Defining the Value of the Cooperative Business Model: an Introduction

This white paper is available through CHS Center for Cooperative Growth, www.chscenterforcooperativegrowth.com, an initiative that gathers and shares diverse viewpoints from agribusinesses, independent agricultural producers, academia and other leaders to foster greater success among America’s cooperatives.

DEFINING THE VALUE OF THE COOPERATIVE BUSINESS MODEL: AN INTRODUCTION

By: Anne Reynolds, Assistant Director, University of Wisconsin Center for Cooperatives, Madison, Wis.

Introduction

People who are unfamiliar with the value by successfully translating and In the following discussion, we will cooperative business model often define aggregating information about their discuss how the value of cooperatives cooperatives in relation to the dominant members’ needs into valued products is expressed and defined. We will model of a firm: investor ownership. and services. Successful cooperatives begin by considering cooperatives’ There is a rich body of knowledge and must find a balance between complex economic value, which is the shared understanding regarding the maximizing the current well-being of value of cooperatives as an influence value of investor-owned firms. Although the owners and maintaining the long- on prices and/or services within the stock prices and financial metrics term economic sustainability of the firm. economy, the value of cooperative don’t reflect the entire value of a firm, business assets at the enterprise level, they are readily available and easily The standard definition of the term and members’ assessment of value. comparable across firms. They can be value combines two concepts: This will be followed by a discussion used by a wide variety of factors in the monetary worth and importance to the of the value of cooperatives’ distinctive economy, including investors, potential possessor. This definition is consistent ability to aggregate and align member merger partners, customers and analysts. with a discussion of the value of the needs while generating trust, loyalty cooperative business model. Important and mutual commitment. In an Lacking transferable shares and strands of thought regarding cooperative increasingly complex and globalized other standard indicators of firm valuation include the economic value business environment, cooperatives are value, cooperatives require a more of the firm, the value of cooperative’s positioned to gain significantly from complex assessment. The source presence in the marketplace, and their special relationship with their of the complexity is embedded in the value of the firm to its owners, member-owners. the cooperative ownership model. which may include both concrete and Cooperatives are owned by their intangible benefits. patrons, and cooperatives create

Value of Cooperatives in the Economy Cooperatives are often formed in beneficial influence may fade from of 200–1000%. A statute establishing response to a problem in the market, memory (Hueth, 2011). Credit unions, credit unions was passed in 1931, and usually due to an imbalance of power which are consumer owned financial by 1939 there were over 500 credit between a supplier of goods and cooperatives, provide a good example unions operating in Wisconsin, meeting the customer. By pooling members’ of this phenomenon. Credit unions the market demand for fair consumer purchasing power, a cooperative may began offering savings and lending loans. In 2013, almost 75 years later, serve as a force to lower prices or raise services to consumers in the 1920s, at banks and credit unions offer fairly the quality of service, or influence the a time when many banks did not offer standard consumer credit products. market in other significant ways. these services to ordinary working In order to compete, credit unions people. In Wisconsin, for example, must differentiate themselves through The cooperative’s positive impact on 85% of the citizens did not qualify for qualities like price, access and service. prices or services will eventually be met bank credit. An early version of today’s by competitors, and the cooperative’s payday lenders offered credit at rates

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Cooperative firms are evaluated based on value; and replacement value (what Cooperatives have adopted industry their business assets, with the same tools would a willing buyer have to pay to expectations for return on investments, used to value other firms. As with other replace assets at current prices?). EBITDA using the same benchmarking tools. closely-held businesses, where there is is a financial metric used to value and For example, value creation is defined no public market for stock, analysts use assess the performance of companies by the return on invested capital minus financial metrics and estimated revenue across industries. It focuses on how much the cost of capital times the amount of projections to assess cooperatives. profit is made on the products that a firm invested capital. This financial metric buys and sells, under present operations shifts attention from revenues to return Business valuation tools include the and assets. The goal of estimating future on investment, providing a critical balance sheet method, EBITDA (earnings cash flows is to accurately understand tool for analyzing use of capital. Like before interest, taxes, depreciation and the projected value of an investment, their competitors, cooperatives have amortization) and estimated future cash based on future costs of money and increased profits by focusing on strongly flows. The balance sheet method of revenue projections. performing sections of their business and valuation looks at net book value (total maximizing their strengths. assets less total liabilities); liquidation

