choose to establish a new cooperatively-owned business. While it obviously depends upon the service, start-up and operating costs may not be very significant when spread over a wide range of members.
Like its dairy farms, Wisconsin’s aquaculture operations vary in size. To accommodate for this, both start-up capitalization and on-going costs may need to be assessed to members in proportion to business size. Alternatively, operational costs may be assessed according to a flat per/hour fee if services can be measured in that manner.
The advantage to forming a service cooperative is that members can obtain a service "at cost". It must be remembered, however, that, if the business is to continue meeting changing needs well into the future, then the "at cost" approach must take into account the need for on-going reinvestment. In other words, fees charged for services must comply with a business plan for the cooperative that ensures its viability for as long as the cooperative is expected to be needed.
By purchasing goods together in bulk, members of purchasing (or supply) cooperatives can often secure volume discounts and thereby reduce cost of inputs for their individual members. Cooperatives can also reduce prices by operating at cost when existing suppliers do not price competitively. Again, cooperatives are formed to meet needs not met well enough by the existing marketplace. Are there goods or inputs that Wisconsin’s aquaculture operators cannot obtain at acceptable prices? Fingerlings? Chemicals? Feed? Equipment?
Many of the purchasing cooperatives in Wisconsin agriculture provide goods as well as services. Many farm supply co-ops, for example, provide farm management services like crop planning assistance, nutrient and pesticide application, and market forecasting. (In fact, Wisconsin’s aquaculture producers may want to consider working with existing farm supply co-ops to attain goods and services to meet their particular needs.)
The more a cooperative provides its members, the greater the start-up and operational costs, and consequently the more members will need to invest start-up capital for purchasing cooperatives. Once the cooperative is up-and-running, operating costs are figured into prices of goods offered. In this way, members contribute capital to the cooperative in exact proportion to the business they do with it.
It is necessary that some members volunteer to serve on the cooperative board and direct the business, while all members should participate in voting and annual membership meetings. However, the primary relationship that most members will have with their purchasing cooperative is essentially a customer relationship.
In the continuum of member-business involvement, cooperative associations, service cooperatives, and purchasing cooperatives often involve less capital investment and less business risk than occurs when producers engage in cooperative marketing.
Simple Marketing Cooperatives
A meaningful distinction exists between a cooperative that provides members with goods or services and one that processes and markets members’ products. In a marketing cooperative, members who have invested much personal time and effort producing their private products are sharing with other members the costs and benefits of cooperatively marketing all members products.
Simple marketing cooperatives compared to processing and marketing cooperatives. involve relatively minor capital requirements. Some milk marketing cooperatives, for example, do not process or physically market their members milk but instead only represent members in pricing or establishing other terms of trade with processors on their members behalf.
That simple marketing approach may only require an office and computer, a telephone and fax machine, and, very importantly, a competent manager. A marketing staff may be necessary if sales and marketing are functions performed by the cooperative.
Advances in communication technology has meant that more and more marketing functions can be done "virtually", or through electronic transactions between and within businesses. The effect can be lower marketing costs and increased effectiveness.
Simple marketing cooperatives can perform important functions that individuals cannot perform as well on their own. They can coordinate supply among many producers to meet larger buyers’ demands for quantities and service. They can provide the economies of scale to break into new markets. They can establish high quality standards and educate all members to produce according to those standards.
Finally, by pooling their resources, producers can spread the costs of running effective promotions and hiring competent managers and sales people to market their products. By taking these steps, simple marketing cooperatives can often secure higher and/or more stable prices than members could achieve trying to serve larger buyers individually.
Wisconsin aquaculture farmers produce a wide variety of fish for food, game, and baitfish markets. Certainly some products and markets would be more appropriate for cooperative action than others. Producers with new entry products like perch, for example, may now lack the marketing infrastructure to break into new markets. By banding together, perhaps they can provide the quality, quantity, promotion, and service necessary to enhance their product’s presence in restaurants and groceries.
A marketing cooperative is set up to serve its members AND meet the demands of its customers. To achieve the latter, the co-op generally needs some guarantee that its members will provide adequate supply (of consistent quality) to meet those demands. For this reason, most require that members sign binding contracts that commit all or at least a set portion or amount of their production to the cooperative.
With this contract, members’ private businesses become significantly more integrated and involved with the business of the cooperative. When marketing cooperatives get into processing their members products, higher capitalization requirements typically involve even greater integration of member businesses.
Processing Cooperatives: Traditional vs. New Generation Approach
Simple marketing cooperatives usually do not handle or process their members’ raw products. When cooperatives do start transporting, processing, and marketing members’ raw products, on the other hand, significant levels of capital may be required. Whether turning raw milk into cheese, smoking and packaging tilapia for food markets, marketing cranberry juice under a national brand, or processing grain-into-chickens-into-separated egg whites (to supply a contract with McDonalds Corporation), the capital needed to process and market these value-added products will likely involve large contributions of "risk" or "equity" capital from members.
What primarily distinguishes the so-called "new generation cooperative" (NGC) from more traditional types is essentially their capitalization strategy, combined with a closed or limited membership policy. A quick summary of traditional capitalization strategies will help explain this distinction.
