Microsoft word - diff ngc&trad3.doc

David Coltrain
Extension Assistant, Arthur Capper Cooperative Center Department of Agricultural Economics, Kansas State University For information call 785-532-1523 or e-mail David Barton
Director, Arthur Capper Cooperative Center Professor, Department of Agricultural Economics, Kansas State University Michael Boland
Assistant Professor, Department of Agricultural Economics, Kansas State University Arthur Capper Cooperative Center
INTRODUCTION.1 EXAMINING SPECIFIC DIFFERENCES .1 1.21 Cash Patronage Rate .5 1.22 Investment or Retained Profits .5 1.23 Pooling Distributions .5 1.31 Initial Investment .5 1.33 Liquidity or Exchangeability .6 1.36 Business Expansion Investment .6 1.41 Eligibility Restrictions .7 1.42 Voting Power.7
chain, NGCs take advantage of this opportunity Significant changes in the agricultural economy are having profound effects on the viability of rural Both traditional cooperatives (TC) and NGCs communities that are dependent on profitable and are a form of vertical integration with similar innovative agricultural businesses. The trend objectives. However, they are very different in toward fewer, larger and increasingly corporate the way they manage the marketing and finance farms has created a concern among rural residents business functions. Understanding the difference that many small and midsize family-owned farms is critical for those producers who choose to participate in value-added activities through One way for small and midsize farms to remain viable businesses is to increase income to their operation by participating in profitable value-added EXAMINING SPECIFIC DIFFERENCES
processing and marketing activities. A popular
A cooperative is defined as a business operated strategy being used by producers to achieve this primarily to provide benefits to members through goal is to pool their limited resources through marketing transactions and through a distribution cooperative development. Cooperatives can play a of earnings from these transactions. In return, greater role by helping producers earn a larger members have a responsibility to provide equity share of the consumer’s food dollar. While capital and govern the business. Both TCs and producers are examining alternatives for continued NGCs fit the definition. A NGC, or closed success, consumers are challenging the food cooperative, is more restrictive in terms of industry to tailor food products for precisely marketing and finance. The NGC’s members or defined market niches – niches that individual users are (1) customers who have a contractual producers cannot always fill, but are attainable right and obligation to deliver a particular quantity with the coordination of producer groups and and quality of product as specified in a marketing alliances. This coordination has led to producer- agreement and (2) owners who are required to owned processing and marketing cooperatives purchase shares of equity stock, as specified in the with the potential to generate rural wealth and stock subscription agreement, which conveys the right to deliver a certain quantity of product Most of these cooperatives have used the New consistent with the marketing agreement. For Generation Cooperative (NGC) model. NGCs example, a member may be required to buy one vertically integrate and provide producers larger share of stock at $3.00 per share for each bushel earnings by selling processed products instead of of grain the member delivers annually to the cooperative. Current members may transfer or sell In other words, NGCs have been established by equity stock to new members at an agreed upon producers to increase their share of the consumer price. Transfers must be approved by the dollar and to add value to their basic commodities through processing and forward linking to the Many specific characteristics of NGCs are market place by selling processed products instead different than TCs. Table 1 summarizes the of raw commodities. NGCs are expanding into characteristics that differ between NGCs and TCs. value-added enterprises and forming creative joint The differences can be categorized into four ventures and strategic alliances with successful groups based on the producer’s role or marketing companies. NGCs allow farmers to relationship with the cooperative and the work together in marketing, while maintaining associated cooperative business functions. The independence on their own farms (Cropp). Many consumers prefer and trust food that is produced transactions, (2) patron profit distributions, (3) and sold by farmers. By moving up the food owner investment obligations and (4) member voting control. Table 1: Characteristics of Traditional (TC) and New Generation (NGC) Marketing Cooperatives PRODUCER ROLE BUSINESS FUNCTION


