4. Theoretical and Empirical Literature on Cooperatives

In this section we provide brief surveys of the theoretical and empirical economics literature on a number of topics pertinent to an understanding of cooperatives, and where possible, to an assessment of their merits relative to IOFs. The focus is mainly on farm output cooperatives, but farm supply cooperatives are also touched on. These surveys contain much material and are provided for reference purposes. Readers more interested in the application of the economics of cooperatives to our survey of the role and significance of cooperatives New Zealand agriculture can safely skip to the next section.

We begin our surveys by looking at the (relative) efficiency and financial performance of cooperatives, to see if cooperatives can be expected to, or do, exhibit systematic advantages or disadvantages in this regard. How cooperatives compete, both with other local firms for procurement but also in their output markets, is then examined. We follow with an examination of the extent to which cooperatives innovate, and differentiate and/or add value to their products. The governance of cooperatives is considered to see if it exhibits systematic (relative) advantages or disadvantages. We then look at whether or not cooperatives face obstacles in accessing capital, with any associated increases in bankruptcy risk, or curtailment of investment and growth. Finally, before summarising possible policy implications, we look at whether cooperatives contribute to or detract form the “adaptive efficiency” notion introduced in Section 3.1.

In providing this survey we add the caution that the simple identification of differences between cooperatives and IOFs does not automatically indicate the existence of policy issues requiring attention. Indeed, only if cooperatives detract disproportionately from adaptive efficiency would there appear to be a clear case in favour of policy response, since in that case the normal process of organisational adaptation and competition might be thought to fail, entrenching possibly inferior organisational solutions. If they do not clearly detract form organisational efficiency, then differences predicted to arise, or actually arising, between cooperatives and IOFs do not inherently represent areas requiring policy attention. For the reasons set out in Section 3.1, it may well be true that cooperatives are superior or inferior to IOFs in some respect, but given the enduring coexistence of either form it must be assumed that they each have counter-veiling costs or benefits that mean they are least-imperfect organisational responses to the issues faced by owners and other parties in their respective industries, assuming adaptive efficiency.

Conversely, where cooperatives exhibit particular disadvantages relative to other organisational forms, such as increased bankruptcy risk – especially if these give rise to significant externality costs – then these areas may merit policy consideration. However, even then, it must be asked whether these features are genuine differences between cooperatives and IOFs, or simply a reflection of the fact that each organisational form arises more naturally in response to particular economic drivers, meaning that a direct comparison of cooperatives and IOFs without controlling for these drivers is not meaningful. For example, if cooperatives more naturally arise in declining industries where bankruptcy risk is inherently high and IOFs are not viable, then this raises different policy questions if they are more prone to bankruptcy and coexist with IOFs in non-declining industries. We will attempt to draw out some of these issues in our discussion of possible policy implications in Section 4.7.

4.1 Efficiency and Financial Performance

As noted by Hardesty and Salgia (2004), recent troubles at high-profile agricultural cooperatives in the US have lead to debate about whether cooperatives as an organisational form are “destroying value.” For the reasons discussed above, the question is misplaced without also considering whether there are inherent or artificial obstacles to organisational competition. Indeed, the failure of non-performing cooperatives – just like that of non-performing IOFs – is prima facie evidence of adaptive efficiency. It would be the entrenched poor performance of an organisational form in the presence of obstacles to organisational change that would be more revealing.

However, the question of cooperative efficiency and financial performance has been the subject of many studies. Such studies typically fall into two classes – those focusing on estimated production functions and other measures of economic efficiency (such as pricing, technical, and scale efficiency), and those based on various financial ratios. Hardesty and Salgia point out that it is not strictly meaningful to consider cooperative performance in isolation, since cooperatives represent an extension of the production process beginning with their owner-suppliers (or customers). Thus from the perspective of a cooperatives’ owner-patrons, an assessment of cooperative performance should not consider just the cooperative portion of the productive entity. It should account for the total benefits derived by these owner-patrons relative to what they would achieve from alternative supply and investment routes.16 Care must be paid to the fact that cooperatives are often modelled as having a zero profit objective, with patrons securing their returns not on capital investment but via patronage returns. Hence simple comparisons with the profitability of profit-maximising IOFs will be skewed. Moreover, comparisons of cooperatives and IOFs should allow for the various “ancillary services” provided by cooperatives, such as member education and political representation, which increase cooperative production costs and affect efficiency assessments. However, as these authors note, data limitations, and stakeholder interest in cooperative-level performance measures, often result in researchers examining only cooperative-level data.

We consider various studies from each of the two main classes below.

4.1.1 Studies based on Financial Ratios

Main Classes of Financial Ratios and Predicted Relationships

Rimassi (1999) summarises the five main classes of financial ratio typically used in studies examining cooperative performance or comparing it with IOF performance:

  1. Profitability – typically measured as return on equity. Cooperatives are expected to have lower profitability rates than IOFs due to their zero profit objective.
  2. Leverage – typically measured using a debt to equity ratio based on book values. Cooperatives are predicted (specifically, by Lerman and Parliament (1990)) to have higher leverage than IOFs due to the capital constraint caused by property rights limitations (in traditional cooperatives, at least), and evidence for a moral hazard whereby cooperative managers perceive that their cooperative is more likely (than an IOF) to merge with another in the event of financial distress than to face bankruptcy. Thus IOF managers would be more concerned about the costs of bankruptcy and hence adopt lower leverage than would cooperative mangers.17
  3. Solvency – the cooperative’s ability to service its debt, typically measured as an interest coverage ratio such as earnings before interest and tax to annual interest expense. In cooperatives solvency is expected to be lower than for IOFs for the same reason that leverage is expected to be higher.
  4. Liquidity – typically measured by cash plus receivables to current liabilities (i.e. the quick ratio), measuring the firm’s ability to meet short-term liabilities as they fall due. For the same reason that solvency is predicted to be lower in cooperatives than IOFs, it is expected to be lower here also.
  5. Efficiency – typically measured by some form of asset turnover ratio, e.g. sales to total assets. Because of the moral hazard issue described above, cooperatives may over-invest relative to IOFs, suggesting they should have lower asset turnover. Similarly, where cooperatives stand ready to accept all produce supplied by their members (whereas IOFs will contract for supplies and hence have better control over processing requirements), this creates a need for excess capacity to cover uncertain demand for processing.
Comparing Cooperatives to IOFs

Lerman and Parliament (1990) investigate the comparative financial performance of cooperatives and IOFs in the US fruit and vegetable processing and dairy industries over 1976 – 1987, controlling for size differences, based on such ratios. Contrary to their predictions, cooperatives and IOFs were similarly leveraged and generated similar returns on equity. Fruit and vegetable processing IOFs had higher liquidity and asset efficiency than cooperatives, but the reverse was true for dairy cooperatives. These authors conclude that cooperative dairy processors outperformed comparable IOFs, whereas the performance of cooperative fruit and vegetable processors was lower but not significantly different from that of comparable IOFs.

Similarly, Parliament et al. (1990) focus on the relative performance of a sample of cooperatives and IOFs in the US dairy industry over 1971 – 1987. They found that the cooperatives performed significantly better than the IOFs in terms of leverage, liquidity and asset efficiency, but that there were no statistically significant differences between the two types of organisation in terms of profitability.

These results vary with those of Schrader et al. (1985), who examined the relative performance of US cooperatives and IOFs across various agricultural sectors over 1979 – 1983. They found no differences in asset returns for cheese plants, grain elevators and farm supply firms, but large, diversified agribusiness IOFs had significantly higher returns on assets. Contrary to predictions, IOF cheese plants, grain elevators and farm supply firms were more leveraged than their cooperative counterparts, but large, diversified agribusiness IOFs had lower leverage than their cooperative counterparts. Consistent with predictions, cooperative cheese plants, grain elevators and farm supply firms had lower asset turnovers (i.e. were less efficient) than IOFs, but this was reversed for large, diversified agribusiness cooperatives.

Using more recent US data, Hardesty and Salgia (2004) examine claims that cooperatives “destroy value” by comparing the performance of cooperatives and IOFs in the US dairy, farm supply, fruit and vegetable, and grain sectors over 1991 – 2002. Overall they find comparable performance between the two types of organisation. Except in the dairy sector, cooperatives had lower asset turnover (i.e. lower efficiency) than IOFs, as predicted due to the need for cooperatives to maintain greater peak capacity than IOFs. However, cooperatives in all four sectors had lower leverage than IOFs, contrary to Lerman and Parliament’s predictions. The authors suggest that this means that the tax-based preference for debt faced by US IOFs relative to cooperatives outweighs any capital constraint faced by cooperatives.

Hardesty and Salgia found no conclusive differences between IOFs and cooperatives regarding profitability and liquidity, and in the cases where cooperative liquidity was lower, they attribute this to the need for cooperatives to redeem the equity of exiting patrons. Cooperatives in the fruit and vegetable sector were the weakest, concentrating on generic, low-value added products, with low asset turnover and cyclical profitability. Where cooperatives were involved in value-added activities they could increase asset turnover by utilising plant year-round, and enjoyed more stable profits. No evidence of declining cooperative relative performance was found. The authors conclude that claims of cooperatives destroying value are not supported by their analysis.

Finally, Chan and Robb (1998) present New Zealand evidence on the relative profitability of a cooperative and IOF operating in the same industry, albeit in the wholesale grocery and distribution industry – i.e. a customer rather producer cooperative, and not in the agricultural sector. Specifically, these authors compare the performance of Foodstuffs (an NGC-like cooperative) and Progressive Enterprises Limited (an IOF) over 1991 – 1997 following the methodology of Lerman and Parliament (1990). They found that the financial ratios were consistently of the opposite relative magnitude to those predicted. Furthermore, comparing the two organisations in terms of a combined measure of cash flows and profits also rated Foodstuffs ahead of Progressive, with the latter generating cash flows but not profits, whereas Foodstuffs has enjoyed growth in both cash flows and profits. Despite theoretical predictions to the contrary, the authors conclude that Foodstuffs has outperformed Progressive, having higher profitability, less leverage, better solvency and liquidity, and greater asset efficiency. Consistent with evidence discussed in Section 4.4, Chan and Robb suggest that the cooperative need to monitor both profitability and cash flow (since the latter is required for annual patronage returns and to meet member equity redemptions) forces cooperatives to be more accountable to their owners than IOFs, and better able to withstand financial difficulties.

Inter-Cooperative Comparisons

Lerman and Parliament (1989) examine whether there are size and industry effects on the profitability, efficiency, liquidity and capital structure of cooperatives. Their sample comprised 43 US dairy, supply, food marketing and processing, cotton and grain marketing cooperatives over 1970 – 1987. They found that significant size effects were evident, with larger cooperatives having higher asset turnover (i.e. greater efficiency) than smaller ones. Conversely, smaller cooperatives were more profitable and liquid than larger ones. This suggests that the benefits of size do not necessarily translate into profitability. However, no significant size effects were evident in capital structure (i.e. leverage).

As to industry effects, dairy cooperatives exhibited the highest efficiency, followed by grain and supply cooperatives, and then food marketing cooperatives. Dairy and supply cooperatives had the highest liquidity, and food marketing cooperatives that operated on a pooling basis had higher profitability. Overall the dairy cooperatives were concluded to show the strongest performance, but the authors suggested this may have been due to government guaranteed milk prices. Conversely, food cooperatives were the worst performers, causing the authors to suggest (contrary to Hardesty and Salgia (2004)) that cooperatives may be ill-suited to value-added processing, instead better at raw produce marketing. Interestingly, they observed an overall declining trend in the profitability of all cooperatives examined regardless of industry or size, once again at odds with the more recent evidence of Hardesty and Salgia.

4.1.2 Studies based on Economic Efficiency and Other Measures

Comparing Cooperatives to IOFs

Using 1972 data for a sample of US milk processing cooperatives and IOFs, Porter and Scully (1987) examine the relative efficiency of these organisations according to eight different measures (such as price, scale, and technical efficiency). They find that cooperative milk processors were on average only 75.5% as efficient as their IOF counterparts, and that by reorganising as an IOF a cooperative milk processor could raise output 32.4% without requiring extra inputs. They attributed this inefficiency to problems with cooperative property rights, specifically the horizon, control, free rider, and portfolio problems as summarised in Cook (1995). Porter and Scully’s analysis assumes there is no monopsony power in milk processing, which can be supported in the US where milk processing is more oligopsonistic in nature, but they acknowledge that cooperatives may enjoy efficiency gains in the presence of monopsony power.

Boyle (2004) investigates the economic efficiency of Irish dairy cooperatives over 1961 – 1987. He notes that cooperatives are thought to give rise to inefficiencies in two ways:

  1. Cooperatives suffer from technical efficiency because of principal-agent problems (the control problem), and allocative inefficiency due to the horizon problem; and
  2. Cooperatives price inefficiently, paying producers more than the cooperatives’ marginal product of milk.

Focusing on the second type of inefficiency, Boyle’s data suggest that cooperatives price their inputs “as if” they were profit maximisers (i.e. like IOFs), and did not price inefficiently as postulated. In fact, these cooperatives were pricing as efficiently as other organisational forms, and Boyle concludes that the emergence of Irish IOF dairy companies in the 1980s and 1990s was not a consequence of this postulated form of cooperative inefficiency.

