University of Wisconsin Center for Cooperatives

Cooperatives: A Tool for Community Economic Development


CHAPTER 3

INTRODUCTION TO COOPERATIVES
 
 
THIS CHAPTER outlines the basic information you need to know about cooperatives:  
  • what they are;
  • what they can do for your community;
  • benefits to co-op members; 
  • co-ops’ abilities to achieve economic goals;
  • historical significance of co-ops;
  • how co-ops are like other business models; 
  • how co-ops differ from other business models; and
  • different types of co-ops and sectors in which they operate.
 

BIRTH OF A COOPERATIVE

IN THE LATE 1980s Wisconsin’s dairy farmers were facing more of what they’d already seen too much of: falling milk prices, rising operational costs and fewer economic choices.  Hardly a farmer out there didn’t know several of his kind who had gone out of business due to these factors.

A small group of organic dairy farmers in the southwestern part of Wisconsin decided to take some control over the processing and marketing of their milk. They felt that forming a cooperative was the only way they could survive in the chaotic farm economy.

Today their cooperative (CROPP) has 160 farm family members  throughout Wisconsin and the upper Midwest.  It produes a wide variety of dairy products, including 20 kinds of cheese, ice cream, butter, yogurt, half and half, and fluid milk in addition to marketing eggs and vegetables.

Headquartered in La Farge, CROPP is the largest organic dairy co-op in the United States, and is planning to double its production over the next few years
 
As governments around the world cut services and withdraw from regulating markets, cooperatives are being considered useful mechanisms to manage risk for members and keep markets efficient. 
Brian Henehan
Cornell University


Why do people start cooperatives?

For over  150 years, cooperatives have been an effective way  for people to exert control over their economic livelihoods.  As the story above illustrates, cooperatives continue to have a powerful impact on Wisconsin’s economy.
Today, in an era when many people feel powerless to change their lives, co-ops represent a strong, vibrant, and viable economic alternative.

Co-ops are formed to meet peoples’ mutual needs.  They are based on the powerful idea that together, a group of people can achieve goals that none of them could achieve alone.

There is a rich history of cooperation in our state and country.  In Wisconsin, 2.7 million residents (more than half the population) are served in some way by cooperatives.

Cooperatives in the U.S. play a vital role in the economy.  Over 47,000 cooperative businesses generate $100 billion in economic activity.  Nearly 40% of the U.S. population participates in some kind of cooperative.


COOPERATIVE DIVERSITY
Cooperatives have been used to address a wide variety of economic conditions and meet diverse challenges.

  • WISCONSIN’S FIRST DAIRY COOPERATIVE was started in 1841 by Anne Pickett. She pooled milk from her neighbors’ farms to make cheese, and shared the profits with all the farmers involved.
  • RURAL ELECTRIC COOPERATIVES were started by farmers in the 1930s to obtain electric services when private utility companies refused to serve rural areas.
  • COOPERATIVE INSURANCE SOCIETIES were formed in America in the late 1700s, enabling working people to obtain fire insurance at prices they could afford.
  • CREDIT UNIONS, or financial cooperatives, were organized in the early 1900s to provide access for working people to saving accounts and credit.
 
Successful cooperatives are formed to solve problems and seize economic opportunities. 
Bill Patrie
North Dakota Assn. of 
Rural Electric Co-ops

What exactly is a cooperative?

A cooperative is a business that is owned and controlled by the people who use it.  Its primary purpose is to provide goods and/or services to its members for their mutual benefit.

Cooperatives provide a unique tool for achieving economic goals in an increasingly competitive global economy.  These goals may include:

  • Achieving economy of size;
  • Increasing bargaining power;
  • Sharing costs of new technology;
  • Adding value to agricultural products;
  • Gaining access to new markets;
  • Reducing risks associated with new enterprises;
  • Obtaining new services;
  • Purchasing in bulk to achieve lower prices; and
  • Securing credit from financial institutions.
Cooperation is most effective under economic conditions which respond to group action.  For example, when individuals acting alone can’t achieve sufficient economy of size to compete in the marketplace, pooling their resources and marketing together can be an effective strategy.  Or there may be other barriers to market entry, a lack of sufficient capital, or an imbalance of market power which individuals alone can’t effectively address.  Cooperatives enable groups of people to achieve goals which are only possible through joint effort.

