fedgazette

With a little help from our friends

Though declining in number, co-ops find new ways to help farmers and rural communities

Jane Brissett - Contributing Writer

Published March 1, 2002  |  March 2002 issue

The coffee pot is always on at the Nassau Farmers Elevator. Every day a handful of farmers sit in the lobby, sip java and solve the world's problems, now that the local coffee shop is gone.

"We appreciate that," said Roger Longhenry, manager of the Nassau, Minn., cooperative. "We are a local co-op and we're here to serve our patrons."

In an agricultural marketplace that has become much more complex during the past 10 years, the future independence of the 1,200-member cooperative is uncertain. There are no plans to merge or be acquired, but members know that the trend could affect them. More small farmer cooperatives than big ones are scattered across rural America, but it's the big ones that do most of the business.

After more than half a decade of a down market behind them and little hope of a quick recovery, farmers are doing all they can to get good prices when they buy and squeeze out more profits as they sell. Because most farmers do their business with cooperatives, change in the way co-ops do business seems inevitable.

"There's a real need for restructuring of these cooperatives," said Bob Cropp, director of the University of Wisconsin Center for Cooperatives in Madison. In this era of globalization and technology, farmers need more sophisticated services and support, he said. To some extent, that is happening already.

Maybe more intriguing than consolidation is a slow-growing, higher-risk, higher-reward trend of farmer co-ops moving up the value-food chain by processing crops and livestock and capturing more of the consumer's dollar.

A flexible business model

The co-op model has been used in many industries, including insurance, telephone, electric, health care and transportation, not to mention for local businesses and organizations like grocery stores, child care, credit unions, housing, and funeral and memorial societies. But it has proved particularly useful for farmers, who despite declining numbers still constitute a widely dispersed and decentralized industry.

District states have a long history of cooperative businesses that have played important roles in the region's economy, especially in rural areas. Farmers—who are notoriously independent—found they had more buying and selling power when they banded together instead of doing business individually with the large companies that bought and sold seed, feed, crops and livestock. And if the co-op made money, farmers shared in the financial success.

In the eyes of the general public, co-ops often don't command the same business stature as corporations, but they're businesses all the same. Cooperatives are different from corporations because members own co-ops, and the primary purpose is to provide service at the lowest cost rather than generate profits. Profits are returned as "patronage refunds" on the basis of how much each member uses the co-op. In general, income tax is paid by members on their shares of the profits while in a corporation both the business entity and the shareholders are usually taxed. Also, each co-op member has one vote while corporate shareholders usually have as many votes as they have shares of common stock.

U.S. Farm Co-ops, 1990-2000

Source: U.S. Department of Agriculture

Nationwide, the number of co-ops and co-op memberships has fallen dramatically in the past 50 years. In 1950-51, 10,064 cooperatives dotted the United States with more than 7 million members. In 2000, the U.S. Department of Agriculture (USDA) reported 3,345 co-ops with slightly more than 3 million members. Since 1990 the number of co-ops has dropped by 28 percent and membership by 25 percent. At the same time, however, both co-op sales and profits surged from 1990 to 1997, although they have since slipped due to low commodity prices, according to the USDA.

Cooperatives are different from corporations because members own co-ops, and the primary purpose is to provide service at the lowest cost rather than generate profits. Profits are returned as "patronage refunds" on the basis of how much each member uses the co-op.

The declining number of agricultural co-ops closely parallels the dwindling number of farms, said Randall Torgerson, deputy administrator for cooperative services at the USDA in Washington, D.C. It also reflects restructuring among cooperatives. Torgerson noted that giant co-ops such as Ocean Spray, Sunkist, Land O'Lakes and CHS Cooperatives (formerly Cenex and Harvest States) have become multibillion dollar companies by buying and merging with other co-ops.

Cooperatives are common throughout the world and are especially widespread in Scandinavia. Their popularity in the district undoubtedly reflects the ethnic heritage of many of its residents. Minnesota has more cooperatives than any state and in 1999 led the nation in business volume, while Wisconsin had the country's second-highest membership and was second in volume, according to USDA figures.

The co-op movement in the United States began in the early 1800s. Farmers banded together to gain more control over prices they received, forming marketing cooperatives. In purchasing cooperatives they pooled their orders for feed, seed and other goods so they could pay lower prices. The National Grange, a farmers' organization founded in 1867, promoted cooperative businesses in its heyday, and federal laws enacted in the 1920s established the right for co-ops to exist and gave them government support through the USDA. One special advantage given to co-ops is the 1922 federal Capper-Volstead Act, which allows farmers to agree on the prices they will accept for their products, giving them limited exemption from antitrust laws.