Member Assessment of Value

In order to fully understand the value make the connection between present prices were high, this allocation of their cooperative to their life or investments and future gains, with both system rewarded fertilizer patrons, business, cooperative members must short- and long-term advantages. who might otherwise have left the estimate several things: the economic cooperative for the competition. The value of the prices and services Cooperatives price their products and additional cash patronage contributed offered by the cooperative; the future services competitively, and then use significantly to members’ perception value of the investments made by the patronage refunds (and occasionally of the cooperative’s value. Cooperative cooperative, the value of annual cash dividends) to return a portion of Group UK uses a similar system to patronage distributions, and the value the profits to members after the encourage members to patronize its of their investment in the cooperative. completion of the financial year. When various retail locations. With 4,800 The cooperative model depends on the cooperative is competitive within retail outlets offering members banking, collective investment in a firm that a market, patronage and equity may grocery, insurance and utility services, delivers most of its value through use of differentiate it from competitors. the Cooperative Group offers one the cooperative. Members may view cash patronage membership card, which tracks patron distributions as a significant incentive usage. The card allows the Cooperative This means that cooperative firms to patronize the cooperative. Group to distribute patronage refunds must anticipate the needs of their based on a strategic formula. Members Cooperatives also have the option members, in order to be relevant to are encouraged to patronize the various of using patronage distributions current and future demands. As they retail outlets through a system of strategically, to reward members assess strategic decisions, they should rewards and “bonus” points, all related for patronizing profitable business have a long-term time horizon. This is to annual patronage distributions. where cooperatives have an important units, or to increase loyalty by easing advantage over public companies, difficult conditions for their members. Except for the membership share, the which are increasingly challenged Badgerland Financial, a Wisconsin-based other equity owned by cooperative by their focus on quarterly reports. farm credit association, used a special members does not require an upfront On the other hand, cooperatives, as patronage distribution to help members investment. As Michael Boland writes member-driven organizations, must with post-drought financial burdens in in another section of this website, consider members’ differing time October 2012. Producers Cooperative cooperatives are continuously horizons for active participation in of Bryan, Texas, offers differential cash innovating in the way that they handle the cooperative. Cooperatives may patronage allocations to encourage member equity and capital. Several be pressured to return high cash use of profitable divisions. After an cooperatives, including West Central patronage refunds, preserve under- annual analysis of each unit’s financial and Organic Valley, convert member utilized services or revolve equity, results, the cooperative gives patrons equity into preferred stock, which rather than investing in valuable future. of top performing areas higher cash is not tradable but earns an annual allocations. In 2008, when fertilizer Leadership must educate members to >>>

© 2013 CHS Inc. • For more information, contact us at [email protected] or call 1-800-232-3639, ext. 4502. 2 Member Assessment of Value, continued dividend. The innovative model of a high level of tradable membership they have evolved toward traditional “new generation cooperatives” was stock, but the stock is based on use cooperatives, returning patronage developed to solve problems of of the cooperative, and only tradable refunds and retaining earnings, with liquidity and market value. These among members. As many of these limited stock trading. cooperatives are capitalized through cooperatives have continued to operate,

Value of Aggregating and Aligning Members’ Needs

When a group of people creates a Spanish farmers need to constantly Successful cooperatives take cooperative, they want it to return adopt new technologies in order to advantage of this deep organizational value based on their use of its products retain their position in the competitive alignment. Many cooperatives have or services. Profits retained by the export market. The Association of Fruit multiple relationships with their firm are invested in assets to support and Vegetable Producers of Almería member customers, giving the firm future services or earnings, with limited (COEXPHAL), a federation of 100 a deep knowledge of their members’ returns to investors. small marketing cooperatives, adds attitudes and business requirements. value by helping farmers comply with Cooperatives can capitalize on this Increasingly, cooperatives return value both market forces and regulatory knowledge, especially if they integrate by strengthening their members’ ability changes. COEXPHAL markets 65% information systems across operations to anticipate and adapt to changing of the exports and 70% of fruit and and divisions to fully track their markets, economies and environments. vegetable production in Almeria, a relationship with each member. Cooperatives strategically invest in highly productive region in southeast systems, research, assets, marketing and Spain. With 8,100 farmer members and Cooperatives can take advantage of new ventures that will provide long- sales of almost $2 billion, they can ship their multiple connections with their term value for their members. consumer-ready product directly to members to understand and anticipate large customers, and comply with the their fundamental needs, and then FrieslandCampina, a Dutch dairy growing demands for food safety and invest in high quality and stable systems cooperative, evaluates each new quality preservation, and increased use to fulfill these needs. CHS has invested business opportunity using two criteria: of biological controls. to mitigate risk in a volatile marketplace the expectation that it will deliver through ownership of facilities and profits to members and the expectation The cooperative model provides a global partnerships. Investments in that it will help boost members’ regular powerful mechanism for organizational origination and export infrastructure income. Investments that meet both alignment and employee motivation. have been made to ensure long-term criteria are prioritized. Its “Route2020” A study by McKinsey & Company access to global grain markets for strategy includes significant investments found that cooperatives outperform members. CHS looks at investments that in marketing, research and assets to similar investor-owned organizations in will position owners to take advantage support the growth categories of infant these areas. Since members participate of future opportunities. For example, and child nutrition products, dairy- in setting the direction of the firm, it is investing in soy sourcing and based beverages and branded cheese. business strategies tend to be well processing, as a key nutrition source for It believes that these categories will aligned with key stakeholders. This a growing world population. provide increased market share, higher sense of shared purpose, and a service- premiums to members, and higher oriented mission, appeals to employees profitability for the firm. and provides a powerful motivational tool (Borruso, M, 2012).

