Author: Phil Kenkel

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

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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