University of Wisconsin Center for Cooperatives
New Generation Farmer Cooperatives Information
"New Generation" Farmer Cooperatives Conference: A Summary
April 1, 1996
Stevens Point, Wisconsin
By Greg Lawless, University of Wisconsin Center for Cooperatives
The summary below includes a general explanation of New Generation Cooperatives. If you're interested in exploring whether this new co-op model may work in your community, contact Bob Cropp or Greg Lawless here at the UW Center for Cooperatives. If we cannot help you, we'll try to direct you to someone can.
On April 1st in Stevens Point, Wisconsin, the UW Center for Cooperatives hosted a state-wide conference to explore the "New Generation" farmer cooperatives of North Dakota and Minnesota. Co-sponsored by University, Extension, and non-profit organizations that share our concern for Wisconsin's rural economy, the conference assembled many of the leaders of this new co-op activity, and it attracted a large and diverse audience. Farmers, cooperative leaders, university staff and extension agents, lenders, and leaders from many other sectors gathered to learn about this new development, and discussed how it might be applied in Wisconsin.
Introduction to New Generation CooperativesUWCC's Bob Cropp began the day with an introduction to New Generation Cooperatives (NGCs). The term has been applied to the fifty or so farmer cooperatives that have emerged in North Dakota and Minnesota over the last four or five years. This new wave of cooperative development has already had a substantial economic impact in the region. 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 during that period. This followed a long period of economic decline in the state throughout the 1980s.
The New Generation Cooperatives differ from more traditional marketing co-ops in that their major focus is on "value-added" products, rather than commodities. NGC members sell raw products grown on their private farms to their cooperatively-owned processing plant. Profits from this cooperative enterprise are then distributed back to members in proportion to raw product delivered.
The role of shares in New Generation CooperativesCropp explained two policies that further distinguish NGCs from traditional cooperatives. First, shares in an NGC do not simply assign membership, they allocate delivery rights. Each share entitles a member to deliver one unit of product to the cooperative. This represents a "dual contract"-- the farmer must deliver a unit for each share purchased, and the cooperative must accept and compensate the farmer for each unit delivered.
The initial price of each share is determined by the total amount of equity capital needed to start the business, divided by the number of units of product that can be absorbed by the facility. For example, to build a plant that will process $5 million worth of corn each year, $2 million dollars in equity capital may be required. To meet this goal, 1,000 shares may be offered to prospective members. The initial price of each share, then, would equal $2,000 ($2 million capital requirement ö 1,000 shares). In turn, each of the 1,000 shares would allocate delivery rights for $5,000 worth of corn each year ($5 million plant capacity ö 1,000 shares).
This initial price per share of $2,000 would be set by the steering committee organizing the proposed cooperative. Prospective members decide whether it's cost-effective to invest in the business at that price. Once the cooperative is started, shares may be traded among members, or, with board approval, to outside farmers looking to join. The market then determines the value of the shares, which may go up and down, reflecting the cooperative's performance.
There are at least four advantages to this policy of delivery shares. First, adequate equity capital is raised at the outset of the business. Second, the burden of capitalization is distributed equitably, in proportion to the future use each member will make of the cooperative. Third, because each member is substantially invested in the business, they all have an interest in seeing it succeed. Finally, by selling their membership shares, exiting members may redeem their invested equity immediately-- at a value that reflects the performance of the cooperative.
Cropp also noted that the cooperative may offer preferred shares to the local community or general public. This allows community members to support the project and its associated economic benefits. These preferred shares would not include voting rights, so that control of the business would remain in the hands of producers. There is also an 8% limit on dividends that can be paid in a cooperative enterprise.
Closed or restricted membershipIn addition to the policy of delivery shares, a second policy that distinguishes NGCs from most traditional cooperatives is that of restricted, or closed membership. Membership is restricted for two reasons. First, the cooperative does not want to accept more raw product than its facilities can absorb. Second, shares of this finite quantity of annual raw product inputs are divided by a number small enough to ensure that purchase of one share may be enough to justify investment. In this way, every member has a substantial stake in the enterprise, and each may enjoy an adequate return from profits generated by its business.
Essentially, this closed membership policy stems from the market-driven nature of New Generation Cooperatives. Value-added products are chosen because they typically provide a higher return to producers than can commodities. Furthermore, NGCs often target niche markets to garner additional value. Having located a market and quantified total demand for the year, NGCs restrict membership to ensure a supply to match that demand. As demand in the marketplace is expanded, the co-op itself may expand, and members may either purchase newly created delivery shares themselves, or the board may invite new farmers to join.