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Research on consumer attitudes counted on to meet customers’ needs Trust is vital to economic transactions, has found that quality and price are and are committed to providing the which always involve some form of only two of the factors that create a best service to their customers, and that cooperation and exchange. A study of perception of value. Other important they outrank for-profit businesses in Missouri corn and soybean producers components include institutional these vital areas. found that they viewed cooperatives reputation, associations, and the as more honest, competent and psychological benefit derived from Trust may be particularly critical in trustworthy than investor owned bonds shared with other customers/ market niches where the consumer firms. One question asked respondents members. Perceived value combines of a product or service is particularly to assess the “honesty and integrity tangible and intangible components of vulnerable to the consequences of poor of the people (in the cooperative a relationship (Dacin, 1995). behavior. Everyone can agree on the or agribusiness) who explained the value of trust, but the concept of trust contract to you and who paid you One of the critical intangible may be very individual. This is because and took delivery of your grain.” A components of a relationship is trust. trust is directly related to the belief that perception of honesty and integrity The cooperative model creates trust another person or institution will not contributed to trust, which was a through a tacit understanding that a exploit personal vulnerabilities. If the significant factor in producers’ choice member-owned business will operate relationship involves multiple contact of firm to use in marketing their crop in the best interests of members. As points, deals with a core element of the (James, 2005). a cognitive concept, the definition of member’s livelihood, or requires a long- trust varies among individuals, but it term commitment, the importance of Trust can lower the costs of creating has some very concrete benefits in the trust rises substantially. and maintaining global relationships. marketplace. Trust is a quality that has CRI, which markets cattle genetics three advantages to a firm: it creates The first modern cooperatives, British internationally, has intentionally built loyalty, encourages sharing of valuable retail groceries, provide an early partnerships with other cooperatives insights, and reduces the need for costly example of cooperatives successfully in order to increase its global market contracts and adversarial negotiations. operating in a niche that was vulnerable share. This strategy has created stronger to negative behavior. During the market relationships and increased A 2013 survey found that only 59% of Industrial Revolution, people moving margins. Since trust is an important Americans trust institutions and their from farms to urban areas were factor in marketing relationships, shared leaders, and that the public perceives suddenly dependent on purchased food. farmer-ownership has helped reduce that the wrong incentives are driving Long before government regulation cultural boundaries and jumpstart decisions in major institutions. The of food safety, adulterated milk and relationships. Edelman Trust Barometer is an annual mealy flour was a huge problem. The global survey that reports trust levels British consumer-owned cooperatives Practices like open communication and in institutions like business, media, built their astonishing success on a member participation in governance non-profits and government. In its reputation for providing safe and high help to create a perception that a firm years of research, Edelman has found quality food. Within 30 years they is fair. Fairness is a powerful human that the essential building blocks of grew from one small store in Rochdale, preference, and organizations that trust are engagement, integrity and England, to more than 1,000 stores can capitalize on this preference have high quality/innovative products and throughout the British Isles. In order an advantage in the marketplace. If services. Engagement is described as to ensure safe and reliable products members assume that the cooperative “places customers ahead of profits, for consumers, these stores created has treated them fairly, and dealt communicates frequently and honestly federations that aggressively built and with them honestly, they may accept on the state of its business.” bought food-manufacturing plants. They a competitive price that is not the created a food system that used local absolute best price in the market. One These attributes closely mirror the products and imported items like high long-time member of a marketing qualities that consumers value in quality butter from the United States cooperative made this comment when cooperatives. A 2012 study by the and tea from India. These products comparing private brokers to his co- Consumer Federation of America were distributed within a cooperatively- op: “In a cooperative, you may not be reported that consumers believe that owned supply chain, and created happy, but you’re content.” cooperatives have the best interests of a highly trusted cooperative brand customers in mind, that they can be (Webb, 1891). >>>