In addition to the direct benefits they provide to members, co-ops strengthen the communities in which they operate.  Many co-ops provide jobs and pay local taxes because they operate in specific geographical regions.  The co-op’s financial benefits to members, including patronage refunds, provide an economic boost to the community as well.

It is important to note, however, that forming a cooperative is not a guarantee for success.  Co-ops are subject to the same marketplace demands and planning requirements as any business, including

  • careful market analysis;
  • sound business planning;
  • competent management; and
  • adequate capital to start-up and grow.
A co-op must not only meet its members’ needs, but survive in the marketplace while doing so.


How do co-ops differ from other businesses?

Like other businesses, cooperatives start with the recognition of a need or an opportunity.  In fact, the economic motivation for starting a co-op is very much the same as for starting other businesses.

Cooperatives also operate very much like other businesses.  They must serve a market efficiently and effectively, they must be well managed, and they must survive financially.

However, there are important distinctions that make co-ops unique.  The principal ones are:

  • Members own their co-ops.

  • As owners, they provide the capital necessary  for start-up and growth of the business.
  • Members control their co-ops.

  • Each member usually gets one vote, regard less of the amount of equity they have invested in the co-op.  The board of directors is elected by the membership.
  • Members benefit from their co-ops.

  • Profits are distributed to the members in proportion to each member’s use of the co-op.
These distinctions mean co-ops differ from investor-oriented firms (IOF) in significant ways.  Each investor in an IOF has control over the firm only to the extent to which s/he has invested capital in it, and receives profits from it on the same basis.

The owners of IOF’s may never even use the products or services their company produces.  In fact, many IOF’s are capitalized by investors whose primary motivation is obtaining the greatest return on their investment.

In contrast, the member/owners of a cooperative are the primary users of its products and services.  Co-op members want to generate the highest possible returns on their investment as well, but they do it by addressing their common problem.

The chart that follows helps distinguish between different types of business organizations, including co-ops.  It was developed by the University of Wisconsin Center for Cooperatives.
 
Comparison of Business Forms1
 
Business Forms
Advantages
Disadvantage
Notes
Sole Proprietorship
  • You're the Boss.
  • Unlimited liability.2
  • Sole proprietors often invest in other businesses to acquire goods, services, access to markets, and/or profits which they cannot acquire alone.
  • Partnership
  • Pass-through income taxation.3
  • Appreciated assets can be distributed back to orignial owners without recognizing gains.
  • At least one partner must shoulder unlimited liability.
  • There appears to be few good reasons to choose a partnership over an LLC.
  • Limited Liability Company (LLC)
  • Same advantage as partnership, PLUS:
  • Limited liability for all members.
  • Not so well suited for large(+10) numbers of owners or when ownership continually changes hands.
  • Most appropriate for "close-held" joint ventures (involving two to ten owners) with relatively stable ownership (slow turnover)
  • C Corporation
  • Open to any and all investors.
  • Very flexible to reward capital investment.
  • Both individual owners and the corporate entity are taxed (i.e., double taxation).
  • Designed to maximize profits for investors. One share, one vote. Best model for securing capital.
  • S Corporation
  • Open to any investors, up to a limit of 75.
  • Pass-through taxation.
  • A limit to one class of stock prevents varied allocations of profits to different investors.
  • Limit to 75 shareholders.
  • May be appropriate if: the business has between 10 and 75 owners; there is regular turnover of ownership; a single class of stock is sufficient; and not all investors "use" the business.
  • Cooperative Corporation
  • Control of the business is kept in the hands of those who "use" its goods and services.4
  • Most profits, if there are any, are returned to members in proportion to their "use" of the business.
  • Pass through taxation for all profits that are distribution to members in proportion to use.
  • Investment limited mainly to those who "use" the co-op's goods and services, thereby restricting access to capital.5
  • Decision-making can be slowed by democratic process.
  • Added costs for communication and member education.
  • When numerous individuals or businesses agree on a long-term strategy to meet a common need or pursue an opportunity, a cooperative can utilize member investments to puruse that strategy through marketplace transactions.
  • Desinged to serve members. Profits distributed in proportion to use. One person, one vote.
  • Not-For-Proft Corporation Can qualify for grants, donations, and other subsidies. 
    Can avoid income taxation entirely.
    Not appropriate if the organization's annual surplus or profit is to be distributed to members. Even if profits are not generated, the "control structure" of cooperatives may be more appropriate if an organization's mission is to sell goods and services to its own members at cost.