Despite these differences from traditional cooperatives, Cropp noted that NGCs retain the cooperative principles that have served farmers well in the past. Specifically, NGCs are democratically controlled enterprises. Regardless of the number of shares a member may own-- and there may be a maximum limit-- every member receives one and only one vote. Members elect a board of directors from amongst themselves to carry out the mission of the organization.
Furthermore, profits generated from the business are returned to its members, in proportion to their patronage. In most cases, these new co-ops return all or most of the profits each year as cash, keeping only a small portion as capital retains. Generally, if the co-op wishes to finance an expansion, capital is acquired not from the previous year's profits, but through an offering of additional shares. In this way, the added-value that the cooperative captures is returned to producers each year.
Cropp added that there are a great many diverse applications of the NGC model in North Dakota and Minnesota, covering a wide range of agricultural products, in both conventional and niche markets. NGCs have been organized to process alfalfa, bison, carrots, soy and edible beans, sugar beets, beef cattle, corn, milk, and durum wheat. Their value-added products include organic dairy products and specialty cheeses, sweeteners, ethanol, frozen vegetables, pasta, straw-based particle board, and tortillas.
Following Dr. Cropp's introduction, Dr. David Trechter of the UW-River Falls Rural Development Institute introduced two distinguished visitors from Minnesota and North Dakota, and facilitated the lively discussions that followed their respective presentations.
ValAdCo's success in Renville, MinnesotaThe first guest speaker was Roger Kingstrom, a hog and grain farmer from Renville, Minnesota. Kingstrom was a founder and the first board president of a hog breeding operation, or "crossing farm", called ValAdCo-- short for value-added cooperative. One of the first New Generation Cooperatives, ValAdCo was organized to process its members' corn into the maternal line of DK33 gilts. By producing breeding stock, ValAdCo was able to take advantage of a "breeding exception" to Minnesota's anti-corporate farm law.
More to the point, by breeding the grandparent stock of DeKalb, Inc., and selling the finished gilts back to DeKalb for a profit, the cooperative was able to capture an added value that their raw corn products would not have garnered alone. Kingstrom said that the co-op was able to turn $1 dollar worth of grain into $3 worth of livestock.
After five years in business, ValAdCo now has over 100 members, more than 2,000 shares, 8,750 sows, and over 50 employees. Kingstrom noted that this business has not only benefited its members, but it has enhanced the community's economic base. ValAdCo producers patronize agricultural as well as other local businesses. Furthermore, with new economic development, young people in the community have been given a reason to stay.
An early New Generation Cooperative: American Crystal SugarAfter Kingstrom's presentation, Trechtor introduced former governor of North Dakota and long-time NGC organizer, George Sinner. While most NGCs were started within the last six years, Sinner was involved in what is recognized as the first NGC ever developed: American Crystal Sugar, of Moorhead, Minnesota.
Started back in 1972, American Crystal was one of three early NGCs that also included the Southern Minnesota Sugar Beet Cooperative, and the Minnesota Corn Processors Cooperative, both of the Renville area. It was the sustained success of these three enterprises that prompted farmers like Kingstrom to explore new applications of the model in the 1990s. Not only did the annual profits from the three original NGCs provide added income to its members from year-to-year, but shares bought in those first years now sell for a price significantly higher than was originally paid. The capital gains enjoyed by the first NGC members reflects the success of these early ventures.
Recommendations for successHaving been associated with the movement from its start, Sinner offered six recommendations for developing a successful New Generation Co-op. First, farmers need to make significant investments in order to secure an appropriately sized plant and the proper equipment. Second, a dual contract must commit the farmer to specific deliveries, and the co-op must accept those deliveries. This offers stability to both the members and the cooperative. Third, professionalism is required on the part of farmer members, directors, and the hired management team.
A fourth recommendation goes to the heart of NGC idea: the cooperative must be knowledgeable about its customers and about the marketplace in general. The value-added product chosen and the facilities needed to produce it must be based on accurate measurements of demand for that product, and the cooperative must be willing to adjust quickly to changes in the marketplace.
Sinner's fifth recommendation spoke to the issue of scale. He did not suggest there was an absolute scale of operations or facilities that could be defined, but rather the cooperative should aim for a large share of whatever market it has targeted, and build appropriately. As an example, Sinner warned that some of the NGCs producing ethanol may not be large enough to compete effectively in that market-- especially when government support for that industry declines.
To be successful, Sinner argued, a New Generation Cooperative must be large enough to meet the needs of its buyers and to match or beat the prices and the quality of its competitors' products. In a small niche market, the cooperative may be of a small or moderate scale, as long as it's large enough to compete effectively within that niche.