Continuing with dairy industry evidence, but this time turning to Australia, Doucouliagos and Hone (2000) compare the efficiency of dairy processing with “best practice.” They note that the Australian dairy industry was dominated by two large Victorian cooperatives, Murray Goulburn and Bonlac, accounting for half the market. Using data for 1969 through 1996, they find modest technical progress, and observe some convergence in productivity levels across states, suggesting that dairy deregulation had encouraged improved industry performance. They conclude that the Australian industry is operating at a high level of technical efficiency.

Finally, Sullivan and Scrimgeour (1995), consider the performance of the New Zealand Dairy Board (NZDB) relative to that of Nestle (the Swedish IOF), over 1969 – 1992. Although constrained by lack of financial data from the NZDB, and the fact that Nestle was a diversified food processor and the NZDB a statutory marketing and distribution cooperative, estimates were made of each organisation’s costs and the extent to which each organisation added value to its product. They estimate the NZDB’s cost of goods sold to be 27% higher than that of Nestle, suggesting the latter was more efficient. Moreover, Nestle was estimated to add 12% more value to every dollar of sales than did the NZDB. Higher NZDB sales volatility was attributed to its greater proportion of sales accounted for by commodity trading. Their conclusion that Nestle appeared to be more efficient than the NZDB contrasts with that of Lerman and Parliament (1990), and Parliament et al. (1990), for their dairy sector analyses.

Inter-Cooperative Comparisons

Ariyarantne et al. (1997) investigate the following three efficiency measures for a sample of 89 US grain marketing and farm supply cooperatives over 1988 - 1992:

  1. Technical efficiency – measuring whether a producer employs the most efficient technology in its operations;
  2. Allocative efficiency – assessing whether the optimal levels of inputs at a given price are used in deriving outputs; and
  3. Scale efficiency – examining whether a firm’s size is optimal.

These authors cite previous research showing that IOF grain marketing and farm supply firms were more efficient than cooperatives, that there are economies of scale in farm supply and marketing cooperatives, and that more than half of such cooperatives experienced financial stress due to low profitability. Based on their sample, among other things they find that:

  1. While most cooperatives could improve efficiency by increasing their scale, the potential gains were relatively small given high observed scale efficiency;
  2. Larger cooperatives tended to be more efficient overall compared to smaller ones; and
  3. Cooperatives with a more diversified output mix are more technical, scale and overall efficient compared to specialised cooperatives.

Finally, Hailu et al. (2005) examine the productive efficiency of 54 Canadian fruit and vegetable cooperatives over 1984 – 2001. They found their results to be sensitive to the choice of methodology, but in general concluded that production costs for these cooperatives could have been reduced by 28% had they been operating on their respective production frontiers. Significant variation in efficiency was evident in their sample, with smaller and larger cooperatives the most efficient. Finally, financial leverage was found to have a negative effect on cost efficiency, suggesting a negative impact of financial pressure on cooperatives.

Other Efficiency Predictions

Evans and Guthrie (forthcoming) develop a theoretical model showing that supplier cooperatives suffer from an inefficient over-supply of inputs. This arises due to suppliers responding to average rather than marginal revenues (cf Albaek and Schultz (1998)), and because incompletely specified property rights (in traditional cooperatives) – in this case unowned capital – generates capital returns to suppliers in proportion to their supply (boosting the returns to supply). They show that the inefficiency this gives rise to can be resolved if the cooperative’s shares are priced at the present value of expected dividends (i.e. at true “fair value”), and open supplier entry and exit decisions are taken solely on the basis of the profitability of membership. In such circumstances the traditional cooperative horizon problem is also resolved. Hart and Moore (1998) similarly predict that the investment efficiency of cooperatives would be enhanced through tradable ownership rights.

4.1.3 Summary – Efficiency and Financial Performance

The main messages regarding cooperative efficiency and performance emerging from the above survey are:

  1. Despite theoretical predictions, dairy cooperatives tend to outperform their IOF counterparts in terms of various efficiency and financial performance measures. Porter and Scully (1987) find the reverse, but acknowledge that their result is sensitive to the assumed absence of monopsony power in milk processing. Sullivan and Scrimgeour (1995) found the NZDB to be less efficient and to add less value than Nestle, but acknowledge that the activities of each were not very comparable.
  2. For other cooperative types (e.g. fruit and vegetable, farm supply), cooperatives are sometimes to found to exhibit less asset efficiency than IOFs (e.g. Lerman and Parliament (1990), and Hardesty and Salgia (2004)), but otherwise comparisons are mixed (Schrader et al. (1985)) or revel no significant differences in performance. In the case of New Zealand wholesale grocery and distribution industry, Chan and Robb (1998) find that the cooperative outperformed the IOF in all areas considered. As Sexton and Iskow (1993, p. 15) put it after analysing and critiquing available evidence: “No credible evidence exists to support the proposition that cooperatives are inefficient relative to investor-owned businesses.”
  3. Larger cooperatives tend to be more efficient than smaller ones, but smaller cooperatives have been found to be more profitable. More diversified cooperatives have been found to be more efficient than specialised cooperatives.
  4. Overall there is no clear support from the studies surveyed for the theoretical prediction that cooperatives will be less efficient and/or less profitable than IOFs, and certain of the inefficiencies predicted to arise in traditional cooperatives are in any case predicted to be resolved with tradable cooperative ownership rights based on fair values.
  5. It is not possible based on the available studies to adequately gauge the impact of any favourable tax treatments or other policy preferences enjoyed by cooperatives relative to IOFs. Where IOFs coexist with cooperatives despite these cooperative preferences, it remains possible that the relative performance of cooperatives as assessed has been biased by any such preferences.

4.2 Competition and Competitiveness

It is not unusual for industries to comprise both cooperatives and IOFs. This raises the question as to how such coexistence affects the behaviour of the organisations concerned, but also how their choice of organisational form is shaped by their competitive environment. There is little theoretical or empirical work on the question of how the coexistence of cooperatives and IOFs affects welfare where the cooperative competes primarily internationally but also supplies domestically. Much of the available work considers the effects of cooperatives on competition in mixed domestic industry structures and vice versa. However, some material is available on the international competitiveness of cooperatives.

Each of these questions is touched on below, with special mention made on the effects of mixed industry structures on input supply procurement (a topic of interest for the New Zealand meat industry, as discussed in Section 5.3). It is also important to consider the implications of the available research with the international focus of most New Zealand agricultural cooperatives in mind (i.e. welfare analyses in the case of exporting agricultural cooperatives may rightly place greater weight on producer benefits than they do on foreign consumer gains or losses).

4.2.1 Competitive Effects of Cooperatives in Mixed Industry Structures

The Competitive Yardstick Effect

As noted in Section 3.2.1, all of 21 US agricultural cooperatives surveyed in Peterson and Anderson (1996) actively pursued a competitive yardstick strategy, seeking to force IOFs with market power in their industry to behave more competitively. Hoffman and Royer (1997) argue that the favourable public policy enjoyed by cooperatives in the US is due to their perceived pro-competitive influence on IOFs. They summarise the associated competitive yardstick hypothesis as follows: cooperatives will offer farmers more favourable prices for their outputs because they seek to offer service at cost (i.e. breakeven) rather than to maximise profits (as do IOFs). Competing non-cooperatives must therefore match these prices to avoid losing suppliers. This prediction is not universal, however, often being limited to open-membership cooperatives (which allow new members to join and do not limit their supply decisions). Closed-membership cooperatives have greater ability to restrict output and produce socially undesirable market performance in markets that are already not competitive.

Bounds on the Competitive Yardstick Effect

Indeed, while evidence exists in support of the competitive yardstick hypothesis, many authors find that this beneficial effect is not universal. Benham and Keefer (1991), for example, add that cooperatives require relatively homogeneous membership in order to compete with IOFs.

Using 1982 US census of manufactures data, Rogers and Petraglia (1994) examine the effect of cooperatives on industry price-cost margins. They find that the percentage of industry sales attributable to cooperatives has a significant negative effect on price-cost margins, consistent with the theoretical competitive yardstick effect of cooperatives. Within the food and tobacco processing markets, any abuses of market power were found to be more likely from large IOFs rather than agricultural cooperatives that have vertically entered into processing. They suggest this justifies the continuance of cooperatives’ entitlement to limited antitrust exemptions under the US’ Capper Volstead Act 1922.

However, using simulation to examine the competitive effects of cooperatives in oligopoly/oligopsonies under a range of market behaviours, Hoffman and Royer (1997) found that cooperatives can increase welfare under some structures/behaviours, but in fact decrease welfare under others (due to increasing costs of producing raw product, due to disproportionate cooperative market share and increased production intensity of its members).

Sexton (1990) concludes similarly, developing a theoretical model formally characterising the pricing behaviour of IOF processors in oligopsonistic markets in the absence and presence of cooperatives. With this model he examines the conditions under which the competitive yardstick hypothesis can be supported. Consistent with the qualification noted by Hoffman and Royer, open cooperative membership was required (among other things) for cooperatives to have a pro-competitive influence in a mixed duopoly shared with an IOF. He thus concludes that any favourable public policy toward cooperatives should be confined to those with open membership, and that in respect of competition policy, horizontal mergers are less problematic in industries including an open-membership cooperative, since opportunities to exercise market power in such an industry are diminished.

Extension of the Competitive Yardstick Effect

Cotterill (1997) examines a different question, namely under what conditions does the competitive yardstick effect extend from traditional, undifferentiated farmer-first handler situations to differentiated consumer product markets. To motivate his analysis he cites empirical work showing that a cooperative presence in differentiated product markets lowers the consumer prices of all brands. Cotterill develops a model showing that the competitive yardstick effect extends from farmer-first handler markets to differentiated consumer products markets under two market structures:

  1. oligopoly with significant barriers to entry; and
  2. monopolistic competition with entry but only non-price competition, in which case cooperatives can also ensure the socially optimal number of brands (product variety).
Cooperative Oversupply as Credible Commitment and Prisoner’s Dilemma

Like other authors, Cotterill notes that cooperatives with open membership are unable to raise prices anti-competitively because they cannot control members’ supply decisions. Should a cooperative successfully raise the market price for farmer outputs, this elicits increased farmer supply which then depresses the price paid.

Albaek and Schultz (1998), however, argue that this particular mechanism offers cooperatives a competitive advantage over IOFs in an industry comprising a cooperative and IOF. They observe that traditional cooperatives tend to oversupply, since they typically cannot control member supply decisions. Members fail to internalise the full cost of increasing supply, which includes lost revenues to other suppliers if the market price falls in response to such an increase. Under certain market behaviours (Cournot duopoly), credibly committing to a high production level (e.g. by rewarding managers based on sales, not profits) – thereby pushing out a firm’s reaction function – can be advantageous, causing other firm to decrease output.

They show that a similar mechanism works when a cooperative competes with an IOF. The cooperative’s organisational form acts as commitment device for pushing the cooperative’s reaction function outwards, resulting in the profit-maximising IOF producing less and enjoying a lower profit, while the cooperative makes a higher total profit. It also means that the cooperative’s market share is greater than it would have been had it maximised members’ total profit. Albaek and Schultz predict a prisoner’s dilemma. In their model farmers would make more profit per head in a market with only profit-maximising IOFs. But since a cooperative can increase its profit at an IOF’s expense, the best response of both firms is to be a cooperative.

This prediction conflicts with that of Hendrikse (1998), however, who develops a model in which both firms in a duopoly would benefit by being cooperative, but the incentive for each under their prisoner’s dilemma is to instead choose to be an IOF, leading to a welfare reducing equilibrium. In his model organisations must try to distinguish between profitable and unprofitable investment projects but only has access to a noisy variable about a project’s true profitability. Cooperatives are modelled as having a two decision units (a board, and general assembly of members) whereas IOFs are modelled with only one (the board). If each decision unit independently assesses project worth, this implies that IOFs will be relatively good at accepting good projects, and cooperatives will be relatively good at rejecting bad ones. He then derives conditions in which an IOF, cooperative, or mixture of the two, is optimal in a duopoly, based on this assumed difference between cooperatives and IOFs in screening good and bad projects.

Hendrikse shows that there are conditions under which a duopoly including a cooperative improves the performance of the IOF, consistent with the competitive yardstick hypothesis, and argues this to justify continuing policy preferences for cooperatives. He also argues that public policy may be used to alleviate the IOF-leaning prisoner’s dilemma. For example, taxes or subsidies could conceivably be used to change the payoffs from firms’ strategic organisational choices to ensure they coordinate around the cooperative form. Finally, like Tennbakk (1995), Hendrikse’s model is able to explain the coexistence of cooperatives and IOFs in equilibrium, though Tennbakk’s model distinguishes the two types in terms of objective function, while Hendrikse focuses on differences in decision-making processes.

