Journal Entry (Reflection)

ARE 132: COOPERATIVE BUSINESS ENTERPRISES

Prof. Kiesel

Midterm Logistics

 On Canvas (as Canvas Quiz)  Available for a limited time starting at beginning of class time (no

class)

 Looked questions  Multiple choice and True/False Questions first

 Two short answer questions requiring typing in your answers

 Similar to practice midterm (Question 3 not covered yet)

Competitive versus Monopoly Prices

 With competitive prices, profit is only a result of cost advantages

 With market power, profit is a result of higher prices and lower quantities

The Competitive Yardstick

Co-op Objectives

If producing at higher output?

 Move to closed membership(lower demand)

 Alter the cost structure and expand physical size

Achieving Minimum Average Total Costs

If producing at lower output?

 IOF (or first objective) would reduce output and increased prices as compared to setting AR=ATC

 Cooperatives could expand to non-member business, but might provide no incentives for members

Decision Making in Cooperatives

 Starting a new co-op What are the steps to starting a new co-op?

 Critical elements of structure of decision making What are the keys to long-term success?

Nine Steps to Starting A New Co-op 1. Preliminary exploration 2. Gauge broader interest 3. Form steering committee 4. Clarify purpose of business 5. Conduct feasibility study 6. Hold membership drive 7. Develop business plan 8. Prepare legal documents 9. Early start-up phase

1. Preliminary exploration

Begin with concept of multi-owner business, not necessarily a co-op

Discuss need for group action (horizontal coordination) and vertical integration

 Identify potential products/services & economic rationale

Conduct preliminary research

What is the economic rationale for creating a co-op?

Back to economic theory Response to what type of market failure?

2. Gauge broader interest

 Identify prospective members Discuss basic concept with them

Participation in Benefits

 Benefits include overall cost efficiency and bargaining power

 Opportunity to buy from closed supply channel or to sell to closed marketing channel

 Benefits arising through the role of cooperatives as competitive yardstick

 Opportunity to share in any distribution of income

(Many cooperative bylaws say that a cooperative must do not more than 50% of its business with non-members)

3. Form steering committee

Assemble 5-9 interested, dedicated volunteers

Seek out those with broad experience base

 Identify leader(s) Draft mission statement Discuss potential functions/

activities of firm

4. Clarify purpose of business

Discuss needs with potential members Fine-tune Mission Statement

Can multiple-owner firm offer a solution? What specific products/services will be

provided?

PACHAMAMA’S MISSION STATEMENT Our mission is to provide customers with premium coffee in the most direct manner possible and, in doing so, improve the lives of family farmers and their families.

5. Conduct feasibility study

Market analysis Operations analysis Financial analysis

6. Hold membership drive

Discuss findings of feasibility study (objectively) with potential members Potential obstacles? Who will be served? How will members be served? What are their projected volumes? How much investment is needed? How will firm be operating?

Participation in Ownership and Control

 Customers who use the cooperative are expected to have ownership:  The easiest way to think about equity investment is direct

investment through purchase of equity shares.  Owners participate in control by setting policies (including the

governance structure of the cooperative) Write bylaws of the organization which include:

1) classes of membership and their qualifications, 2) the governance system, including the role and

responsibilities of the board of directors and how they are elected, and

3) rules for certain actions such as annual meetings, bylaw amendments, or dissolution.

7. Develop business plan Work out details for market, operations

and financial analyses Review plan with business advisors Draft equity program Estimate debt financing needs &

discuss plan with lenders

8. Prepare legal documents

Determine appropriate business structure (Co-op, LLC, S-Corp)

Work with attorney to draft Articles of Incorporation & Bylaws

File Articles of Incorporation with Secretary of State

9. Early start-up phase

Obtain appropriate licenses and insurance

Hold first official meeting to elect officers Acquire capital from members Hire management Begin operations!

Organization of Co-ops

Members

Board of Directors

President/ C. E. O

Division Vice President

Bylaws describe the rights and obligations

(Same as other corporations)

Principal

Agent

Management Issues  Management incentives in co-ops

Does board have business acumen to perform oversight function?

Management might not be inclined to run cooperative in members interest No simple barometers of management

performance such as stock prices (IOF) No stock option incentives

Key to success: Presence of full-time professional manager that jointly optimizes performance of cooperative and members; Management knowledge of cooperative culture is needed Board oversight needs to be supported on business knowledge

Control or Principal-Agent problem in Cooperatives

Control or principal agent problem: is induced by the divergence of interests between the membership, their representative board of directors (principal) and management (agent).

 Decision making can be costly Information asymmetries exist monitoring of performance is incomplete Little external pressure is exerted on

management performance due to the cooperative structure

The Logic of Collective Action  Developed by Olson (1965)

 Challenges optimism of group theory: individuals with common interests voluntarily act so as to try to further those interests (Bentley 1949, Truman 1958)

 “Unless the number of individuals is quite small, or unless there is coercion or some other special device to individuals act in their common interest, rational, self-interested individuals will not act to achieve their common or group interest” (Olson, 1965, p. 2)

 Ostrom’s work addresses: How can individuals jointly using a common-pool resource be able to achieve an effective form of governing and managing their own commons?  Evolving rather than completed theory

Public v. Private Goods

Rival? Yes No

Excludable? Yes

Pure private goods:

•Candy bars •Computer chips •Congested toll roads

Club goods:

•Country clubs •Cable TV •Uncongested toll roads

No

Open-access goods:

•Deep ocean fisheries •Groundwater aquifers •Congested freeways

Pure public goods:

•Biodiversity •Public radio •Uncongested freeways •Public parks

Prisoners Dilemma  E.g. Players in a game as herders and define a “cooperate” and

“defect” strategy

 Classic example:

 Each player has a dominant strategy in the sense that the player is always better off choosing that strategy—to defect—no matter what the other player does

 Solution?

u1=1; u2=1 u1=3; u2=0

u1=0; u2=3 u1=2; u2=2

Suspect 2 (u2) talk silent

Su sp

ec t 1

(u 1)

sil en

t

ta lk

“cooperative” strategy

A Blueprint for Cooperatives

Bylaws are the rules or policies that explain how any organization, including a cooperative, operates.