Finally, Sinner made the point that most, if not all, of the profits from the cooperative must be returned to its members as cash at the end of each fiscal year. This is necessary to keep members interested in and committed to the cooperative. If capital is needed for expansion, the board and management must make the case for expansion and offer new shares to pay for it.
The Coulee Region Organic Produce Pool (CROPP) invests in market developmentAfter a morning already packed with new ideas, the afternoon session began with presentations by representatives of two Wisconsin businesses that typified the niche market approach. While there are apparently no true NGCs in Wisconsin at this time, the Coulee Region Organic Produce Pool (CROPP) of La Farge, and the Specialty Cheese Company of Lowell each exhibit characteristics common to the NGC approach.
Michael Bedessem, business coordinator for CROPP, explained how this cooperative began with the intent to market its members' organically grown produce, but quickly shifted its emphasis to the more lucrative market for organic dairy products. While organic foods represent only .2% of total food sales in the U.S., this represented a large enough niche to offer CROPP's 75 dairy farmers a premium price for their milk. Marketed under the brand name, Organic Valley, CROPP produces twenty varieties of cheeses that are sold in all fifty states.
Bedessem noted that if they resemble a New Generation Cooperative, it came about entirely by accident. They correspond to the NGC model in at least two ways. First, they are a closed cooperative. While they accept all of the milk of their 75 producers, they only pay the premium organic price for the amount of milk needed to meet the demand for organic dairy products. Milk over that amount is sold in the conventional marketplace and receives no premium. This market-driven approach gets to the heart of New Generation Cooperatives. The premium prices that members do receive has enabled them to survive economically with an average of only forty cows apiece.
CROPP deviates from the NGC approach in at least two ways. First, it does not use the policy of delivery shares. It was not clear whether they were still able to enjoy the advantages of this policy as described above: adequate and equitable capitalization, sustained interest and involvement of invested members, and an avenue for immediate equity redemption.
CROPP also differs from most of the NGCs of North Dakota and Minnesota in that it did not invest heavily in fixed assets. They do not own a processing plant. Instead, CROPP delivers its milk to thirteen plants in the region, which process their milk in accordance with organic standards. In this way, CROPP has been able to direct its investments into market development and inventory. Each member still invests approximately $5,000 into the cooperative.
Specialty Cheese Institute markets non-traditional cheesesThe next speaker was Paul Sharfman, president of the Specialty Cheese Institute, and owner of the Specialty Cheese Company. The company is located in Lowell, Wisconsin, and owns processing plants in nearby Lebanon and Reeseville. The company employs fifty people and processes the milk of some sixty farms, specializing in Middle Eastern, Kosher, and Hispanic-type cheeses. It has markets throughout the US and abroad.
Sharfman started the Specialty Cheese Institute because he believed Wisconsin producers of specialty cheeses could fare better working together than in direct competition. While its members found it difficult to trust one another in the beginning, Sharfman says they soon discovered ways to help one another, sharing customer lists and attending trade shows together.
Neither the company nor the institute are organized as a cooperative. Nevertheless, Sharfman was invited to make a presentation because his market-driven approach and niche market specialization so typifies the New Generation Cooperative phenomenon. Furthermore, by pulling together former competitors in Wisconsin's growing specialty cheese industry, Sharfman's Institute demonstrates the spirit of cooperation that has fueled NGC development in our neighboring states.
Sharfman posed questions and challenges to the audience that remained to be answered. Can the Wisconsin dairy industry shift to a more market-oriented approach, maximizing opportunities that niche markets may offer? Can Wisconsin producers of other commodities come together to explore value-added strategies and niche markets in order to increase their individual incomes?
Legal implicationsThese questions could not be answered by the two remaining speakers, but they were able to provide valuable advice to those considering a New Generation Co-op approach. Ralph Morris, an attorney from St. Paul, and Lee Estensen, vice president and lending team manager for the St. Paul Bank for Cooperatives, have both been instrumental in the development of NGCs over the past six years. The two have provided legal and financial advice that have guided many of the fifty-plus NGCs toward success.
Morris reminded the audience of the legal advantages that the cooperative model offer producers. Aside from several tax advantages, cooperatives essentially allow farmers to do what other private businesses cannot-- market their products together through shared marketing strategies. It is this exemption from anti-trust laws that enables farmers in North Dakota and Minnesota to supply the capital and the inputs together to "move up the food chain", and capture dollars from collective processing and marketing of value-added products.
Morris noted that it is in the area of marketing that the NGCs are proving themselves superior to the more traditional cooperatives. As other speakers made clear, limiting supply to match demand, and targeting opportunities in developing niche markets, are two keys to the success of New Generation Cooperatives. Morris also pointed out that many consumers show a preference for and a trust in food produced and sold by farmers, and, by moving up the food chain, NGCs take advantage of this opportunity.