Effect of Cooperative Competition on Innovation

On a different tack, Giannakas and Fulton (2002) develop a model examining the relationship between cooperative competition in an industry and innovation. They develop a model showing that cooperative involvement in R&D, depending on the size of R&D costs, can be welfare enhancing, and hence socially desirable. In particular:

  1. When innovation costs are relatively low, total R&D is not changed by cooperative presence in a market, but the cooperative’s pricing strategy reduces the prices of inputs faced by producers and IOF profits, while increasing cooperative market share and the welfare of all producers (whether cooperative members or not); and
  2. When innovation costs are relatively high, cooperative involvement can increase the total amount of R&D in the market, with cooperatives spending more than IOFs in a pure oligopoly (with this increased R&D outweighing that displaced due to competition between the cooperative and remaining IOF). With a cooperative choosing its pricing strategy to maximise member welfare, this increased innovation reduces farmers’ input prices and increases the welfare of all agricultural producers sufficiently to outweigh an associated reduction in suppliers’ profits, raising social welfare.
Other Effects of Cooperatives on Competition

Karantininis and Zago (2001) develop a model predicting that an industry structured with a cooperative and an IOF produces higher profits and output than a pure duopsony with two IOFs – once again at odds with Albaek and Schultz. Consistent with Albaek and Schultz, however, in the former case the cooperative produces more than the IOF, but individual farmers each supply less to the cooperative than those supplying the IOF.

Cross and Buccola (2004) develop a model that can not only support the competitive yardstick effect, but which also predicts that cooperatives become suboptimal when the weakness in competition that initially spurs cooperative development is resolved. As they put it (p. 1254) “Cooperatives flourish when competition is weak and decline when it is robust.” In particular, when cooperative industries become competitive, the optimal capitalisation for active-member controlled cooperatives is zero, and the probability of bankruptcy high. In these circumstances the risk of bankruptcy is reduced with greater inactive-member control of the cooperative, or by moving toward IOF structures through more NGC-like arrangements.

Effect of Competition on Cooperative Merits

Finally, analysis by Hart and Moore (1998) addresses the opposite question to that above, namely how competition affects the merits of cooperatives vis-à-vis IOFs, in the case of consumer rather than producer cooperatives. They find that outside (i.e. IOF) ownership is first-best under perfect competition, assuming cooperative members cannot realise the full value of their cooperative investment due to poorly specified property rights, but no better than cooperatives when sales are allowed (although they note that cooperatives will not maximise value even under perfect competition). Consumer cooperatives are shielded from the full effects of competition because any economic rents they produce from having lower costs are used by the cooperative to shield members from competitive pressure.

4.2.2 Implications of Mixed Industry Structures for Procurement

As mentioned above, Hoffman and Royer’s (1997) summary of the competitive yardstick hypothesis points to cooperatives’ breakeven (i.e. service at cost) objective function as the source of cooperatives being able to pay higher prices to their farmer suppliers. This forces IOF competitors to match those higher prices if they wish to maintain their input supplies. However, the model of Karantininis and Zago (2001), also mentioned above, predicts differential impacts for different supplier types. In a mixed oligopoly comprising a cooperative and an IOF, when farmers are heterogeneous in terms of efficiency, the cooperative will tend to attract the less efficient farmers (suggesting possible disadvantage to open membership cooperatives).

In fact, Sexton (1994) argues that cooperatives can be at a further disadvantage relative IOF competitors in procuring input supplies, specifically where they cannot identify or reward high quality production (e.g. due to “equality of treatment” principles). An adverse selection problem arises with only high quality producers supplying the IOF and, echoing Karantininis and Zago, all low-quality producers supplying the cooperative. Reynolds (1997) argues similarly, developing a model predicting that where cooperatives compete with IOFs for supply by large-scale producers, they can mitigate the impact of IOFs being able to offer more individualised terms to suppliers by offering differential terms in distributing earnings and voting power in proportion to member patronage volume or patronage-generated equity (i.e. adopting more NGC-like characteristics).

Similarly, Seipel and Hefferman (1994) argue for further procurement advantages of IOFs over their cooperative rivals. They observe that 40% or more of processing in most US commodity sectors is controlled by just four firms. Many of these firms process multiple commodities, allowing them to cross-subsidise product categories. This places such IOFs at a distinct advantage in procurement, since cooperatives attempting to match their commodity diversity to enable procurement cross-subsidisation can encounter heterogeneity problems that raise the costs of cooperative ownership.

Conversely, Fulton and Giannakas (2001) argue that some cooperatives face advantages in securing supplier commitment. They observe that large, centralised, multi-purpose cooperatives are facing substantial financial pressures, which they explain in terms of members’ perceiving little linkage between the cooperative’s and their own success, cross-subsidisations, growing member heterogeneity, and instances where managers and/or particular member interest groups are perceived as having undue influence. Conversely, smaller cooperatives focussing on a core set of activities or on highly integrated activities have been performing relatively well (e.g. NGCs), which they explain in terms of greater member commitment due to greater member homogeneity, better defined property rights, and governance structures that are transparent, responsive, and less subject to capture by management or interest member groups.

Fulton and Giannakas develop a game theoretic model in which consumers exhibit greater commitment to cooperatives than to investor-owned firms, assuming consumer homogeneity. They predict that member commitment is linked to the cooperative’s ability to develop a reputation as an effective agent for the members (i.e. as acting on their behalf), and that an inability to do so can lead to a loss of member commitment.

Finally, Hobbs (2001) describes how cooperative Danish pork producers have successfully resolved producer heterogeneity issues that would otherwise trouble the cooperative approach, enabling better servicing of differentiated customers. The Danish pork industry’s umbrella body, Danske Slagterier, has developed set production standards for specific markets (e.g. higher slaughter weights for Germany, and animal welfare and food safety requirements for the UK). Additionally, market-specific contracts are also used by Danish pork cooperatives, overcoming the classic “hold-up” problem faced by hog producers investing in market-specific assets to breed animals to particular market specifications. Such contracts, guaranteeing farmers a market premium for investing to produce for specific markets, reduce the higher costs and risks such farmers incur, even under a cooperative structure.

4.2.3 International Competitiveness of Cooperatives

Schroder et al. (1993) argue that agriculture faces inherent obstacles to globalisation, but that statutory producer boards and agricultural cooperatives (together, producer marketing organisations, or PMOs) face additional such barriers. First, they note that producer control of PMOs makes them somewhat anachronistic in a globalised, customer-focused market, in that marketing-oriented companies start with a customer – not producer – focus. Also such organisations are typically located near the beginning of the agri-food supply chain, and therefore receive much weaker market signals from the consumer than businesses such as the increasingly dominant retailer chains. Global food companies enjoy the advantage of being able to source materials from around the world, which once again is not an advantage enjoyed by typically geographically-based, producer-controlled marketing organisations. Finally, statutory marketing organisations (more so than cooperatives) can become more focused on satisfying legislative requirements and constraints than meeting customer demands. They conclude, however, that these obstacles are not insurmountable.

Seipel and Hefferman (1994) similarly look at the inherent advantages and disadvantages of agricultural cooperatives in a globalised agri-food supply chain. They argue that the increasing concentration of food processing and marketing in the hands of a few trans-national corporations (TNCs) is raising the possibility of market failure for farmers and consumers not just locally – as has often been the case historically – but also possibly on a global scale. However, the capital and human resources needed by cooperatives to provide a competitive yardstick at this level are much greater, as are the risks they face.

Just as the producer focus of PMOs can be anachronistic in consumer-focused competitive environments, so too can international involvement by cooperatives. Cooperatives need to internationalise to compete, but such competition, as developed by IOFs, (p. 11) “is premised on the logic of shifting capital among enterprises and nations based on anticipated rate of return. Such a “light-footed” investment strategy often appears at odds with cooperatives’ founding purposes, which were tied to enhancing services, providing markets, or reducing input costs for a group of members within a specific region and nation.” Indeed, this regional and national focus can be tightened further where cooperatives focus on a narrow range of products, and also because their products are tied to the inputs supplied by their owner-patrons.

Siepel and Hefferman summarise the limitations on international involvement by cooperatives as:

  1. Diverse interests of members in regional, multi-commodity cooperatives may present a structural constraint to international involvement, with the resulting heterogeneity of interests leading to controversy and contest.
  2. Cooperatives often have ties to a domestic resource base - not to mention, specific commodity (and sometimes, social group) - including capital plant, which may result in conflicts if a cooperative internationalises and devalues the value of its members’ assets (e.g. through enhancing markets for competitors).
  3. The high-risk and long-term nature of international investment does not sit well with the property rights limitations associated with cooperatives, particularly traditional cooperatives (e.g. portfolio problem, horizon problem).

On the other hand, cooperative advantages in international involvement include:

  1. Cooperatives are often perceived as reliable, quality suppliers, making foreign end-users more inclined to form alliances with cooperatives to ensure supply security (after all, farmers are unlikely to quickly exit the industry, hence they have an incentive to invest in reputation).
  2. Cooperatives are often seen as highly ethical and trustworthy business partners by business entities in other countries (once again, reflecting the value of investing in reputation in the context of repeated interactions).
  3. Cooperatives can be well-placed to fill emerging international niche markets, for example, representing an alternative form of food distribution system better able to credibly satisfy consumer concerns regarding food safety, environmental standards and animal welfare.
  4. Federated cooperatives, in which smaller cooperatives gain scale while preserving farmer ownership and control, with some trade off of coordination and incentives, may well represent a competitively viable global model.

Similarly, based on survey data from 31 US agricultural processing/marketing cooperatives Buccola et al. (2001) argue that cooperatives face disadvantages in investing or selling directly abroad, although with some tempering considerations. Significant among these disadvantages are cooperative owners’ risk aversion, since international ventures increase farmers’ exposure to an already relatively undiversified investment. Cooperative financing methods, such as capital retains, were also found to contribute to the risk of overseas ventures. On the other hand, like IOFs, cooperatives appeared to be making the type of risky investments required to develop overseas markets, and cooperatives’ overseas experience was found to be a factor influencing the extent of their overseas involvement.

Ohlsson (2003) reports that New Zealand’s largest dairy cooperative, Fonterra, seeks to augment its strategy of being a low-cost producer of dairy commodities by also being an effective developer of dairy industry partnerships in selected markets. Examples of this include an alliance with Nestle in North, Central and South America, and joint ventures with Arla Foods in Great Britain and Dairy Farmers of America. The evidence of Desai et al. (2003), that US multinationals are now strongly inclined to adopt outright ownership where they previously were content with strategic alliances, perhaps hints at growing limits to the effectiveness of such a strategy.

Finally, Hobbs (2001) argues that the Danish pork industry should be at a considerable competitive disadvantage relative to its major export competitors. Land is scarce and relatively costly, farm sizes are limited due to environmental regulation, the European Union’s Common Agricultural Policy (CAP) inflates feed prices, labour costs are relatively high (e.g. two to three times those in Canada) and it is distant from the important Japanese pork export market. Yet the Danish industry exports 80% of production, and accounts for 25 – 30% of global pork exports, enjoying an almost 30% market share in Japan by volume (and more than that by value since it exports high-value products to that market). Hobbs explains this success in terms of the industry’s close coordination provided by its cooperative structure (see the box below for a case study).

Box 4.1 – Hobbs (2001) Case Study of Exporting Success in the Danish Pork Industry

Denmark has a long cooperative history, with its first dairy cooperative established in 1882. Today slaughterhouses account for 44% of the cooperative sector, followed by dairy (28%), and farm supply (15%). Insurance (7%), gasoline and fuel (2%), and other activities comprise the balance. All agricultural cooperatives belong to the Federation of Danish Cooperatives.

The Danish pork industry should be at a considerable competitive disadvantage relative to its major export competitors. Land is scarce and relatively costly, farm sizes are limited due to environmental regulation, the European Union’s Common Agricultural Policy (CAP) inflates feed prices, labour costs are relatively high (e.g. two to three times those in Canada) and it is distant from the important Japanese pork export market. Yet the Danish industry exports 80% of production, and accounts for 25 – 30% of global pork exports, enjoying an almost 30% market share in Japan by volume (and more than that by value since it exports high-value products to that market).

This success is explained in terms of the industry’s close coordination provided by its cooperative structure, being centred around three farmer cooperatives which together slaughter 89% of pork production (one, Danish Crown, accounts for 78% of cooperative slaughtering). Average farm size has increased as farm numbers have declined over the past two decades, while total hog production has steadily increased, and hog processors have declined from 50 cooperative slaughterhouses in 1970 to the current three.

This close horizontal and vertical coordination encompasses supply chain activities from breeding and genetics, production, slaughter, processing, further processing and exporting, enhancing information flows through each. An industry umbrella body, Danske Slagterier, has played a pivotal role in coordinating research and formulating industry-wide strategies. These strategies include the voluntary eradication of salmonella from the Danish pig herd, the voluntary ban on the use of artificial growth promoters, and barcode labelling enabling consumers to trace farm of origin, animal welfare, environmental practices, etc. Together these coordinating institutions reduce transaction costs, enhance product quality, enable products to be tailored to specific markets, and help the industry respond to changing market circumstances. Danske Slagterier’s initiatives, coming from a recognised, industry-wide body, also add “credence attributes” to Danish pork products that export customers rely on and which reduce the need for monitoring activities by those customers. Individual producers can build on their own additional quality standards to meet the needs of specific buyers.

Danske Slagterier has developed set production standards for specific markets (e.g. higher slaughter weights for Germany, and animal welfare and food safety requirements for the UK). Additionally, market-specific contracts are also used by Danish pork cooperatives, overcoming the classic “hold-up” problem faced by hog producers investing in market-specific assets to breed animals to particular market specifications. Such contracts, guaranteeing farmers a market premium for investing to produce for specific markets, reduce the higher costs and risks such farmers incur, even under a cooperative structure.

Hobbs (2001, p. x) concludes: “The Danish pork industry offers an example of how the private sector, through the operation of an industry-led co-ordinating body, can offer a flexible, efficient, and credible alternative to legislative control of food safety and quality assurance issues.”