Call it a legal kickback

Much has changed at the Nassau Farmers Elevator Co. since it was founded in 1899, but it's still the center of the community and it's fairly typical of a traditional co-op. To join, all a farmer has to do is to start buying there. The more money the customer spends, the larger the portion of the co-op's net worth he or she acquires.

Thirty percent of the profit on a member's purchases is returned in cash within the year; 70 percent is retained for things like expansions and returned to members later as more money is added to the coffers from additional profits—a revolving fund of sorts. Among the purchases members can make are gasoline, diesel fuel, tires, batteries, feed, fertilizer and chemicals. It's one of two major businesses in the town of 80 residents just east of the South Dakota border. The other business is an implement dealer.

Competitive prices for both buying and selling keep people coming to the co-op, said farmer Robert Wittnebel, but it goes beyond that. "Among the reasons people do business with the local co-op is convenience, loyalty and trying to keep the small community alive," said Wittnebel, the third of four generations of his family to belong.

A quarter-century ago the cooperative had an additional 300 members, Longhenry said. Most were lost with the decline of family farms. But the co-op's volume of business has increased by 30 percent over the past decade despite fewer members, he said. In 2000 it took in 2.2 million bushels of corn and 1.2 million bushels of soybeans as well as other grains. Gross sales were $14 million and $150,723 in profits were returned to members. "We've got some members getting $4,000 checks and some get $5 checks," Longhenry said.

Choice of a new generation

In many parts of the district, farmers have gone beyond the traditional parameters of cooperatives in an attempt to make their commodities into consumer products—but they're also taking a gamble by investing thousands of dollars in a start-up business that could fail.

Ninth District Farm Co-ops, 1999

Source: U.S. Department of Agriculture

The idea is that individual farmers can increase their net income by realizing profits beyond those normally generated on the farm if they own and control businesses that add value to what they produce. These nontraditional cooperatives, often labeled "new generation" or "value-added" co-ops, are growing in number and are being watched with interest by agriculture industry experts.

Value-added co-ops usually restrict membership in an attempt to control the supply of their specialized products. According to the law of supply and demand, if consumers want the product, the limited supply should keep prices up.

Today, these co-ops in the district and elsewhere are making gasoline additive ethanol from members' corn, pasta from members' wheat and meal from members' soybeans, just to name a few. Torgerson estimated that 100 to 140 of the nation's 3,345 co-ops fit the new generation description. Bill Nelson, director of the Burdick Center for Cooperatives at North Dakota State University, said his educated guess is that Minnesota has 20 value-added co-ops, 13 of which are ethanol producers. Montana, he estimated, has two; North Dakota, 12; South Dakota, eight to 10, including three to four ethanol producers; while Wisconsin has "maybe one."

A growing number of farmers—many of them younger than the average age of 50-something—are expressing interest in value-added cooperatives. State law changes as well as state and federal government subsidies (especially for ethanol plants) in recent years have helped encourage their development.

The concept isn't new. Dairy cooperatives such as American Milk Producers Inc., Foremost Farms USA, Dairy Farmers of America and Land O'Lakes have added value to milk and cream for decades, making them into butter, cheese, powdered milk and other products. And many co-ops add value to farmers' production in limited ways such as cooperative elevators, which often do some milling. But the foray deeper into that realm began around the late 1980s and continues.

Value-added farm co-ops also have tax advantages over corporations doing similar food processing, because co-op profits are taxed on income only once (on each member's share of the earnings) rather than twice as a corporation is (at the corporate level and at the individual shareholder level).

Federal corporate income tax rates range from 15 percent to 39 percent. Since the co-op doesn't have to pay that, the absence of the tax "can be a significant advantage," Nelson said. The rationale for taxing only at the individual level is that "these co-ops are really considered to be an extension of the individual members' businesses," Nelson said.

Consumers, though, see little retail price advantage, Nelson said. It is diluted by small quantities purchased and other costs, including packaging. "By the time you get this to the consumer, it's probably a fraction of a penny," he said.

Show me the money

About a decade ago, Paul Casper, who farms 4,500 acres of soybeans, corn and wheat in Lake Preston, S.D., wanted to find a way to get more money for his beans and he had an idea. "If you look at who makes the money, it's the people who prepare the food for the customer," Casper said.