The articles of incorporation lay out the basic framework of the firm and are broader than its bylaws. They describe:

 Type of organization (non-stock cooperative, stock cooperative, cooperative association, etc.),

 Purpose of the business, number of shares of common stock and any preferred stock that might be issued,

 Structure including number of directors and how a member votes on those directors,

 Legal definition of membership

 Location of the headquarters (legal address)

 Asset disposal upon liquidation

Cooperative Bylaws

Cooperative Bylaws should address: Membership requirements, rights Voting Procedures Election of Directors Meetings of Directors

Patronage allocation & distribution Board-management relations Membership termination Co-op dissolution

Voting A. One person, one vote (pure democracy) B. Patronage or proportional voting

Which is attracting large suppliers? Why is attracting large suppliers important?

 Possible Solution: Mixed voting strategies

𝑣𝑣𝑖𝑖 = 1 + 𝛼𝛼(𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝) 𝑖𝑖 s.t. 𝑣𝑣𝑖𝑖≤ 𝑣𝑣∗

Especially important when large size of diversity

Two main functions: Vote on Bylaws and Board of Directors

Board of Directors  Status of directors

Member of co-op or representative of co-op Outside directors

 Number of directors 2/3 of coops have 6-15 directors Large regional (federated) coops often have

more  Election of directors

Procedure specified in Bylaws At large vs. district elections

 Time limits

How Are Directors Selected?  Manner in which corporate directors are chosen is straight-forward:

 Potential directors are assumed to have some core of knowledge( e.g. accounting or finance, governance, human resources, or strategy)

 Desire for broad background in core areas of knowledge plus additional attributes such as diversity

 Usually two members of management (which include the CEO and another senior leader)

 Nominating committees identify directors with certain skill sets (directors are chosen at-large subject to meeting the needs identified by the board)

 Shareholders in the firm vote for the board based on their proportion of shares with number of votes linked with their share of equity.

 Stakeholder cast vote for the entire slate of directors as opposed to each director separately

How Are Directors Selected? (cont.)

 Important difference in selecting directors over non- cooperative corporations:  Directors are selected from their customers who are members

 Many cooperatives use similar tools to identify directors in an effort to identify suitable candidates for the board, however:  Because of their unique nature, directors are often chosen based

on geography and districts based on the population of its members are created

 Nominating committees consider the pool of directors in that geographical district only

 Board elections in a cooperative ask each member to vote for each director individually rather than a slate of directors in IOF

 Terms of directors ¾ have 3 year term Most stager terms to provide continuity

 Power of directors  Bylaws outline power

Board is responsible for full oversight of co-op affairs Members often only indirectly responsible

Member participation in nominating and voting for Board of Directors is key

Board of Directors (cont.)

Performance Evaluation

 Key Question: Are you better off with a co-op structure? Compare net prices (after payment of discounted

refunds) to net prices being offered through alternative sources

 Yardstick dimension of co-ops; Does co-op make rival non-co-ops perform better?

 Use financial statement comparisons Must evaluate relative to the performance of joint

entity Don’t use common measures such as return on equity

(ROI or ROE)

Engage members and measure member satisfaction

Membership Issues Membership upon inception

Organizing co-ops involves free rider problem Why?

 Entrepreneurship not directly rewarded

Membership Issues (cont.)  Membership upon inception

Organizing co-ops involves free rider problem Why?

 Entrepreneurship not directly rewarded  Access to goods and services to everyone once

established

 Free-rider problem: arises when members or non- member can use a resource (Co-op) for their individual benefit but property rights are not well defined to ensure that they bear the costs of their actions. (Particularly an open-membership problem)

Solutions: Develop a Broad Initial Coalition and Common Values

1. Appeal to sense of civic responsibility (e.g. define common cause).

2. Involve as many people as possible to spread entrepreneurial costs.

Membership Issues (Cont.)  Membership upon inception

 The larger the membership, the better Why? Physical benefits (economies of size) Pecuniary economies (discounts and price premiums) Reliability of supply (marketing) and demand

(purchasing) Discourage ‘wait and see’ behavior

Why?  Need to exploit economies from the outset

Short-run versus long-run costs (important to get members to join initially)

Reasons for (Physical) Economies of Size

Membership Issues (cont.) Membership long term commitment

Encourage long-term commitment Penalties to failure to meet obligations

Forfeiture of membership Forfeiture of equity

“Tragedy of the Commons”

 Hardin (1968) symbolizes expected degradation of the environment when many individuals use a scare resource in common:  Uses pasture as an example: 1. Each herder receives direct benefit from letting hi sherds graze 2. Each herder suffers delayed costs from overgrazing  Each herder is motivated to add more and more

animals because he/she/they receive direct benefits and only bear a share of the (delayed) costs resulting from overgrazing

“What is common to the greatest number has the least care bestowed upon it” (Aristotle)

Membership Issues (cont.) Membership long term

Encourage long-term commitment Penalties to failure to meet obligations

Forfeiture of membership Forfeiture of equity

 Horizon problem: arises when members focus on short-term constraints and benefits returns and might not adequately retain commitment, involvement and equity to ensure longer-term viability.