Morris went into more detail about legal considerations facing an NGC. He discussed organizational structure and tax laws that would affect NGCs much the same as they would traditional cooperatives. With the use of tradable and appreciable shares, there were additional tax rules and securities laws that might be applicable to NGCs.
Morris mentioned basic and optional membership qualifications and other rules that could give shape to a proposed NGC. Articles of incorporation and bylaws could define classes of stock; limit membership to active farmers and/or state residents; set minimum and maximum limits on stock ownership; require certain grower standards or practices; define member marketing agreements; require a certain proximity to a factory; etc. With so many options and issues, Morris advised that competent counsel be acquired to help groups choose the best course to fit their needs.
Risk evaluation and financial structuresLee Estensen followed Morris and offered his perspective as a lender and financial expert at the St. Paul Bank for Cooperatives. Estensen first made the important point that there is no "cookie cutter" approach to starting a New Generation Cooperative. The presentations by representatives of ValAdCo, American Crystal Sugar, CROPP, and the Specialty Cheese Company made it clear that there are many ways to go about it.
Nevertheless, Estensen was able to provide general advice that should be considered carefully by any group looking to start an NGC. In short, he said there are three "keys for success": quality people, risk evaluation, and financial structure.
His first point was in line with Sinner's call for professionalism among farmer members, directors, and the management team. Because members must be focused on their own individual farms, competent managers must be hired that have experience in the industry, with the processing operation, and in the market that the cooperative has targeted.
Cropp had also mentioned that a successful NGC requires motivated, determined, and committed people, and that access to competent consultants was also critical. Estensten added that most successful NGCs include a "project champion" that keeps the project going when others have their doubts. It was clear from his enthusiasm that Roger Kingstrom must have played just such a role at ValAdCo.
Regarding risk evaluation, Estensen noted that NGCs face many of the same risks that any new business faces. These risks cannot be eliminated altogether, they can only be controlled. Feasibility studies and financial projections will help determine a "comfortable" scale of operations-- one that promises Sinner's call for a significant share of the market targeted, and yet recognizes the capitalization limits of the group. These studies should also help in preparing a solid marketing plan and hiring staff capable of carrying that plan out.
Constructions costs can be minimized with proper consultation and, if possible, turn-key (fixed price) contracts. Third-party engineers should be hired to inspect construction, and, to be safe, a "cushion" should be built into the capitalization strategy to deal with cost overruns. The risk of changes in government regulations should also be considered, so that, for instance, construction plans meet current as well as foreseen changes in environmental laws.
Regarding financial structure, Estensen listed three goals: liquidity, leverage, and profitability. Liquidity means the ability to pay bills on time, always having enough money on hand to run the enterprise. Again, a cushion should be built into the initial capitalization strategy that takes this into account. Estensen cautioned that every new cooperative should expect financial struggles in the early years of the operation.
With regard to leverage, NGCs should always aim for at least a 50-50 equity-to-debt ratio. Banks may accept a slightly lower ratio if risks are effectively minimized. Finally, profitability must be achieved as soon as possible. Estensen made the very important point that new jobs must not be the primary goal of the new venture. Profitability, if achieved, will result in new jobs, and that is the way to approach it. In summary, Estensen advised that the group must determine what factors will make the project a success, they must ask which of those factors are in their control, and they must then take appropriate steps to achieve their realistic goals.
Advantages of New Generation CooperativesAt the start of the long day, Bob Cropp had mentioned some of the advantages to this New Generation Cooperative approach. NGCs allow farmers to work together in marketing, while maintaining their traditional independence on their own farms. Up-front capitalization, combined with sound advice and a solid marketing plan, can allow producers to react quickly to opportunities in the marketplace.
Furthermore, Cropp noted that the closed membership policy and the dual contract provides stability for the producer and efficiency for the cooperative. By requiring significant investment from producers, the NGC model will ensure their commitment to quality and success. Finally, preferred shares allow the community to support the project, which, if successful, can capture profits and create jobs and wealth that can be shared by that community.
Jim Arts of Cooperative Development Services of Madison had the last word at the end of the afternoon. He expressed the hope that one day we might look back on the conference in Stevens Pint as the start of a new era of cooperative development in our state. He challenged us to make that vision a reality by working together to address the needs and take advantages of the opportunities in Wisconsin's rural economy.
Finally, at the end of the conference, survey questionnaires were distributed that allowed members of the audience to express their interest in exploring opportunities for New Generation Cooperatives in their community. If you would like learn more about NGCs, and explore next steps to forming one in your area, contact us at the UW Center for Cooperatives.