4.2.4 Summary – Competition and Competitiveness

The main messages regarding cooperative competition and competitiveness that emerge from the above survey are:

  1. The cooperative competitive yardstick hypothesis enjoys some empirical support, suggesting that the existence of a cooperative in an imperfectly competitive industry can be pro-competitive.
  2. While this beneficial effect also extends from farmer-first handler situations to differentiated consumer product markets, it is not to be universally expected, with open membership often shown to be necessary for cooperative presence in a mixed oligopoly to be pro-competitive.
  3. The ability of cooperatives to raise prices by restricting output, particularly where cooperative membership is open, is constrained by their inability to control member (and non-member farmer) supply decisions. In fact this feature also provides cooperatives with a competitive advantage relative to IOFs, in that they can credibly commit to oversupply, forcing IOFs to reduce output.
  4. The welfare effects of mixed duopolies comprising a cooperative and IOF are not uniform. In some cases a prisoner’s dilemma emerges in which each industry member’s best response is to adopt a cooperative form, while they would both be better off adopting the IOF form. In other cases the reverse is true. The presence of a cooperative in a mixed duopoly is predicted to increase innovation in that industry.
  5. Conversely, in terms of price and quality choices the IOF form is predicted to be superior to the cooperative form where an industry is competitive, although not always.
  6. Cooperatives are predicted to suffer disadvantages relative to IOFs in situations of competitive procurement, particularly where farmers are heterogeneous (although the Danish pork industry offers a solution in this case), but also where they compete with multi-product IOFs.
  7. Cooperatives suffer unique disadvantages when competing in a globalised context, but also certain advantages, both reflecting their particular organisational character.

4.3 Product Differentiation, Value-Added and Innovation

As globalisation of the agri-food industry places greater demands on agricultural producers to provide more differentiated products (e.g. either in terms of inherent type/quality, or food safety/GE-free status, animal welfare and/or environmental sustainability), it is natural to ask whether cooperatives offer any advantages or disadvantages in meeting these demands. A key question is whether traditional agricultural cooperatives can move beyond the provision of undifferentiated, low-value added agricultural commodities into more high-value added and differentiated food products. This section surveys research on the role of cooperatives in product differentiation, value-added/quality choice, and innovation.

4.3.1 Product Differentiation

Hayes et al. (2004) present four case studies of farmer-owned brands (FOBs) in the EU and US to identify features contributing to the successful development of such brands. They emphasise the importance of farmers being able to restrict the supply of any successful brand, such as basing brands on some fixed attribute (such as product locale), limiting membership of the producer group (as in NGCs), imposing strict production and/or quality standards, or using some ingredient or process to which the producer group can control access. In one of their case studies such measures are shown to run foul of anti-trust regulations.

To illustrate the benefits of an effective brand, Raynolds et al. (2004) examine the benefits of Fair Trade coffee networks on seven Latin American coffee producing cooperatives. The Fair Trade movement grew out of various European initiatives seeking to alleviate poverty in the global South. It has rapidly grown over the past 15 years, with three Fair Trade labels introduced in Europe and extended to the US, Canada and Japan, harmonised under the Fairtrade Labelling Organizations International. These authors argue that fair trade coffee networks, linking Southern growers with Northern buyers, provide growers with a range of economic and social benefits, including a coffee price more than twice the world price, and increased cooperative credibility with banks, governments and members.

Janzen and Wilson (2002) investigate the marketing of specialty and identity preserved grains in the US. Grain marketing strategies have become increasingly important given consumer- and processor-driven demand, and interest in non-GE products. Key factors in the successful marketing of specialty and identity preserved grains were found to include effective market development, information systems to support traceability at all levels of the supply chain, and contracting to provide producers of specialty grains with some assurance of a market (cf similar mechanisms used for specialty products in the Danish pork industry noted by Hobbs (2001)). Cooperatives and producer alliances were found to have a key strength in this regard, as they have more direct access and influence over their members and producers. Traditional cooperatives have been moving to adapt to the need for greater specialty and identity-preserved grains marketing. NGCs and producer alliances have also been organised to achieve the required investments in quality and coordination.

An example of such a producer alliance, AgGuild of Illinois, is discussed in Whitacre and Winter (2004). AgGuild is an affiliation of 50 grain producers involving the negotiation of contractual agreements with product users, providing protocols for maintaining quality standards, and information gathering and sharing. It attempts to capture a premium over the general commodity grain price by producing viable quantities of crops meeting the quality and attribute specifications of contracting users. Producer affiliations are offered as a successful alternative to NGCs – another strategy increasingly employed by agricultural producers to capture some of the downstream value of their products – and one requiring less capital outlay and risk: an NGC “without the bricks and mortar.”

Hobbs (2001) explains the exporting success of the Danish pork industry, despite apparent competitive disadvantages, in terms of the industry’s close coordination provided by its cooperative structure. This close horizontal and vertical coordination encompasses supply chain activities from breeding and genetics, production, slaughter, processing, further processing and exporting, enhancing information flows through each. Industry-wide strategies include the voluntary eradication of salmonella from the Danish pig herd, the voluntary ban on the use of artificial growth promoters, and barcode labelling enabling consumers to trace farm of origin, animal welfare, environmental practices, etc. Coordinating institutions reduce transaction costs, enhance product quality, enable products to be tailored to specific markets, and help the industry respond to changing market circumstances. Initiatives of the industry’s coordinating body, Danske Slagterier’s, coming from a recognised, industry-wide body, also add “credence attributes” to Danish pork products that export customers rely on and which reduce the need for monitoring activities by those customers. Individual producers can build on their own additional quality standards to meet the needs of specific buyers.

Furthermore Danske Slagterier has developed set production standards for specific markets (e.g. higher slaughter weights for Germany, and animal welfare and food safety requirements for the UK). Additionally, market-specific contracts are also used by Danish pork cooperatives, overcoming the classic “hold-up” problem faced by hog producers investing in market-specific assets to breed animals to particular market specifications. Such contracts, guaranteeing farmers a market premium for investing to produce for specific markets, reduce the higher costs and risks such farmers incur, even under a cooperative structure. Hobbs concludes (p. x): “The Danish pork industry offers an example of how the private sector, through the operation of an industry-led co-ordinating body, can offer a flexible, efficient, and credible alternative to legislative control of food safety and quality assurance issues.”

Finally, Miranowski et al. (2004) compare IOF and cooperative product differentiation and segregation of non-GE and specialty corn and soybean crops in Iowa using 2003 survey data. While they did not test any specific hypotheses, they find that cooperatives tend to have a higher probability than IOFs of handling specialty crops, and on average, of handling a higher volume of such products. However, the volume of specialty crops handled by cooperatives accounted for less of their total volumes than they did for IOFs. They leave for future investigation the question of whether cooperatives or IOFs enjoy cost advantages over the other in terms of the added handling and transaction costs incurred in dealing with specialty crops.

4.3.2 Value-Added and Quality Choice

Cook (1995) notes that US agricultural cooperatives are not dominant in the R&D-intensive seed sector. The 100 largest agricultural marketing cooperatives in 1991 accounted for just 7% of the value of all shipments, and only 3.6% of value added, indicating that such cooperatives tended to operate in low value-added, first-stage food manufacturing industries. Despite this, the importance of cooperatives in helping farmers to participate in downstream value-added activities is widely acknowledged (e.g. Canadian Minister’s Advisory Committee on Co-operatives (2002)).

Furthermore, Nilsson (1997a) notes the rise of vertically integrated, market-driven, value-added focused NGCs in the US, and discusses the success of such NGCs in contributing to a revitalisation of the Great Plains communities and economies. Using production contracts, and delivery rights and obligations, to streamline all business functions, the first such NGC was created in South Dakota, and the model has since been exported. More than 50 NGCs were created in just a few years, investing around US$1 billion by 1994, spawning what came to be called “co-op fever.” Donoso et al. (2003) note the use of alternative new cooperative models to help farmers to participate in downstream value-added. These involve larger cooperatives which remain involved in collection and first-stage processing, but with subsequent processing occurring through partly-owned subsidiaries (e.g. as in Ireland and the UK).

Herbst and Prufer (2005) formalise the general ownership framework of Hansmann (1996) to examine the role of organisational form on the provision of quality. Non-profits, cooperatives and IOFs are predicted to provide different price-quality combinations. Non-profits are found to serve as a means to commit to the production of high quality due to the lack of alternative use for their profits. Cooperatives are the optimal organisational form in some cases, such as when the costs of collective decision-making are sufficiently low (e.g. when cooperative members are sufficiently homogeneous). Conversely, IOFs are optimal if the costs of collective decision-making make cooperatives infeasible, and if the costs of inducing a manager to increase quality are high. They predict that:

  1. Cooperatives will prevail where an organisation’s owners have an interest in consuming its output and the costs of collective decision-making are low; and
  2. The quality produced by an organisation is higher, the higher the share of buyers in that organisation’s owners, and the lower the share of profits in those owners’ total payoffs.

Hoffmann (2002) examines how ownership structure affects quality choice in a mixed duopoly framework comprising coexisting IOFs and/or cooperatives. He finds that each type of organisation produces higher quality in different conditions. IOFs produce higher quality at lower prices and generate a larger consumer surplus than cooperatives when the cost of quality at farm level is fixed (with respect to the level of quality and quantity produced). This arises because only cooperatives consider these costs in this case. Conversely, where the farm level cost of quality is variable, the cooperative has a cost advantage, as the IOF processor has to pay farm-level marginal cost for all its farm inputs. Furthermore, in this case cooperatives generate higher levels and larger quantities of the high quality good at lower prices, producing higher profits and a larger market share of that good. They also generate larger consumer surplus and higher total welfare than IOFs in this case.

Zeuli and King (2004) extend the usual consideration of factors underlying farmers’ choice of agricultural contracts (over spot contracting) to include the influence of organisational structure of their counterparty: traditional cooperative, NGC or IOF. They develop a one-period model (hence ignore inter-year price variability) with heterogeneous suppliers differentiated by farm supply and risk-aversion. They find that NGCs may be the only viable organisational form where value-added processing is only marginally viable, and hence where it may not be feasible for an IOF to invest.

Winfree and McCluskey (2005) investigate the association between collective reputation (where quality is not traceable to specific firms in a producer group) and product quality, as might arise in the case of specialty, regional or local food products. They develop a game-theoretic model showing that where collective reputation is based on past average quality, as the number of firms in the producer group increases the incentives to provide quality decreases. They offer minimum quality standards, or producer group strategies to punish supplier firms failing to meet quality requirements, as methods to elicit optimal quality choices. By implication, cooperatives can thus be an alternative to quality regulation, where they have the means and incentive to themselves monitor the quality of their supplies and sanction suppliers who skimp on quality.

Jermolowicz (1999) notes a practice, unique to cooperatives, with a bearing on the ability of cooperatives to control supply quality. Cooperatives often engage in “pooling” whereby producers are paid an average price received by the cooperative for all product of a like quality during the duration of the pool. Individual suppliers receive a volume-based pro rata share of income from the pool, with adjustments for quality differences. While such arrangements enhance the cooperative’s marketing leverage and help to spread individual producers’ marketing risk, they require individual producers to forego marketing control to the cooperative. This is likely to function more effectively where producers are homogeneous, but encounter tensions where they produce significantly differentiated produce (in terms of quality or type). The durability of pooling will come under pressure as consumer demands for product traceability increase.

Ohlsson (2003) examines how New Zealand’s dairy cooperatives have adjusted their market strategies and organisational structures as a result of changing market characteristics. She notes that New Zealand’s largest dairy cooperative Fonterra, and smaller cooperative Westland, maintain a focus on being a low-cost producer of dairy commodities. However, both have made investments in value-added products. Indeed, among Fonterra’s seven strategic themes, first is to be (p. 26) “the lowest cost supplier of commodity dairy products”, but also “leading specialty milk components innovator and solutions provider” and “leading consumer nutritional milks marketer.” Another strategic theme is to be an “effective developer of dairy industry partnerships in selected markets.” Examples of this include an alliance with Nestle in North, Central and South America, and joint ventures with Arla Foods in Great Britain and Dairy Farmers of America. Conversely, dairy cooperative Tatua is the most specialised of the three, producing consumer products and value-added ingredients. It is also the most individualised and NGC-like, with practically closed membership, tradable shares, and voting rights and capital contributions linked to delivery rights (and like Westland, is geographically limited).

Finally, Clement (2003) discusses the importance of secure property rights and cooperation for product quality and value-added in New Zealand fisheries. He offers the Orange Roughy Management Company (ORMC), formed in 1991 by a consortium of orange roughy and oreo dory quota-owners, as an example of a cooperative venture to maximise the value of the deepwater fisheries through sustainable management. It represents 99% of such quota-owners. Secure fishing property rights (Individual Transferable Quota, ITQ) have provided the incentive for more efficient operators to invest in additional quota, new vessels, improved harvesting and processing capabilities, and market development. Also, security of resource access through ITQs has resulted in a move away from bulk fishing during spawning seasons to fishing for small catches all-year-round, improving both fish quality and supply continuity. Processing aboard modern factory trawlers has also enabled frozen-at-sea, consumer-ready products. Marketing advantages have been gained with customers due to improving the long-term sustainability of the fishery.