    The University of Wisconsin Center for Cooperatives, University of Wisconsin-Extension, February 1998


    1The best choice of business structure will vary from situation to situation. Sometimes, a combination of two or more business forms is recommended. This chart is offered only as a basic introduction. It is strongly recommended that individuals consult legal and financial professionals before selecting a business form.
    2This means that the owner risks not only the money invested in the company, but all personal assets are places at risk.
    3Sometims referred to as single(va. double) taxation, pass-through taxation means that the individual owners (partners and members) pay income tax on profits, but the joint entity does not. "Double" taxation", when both owners and the joint entity pay income taxes on profits, occurs in C Cooperations, and in limited circumstances in S and Cooperative Cooperations.
    4There are many ways that member can "use" a cooperative: to acquire goods and services; to produce value-added products for sale; etc. This use is measured (in dollars spent, in hours worked, in bushels processed, etc) and the profits generated by the cooperative are returned to members in an "equitable" fashion -- i.e., in proportion to use.
    5Acutally, "outsiders' or non-users can invest in a cooperative, but by alw their law their return on investment is limited to 8%. This limit also restricts access to capital.
     
    Co-ops are formed for a wide range of reasons to enhance the economic and social well-being of members 
    Brian Henehan
    Cornell University

    What are the different types of cooperatives?

    The cooperative form is highly flexible and adaptable. Several different types of cooperatives exist, each performing a different function.  Co-ops also operate in a variety of industries.

    Given all these factors, different ways of categorizing cooperatives have been developed.  This Manual and the Cooperative Development Conference which it accompanies use the following categories:

    AGRICULTURAL CO-OPS include producer, farm supply, and new generation co-ops.  These co-ops are formed by farmers and other producers to process and market their products (including agricultural goods, crafts and manufactured products) or to provide supplies needed for their farms and businesses.  During the last decade, a  movement toward value-added, new generation agricultural co-ops  has swelled throughout the upper Midwest.

    CONSUMER CO-OPS are formed to buy groceries, financial services, and many other goods and services.  Examples include retail food co-ops and credit unions.

    BUSINESS CO-OPS are formed by a group of businesses or organizations in order to purchase supplies or services in bulk.  Examples include wholesalers owned by retail hardware stores and grocery stores.

    WORKER CO-OPS are owned by the employees who work in them.  Another form of worker ownership is the Employee Stock Ownership Plan (ESOP). 



     
    COOPERATIVE PRINCIPLES 

    The cooperative form of business has been in use for more than 150 years. 

    In 1995 the International Cooperative Alliance adopted the following set of principles which are intended to articulate guidelines by which cooperatives put their values into practice. 

    1. Voluntary & Open Membership 
    Cooperatives are voluntary organizations, open to all persons able to use the co-op’s goods & services and willing to accept the responsibilities of membership. 

    2. Democratic Member Control 
    Cooperatives are democratic organizations controlled by their members.  In general, members have equal voting rights (one member, one vote). 

    3. Member Economic Participation 
    Members contribute to and democratically control the capital of their co-op.  They receive limited compensation, if any, on capital contributed as a condition of membership.  Profits are allocated to reserves and/or are used to benefit members in proportion to their transaction with the cooperative. 

    4. Autonomy & Independence 
    Cooperatives are autonomous, self-help organizations.  Democratic control by the members must be maintained in all contracts the co-op enters into. 

    5. Education, Training & Information 
    Cooperatives provide education and training for their members and staff to help them fully participate in the democratic control and development of the cooperative. 

    6. Cooperation Among Cooperatives 
    Cooperatives serve their members most effectively and strengthen the cooperative movement by working together through local and national groups. 

    7. Concern for Community 
    While focusing on member needs, cooperatives work for the sustainable development of their communities.

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