Author: Phil Kenkel

Cooperative firms return profits to their member-owners in proportion to their use of the firm.  Those profit distributions are referred to as “patronage refunds”. In contrast,  most other corporations distribute profits in proportion to investment. Cooperative members may be somewhat familiar with patronage refunds but often do not understand all of the structures and issues.  Producers who are not a member of a cooperative may wonder what they are missing.  Patronage refunds are the most unique and, perhaps, the most interesting feature of cooperatives.

In cooperative terminology, a patron is a cooperative customer who qualifies to receive patronage refunds.  That typically means that they are a member of the cooperative.  Patronage refunds are profits that are distributed in proportion to use. Usage can be measured in multiple ways.  Patronage can be based on the dollar amount of purchases or commodity payments or on physical units such as bushels or tons.  A cooperative can track member use as a single patronage pool, or as multiple pools reflecting separate commodities, products or departments.   Each cooperative selects the patronage base that most fairly represents member use.

Cooperatives can pay patronage as a combination of cash and equity. Equity patronage is eventually redeemed into cash and, for that reason, is often called “revolving equity”.  Equity patronage has two functions.  First, it allows members to build ownership without an out-of-pocket investment.  Second, it capitalizes the cooperative, funding the property, plant and equipment.

Patronage refunds have tax implications.  Cooperatives are taxed as corporations but are allowed to deduct patronage distributions.  Those patronage refunds become taxable income for the patrons. Cash patronage is immediately taxable to the patron but equity patronage can be structured to be taxable when issued or taxed at the later date when it is redeemed into cash.

Many local cooperatives are in turn members of regional cooperatives.  Those regional cooperatives issue patronage refunds to the local cooperatives, which becomes part of the local cooperative’s net income.  Therefore, the patronage refunds that producers receive from their local cooperative reflects both the local cooperative’s profits and the pass through share of the regional cooperative’s profits. 

Many younger producers wonder why a cooperative cannot simply offer more favorable prices (more than what competition might dictate) in lieu of paying patronage refunds.  There are some very good reasons.  Equity patronage capitalizes the cooperative.  One way to think of equity patronage is that the members are receiving their share of the total profits and then temporarily reinvesting a portion of those profits in the cooperative. The second rationale for not substituting favorable prices for patronage is the danger of misestimating costs and creating a loss.  Finally, favorable prices would result in zero profits and zero return on assets and equity.  Basically, profits have been given away in the form of prices. Many members will not perceive the price benefit and conclude that the cooperative is poorly managed.  By setting prices at market level, generating profits and then returning those profits as patronage refunds, members can observe the cooperative’s performance and appreciate its benefit, and the cooperative will be capitalized and able to respond to member needs.

Most producers wish they could purchase their inputs a little cheaper and sell their commodities at a slightly higher price.  Most producers would also like to invest for the future.  Producers can achieve all of the goals with no out-of-pocket investment by joining and patronizing their local cooperative.  When you are a cooperative patron, the check really is in the mail!

Kenkel, Phil. “Demystifying Patronage Refunds.” Southern Ag Today 3(41.5). October 13, 2023. Permalink

Agricultural cooperatives are an important part of the U.S. agricultural industry. In 2020, the USDA counted 1,744 farmer owned cooperatives with 9,500 locations, $200B in sales, $8.4B in net income and 1.8M members (USDA, 2021).  Earlier USDA studies indicated that agricultural supply and marketing cooperatives contributed to slightly over 38% of total farm output, (USDA 2004, 2006).  Despite their prevalence, many producers do not understand the cooperative business model.  That is unfortunate because it may prevent them from understanding the economic value of existing cooperatives or considering the formation of new cooperatives to improve their farm profitability. 

Cooperatives can add value at the farm level as well as at the cooperative level.  That is a result of the cooperative having transactions with and providing service to its member-owners.  In some cases, the existence of the cooperative allows producers to grow a more profitable crop.  For example, in the cotton producing regions of Oklahoma, OSU crop enterprise budgets have consistently shown a $100/acre profit advantage for cotton relative to alternative crops (Kenkel, 2021).  This would not be possible without a cotton gin. Further, a producer-owned cooperative may maintain locations that investor-owned agribusinesses might abandon, or offer services or product lines that would otherwise not be available.  Cooperatives can also create farm level benefit through favorable prices.  The common thread of all these benefits is that they are not reflected on the cooperative’s financial statements and the portion of farm profits attributable to the cooperative is not readily observable.  

However, some benefits of a cooperative are more easily observable.  Most agricultural cooperatives distribute profits to members in a combination of cash and equity (that is still redeemed for cash at a later date).  A classic assessment of the return on investment in a cooperative compares the discounted value of member cash flows to value of the member equity (Reynolds, 2013).  Bear in mind that an individual member’s return on equity is unique in that both the cash return and the equity holdings were a result of the amount of business they did with the cooperative. Thus, there was no out of pocket investment.