Traditional Capitalization Strategies for Cooperatives
If a proposed cooperative has minor capitalization requirements, then it may only be necessary to ask a nominal membership fee of prospective members. Payment of this fee may entitle a member a share of common stock (in stock cooperatives) or membership certificates (in non-stock cooperatives).
In addition to membership fees, the cooperative may issue preferred stock (in stock cooperatives) or capital certificates (in non-stock cooperatives). Both preferred stock and capital certificates may reward investors with dividend payments, but, according to Wisconsin cooperative law (Chapter 185), the return paid cannot exceed 8%.
The greater the capital requirements, the more likely debt capital will be necessary. Cooperatives may borrow capital from members, from supportive non-members, or from private lenders. As a general rule, private lenders require that a cooperative’s debt-to-equity ratio should not fall below a 50-50 split, especially for higher risk start-ups.
Once sufficient capital has been raised to begin operations, the capitalization strategy must also include a means of meeting on-going capital needs. In many service and purchasing cooperatives, "surplus revenue" from service fees & prices for goods may be allocated to member accounts but retained for a limited time to meet capital requirements. Capital raised in this manner is allocated to members "equity accounts," in proportion to the business each member does with the cooperative.
Traditional marketing cooperatives, whether they are simple or more complex processing ventures, often use "check-offs" or "capital retains" to meet on-going capital requirements. Capital retains are assessed to members on a per unit basis reflecting the amount of their raw product that is processed and/or marketed through the cooperative. Again, members’ equity accounts measure the changing level of capital each has invested in the business.
The reason member equity accounts are kept is that equity belongs to members and must be returned someday. Therefore, in addition to meeting start-up and on-going capital requirements, a third aspect of a sound capitalization strategy would involve a plan to return equity to members in a timely fashion.
Many "equity revolvement" strategies have been introduced over the years in traditional cooperatives. Perhaps the most heralded strategy in recent years has been the "base-capital plan." In some ways, the base capital plan represented a step toward the "new generation cooperative" (NGC) approach in that it linked a cooperative’s capital needs to members’ use of the cooperative through an integrated plan for raising and returning equity capital.
The New Generation Cooperative (NGC) Approach
The rationale and structure of the NGC approach have been described in a number of ways in recent years. Dr. Robert Cropp, agricultural economist at the UW-Madison, has described three distinguishing characteristics of a new generation cooperative:
(each share of common stock = one delivery share)
Marketing rights (which also become legal obligations) are allocated as "delivery shares". Each share guarantees and obligates a member to deliver a set quantity of raw product to the cooperative. There may or may not be a limit to how many shares any one member may purchase.
The original price of common stock, which is normally tied to a delivery share or marketing right, is based on three numbers: (1) the overall equity capital requirements of the cooperative, (2) the total value of raw product that can be absorbed by the plant and successfully marketed, and (3) the number of common stock (delivery shares) created.
As an example, the overall capital requirement to build a fish processing plant and begin operations may be $1,000,000. Fifty percent of that may be covered with debt capital, so $500,000 is needed from members. Furthermore, the business plan projects that the plant will be able to process 2,000,000 lbs of members’ fish per year. The set number of shares may be established in the cooperative’s by-laws and approved by the membership.
Using the equations above, creating 1,000 shares would set the original price of a delivery share at $500, and commit a member to delivering 2,000 lbs of "raw" fish for each share held. Creating 5,000 shares, on the other hand, would set the original price of each share at $100, but each share would then guarantee/obligate members to deliver just 400 lbs per share.
Limiting the total number of shares obviously implies limited membership. If the number of shares is set low enough, it will mean that every member will have to be significantly invested in order to meet the equity capital requirements. Indeed, significant investment by every member is an important aspect of the new generation cooperative approach.
The first example in the equation above shows that no member will invest less than $500 up front. Furthermore, the by-laws may require that a minimum number of shares must be purchased as a condition of membership. A minimum requirement of five shares per member would mean then that each member would invest at least $2,500 (five times $500). In that case, there could be no more than 200 members at any given time ($500,000 divided by $2,500).
There are a number of reasons for limiting membership. As mentioned, so doing can ensure that each member is sufficiently invested in the cooperative to stay committed and involved. It also can ensure that the rewards to membership are distributed in proportion to delivery rights. This avoids diluting rewards in ways that discourage investments in the cooperative in the first place.
It has frequently been said and written that new generation cooperatives play an "offensive" (as opposed to defensive) role in the marketplace; that they are profit-oriented; that they aggressively target niche markets and/or secure contracts to serve non-cooperative enterprises. All of these things may be true.
But what really distinguishes these NGCs from traditional marketing and processing operatives is that when they earn money at the end of the year, almost all of that money is typically distributed back to members, in proportion to their use of the cooperative (i.e., in proportion to what they delivered). These profits are returned to members in the form of an annual "value-added check." The reason that all, or nearly all, of the profits may be returned to members each year is that those members already invested sufficiently in the business to keep it running.