4.3.3 Innovation

As reported in Section 4.2.1, Giannakas and Fulton (2003) develop a model examining the relationship between cooperative competition in an industry and innovation. Their modelling predicts that at worst, when innovation costs are relatively low, total R&D is not changed and producers’ welfare is enhanced by cooperative presence in a market. Conversely, when innovation costs are relatively high, cooperative involvement can increase the total amount of R&D in the market, and the welfare of all agricultural producers. Key to their conclusion is the difference between IOF and cooperative objective functions they assume. Whereas an IOF maximises total profits, a cooperative is assumed to maximise total member surplus. Because of this difference the cooperative faces a greater incentive to innovate because it internalises the effects of reduced costs and prices (due to process innovation) on member welfare.

4.3.4 Summary – Product Differentiation, Value-Added and Innovation

The main themes emerging from this survey of literature on cooperative involvement in product differentiation, value-added/quality choice and innovation are:

  1. Despite their undifferentiated, low-value added commodity origins, there is evidence of agricultural cooperatives either adapting their strategies within existing cooperative forms to provide greater value-added and/or differentiated products, or their organisational form (e.g. by adopting NGC-like characteristics) where existing forms do not facilitate the necessary changes. Indeed, in some circumstances only NGCs are predicted to be viable organisational forms where value-added activities are marginal for IOFs.
  2. With respect to product traceability, cooperatives and producer alliances are found to have advantages over other organisational forms, given their direct access to and possibly greater influence over members and producers. The cooperative practice of pooling is likely to face pressure in the light of increased needs for product traceability.
  3. Evidence exists of cooperatives being more likely to be involved in handling specialty produce than IOFs.
  4. Cooperatives are theoretically predicted to provide higher quality levels and consumer welfare than IOFs, for example where the costs of collective decision-making are low, or when the farm-level cost of quality is variable.
  5. The presence of a cooperative in a mixed duopoly is predicted to increase producer welfare, and either preserve or increase the rate of innovation.
  6. There is evidence of New Zealand cooperatives adopting various types of organisational and strategic measures to participate in increased value-added processing and to enhance product quality.

4.4 Governance

In Section 3 we introduced the argument that limitations on cooperative property rights that are not shared with IOFs make cooperatives vulnerable to principal-agent conflicts, and increased costs of collective decision-making relative to IOFs. Cook (1995)points to free-rider, horizon, portfolio, control, and influence cost problems, all of which can be worse to some degree than in IOFs. On the other hand, Hansmann (1996) and others point to features peculiar to cooperatives that in fact resolve certain governance issues better than can IOFs. Here we survey some of the theoretical and empirical results touching on the relative efficacy of cooperatives and IOFs on various governance dimensions.

4.4.1 Agency Cost Problems

Evidence of Agency Costs

Porter and Scully (1997) compare the relative cost efficiency of a sample of US cooperative and IOF dairy processors in 1972, assuming no monopsony market power in processing. They found cooperative processors to be only 75.5% as productively efficient as IOF processors, attributing the main source of inefficiency to the structure of cooperative property rights. They concede, however, that vertical integration into processing by cooperatives where there is monopsony market power can result in improved efficiency.

Russo et al. (1999) examine the effect of managerial power on cooperative leverage using a sample of 521 Italian agricultural cooperatives. They note excess leverage in Italian agricultural cooperatives, with 48% of 2,322 such cooperatives having an equity/asset ratio of less than 10%, and other research showing cooperatives to have less equity than investor-owned firms (equity/fixed assets of 40%, versus 70%). The associated financial distress reduces cooperative efficiency, increasing transaction costs and missed profit opportunities, and also limits cooperatives’ ability to respond to global demands.

Under the principal-agent model, if cooperative members cannot monitor or otherwise control management, then managers have an incentive to behave opportunistically by pursuing their own goals rather than their members’. Given many Italian cooperative managers are on fixed salaries not related to performance, Russo et al. predict they will support risk-minimising strategies. Thus, if such managers influence capital structure through their bargaining power, the expected average equity/asset ratio should be higher, more sensitive to risk, and less sensitive to cooperative profitability and financing costs.

In fact they find capital structures of cooperatives with powerful managers to significantly differ from those where managers are non-powerful, and to respond in different directions to increases in profitability (increasing equity ratios for the former; decreasing for the latter). Leverage was higher for cooperatives with non-powerful managers than for those with powerful managers, with 69% of the non-powerful manager cooperatives having an equity ratio of less than 10%, versus only 40% for the others. Average equity ratios for these two classes of cooperative were 10% and 19% respectively.

While these differences in capital structure support the hypothesis of agency conflicts for some cooperatives, the authors argue that those with more powerful managers are better placed to compete internationally in changing global food markets due to weaker capital constraint (i.e. less financial distress). They note the dilemma this creates – members prefer to minimise their capital commitments to cooperatives, but where powerful managers influence higher equity ratios this enhances competitiveness.

Katz (1997) empirically examines the influence of competitive strategy on productivity for cooperatives and investor-owned firms in 14 sub-sectors of the US food products industry over 1988 – 1992, using an agency theory and property rights framework. He finds that cooperatives with higher productivity tend to resist diversifying growth strategies, maintain higher liquidity (to avoid bankruptcy) and limit technology-related expenditures. Members cannot easily diversify their cooperative ownership and so demonstrate risk-aversion.

Conversely, owner-influenced investor-owned firms with higher productivity were smaller, diversified into unrelated markets, had lower liquidity, and paid their chief executives more for performance. Manager-controlled investor-owned firms – those with no single shareholder owning more than 5% of the firm’s equity – with higher productivity tended to be smaller, avoided unrelated diversification, and had higher liquidity. He concludes that these results confirm the importance of agency costs in determining competitive strategy and influencing productivity.

Keeling and Carter (2004) examine the failure in 2000 of an 80-year old Californian rice cooperative, Rice Growers Association (RGA), from an agency cost perspective. Based on survey responses they found that RGA members thought it failed due to poor management, including a decision to pursue product differentiation, and an inability to contain costs. RGA’s board was regarded as passive and ill-equipped to scrutinise management decisions, and management skills were not well-regarded, with management failing to evaluate complex business decisions and being remiss in planning for future contingencies. Despite these governance flaws, members did not actively involve themselves in running RGA, highlighting free-rider problems at both member and board levels (which were also indicated by management complaints at a lack of member feedback).

Resolving Agency Costs

Trechter et al. (1997) cite a 1993 US survey finding that managerial bonuses in cooperatives were more closely tied to firm size than performance, with ex post bonuses preferred to those set ex ante. They also cite a 1994 survey finding that ex ante bonuses are more likely to be associated with profits, while ex post bonuses were more likely to be based on sales.

Drawing on case studies they find that cooperative boards are sceptical of ex ante bonuses for reasons including difficulty in defining appropriate variables to tie bonuses to, problems in distinguishing managerial performance and exogenous effects, and inexperience with this type of compensation. They also find that the principal agent problem in cooperatives is primarily dealt with in two ways. First, by frequent interaction between the cooperative board and manager, particularly for long-serving managers. Second, because the cooperatives studied make most of their sales to members, managerial performance is directly assessed by members in most transactions. Trechter et al. conclude that cooperatives do not tend to solve the principal agent problem via high-powered financial incentive schemes (as is more common in IOFs), but by continual oversight by cooperative boards and members.

This conclusion squares with the findings of Peterson and Anderson (1996), based on their survey of cooperative strategies identified in a survey of 21 US cooperatives. Despite the theoretical argument for cooperatives to be formed to reduce agency costs by achieving economies in monitoring managers and strategies, survey respondents did not indicate this strategy was pursued in practice. In fact their survey provided mixed signals about agency cost issues. More than half (52%) of cooperative chief executives felt their boards made strategic decisions too slowly and lacked the expertise required for quality decisions. Many managers expressed a sense of “being alone” when it came to making major decisions, and did not find their boards could offer helpful advice in difficult situations. Cooperative boards were seen as giving managers too much latitude on important decisions, and not handling management evaluations effectively, suggesting high agency costs, not low. On the other hand most cooperative chief executives indicated their responsiveness to member needs, and 76% of those surveyed emphasised that members had direct access to them for making complaints and suggestions, and importantly to provide them with feedback and information.

4.4.2 Impact of Member Heterogeneity

The Heterogeneity Problem

Hendrikse (2004) observes the increasing differentiation and need for innovation in the supply side of agricultural and horticultural markets. These arise due to both competition flowing from globalisation, and because of increasing consumer demands for variety and quality. Both have resulted in governance changes among growers, and between growers and wholesalers. Product and quality differentiation, and differential rates of innovation, create heterogeneity of interest among (horizontally and vertically integrated) cooperative and (horizontally integrated) grower association members. It also strains the equality of treatment principle underlying traditional cooperative structures.

Hart and Moore (1996, 1998) analyse the circumstances in which cooperatives are relatively more or less efficient (in terms of pricing and quality choices) than IOFs, contrasting objective functions and voting mechanisms under each organisational form. Arguing that both IOFs and cooperatives are inefficient forms of organisations but in different ways, they find that outside ownership (i.e. as in IOFs) is superior to cooperative ownership as member heterogeneity rises, with cooperatives being first best only when the median member has average preferences (in which case one-member-one-vote becomes efficient). Also, IOFs are superior to cooperatives as the industry becomes more competitive. Some cooperative problems, such as the horizon problem, can be overcome with transferable cooperative property rights. Also, pricing efficiency is increased when cooperative membership is open.

Like Hansmann (1996), Hart and Moore argue that cooperatives work well when their activities are narrowly defined, but poor at dealing with significant change (when members’ interests are more likely to diverge). Interestingly, they predict that traditional cooperatives’ use of one-member-one-vote may in fact be the least inefficient voting mechanism (e.g. compared with IOF’s one-share-one-vote) due to its clarity and protection against abuse.

Banerjee et al. (2001, p. 139) construe firms as “domains in which disparate interest groups compete over rents, resulting in considerable loss of efficiency”, with conflicts exacerbated when there is substantial heterogeneity among firm members. They focus on Indian sugar processing cooperatives, which are meant to pay uniform prices to all growers. In practice, they argue, larger members (who are more powerful within the cooperative) use their power to depress the sugarcane price, generating retained earnings that they then appropriate in pecuniary and non-pecuniary ways (such as through cooperative expenditure on temples, and schools and hospitals, as well as through direct expropriation). They find support for this prediction from a dataset comprising nearly 100 sugar cooperatives in the Indian state of Maharashtra over 1971 – 1993.

Bogetoft and Olesen (2003) cite research criticising cooperatives for too little investment in product and market innovation. They show that members of agricultural marketing cooperatives who produce standard products have conflicting interests with those producing specialty products where farm-level differentiation arises to meet requirements from high-quality market segments. This implies member heterogeneity, and increased influence costs. Since the increased sale of specialty products increases the bargaining position of the specialty producers, the standard producers are reluctant to promote the sale of specialty products.

Finally, Emmons and Schmid (2002) show that the pricing and dividend policies in open-membership credit cooperatives are affected by both the proportion of customers that are members, and heterogeneity in member preferences. This arises even when there is no business discrimination between members and non-members.

Solutions to the Heterogeneity Problem

Reynolds (1997) uses game-theoretic arguments to model incentives to cooperate in agricultural cooperatives when there are diverse member interests. He examines the role of member consensus and policy consistency in a cooperative, and member consensus and policy in a strategic framework of competition, where competitors offer individualised terms to selective producers that are difficult for a cooperative to match. He concludes that cooperatives can address the problem of losing some of their largest patrons to competitors by distributing earnings and voting power in proportion to member patronage volume, or to patronage-generated equity.

4.4.3 Information, Adversity and Trust

Cooperative Informational Advantages

Bontems and Fulton (2004) argue that cooperatives can have informational and hence cost advantages relative to for-profit firms deriving from their greater alignment of member and firm goals, and depending on the extent of income redistribution among members. They observe that (p. 2) “An important insight obtained from incentive theory is that privately held information is valuable to those that possess it, while it imposes a cost on those that do not.” This suggests that organisations in which the goals of the principal and agent are more closely aligned might have different cost structures than those where they diverge – i.e. their information costs (the costs associated with eliciting the desired behaviour from agents) are lower.

Cooperatives and IOFs represent well-known cases where principals’ and agents’ goals diverge. In agricultural markets, for example, IOF processors wish to maximise profits which involves a conflict with their farmer-suppliers’ objective of maximising farm-gate returns. Conversely, an agricultural marketing cooperative typically seeks to maximise service at a price, or maximise member welfare, representing a closer alignment between principal and agent goals. Thus cooperatives should have an organisational advantage where privately held information is important (e.g. by farmers regarding their output quality). Hence, all else equal, cooperatives should have lower production costs. These authors develop a model demonstrating this result. Under complete information cooperatives and IOFs are equally first-best. Under incomplete information, however, cooperatives always induce output closer to first-best than do IOFs.

Cooperative Financing Advantages in “Bad Times”

Hueth et al. (2005) develop a model explaining cooperative formation in “hard times” due to improved farmer/processor incentives outweighing deadweight governance costs, thereby facilitating financing not otherwise available. They observe that cooperatives are often formed in declining industries, or alternatively, that cooperatives seem to be sustainable in relatively low-return environments that do not support IOFs. This suggests an apparent advantage of the cooperative firm.