Delivery Rights
Limited to purchased
Delivery Obligation
Quality Accepted
Identity Preserved
Usually not
Usually is
Initial Payment
Market price
Contract price
Cash Patronage Rate
Investment or Retained Profits
Pooling Distributions
Initial Investment
Very high
Proportionality to Use
Low to high
Very high
Liquidity of Exchangeability
Exchange Value
Fixed at par
Variable at market
Redemption Obligation
Ability to pay
Business Expansion Investment
High for delivery rights
Eligibility Restrictions
Voting Power
Usually one vote
Variable number
All types of businesses engage in activities three of these four relationships. To represent related to the four business functions of reality and to better understand the nature of a marketing, income or profit distribution, equity cooperative it is useful to identify separate roles investment, and control or governance. Each function includes a collection of related activities. The four roles are (1) customers, (2) patrons, Cooperatives differ from investor oriented (3) owners and (4) members. Customers are those businesses in the way they operate with respect to who use the cooperative by buying inputs or by these four business functions. TCs and NGCs also selling products. Patrons are those eligible to differ from each other with respect to the nature receive a share of the profits, usually as patronage of the activities in each business function. The refunds. Owners are those who invest in or own relevant activities for each function are listed in equity. Members are those who have voting power to govern or control the cooperative, elect Associated with each business function is a directors, adopt articles of incorporation and unique stakeholder role or relationship. In the bylaws, and vote on other major member issues simplest view, members (or sometimes patrons) such as mergers, acquisitions and dissolution. Traditional or open cooperatives often have cooperative, receive a share of the income (based users who have various combinations of these on use), and own and control the cooperative. It is roles. For example, many users may be generally true that a member engages in all four customers; but not patrons, owners or members. functions, so using one term (member) is These users are called nonpatronage customers. sufficient to refer to all four relationships. In Other users may be customers, patrons and reality, some stakeholders have only one, two or owners, but not members, and are called non- member customers or patrons. In contrast, new elsewhere, possibly from other members, or a generation or closed cooperatives usually require penalty is imposed. Most often, members only contract a portion of their total planned production 1.1 Customer Marketing Transactions
There are five characteristics that differentiate 1.13 Quality Accepted
how cooperatives perform marketing transactions with individual customers when comparing agreements with members, the quality accepted traditional (open) and new generation (closed) normally covers a broad range. A TC is expected cooperatives. The five characteristics are (1) to find a market for all qualities of product that delivery rights, (2) delivery obligation, (3) quality are delivered. NGCs usually have a much accepted, (4) identity preserved and (5) initial narrower range of quality that can be delivered since they usually are processing or marketing a 1.11 Delivery Rights
In a TC, delivery rights are normally unlimited. Most traditional cooperatives allow any amount of 1.14 Identity Preserved
product to be delivered by customers and the
With a wide range of quality accepted, TCs cooperative then markets the total amount typically have not handled identity-preserved (IP) customers. Some TCs have contractual marketing Increasingly, an opportunity is available to market agreements with members that control the amount IP commodities along with non-IP commodities in of product each member can deliver, but they are In contrast, the delivery rights of customers of identity-preserved product as a means to ensure an NGCs are limited to the level of stock each acceptable quality product is produced. However, member has purchased in the cooperative. As an some large grain-oriented NGCs “trade” member example, each share of common stock in the 21st deliveries for other grain that is procured in a Century Grain Processing Cooperative entitles a member to deliver 2,850 bushels of wheat. 1.12 Delivery Obligation
1.15 Initial Payment
Delivery obligations and delivery rights are usually paired together. They either exist in a commodities marketed through or sold to a marketing agreement or they do not exist. TCs cooperative is an important aspect that differs normally do not have delivery obligation between TCs and NGCs. A traditional “buy-sell” agreements with their customers. Customers may cooperative pays the current market price at the market their products elsewhere because of higher time the commodity is marketed since it is not prices, more convenience or personal relying on a marketing agreement or pooling relationships. However, delivery obligations are program. In contrast, NGCs pay the contracted price stipulated in the marketing agreement obligation is coupled to the total supply of product between members and the cooperative. The that will be needed by the NGC in its value- contracted price could be either lower or higher adding processing and marketing. NGC members than the current market price. Producers should are expected to deliver the amount specified in recognize that they are not just producing raw their delivery rights. If extenuating circumstances commodities, but are really producing processed prevent sufficient production, NGC members or goods. Total revenue or income is based on the their agent usually purchase the contracted amount initial payment and other payments, usually as income distributions based on returns from further cooperative less sell their stock to members processing and/or marketing of raw commodities. 1.2 Patron Profit Distributions
Many important differences between TCs and NGCs become evident in the activities relating to
the income or profit distributions by cooperatives
to their members. Three characterizing activities
are (1) cash patronage rate, (2) investment or
retained profits and (3) pooling distributions.

1.21 Cash Patronage Rate

A patronage refund is a payment cooperatives make to members from total patronage income or margins based on the quantity or value of business done by each member. Part of the refund is paid in cash and part is retained as an equity investment by the member. In TCs, the cash patronage rate is relatively low. Payments of 20 to 35 percent are common. The retained patronage refund amount is then redeemed later based on the cooperative’s redemption program. The cash patronage rate is often much higher in NGCs. Cash rates are usually 65 to 85 percent.
Since each member has invested equity in the
cooperative “up front” to purchase marketing
rights when the cooperative is established, a high
cash patronage rate can be paid each year.