Members see the new generation cooperatives as an investment opportunity. Rather than investing individually and expanding horizontally through expansion of their own farms, they invest vertically up the so-called food chain in cooperation with other producers.
However, as is true with all cooperatives, the burden and the rewards of investment in NGCs are tied to their members’ USE of the business. Members must deliver as much raw product as their shares oblige them, accept the going market price for that raw product, and then wait to see if their cooperative’s performance will generate surplus revenue at the end of the fiscal year.
One last characteristic distinguishes NGCs from more traditional cooperatives: that equity, in the form of the delivery shares, may be traded among members at prices that reflect the current and projected performance of the cooperative. That means that the price of shares can appreciate or depreciate over time.
Appreciable/depreciable, and transferable equity means that it is possible for members to recover their investment in the cooperative when they want out or no longer meet membership criteria. (Membership criteria typically requires that members be active producers.) Of course, there is a risk inherent in this approach. Poor performance by the cooperative may mean only a portion of the original investment may be recovered.
However, one of the reasons put forth for the sudden expansion of NGC development in North Dakota and Minnesota in the 1990s is that that area saw two major successes from this approach dating back to the early 1970s. Sugar beet and corn processing plants that were organized as NGCs at that time not only provided their members with satisfying "value-added checks" from year-to-year, but original members trading their shares now are recognizing significant capital gains.
Two other important reasons why NGCs have done so well in those two states is that (1) both states have a strong cooperative tradition dating back to their first European immigrants, and (2) in both states there were research programs, seed money, and technical assistance available from a host of sources: state government, universities, electric cooperatives, St. Paul Bank for Cooperatives, and cooperative development specialists.
Box 4 below briefly explains how two different aquaculture cooperatives were started in the past five or six years. One in West Virginia, started in the early 1990s, took a more traditional approach, while a tilapia processing plant in North Dakota, operating now for two years now, took more of a "new generation" approach. Both have run into problems and offer lessons for those considering a cooperative approach.
The leaders in Wisconsin’s aquaculture industry have to decide whether it makes sense for them to pursue any of the cooperative strategies described in this report. The final two parts of this report offer a brief summary of the general steps to take when forming a cooperative, and a list of ten conditions for sustaining success in a cooperative venture.
Part III: How to Start a Cooperative
Is there an economic need for a new cooperative? Any combination of the steps below may answer that question.
If any of these steps indicate there is strong enough interest by prospective members to continue a more formal exploration, then...
Legal papers include "articles of incorporation" and "by-laws". The articles are generally kept rather simple, even vague. In Wisconsin, five "charter members" must sign the articles, which are then filed through the state’s new Department of Financial Institutions. By-laws need not be filed at that time, but they should be developed as soon as possible by the steering committee (with outside help, if necessary.) See Box 5.
Charter and prospective members meet and vote to approve the by-laws. Once approved, the new membership elects a Board of Directors, and at that point, a formal cooperative meeting can be convened. The board may create committees to address specific issues. Usually, any member may serve on a committee.
The business plan should include a detailed capitalization strategy. Typically, new generation cooperatives require major capital contributions as a condition of membership. In that case, equity capital may be acquired prior or parallel to the first membership meeting (Step 8).
Part IV: How to Achieve and Sustain Success
The list below was generated from earlier lists of "potential pitfalls and difficulties" that were presented in the publication of Year in Cooperation, Vol. 1 No. 1 of the Minnesota Association of Cooperatives.
Footnotes1 Because surplus revenue is allocated to members' individual "equity accounts", the cooperative is not required to pay taxes on that income. By law, at least 20% of allocated equity must be paid to members in cash each year, a practical requirement since members are required to pay taxes on the total amount allocated. While this is a burden for members to bear, federal law does favor cooperatives over conventional (subchapter C) corporations, which must essentially pay taxes twice-- at the entity level and at the shareholder level.
2 Income from non-members, who may be charged higher fees for goods and services, may remain in the cooperative coffers as "unallocated equity." Business with non-members is generally limited to 50% of the total business done. Furthermore, unallocated equity is taxed at the cooperative or "entity" level.
3 With a base capital plan, the cooperative board sets the equity capital goal that each member must eventually meet. The goal for each member is based on the portion of the overall capital needs of the cooperative that reflects the amount of business each member did with the cooperative the previous year. Ideally, a member would meet that goal as soon as possible. By so doing, the cooperative can acquire the capital it needs sooner than later, and, in addition, once a member's capital goal is met, no further patronage refunds or check-offs are retained, and the member is allocated 100% of these payments in cash.
4Three good sources include: (1) Harris, Andrea, Brenda Stephanson, & Murray Fulton, "New Generation Cooperatives and Cooperative Theory," Centre for the Study of Co-operatives, November 1995. (2) Minnesota Association of Cooperatives (of St. Paul, MN), "New Generation Cooperatives" The Next Chapter in Community Development," from Year in Cooperation, Fall 1994. (3) Nadeau, E.G., "Valued-Added Co-op Article," draft, Cooperative Development Service (of Madison, WI), March 1996.