These authors argue that cooperative formation is a costly mechanism for increasing the power of farmers’ incentives. While cooperative formation gives rise to advantages in terms of mutual monitoring and reduced supervisory expenses, by farmers pledging farm assets to acquire production facilities it also increases the amount available to pay to lenders (“pledgeable income”), enabling greater funding access for processing. Such advantages must be weighed against any inherent inefficiency in the cooperative governance structure (due to internal decision-making frictions arising from illiquid ownership that are not present in IOFs), and any deadweight costs associated with the loss of asset-specific human capital in the event that the firm fails.

Thus cooperative formation, being a mechanism for relaxing the limited liability constraint, is predicted to be an efficient response when there is otherwise insufficient pledgeable income, arising for example when market returns are low, or lending rates are high. They thus predict that a cooperative firm is financially viable in a larger class of environments than an IOF (but that the latter dominates when both are feasible). Consistent with their model’s predictions, using data for 15 agricultural commodity sectors in the US over 1930 – 2002, they find a positive causal relationship between annual real lending rates and the level of cooperative activity. In contrast to the prevailing view on cooperatives – that they suffer from a lack of access to external capital – their analysis suggest that a lack of external capital is required to elicit internal financing from cooperative members, which can then be considered a key advantage of the cooperative firm.

Role of Trust in Cooperatives

Hansen et al. (2002, p. 42) define trust to be “the extent to which one believes that others will not act to exploit one’s vulnerabilities.” They observe that most cooperatives seek to build trust among their membership and management teams, and many include trust among their guiding principles in mission statements. They also note the importance of trust in economic exchange – e.g. empirically trust has been found to reduce transaction costs by avoiding costly negotiations and contracting, and may also enhance alliance revenues by facilitating a more complete interaction of alliance partners’ resources.

Hansen et al. argue that cooperatives tend to couple complex services with greater geographical dispersion, and less complex services with less dispersion. They suggest this flows from scale economies, with highly complex services requiring specialised skills that are scalable over larger areas. Based on a survey of a simple grain marketing cooperative and a more complex cotton marketing cooperative (both in the US), they argue that the trust developed among members and between members and management will vary depending on the complexity of the cooperative’s services and its geographic dispersion. In cooperatives with complex services and geographic dispersion trust between members and management is most important, since members need to evaluate the extent to which management can add value through their services, and trust is more cognitive (based on facts) than affective (based on feelings). Conversely, for cooperatives offering less complex services and which are less dispersed, inter-member trust is more important, helping to meet members’ social goals (which are argued to matter more in such contexts, in addition to economic goals), and affective trust is predominant.

Again looking at the importance of trust, James and Sykuta (2004) examine the choice of organisation (IOF or cooperative) to which Missouri corn and soybean farmers marketed their 2002 crop year harvest, based on a survey of 2,000 producers. They find their results puzzling, in that farmers marketing soybeans place significantly higher trust in producer-owned firms than in IOFs, and that trust is a significant factor affecting the decision of such farmers to market their grain to a producer-owned firm, all other things equal. However, for corn farmers trust is not different between the two firm types. They suggest this could be due to the fact that while two thirds of corn farmers also grow soybeans, almost all soybean farmers grow corn, implying that the choice of marketing organisation for soybeans may also affect that for corn. Alternatively, corn producers are more likely to diversify their crop products, perhaps indicating higher risk aversion or higher perceived uncertainty, noting that uncertainty and vulnerability are core elements of trust-based relations.

4.4.4 Summary – Governance

The main messages regarding cooperative governance that emerge from the above survey are:

  1. Evidence exists for agency costs arising under cooperative ownership, which of itself does not distinguish cooperatives from IOFs (since IOFs also suffer from such costs), and there is some suggestion (Russo et al. (1999)) that the expression of these costs – lower leverage – may in fact enhance cooperatives’ competitive ability.
  2. Cooperatives differ from IOFs in terms of their solutions to agency costs, using closer monitoring in place of high-powered incentives (which are more common in IOFs, especially when they have listed shares).
  3. Evidence also exists in support of common theoretical predictions that increases in member heterogeneity in cooperatives increases inter-member conflicts and hence the costs of cooperative ownership. Conversely, cooperative strategies to reduce member heterogeneity can result in other adverse consequences, such as reduced product and market innovation.
  4. Some inter-member conflicts can be reduced where cooperatives deviate from the traditional cooperative model and tie earning and voting power to patronage, or to patronage-generated equity.
  5. Closer alignment of supplier and firm goals under cooperative ownership can provide cooperatives with an informational and hence cost advantage over IOFs where suppliers have private information.
  6. Cooperatives can be more efficient than IOFs in “hard times” due to farmer ownership, relaxing the organisation’s limited liability constraint and enabling better access to capital.
  7. Inter-member and member/manager trust plays differing roles depending on cooperative type, and it is not clear that cooperatives enjoy greater trust from their suppliers than do IOFs.

4.5 Access to Capital, Investment, and Growth

A key question when comparing cooperatives with alternative organisational forms is whether they have the capacity to finance growth and investment necessary for their survival in an increasingly globalised and hence competitive agri-food chain. Theoretical arguments suggest cooperatives are capital constrained (although see the Heuth et al. (2005) discussion in Section 4.4.3), and that this is an inherent obstacle to their growth and competitiveness. It also raises their risk of failure. This section surveys evidence on each of these questions.

4.5.1 Access to Capital

Chaddad and Heckelei (2003) compare the investment behaviour of agricultural cooperatives and IOFs in the US food industry, in particular examining the role of financial constraints by exploring whether ownership structure affects investment sensitivity to cash flow. They note that many scholars regard agricultural cooperatives’ imperfect access to capital as their “Achilles’ heel” in an increasingly concentrated and tightly coordinated agri-food chain. Thus cooperatives may lack the capital resources to grow and to remain a viable organisational form.

They summarise the main theoretical arguments for cooperatives facing capital constraints as:

  1. Cooperative residual claims are restricted to active owner-patrons;
  2. Cooperative members lack investment incentives due to vaguely defined cooperative property rights (giving rise to the free rider, portfolio and horizon problems discussed in Section 2.4.2);
  3. Cooperatives must rely on internally-generated capital as they have limited access to external funds; and
  4. Cooperative equity is often not permanent (e.g. where it is subject to redemption at “fair value” when owner-patrons retire).

Noting that previous empirical evidence on the capital constraint hypothesis is inconclusive, Chaddad and Heckelei identify two classes of relevant empirical studies: growth studies and direct empirical tests. They provide a test of the latter type, using data on 131 agricultural cooperatives and 227 listed IOFs in the US food industry over 1991 – 2000. Given that IOFs in principle can raise equity capital via the public capital markets by virtue of their unrestricted residual claims (i.e. shares), they predict that cooperatives should have a higher sensitivity of investment to cash flow. Indeed they establish a significant cooperative investment-cash flow sensitivity, concluding that the cooperatives they considered are financially constrained. As a public policy response they recommend the removal of unspecified regulatory restrictions to organisational change if a policy objective is to mitigate cooperative financial constraints.

In a similar vein, Chaddad and Cook (2002) also argue that existing evidence on the cooperative capital constraint is inconclusive, and directed at the question of cooperative access to capital rather than their demand for investment funds. Applying a similar methodology to Chaddad and Heckelei, but looking only at cooperatives, they test the capital constraint hypothesis using data on 507 US agricultural cooperatives over 1991 – 2000, split into sub-samples based on size, permanent equity and credit risk. They find that cooperative investment responds positively and significantly to both the marginal profitability of capital and cash flow.

All three cooperative sub-samples face binding financial constraints when making investments. However, small cooperatives, cooperatives with relatively high permanent equity and low credit risk cooperatives were relatively less constrained than large, low permanent equity and high credit risk cooperatives. Chaddad and Cook are careful to observe that eliminating restrictions on cooperative residual claims may not be sufficient to relieve the capital constraint, and suggest it is not surprising that cooperatives have been adopting new organisational forms. Indeed, they note that agricultural cooperatives have not tended to convert to IOFs as has occurred with mutual firms in other industries, instead adopting new organisational forms while maintaining farmer ownership and control.

Earlier evidence produced by Lerman and Parliament (1991) in fact contradicts the capital constraint hypothesis. They compare the use of debt in 60 US dairy, food, grain and farm supply cooperatives over 1973 – 1987 with that in US IOFs, finding that cooperative equity financing proportions were indistinguishable from IOF proportions over 1973 – 1983, and consistently higher than the national average over 1984 – 1987. If cooperatives did face capital constraints, this would suggest that they rely more on debt than IOFs, and hence have lower such proportions. Moreover, cooperatives were found to finance nearly half their growth with equity. The finding that cooperatives had lower debt levels than IOFs was confirmed by Hardesty and Salgia (2004), as discussed in Section 4.1.1.

Finally, Kyriakopoulos and van Dijk (1997) present evidence on the use of innovative capital raising techniques by entrepreneurial and market-oriented agricultural cooperatives in the EU. Among developments in cooperative financing they note the use of:

  1. Subsidiaries and strategic alliances;
  2. Non-voting, fixed rate debt instruments (bonds) to non-members;
  3. Proportional tradable shares, tying ownership rights to fixed supply obligations, and allowing cooperative members to trade such rights among themselves;
  4. External participation shares, which enable non-members to participate either on a non-voting or restricted voting basis; and
  5. Conversion to publicly listed IOFs (mainly in Ireland).

Aside from normal cooperative membership shares and retained profits, bonds are the next most popular source of funding, with EU cooperatives issuing bonds in eight out of 15 countries. Proportional tradable shares are less widely adopted, occurring in only two out of 15 EU countries.

4.5.2 Investment

Puaha and Tilley (2003) examine factors underlying decisions to either invest or not invest in a new value-added NGC, called VAP Cooperative, formed in Oklahoma in 2000. They note that state legislation had been passed to encourage the formation of NGCs, allowing tax credits on up to 30% of capital invested in such cooperatives. They argue that investments in closed cooperatives such as NGCs are inherently risky. In the case of VAP cooperative, for example, it was a start-up venture, beginning with a small customer base and limited product distribution system, and its single product (pizza dough) faced a highly competitive market. Using survey responses from 298 wheat growers who did not invest in VAP cooperative and 323 who did, they find that social and non-monetary factors played a significant role in members’ decision to invest. This is despite VAP Cooperative having NGC features more closely aligning its equity value with market value.

In a related vein, Russo et al. (2000) develop a model showing that cooperatives evaluate investments differently from IOFs due to the unique characteristics of their owner-patrons compared to other investor types. These characteristics raise the transaction costs of the cooperative decision process, making internal coordination among members more complicated. While the investment decisions of IOF investors are modelled according to standard financial theory as depending only on parameters about which in equilibrium they should agree (risk and return), cooperative investors are modelled to base their decisions on additional factors:

  1. Factors relating to individual member preferences – their risk aversion, portfolio composition, and covariance between farm and cooperative returns;
  2. Institutional factors affecting cooperative decision-making – e.g. cooperative voting rules and director election processes; and
  3. Distribution of bargaining power across members – their model shows different members may have different investment project evaluations but may face obstacles in securing compensation by acquiescing to others.

Hence, while IOF investors can be assumed to have a coincidence of interest in project evaluation – caring only about commonly-held, market-determined valuation parameters – divergences in cooperative member interest and associated internal costs of collective decision-making can more clearly arise (particularly where members are heterogeneous). However, these authors emphasise that cooperatives may face lower external transaction costs than IOFs where they are used by farmers to improve vertical coordination and reduce their exposure to opportunistic behaviour (i.e. hold-up).

4.5.3 Growth, and Failure Risk

Fulton et al. (1995) examine whether cooperative growth is constrained, based on a long-term sample of three Canadian and four US large regional agricultural cooperatives over 48 – 60 years. They find cooperative growth is unrelated to cooperative size, and the long-term growth rate for the sample is low, perhaps even zero.

On the question of a flip-side to growth, financial stress, Moller et al. (1996) examine the sources of financial stress in 718 of the largest group of centralised US agricultural cooperatives from 14 states over 1987 – 1992. They note that studies comparing cooperatives and IOFs find little difference between the two organisational types in terms of leverage, liquidity, profitability and efficiency. Their study instead focused on which of three factors, asset return, leverage and interest rates contribute to cooperative financial stress (defined as profitability over a series of years). Around 30% of the cooperatives they examined suffered financial stress in the sample period. Of those cooperatives, financial stress arose due to low earnings in 54% of cases. High interest rates accounted for around 24%, while leverage accounts for the remaining 22%. Smaller cooperatives were also twice as likely to face financial stress as larger ones. They were also more likely to face profitability problems, while larger cooperatives were more likely to face debt and interest rate problems.

Manfredo et al. (2003) suggest that US agricultural cooperatives, particularly smaller regional ones, have been slow to adopt modern risk-management strategies such as futures, options and swaps. Instead they rely on holdings of capital reserves to provide a buffer against profit swings due to adverse market conditions, which is a costly alternative given cooperatives are relatively capital constrained due to an inability to access pubic equity.