1.22 Investment or Retained Profits

Equity investment can be from external sources or from internal cooperative operations including retained patronage refunds, retained earnings and per unit retains. In TCs, most new equity comes from internal operations, especially retained patronage refunds. Therefore, a high percentage of the income distributed to patrons is retained and invested to finance assets including business expansion and improvement and to replace the “old” equity of those using the cooperative less with “new” equity of those using the cooperative more. This contrasts with NGCs, which usually invest a small percentage of the members’ profit distributions back into the cooperative. NGCs usually have a high proportion of their equity from directly invested, permanent capital when they are established. Members intending to use the
1.23 Pooling Distributions
their shares. Often NGCs limit the total amount of Pooling is an alternative way to set and pay the price for the products each cooperative member 1.32 Proportionality to Use
markets through the cooperative. Pooling is based Proportionality to use is the extent to which on using a marketing agreement and then setting members have invested equity in proportion to the the price paid after the pool has been marketed use of the cooperative. For example, if a producer and a net margin has been determined. In effect, a did one percent of the business, they would be delayed pricing or payment mechanism is used. expected to have an investment equal to one An initial or advance payment is made upon percent of total producer allocated equity. In delivery and then one or more progress payments traditional, open cooperatives, a member might are made until the pool is closed and a final choose to employ the cooperative as the marketing margin is known and paid. A pooling distribution agent for a great deal of their products or, at the in TCs is relatively rare, but more common in other extreme, to not use the cooperative. From one year to the next, the range of use and proportionality could vary as the member chooses. 1.3 Owner Investment Obligations
Even if the amount of business is uniform each In a cooperative, users who are patrons and year, over time proportionality is low because members are also expected to be the owners. equity investment comes from operations and Many significant differences surface when accumulates during the “life cycle” of the comparing the investment obligations that members (owners) are responsible for in TCs and However, NGCs have a contractual delivery NGCs. Six ownership activities or characteristics obligation with members who are required to can be used to describe the differences in TCs and market their products at a steady, agreed upon NGCs. The six are (1) initial investment, (2) amount. Furthermore, marketing rights are proportionality to use, (3) liquidity of purchased with equity investments and so exchangeability, (4) exchange value, (5) investment is proportional to use in the beginning. redemption obligation and (6) business expansion Proportionality may decline over time if significant amounts of patronage refunds are 1.31 Initial Investment
One of the most significant differences between 1.33 Liquidity or Exchangeability
TCs and NGCs is the initial equity investment. In Liquidity or exchangeability refers to the extent TCs, the initial investment is usually very low, to which ownership can be transferred between often less than $100. However, each member of owners. In publicly held companies, an open many NGCs typically invests $10,000 to $12,000 market exists for stock on a stock exchange. In to purchase marketing rights. For example, to become a member of United Spring Bakers, companies that are closely held, no open market Fargo, North Dakota, a minimum of 800 delivery exists and transfers are highly restricted. TCs are right shares at $6 per share plus $200 in much more restrictive than NGCs. Members membership stock, or $5,000 total, was required. increase equity in TCs primarily through retained patronage refunds and per unit retains. Members minimum amount. As another example, the 21st decrease equity through equity redemptions made Century Ladder Creek Dairy, Tribune, Kansas, by the cooperative. These are transactions with offered a minimum of five shares at $1,000 each. the cooperative and are at the discretion of the In lieu of cash stock purchases, this cooperative board of directors. Transactions between members also allowed farmers to transfer ownership of corn, grain sorghum or alfalfa hay in exchange for NGC members increase equity primarily by purchasing stock that represent or convey transferable delivery rights. NGC members can decrease equity by selling their stock to other 1.36 Business Expansion Investment
members, approved by the board, at a negotiated When a business expands by adding assets, a price. NGC members therefore have much more portion of those assets is usually financed with ownership flexibility or liquidity than TC additional equity. When a TC business expands, members. At the same time, NGCs have a much there is usually no immediate investment higher proportion of allocated equity that is obligation by individual members. This is because “permanent” capital than TCs because NGCs have TCs do not directly link volume of business by more purchased stock that does not get redeemed. members with up front direct equity investment by members. However, equity investment will come 1.34 Exchange Value