When the Cooperative Group UK was management. The cooperative makes some of them must also participate in planning to make a large investment in every effort to close the feedback loop, self-governance. Although they can be a significant number of new locations, so that delegates know how their input costly, cooperative annual meetings it turned to its members for on-the- affected decision-making. provide a valuable opportunity to ground local knowledge. Using a simple encourage dialog among members and online survey, it asked the 6 million Cooperatives are well positioned to leadership. According to preliminary members to suggest new sites, and then take advantage of members’ collective findings from research conducted by used technology to map the responses, knowledge. For example, a cooperative the University of Wisconsin Center creating very useful intelligence for owned by 75 licensed fishermen in for Cooperatives, average attendance store locations. Presumably, Cooperative Chignik Bay, Alaska, was faced with at agricultural cooperatives’ annual Group members were willing to share dwindling catches and low prices meetings is about 32%, with 35% of their insights because they had a stake for its salmon. It conceived of a fairly members voting in board elections. in the results and believed that their radical plan to pay a small number of Although some people might say input would be influential. They trusted its group to fish extremely efficiently, there is room for improvement, these that the outcome would be beneficial while the rest of the fleet stayed home. numbers are similar to the average to them. Profits were shared equally at the end turnout for U.S. federal elections in non- of the season, with everyone benefitting presidential years. In order to reap the rewards of member from substantially lower costs, higher input, cooperative leadership must quality catches, and efficient resource Cooperatives are owned by people spend time mobilizing members management (Deacon, 2005). who have something in common. around a common vision. The This has value in the public policy dialog is multi-faceted. Businesses The pioneers of organizational arena. Two-thirds of the cooperatives and governmental institutions that psychology found that people will responding to a recent survey said have relied on a top-down power accept major changes if they feel that their firm engages in public dynamic are confronting the power they have been able to influence the relations efforts to influence external of consumers and activists to shape decision. Although this isn’t a universal stakeholders regarding their members’ public opinion. Surveys report that trait, members who value democratic interests. Efforts vary from participating other consumers are trusted twice as control of the cooperative are more in social media to event sponsorship much as CEOs, forcing firms to develop likely to have a positive attitude toward and hosting community workshops a new model of engaged management. the firm. A study of members of large to employing full-time government Cooperative leaders have the advantage Swedish agricultural cooperatives affairs staff. Interestingly, there are of experience with dealing with many found that members’ attitudes towards significant differences in the ways that stakeholders, so this dynamic isn’t governance were more significant than cooperatives describe their value to new to them. One national agricultural volume of use or age in determining external audiences. Some emphasize cooperative asks its large delegate their loyalty to their cooperative impact on local economies, others their group to discuss and answer three (Osterberg, 2009). positive effect on members, and a few to four carefully chosen questions at reported talking about the cooperative Cooperatives may benefit from its fall meetings. The questions range principles and how they differ from members’ perception that there’s a from strategic to operational, with the investor-owned firms (Bond, 2011). value to self-governance, but at least responses forwarded to the board and

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A classic assessment of the value of the cooperative model for Anne Reynolds is a faculty associate and assistant director of the members looks at the discounted value of member equity, value University of Wisconsin Center for Cooperatives. She teaches a of patronage distributions, value of any dividends, and the value course on cooperatives – Agriculture & Applied Economics – of the products and services in supporting a member’s life or and develops courses, conferences and educational programs business. The value equation for a member of a cooperative at the UW Center for Cooperatives. She has led numerous includes their use of the cooperative, their patronage distribution, workshops on board leadership, board roles and responsibilities, the value of their investment, and any dividends. Successful and strategic planning. Reynolds is currently researching cooperatives invest in activities that will return profits to their cooperative governance, behavior and performance, as part of members and support their future success. the UW Center for Cooperatives’ Cooperative Business Study. Her areas of interest include governance, member loyalty, As with any business relationship, the cooperative and members business structure and innovative uses of the cooperative model. must successfully navigate the intangibles that create a sense She has worked with cooperatives in all sectors, including of trust. Trust is a valuable and rare quality in the marketplace, agriculture, food, energy, purchasing and worker-owned. but the cooperative model engenders internal institutions that Reynolds serves on several boards, including The Cooperative build trust and confidence in the firm. Although cooperatives Foundation. Before joining the Center for Cooperatives, she are primarily economic organizations, they have a social aspect worked at the Credit Union National Association. that allows them to call on members’ willingness to share valuable competitive information. Successful cooperatives are Contact info: taking advantage of their close connection to members to fully University of Wisconsin Center for Cooperatives understand their present needs and use this understanding to 235 Taylor Hall, 427 Lorch Street position them for the future. Madison, WI 53706-1503 Michael Boland reviewed this article for CHS Inc.; Boland ph 608.263.4775 is the E. Fred Koller endowed chairholder in agribusiness fax 608.262.3251 management and information technology at the University [email protected] of Minnesota. He is also director of the University of Minnesota Food Industry Center and teaches the course in cooperatives.