Cross and Buccola (2004) develop a model predicting that cooperatives become suboptimal when the weakness in competition that initially spurs cooperative development is resolved. In particular, when cooperative industries become competitive, the optimal capitalisation for active-member controlled cooperatives is zero, and the probability of bankruptcy high. IOFs are modelled as having a greater interest in the future well-being of the firm than do cooperative members, as the latter enjoy only time-limited cooperative returns (the horizon problem). Furthermore, in a competitive industry the cooperative no longer serves as a discipline on an IOF processor, so cooperative members only sustain the cooperative to preserve previously-retained member equity. But in this environment the cooperative generates no surpluses, so its members have no interest in whether or not it fails. The authors show that in competitive circumstances the risk of bankruptcy is reduced with greater inactive-member control of the cooperative, or by moving toward IOF structures through more NGC-like arrangements. Each extends the horizon over which cooperative members seek to secure their returns, increasing their cooperative investment and interest in its survival.

Finally, Hogeland et al. (2004) develop a model comparing member expected net present value, and probability of financial ruin, for traditional cooperatives and NGCs, and for IOFs. They affirm the traditional rationale for cooperatives as a means of improving farmers’ returns in the face of imperfectly competitive markets. They question this rationale, however, in the light of increasing competitiveness in the US economy, with reduced trade restrictions, freight market deregulation, and enhanced local market contestability through improved preservation and transportation technologies. Maturing capital markets have also eroded traditional cooperative borrowing advantages, and strong equity performance places pressure on non-dividend paying and illiquid cooperative equity.

These authors demonstrate that as markets become increasingly competitive, traditional cooperatives encourage lower investment and give rise to higher bankruptcy probability than IOFs. However, members become more willing to capitalise cooperatives as inactive members – who place greater emphasis on the firm’s investment value as opposed to their patronage value – gain influence on the cooperative board, or as the firm’s capital structure more closely resembles that of IOFs. NGCs are one way of achieving this, but carry an inherent tension between members’ long-run interests as owners, and patronage returns.

4.5.4 Summary – Access to Capital, Investment, and Growth

The main messages regarding cooperative access to capital, investment and growth that emerge from the above survey are:

  1. Despite theoretical predictions by some to the contrary, both recent and earlier evidence exists for cooperatives having lower debt levels than IOFs.
  2. However, recent studies do establish that cooperatives are financially constrained. While these constraints are attributed to theoretical problems with cooperative property rights, the elimination of such problems may not be sufficient to resolve these financial constraints.
  3. These constraints are being addressed by cooperatives adopting variations on the traditional cooperative form, such as NGCs, or by entering into joint ventures and strategic alliances.
  4. Cooperative members may make investment decisions differently to IOF investors. Non-financial considerations may play a greater role in their investment decisions, and unlike IOF investors, cooperative members are predicted to face higher transaction costs of collective decision-making when deciding on investments. These internal disadvantages relative to IOFs should be tempered by any external benefits cooperatives bring through improved vertical coordination and reduced exposure to opportunism/hold-up.
  5. Large cooperatives in the US have been shown to experience only low or zero growth rates over long periods. The rise of NGCs since the 1990s, and ongoing cooperative consolidation, may cause these patterns to change.
  6. Cooperatives may become less viable and at greater risk of failure than IOFs if the markets they operate in become more competitive. However, cooperatives may be more financially viable than IOFs in struggling or declining industries.

4.6 Cooperative Evolution

As discussed in Section 3.1, whether or not the persistence of cooperatives is regarded as desirable or undesirable hinges largely on whether there are inherent or external constraints on the reorganisation of cooperatives. Evidence of active and/or successful cooperative restructuring should provide reassurance that such constraints are not absolute. Where cooperative’s inherent features constrain reorganisation this provides direct evidence on the question. Where cooperative reorganisations retaining cooperative features can be shown to provide benefits not shared by those retaining fewer such benefits, this too provides evidence on the desirability of cooperative evolution. We consider evidence on each of these questions below, noting that evidence on cooperative adaptation considered in the preceding sections – such as cooperative responses to relieve capital constraints – is also relevant here.

4.6.1 Nature and Incidence of Cooperative Reorganisations

Demutualisations

Birchall (1998) notes a wave of demutualisations in the 1990s in the UK, US, Australia, South Africa and Canada, particularly in the financial services sector. A wave of conversions of agricultural cooperatives to IOFs in the US, Ireland and Denmark also occurred, and Eastern and central European cooperatives were privatised following the collapse of communism. As subsidised state marketing boards are unwound, he argues, farmers have an incentive to cooperate, as occurred with the formation of farmer cooperative Milk Marque when the British Milk Marketing Board was privatised (but which was subsequently broken into three due to competition concerns).

A declining number of Australian cooperatives are reported in Ernst & Young (2002). Cooperatives continue to have a large presence in the dairy, fruit, and cotton industries. But cooperatives are either consolidating to achieve efficient scale for global competition, or converting to other forms. Dairy company Bonlac, Pivot Fertiliser, and a food company (Ardmona Foods) are recorded as having demutualised. Co-operative Bulk Handling is now the only remaining Australian grain cooperative, with most previously government-owned grain organisations opting for corporate structures when faced with privatisation.

Kerr (1999) lists a number of recent listings and conversions of other agricultural cooperatives, in Australasia and elsewhere. In New Zealand, for example, meat processor AFFCO converted from a cooperative to a listed IOF in 1995. In Australia, PLC Industries, a major egg marketer and feed miller converted to a public company in 1998. Dairy Value, a dairy products group based in South Australia, floated on the Australian Stock Exchange (ASX) in 1995. When the ASX introduced more flexible listing guidelines in 1997 covering cooperatives and former cooperatives, several listings resulted. First was Farm Pride Foods Ltd (formerly Egg Industry Cooperative Limited), New South Wales grain-handling company Graincorp followed in March 1998, and the former Australian Wheat Board, AWB, listed on the ASX in August 2001.

In other countries, Kerr notes, three major Irish dairy cooperatives lead the way with demutualisation, including the successful creation of Kerry Group, a partially listed, diversified cooperative involved in dairy, pork and beef processing. Kerry Group was formed after a wave of Irish dairy mergers following Ireland’s entry into the EC in 1973 (O’Connor and Thompson (2001)). Kerr notes that the two other Irish dairy cooperatives that demutualised enjoyed less success than Kerry Group. Also, US dairy cooperative Land O’Lakes reverted to cooperative ownership after experimenting with listing.

Gill (2002) analyses the financial performance of a well-known former Australian agricultural cooperative, Wesfarmers, which became a listed IOF in 1984. It began as a producer-owned stock and station agent in 1902, but followed a pattern of horizontal diversifications, seeing it acquire interests in hardware, gas, coal, fertilisers and chemicals, and rural services and insurance, to name a few. It restructured itself as a listed IOF to improve its access to equity so as to support the continuation of its growth strategy.

Scrimgeour and Sheppard (1998) provide an economic analysis of deregulation of selected Israeli, South African and Argentinian producer boards. In respect of Israel, changes to the Citrus Marketing Board resulted in a deregulated domestic market and multiple exporters. IOFs benefited at the expense of cooperative firms as a consequence. Bayley (2000) reported a similar decline in South African agricultural cooperatives following 1997 deregulation .

Reorganisations Retaining Cooperative Form

Mooney and Gray (2002) paint a different picture of cooperative reorganisation, examining the incidence and type of US agricultural cooperative restructurings over 1989 – 1998. Of the 314 restructurings in their sample, 36.6% involved alliances, joint ventures, or mergers or acquisitions between cooperatives. 23.2% involved cooperative expansions (i.e. building new facilities), and 16.6% involved cooperatives acquiring IOF assets (more than three times the rate of IOFs acquiring cooperative assets). In 15.3% of cases cooperatives formed joint ventures or alliances with IOFs. Only 4.8% of cases involved full conversion of cooperatives into IOFs, and only 3.5% of cases involved cooperative closure. They thus conclude that the dominant form of agricultural cooperative restructuring in the US occurs within the cooperative sector, rather than involving departures from the cooperative organisational form.

Ohlsson (2003) documents successive waves of dairy cooperative mergers, rather than conversions to IOFs, in New Zealand. In 1935 New Zealand had over 400 cooperatives, but with transportation improvements and advances in large-scale processing technologies this number had more than halved, to 180, by 1960/61, and fallen to just 19 by the beginning of the 1990s. Prior to the deregulation of the NZDB in 2001, subsequent mergers left only two major cooperatives, Kiwi Co-operative Dairies Limited and New Zealand Dairy Group, which subsequently merged to form Fonterra (accounting for around 95% of the industry). Two smaller cooperatives, Tatua and Westland chose to remain independent.

Pritchard (1998) paints a different picture to that of Kerr (1999) of the changing role of agricultural cooperatives in Australia, examining the restructuring of the Australian dairy and wheat sectors in the 1990s. In the Australian dairy sector regulation arose from farmers’ attempts to stabilise production during the 1930s recession, paralleling North American experience. State governments regulated “market” (i.e. fresh liquid) milk, with the federal government regulating “manufacturing” milk. This encouraged a production system organised through regional cooperatives as localised vehicles to exploit market conditions embedded in regulation (p. 68): “Changes to milk zone boundaries had their counterpoint in the reorganization of dairy capital through cooperative mergers.”

In the mid-1980s public policy shifted towards deregulation, to generate efficiencies and improve national economic performance, resulting in major reorganisations (p. 68): “Between 1983 and 1993 the number of dairy cooperatives was reduced from 44 to 27 and the number of dairy proprietary companies from 65 to 31.” Mergers – such as those resulting in the formation of dominant cooperatives Bonlac and Murray Goulburn in Victoria – were prompted by the desire to gain economies of scale in preparation for the deregulation of export marketing arrangements. He concludes (pp 69-70): “In sum, these processes have caused the eclipse of the regional cooperative as the main organizational form of capital in the dairy industry. The industry is now composed of a smaller number of cooperatives and proprietary companies with extensive market reach, tightly organized distribution systems and strategic alliances, and innovative equity structures. … deregulation has been associated with a restructuring and strengthening of incumbent cooperative capital, rather than an incursion of globally mobile capital.”

As for the Australian wheat sector, Pritchard notes that until the late 1980s most growers sold wheat into pools administered by the then statutory marketing authority AWB (the Australian Wheat Board), and enjoyed guaranteed minimum prices underwritten by government. In the 1990s AWB’s domestic monopoly was removed, guaranteed minimum prices eliminated and borrowing guarantees were subjected to sunset clauses. Its export monopoly remained under pressure following the Uruguay round of the GATT negotiations, but persists even now (www.awb.com.au). Demand patterns also changed, with emphasis on the bulk sale of wheat to export markets giving way to a greater emphasis on domestic feedgrains (with corresponding investments from US and Japanese interests seeking to integrate Australian beef production into international supply chains).

He argues that (p. 71): “Growth of the deregulated domestic feedgrains sector has opened the possibility for new marketing arrangements within the industry. To date, these opportunities have been captured mainly by newly established wheat marketing cooperatives and by the AWB, rather than by transnational grains traders. The formation of grower cooperatives in the Australian wheat industry has been an important new phenomenon. The history of statutory marketing arrangements has meant that wheat growers have not possessed traditions of rural cooperation. Between 1990 and 1996, however, seven regionally based grains cooperatives were established in New South Wales, the state in which demand for feedgrains has been strongest.”

Thus Pritchard concludes that these case studies suggest the process of agri-food globalisation is being mediated by an ongoing role played by agricultural marketing cooperatives.

Contrasting the AWB and Fonterra Approaches

Finally, Trechter et al. (2003) compares the divergent reform strategies of New Zealand’s largest dairy cooperative, Fonterra, with that of the former Australian Wheat Board, AWB, in response to the loss of statutory single seller desks. Fonterra’s strategy was to achieve cost savings through integrating the New Zealand dairy supply chain under a cooperative structure, to strengthen its ability to compete globally while maintaining farmer control. It focuses on strong, differentiated brands, creating loyalty and price premiums. It adopted features of new generation cooperatives to lessen horizon and portfolio issues, but continues to face influence costs from inter-farmer conflicts of interests, and capital raising issues. The latter are mitigated by leveraging member capital through strategic alliances/joint ventures (e.g. with Nestle), although this can create farmer-partner conflicts of interest. He argues the company is positioned to be a major international player.

AWB, by contrast, opted for listed dual share classes (i.e. an IOF structure). Farmers alone are able to own A shares, with one vote per shareholder, benefits proportional to patronage, and board control. Any investor is able to own its listed B shares, with one vote per share, dividends proportional to investment, and minority control of board. Trechter et al. suggest this approach better resolves horizon, portfolio, agency cost and capital access issues than does the Fonterra model, but creates worse farmer-investor conflicts, and retains inter-farmer conflicts. Moreover, it likely means the ultimate loss of farmer control and focus as a condition of financial success, given the main source of increased profits is lowered farmer returns. They also note difficulties experienced in merging AWB with cooperatives

4.6.2 Results of Cooperative Reorganisations

Research on cooperative post-merger performance has been mixed. Parliament and Taitt (1989) examine the post-merger performance of 53 Minnesota local cooperatives participating in 24 reorganisations over 1979 – 1984. They note a contradiction between earlier research findings showing poor post-merger performance (i.e. reduced profitability despite stronger sales growth) and yet continuing enthusiasm for cooperative reorganisations. Measuring financial performance of reorganisation participants relative to the average performance of a control sample of cooperatives, they find limited improvements in relative financial performance, and significant declines in some performance measures, suggesting that pre-reorganisation weaknesses in the participants rather than inherent reorganisation flaws constrain performance. At least one third of reorganisations, however, were found to improve performance.