from operations by retaining more equity from the One of the major differences between TCs and revenue or income stream and over time, total NGCs becomes apparent when examining the equity investment of a member will increase if no exchange value of equity investment when equity redemptions are made. This will gradually is transferred or exchanged. The exchange value increase the equity investment of those members of TC equity is fixed at the par value at the time who continue to do business with the cooperative. of purchase or retention. In TCs the par value is On the other hand, when a NGC expands in a the value used when equity is redeemed or significant way it usually sells stock and creates purchased by the cooperative from members. New marketing rights to utilize this additional capacity. members are able to join TCs whenever they This process is similar to the process used when desire and their equity investment is valued at par. the NGC initially was formed. Therefore, there is an immediate investment obligation by those variable and depends on the market price members who want to utilize the additional members obtain if they sell their delivery rights to capacity. another member. The price members pay for stock sold by the NGC is usually a set price at par 1.4 Member Voting Control
value and provides equity so the business can be
Businesses are controlled by those who have the established. This exchange value feature of NGCs right to make decisions. Proprietorships, has the potential to increase (or decrease) the partnerships, LLCs and corporations each have value of each member’s equity stock compared to governing mechanisms. Corporations, including the price they paid. The value is highly correlated cooperative corporations, vest those rights in voting stockholders or members. Voting members of cooperatives approve articles of incorporation 1.35 Redemption Obligation
and bylaws, elect directors and may approve other Redemption obligation refers to the expectation actions such as mergers, acquisitions and dissolution. TCs and NGCs may differ in terms of ownership under specified conditions. For two control aspects (1) membership eligibility example, some cooperatives redeem the equity of those members who die or reach a certain age. The redemption obligation is based on the ability 1.41 Eligibility Restrictions
to purchase members’ equity and the policies of TCs commonly have low eligibility restrictions the cooperative’s board of directors. If the funds for membership. In general, agricultural are available, member equity may be redeemed. cooperatives require members to be producers or In NGCs there is no redemption obligation or associations of producers. Some TCs require expectation of members for previously purchased equity stock. The transferable delivery rights of stipulating certain conditions, such as growing or NGCs allow for the sale of equity stock in quality requirements, for membership. This type of marketing agreement is the rule and not just an exception in NGCs. In addition, NGCs require the profits from processing are then distributed back purchase of marketing rights or stock. This results to the members in proportion to their share of in high eligibility restrictions for membership in a equity stock in the NGC. However, their equity stock does not just convey membership rights, but also conveys and allocates delivery rights. A dual 1.42 Voting Power
contract is established between each member of a The voting power for members in TCs is usually NGC and the cooperative business. The producer one vote per member, regardless of the patronage member must deliver the units he has contracted volume done by each member or the level of and the cooperative must compensate each variable amount of voting power for members A major difference between TCs and NGCs is based on stock owned. However, laws in many that a high percentage of the cash patronage from states only permit one vote per member. By far, NGCs are returned to members each year. In most TCs and NGCs follow a one member, one TCs, cash patronage rate is relatively low. The vote rule, but NGCs are more likely to depart retained patronage refund amount in TCs is then One of the most significant differences between CONCLUSION
TCs and NGCs is the initial equity investment. In TCs, the initial investment is usually very low, Traditional Cooperatives in that NGCs focus on often less than $100. However, each member of value-added products instead of raw commodities, many NGCs typically invests $10,000 to $12,000 which is usually one focus of TCs. A strategy that to purchase marketing rights. distinguishes NGCs from TCs is a restricted or Another important difference between NGCs closed membership, which stems from the market- and TCs is that equity stock may be traded; either driven nature of NGCs. This market-driven among established members, or, usually with the strategy often targets niche markets that desire board of directors’ approval, to outside producers. The market value for equity stock is reflected by There are many identifiable differences between traditional open cooperatives and closed new Another distinction between NGCs and TCs is generation cooperatives. The differences can be observed in business expansion, which is usually categorized into four groups based on the financed by additional equity. When a NGC producer’s role or relationship with the expands, it generally sells additional stock and cooperative and the associated cooperative creates more marketing rights. However, when a business functions. The categories are (1) TC expands, usually no immediate investment customer marketing transactions, (2) patron profit from members occurs. Over time in TCs, equity distributions, (3) owner investment obligations investment will come from normal business operations if relatively small or no redemptions NGCs process their members’ products in cooperatively owned processing plants and the REFERENCES
Morris, R. 1996. A presentation edited by G. Cropp, B. 1996. A presentation edited by G. Cooperatives Information.” Available online Cooperatives Information.” Available online Feb. 1, 1999. Nilsson, J. 1997. “New Generation Farmer Co- ops.” Review of International Co-operation, Patrie, W. 1998. Creating ‘Co-op Fever’ A Rural Devloper’s Guide to Forming Cooperatives. USDA RBS Service Report 54. Stefanson, B. and M. Fulton. 1997. New Generation Co-operatives: Responding to Changes in Agriculture. Centre for the Study of Co-operatives, University of Saskatchewan. Stefanson, B., M. Fulton and A. Harris. 1995. New Generation Co-operatives: Rebuilding Rural Economies. Centre for the Study of Co-operatives, University of Saskatchewan.


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