The revolving equity in a cooperative is, in essence, profits that are distributed to the member but temporarily lent back to the cooperative to fund investment.  Revolving equity creates value by funding infrastructure investments that can enhance existing activities or create new value through market access, risk reduction or new services. In this way, revolving cooperative equity benefits existing members by enhancing future profits, and supports future generations of producers by ensuring the perpetuation of the business.

Perhaps most importantly, cooperatives play a role in keeping markets competitive.  Many U.S. agricultural cooperatives were formed in the New Deal era to offset the market power of monopolists who threatened farmer welfare (Hogeland, 2006).  The existence of these cooperatives kept other firms “honest” or realistic in prices and services.  This aspect of the cooperative value package has often been termed “the invisible benefit of cooperatives”.  Because it is unobservable, the value of a cooperative’s existence is often only appreciated when it is dissolved or exits a market area.

While a common feature in agricultural industries, the cooperative value equation is quite complex.  Cooperative members can benefit at the farm level and from cooperative level patronage distributions.  Cash patronage distributions provide an immediate benefit while equity patronage distributions allow members to build ownership with no out-of-pocket investment.  In turn, that equity funds infrastructure thereby creating future value. By its very existence, the cooperative is likely improving market access and maintaining competitive market prices.  

When should a producer patronize a cooperative?  When it makes economic sense!  In making that assessment it is important to realize that some of the economic benefits are subtle and long-term.  Like any business, we should not assume that cooperatives will be there if we do not support them.

References

Hogeland, J. (2006) “The Economic Culture of U.S. Agricultural Cooperative” Culture and Change, Vol. 28 No.2 Fall 2006.

Kenkel, P 2021. “Economic Impact of Oklahoma’s Cotton Cooperatives” Oklahoma State University Department of Agricultural Economics Staff Paper AE#2021-1 July 2021

Reynolds, A. (2013) “Determining the Value of the Cooperative Business Model: An Introduction” white paper, CHS Center for Cooperative Growth

USDA, (2004), “Farmer Cooperative Statistics 2002” Service Report 592, Rural Business-Cooperative Service, Washington, D.C.: Rural Development, USDA. United States Department of Agriculture 

USDA. (2006). “2002 Census of Agriculture”. Washington, D.C.: National Agricultural Statistics Service (NASS). United States Department of Agriculture (USDA). 

USDA, (2021) ”Agricultural Cooperative Statistics Summary, 2020” USDA Rural Developmet, Rural Business-Cooperative services,  

https://content.govdelivery.com/accounts/USDARD/bulletins/300bab5

---

Kenkel, Phil. “The Economic Value of Agricultural Cooperatives.” Southern Ag Today 3(10.5). March 10, 2023.

Photo by Jonathan Borba: https://www.pexels.com/photo/girl-and-elderly-man-picking-strawberries-15672380/

Fertilizer prices exploded during the past year and are now further fueled by the Ukraine conflict.   Interest rates have also increased substantially. There is a theory, associated with economist John Taylor that for every percentage point of inflation, interest rates should be raised by a similar percentage.  That principle would suggest that our interest rate climb is not over.  Numerous articles have discussed the impacts of these trends on farm and ranch profitability.  Many producers are also member-owners of agricultural supply cooperatives.  Those cooperatives are also impacted by both fertilizer prices and interest rates.

The impacts can be illustrated using a cooperative financial simulator developed at Oklahoma State University.  Prior to interest rate and fertilizer increases, the representative wheat marketing and farm supply cooperative had a return on assets of 6.8% and a return on equity of 11.5%.  The representative cooperative distributed 50% of profits as cash patronage and needed 29% to service an 18-year equity revolving program.  The remaining retained profits allowed the cooperative to grow at an annual rate of 2.4%.  If interest rates and fertilizer prices double, the cooperative must either increase farm supply profit margins by 8% or reduce cash patronage to 45%.  The impacts are even more dramatic if members expect to maintain the value of their equity position in the cooperative. If length of the equity revolving period is reduced to 10 years, the cooperative must either reduce patronage from 50% to 35% or increase farm supply margins by 42%.

These results illustrate the challenges that will be faced by cooperative boards of directors.  In coming months, protecting the financial viability at the cooperative level may require increases in margins or reduction in cash patronage.  If interest rates impact producer expectations of equity revolving periods, those challenges will be even more substantial.  Cooperative boards may be tempted to try to isolate the members from increasing interest and inventory costs.  The danger of that strategy is that cooperative’s reserves and growth rate may be reduced to the point that it will not be in a position to serve future members (Table 1).

Kenkel, Phil. “Impact of Increasing Fertilizer Prices and Interest Rates on Farm Supply Cooperatives“. Southern Ag Today 2(20.5). May 13, 2022. Permalink