Richards and Manfredo (2001), offer a possible explanation for continuing cooperative enthusiasm for reorganisation. They argue that mergers, acquisitions, joint ventures or strategic alliances among IOFs are usually justified in terms of improved operational efficiencies or strategic marketing gains, and typically create value through tapping economies of scale (rather than creating market power). Cooperatives’ owners share these motivations, plus others: notably to relieve the cooperative capital constraint, which they argue constrains cooperative profitability for both operational and marketing reasons.

Examining the post-merger performance of US agricultural cooperatives consolidating over 1980 – 1998, they find that the cooperative capital constraint is the most significant factor motivating cooperative combinations with other organisations, by which they increase their financial flexibility and thereby can engage in activities increasing operational efficiency, market power, or both. Indeed, in contrast to the IOF literature, they find cooperative consolidations seek to absorb excess capacity, control supply, or increase negotiating power. They also find that even liquid and efficient cooperatives enjoy improved profitability with such business combinations, although this comes at the cost of sales growth (or vice versa). These authors conclude by arguing that consolidations may not be the least cost way for cooperatives to ease capital constraints, and hence that regulators and government agencies should promulgate legislation or regulations making equity financing more attractive.

Kenkel et al. (2003) examine the post-merger performance of 22 Oklahoma grain, farm supply and cotton ginning cooperatives – accounting for more than 25% of the state’s cooperatives – merging over 1990 – 2001. They note that the pace of cooperative merger and consolidation activity has increased since the early 1990s (e.g. 367 among US grain cooperatives alone in 1993 – 1997), and once again that previous studies show cooperative mergers lead to sales growth but not increased profitability. In contrast, they find that post-merger cooperatives enjoy greater efficiency (lowered expense ratios) and a higher return on equity, compared with the synthetically combined pre-merger business combination. These results remained after controlling for changes in pre- and post-merger business environment, even suggesting that the merged cooperatives enjoyed greater sales growth compared to peers.

4.6.3 Drivers and Success Factors

Hudson and Herndon (2002) assess factors influencing mergers, acquisitions, joint ventures and strategic alliances in US agricultural cooperatives, using survey data from 74 cooperatives. Reflecting wider US trends, they report a proliferation of consolidations in agricultural cooperatives, the majority of which involve horizontal integration of companies with like activities to achieve scale economies. They find that ownership diffusion in cooperatives allows cooperative management to pursue consolidation opportunities, but it also creates problems in their execution and the approvals process. Participation in consolidations was also found to be more likely when cooperatives had greater financial resources, suggesting such cooperatives initiated consolidations. However, asset turnover (the efficiency measure discussed in Section 4.1) did not appear to be an important driver of consolidations, suggesting that non-efficiency related factors were more important (despite efficiencies being obtained through consolidation). Placement in the market channel was found to affect the probability of participation in cooperative consolidations. They conclude that many of the same factors driving IOF consolidations also lie behind cooperative consolidations.

Fulton et al. (1996) examine factors affecting the failure or success of cooperative strategic alliances and joint ventures based on 1995 survey data from 20 US grain marketing cooperatives. They note that cooperative reorganisations are often motivated by the expectation of improved efficiency and financial performance. Recently reorganisations have increasingly taken shape in the form of strategic alliances and joint ventures rather than outright mergers and acquisitions. Based on their survey results they found that such reorganisations can indeed produce scale economies while preserving the identities of the partners. Success factors included trust, commitment and open communication as well as financial and operational considerations.

4.6.4 Obstacles to Cooperative Evolution

Hendrikse and Veerman (2001) develop a model showing that marketing cooperatives face inherent constraints relative to IOFs in entering into differentiated downstream product markets. They identify two types of hold-up that an agricultural production governance structure must address: the post-harvest hold-up due to perishability, and the investment hold-up faced by financiers when they do not control the investments to which their investment funds are applied. The counter-veiling power feature of a marketing cooperative is argued to resolve the first hold-up problem. Conversely, IOFs are argued to more efficiently resolve the latter type of hold-up, as their shareholders usually have proportional control rights; in a traditional cooperative this is not the case, with control rights and ownership stakes unlikely to coincide. This latter disadvantage of marketing cooperatives is resolved where their investments are non-specific, such as when they market homogeneous products. However, the use of IOF over cooperative marketing is suggested where highly specific investments are required in the processing stage, as is the case for differentiated products.

Nilsson (1997b) proposes factors underlying considerable inertia in Swedish agricultural cooperative restructuring. With Sweden’s entry into the EU in 1995, increased competitive pressures strained traditional policy preferences shown towards cooperatives, such as an ability to create regional cooperative monopolies. However, initially at least, Sweden’s cooperatives were slow to adapt to this competitive environment. Nilsson explains some of this resistance in terms of Swedish law imposing the traditional cooperative model – including one-member-one-vote – allowing ideological considerations to dominate economic ones. This has tended to give disproportionate control rights to older and part-time farmers, who have less incentive to adopt new cooperative models than younger and full-time farmers. Societal and farmer attitudes – such as cooperatives being modelled along socialist lines, with various cross-subsidies among member classes – were also slow to change. While new and more flexible Swedish cooperative legislation was anticipated, existing law prevented traditional cooperatives from adopting more economic features in response to the changed competitive environment.

On the other hand, Carman (1997) argues that federated cooperatives and hybrid cooperative-IOF models may be ideal means of enabling cooperatives to achieve the scale required for global competition. Federated cooperatives, in which one cooperative is owned by several others, are suggested to efficiently balance the advantages of local flexibility and property rights protection of the primary cooperatives on the one hand, with the scale and geographic reach made possible through a second-tier cooperative on the other. As a variation, IOF subsidiaries owned by cooperatives but with up to 50% of their equity capital issued to outside investors are offered as achieving a similar balance. Thus it cannot be concluded that cooperatives are inherently unsustainable in a globalised agri-food supply chain.

4.6.5 Summary – Cooperative Evolution

The main themes emerging from this survey of cooperatives’ organisational evolution are:

  1. Despite restrictions on cooperative property rights and high cooperative collective decision-making costs that might be taken to imply that cooperatives will experience obstacles to reorganisation, cooperative mergers, acquisitions, alliances and joint ventures, as well as outright conversion to IOFs, are observable.
  2. Such reorganisations stand on top of other institutional adaptations adopted by cooperatives as discussed in previous sections, such as shifts from traditional cooperative models to more NGC-like models to relieve capital constraints.
  3. Reports of the death of agricultural cooperatives (i.e. their widespread conversion to IOFs) are premature. This should come as little surprise for those countries where cooperatives continue to enjoy tax advantages relative to other organisational forms (e.g. in the US, relative to IOFs). Demutualisations became common in the 1990s in many countries, often in the financial services sector, but also in agriculture. In some countries agricultural deregulation resulted in a decline in cooperatives in favour of IOFs. However, evidence from the US shows that conversions to IOFs form a small fraction of total cooperative reorganisations, with the bulk of such reorganisations maintaining the cooperative form. In Australia a reduced number of larger cooperatives have assumed increased significance in the deregulated dairy and wheat sectors. In New Zealand, widespread dairy sector reorganisations have maintained the cooperative form, despite cooperatives in New Zealand not enjoying the preferences over IOFs enjoyed by many of their overseas counterparts.
  4. Earlier evidence on the success of cooperative reorganisations was not encouraging, but later studies find improved efficiency and profitability, with success factors including interpersonal factors (which might as easily be argued to matter in IOF reorganisations, it should be noted).
  5. Cooperative reorganisations, more so than for IOFs, are motivated by a desire to relax capital constraints, and to absorb excess capacity, control supply or increase negotiating power. These are in addition to the usual motivations of improving efficiency and financial performance.
  6. Inherent features of traditional cooperatives, such as the inter-generational conflicts arising due to the horizon problem – as well as inflexibilities in cooperative legislation and societal/farmer attitudes – can present obstacles to cooperative evolution.
  7. Cooperatives can successfully adapt without abandoning the cooperative form, and where cooperatives convert to IOFs – even with initial farmer control – the sustainability of continued farmer control must be questioned in the light of the conflicts of interests it creates between farmer and non-farmer owners.

4.7 Policy Implications

  1. Cooperatives are often argued to provide inferior financial performance to IOFs, or to be relatively inefficient. The weight of evidence on cooperative performance relative to IOF performance does not support such claims. Indeed, for the dairy sector in particular, the evidence appears to suggest the reverse. Hence the mere existence of cooperatives in an industry cannot be taken to mean that the industry’s performance is being hampered. Moreover, the existence of cooperatives in an industry is predicted to at worst preserve the rate of industry innovation, and otherwise to increase the innovation rate.
  2. Cooperatives tend to arise in industries where there is not strong competition, so assessing the competitive implications of cooperative involvement in an industry must bear this counterfactual in mind. Cooperative advantages are often predicted to decrease when competition is strong. Policies directed towards encouraging or discouraging cooperatives should therefore distinguish between industries in which potential competition is strong, and where it is weak.
  3. Where cooperatives and IOFs coexist in an industry, the presence of cooperatives is likely to result in more competitive pricing of farm supplies. This has implications for competition policy, in that horizontal mergers in industries with coexisting cooperatives and IOFs are predicted to be less anti-competitive than those in which there are only IOFs.
  4. While cooperatives enjoy certain competitive advantages over IOFs, such as an ability to credibly commit to oversupply at IOFs’ expense, they are also often predicted to suffer disadvantages in competitive procurement. For example, when differentiated farm outputs are required, or where IOFs can cross-subsidise across product lines, IOFs are predicted to prevail. Conversely, cooperatives may enjoy procurement advantages over IOFs where farmers have private information. These too have competition policy implications, in that the impact of cooperative consolidations on stock/crop procurement by competing IOFs is not unambiguously negative.
  5. The international competitiveness of cooperatives is not unambiguously better or worse than that of IOFs. While cooperative capital constraints and a producer-focus place them at a disadvantage relative to IOFs in this regard, they enjoy certain advantages over IOFs in providing supply security, and an ability to coordinate at the producer end of the agri-food supply chain. Also, cooperative adaptations, such as relaxing some of the constraints associated with traditional cooperative forms, and the increasing use of joint ventures and strategic alliances to enable greater farmer integration with downstream activities, have been effective in addressing some of the cooperative disadvantages in international competition.
  6. Under some conditions (e.g. farmer homogeneity, or variable farm-level costs of quality) cooperatives are predicted to provide higher quality levels and consumer welfare than IOFs. Under such conditions there is a case for cooperatives acting as a substitute for quality regulation, as may be the case for traceability and food safety standards.
  7. Cooperative governance is at its best when the cooperative owner-patrons have homogeneous interests, as is more likely when they produce an undifferentiated farm output, and/or where farmers are culturally alike. In such circumstances cooperatives are predicted to enjoy governance advantages relative to IOFs, and resolve agency cost issues via close monitoring where property rights constraints mean they cannot instead use high-powered incentives.
  8. While increased farmer heterogeneity raises the costs of cooperative governance, this does not automatically mean they become inferior to IOFs, particularly where other aspects of industry structure mean that vertical integration by farmers remains valuable. Hence, as cooperatives become more involved in differentiated downstream product markets, the tradeoffs inherent in the cooperative form will become more finely balanced, in which case further cooperative evolution should be expected in response.
  9. While cooperatives are indeed found to be financially constrained, this is not true under all circumstances. Evidence exists for cooperatives being the only financially viable organisational form in “hard times”. Where value-added processing investments are marginal for IOFs, cooperatives (particularly NGCs) have also been predicted to possibly be the only viable organisational form. Conversely, cooperatives are predicted to become less financially viable than IOFs when the industries in which they operate become competitive. Thus cooperative failure risk should be assessed in the light of the fact that cooperatives are often the only viable organisational form when the risk of failure is already high, and conversely that risk rises when the market imperfections leading to cooperative creation are not longer present.
  10. Cooperative reorganisation is a common phenomenon, indicating “adaptive efficiency.” As well as the normal motivations shared with IOFs for reorganisation – greater efficiency and financial performance – cooperatives reorganise to relieve their capital constraints. Where cooperatives display inertia in responding to changing market circumstances, this is often due to inflexible cooperative legislation or cooperative/agricultural policy hampering cooperative adaptations, although it can also reflect societal/farmer conservatism. Flexible cooperative legislation is one means to remedy such inertia.

 

16More generally, the welfare implications of cooperatives for society at large would take into account their impact on total producer and consumer surplus.

17Hardesty and Salgia (2004) observe that the prediction that cooperatives will have higher leverage than IOFs contradicts that of conventional, tax-based financial theory. Tax laws in the US encourage IOFs (but not cooperatives) to use higher levels of debt – which is not the case under New Zealand tax law – making it unclear as to which effects should dominate. We thank Eric Hansen of Fonterra for also pointing out that the traditional cooperative portfolio problem encourages more conservative cooperative leverage (to counterbalance higher owner-patron financial risk due to poor diversification). Moreover, the horizon problem means cooperatives tend to return a higher proportion of their returns to owners than do IOFs, reducing the need for higher leverage to decrease the free cash flows available for dissipation by managers. Both of these suggest lower leverage for cooperatives than in IOFs. This prediction appears more consistent with evidence on relative cooperative leverage, as will be seen later in this section.

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