After two years of meetings and investments by 2,100 farmers averaging $10,000 apiece—$21 million—the South Dakota Soybean Processors cooperative began operating the state's first soybean processing plant in Volga in 1996. Previously, a large portion of the soybeans grown in South Dakota were taken to other states for processing into soy meal and returned to the state for livestock feed.

Today, the co-op manufactures soy meal and oil for customers as far away as Australia and China and is considering expanding its product line to include a soy protein additive for human consumption. The regional price of beans has risen about 25 cents per bushel, the town has 65 new full-time jobs, the plant is processing as many as 80,000 bushels per day, and the co-op made a record $9.5 million profit in fiscal 2001 on sales of $144 million. The operation has been profitable from the first year, Casper said, and the co-op has paid $11 million in cash dividends to members, or an average of more than $5,000 apiece. That is money that would otherwise have been earned by companies outside South Dakota, and farmers who grew the beans would have seen little of it.

The biggest difference between value-added and traditional co-ops is that value-added requires members to also be investors, which increases both the risks and the potential rewards.

The South Dakota Soybean Processors co-op got started in a way similar to other new generation or value-added cooperatives. Farmers who wanted to become members paid a $200 membership fee and for that each got one vote. Each was also required to buy a minimum of 2,500 shares at $2 per share—a $5,000 investment, but Casper said the members on average ponied up twice that amount. Each share gives them the right and obligation to provide a bushel of soybeans to the plant each year. Farmers are paid market price for their product upon delivery—and sometimes more. Membership was closed because the co-op would have been unable to handle any more beans than members were obligated to provide.

Quality counts

Many value-added co-ops, including South Dakota Soybean Processors, have strict quality standards. "It ensures farmers that they will have a market for their crop and it assures the processing plant it will have product," said Robert King, professor of applied economics at the University of Minnesota. The high quality also ensures a way to differentiate the product in the marketplace, adding further value to it, which means the ability to command higher prices. If the standards are not met or the member can't provide the beans for some other reason, he or she is responsible for buying them elsewhere and delivering them to the plant.

Value-added farm co-ops also have tax advantages over corporations doing similar food processing, because co-op profits are taxed on income only once (on each member's share of the earnings) rather than twice as a corporation is (at the corporate level and at the individual shareholder level).

But finding the money to back the new businesses is difficult at best because only farmers can invest in such co-ops and many are already struggling financially. One way to widen the circle of investors has been for value-added co-ops to own controlling interest in limited liability companies that produce their products, and allowing nonfarmers to invest in the LLC.

Common stumbling blocks for new generation co-ops include lack of understanding of the competition, management and technology problems, lack of capitalization and vulnerability to changes in the marketplace because they have only one product, Nelson said.

The success rate has not been tracked, but Nelson estimated that about one-third of the value-added co-ops fail, one-third are in the "red zone" with major problems and one-third are doing well.

Dakota Lamb Growers Cooperative, for example, was conducting a second equity drive early this year to raise working capital and pay for lambs it purchased last year from members. The co-op sells natural, lean, grain-fed lamb to high-end grocery stores and specialty markets and contracts with a Jamestown, SD, meat processing company to prepare the meat for sale. Demand was slow after the co-op started up in March 2001. But by January of this year, "we have way more market than we have lambs," CEO David Merwin said. The goal is to sell 20,000 shares (meaning 20,000 more lambs to be processed) at $30 per share. "We're asking them (new shareholders) to supply the market we've already established," Merwin said.

Co-op capital

The economic benefits of co-ops extend beyond farmers. Like other businesses, co-ops pay property taxes and provide jobs, which strengthens communities. Furthermore, they're less likely to pull up stakes and relocate than other businesses because they are owned by hundreds or perhaps thousands of local members.

"Co-ops have made a big difference in the economy of our community," said Quent Rath, mayor of Renville, Minn., population 1,300. The southern Minnesota city, surrounded by rich farmland, is home to eight co-op headquarters while a ninth sits just outside the city limits.

Renville County is the state's top corn, soybean and green pea producer. It's fifth in hogs and sixth in sugar beets. "These are the products that drive the co-ops," the mayor said.

Ultimately, consolidation could yield just 60 to 70 farms in the entire county, which Rath believes is not enough to support the town's infrastructure and businesses. Instead, co-ops are taking on that role.

About half of Renville's 508 households have someone who's working at a cooperative and co-op payrolls run into the tens of millions. The city isn't currently reaping the full benefit of co-op property taxes, having created tax increment finance districts that reinvest taxes on improvements to the property in public projects in those districts. However, when the districts expire in three to five years "these eight co-ops probably will pay as much or more than all citizens and businesses will pay," Rath said.

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