Developing Strategy in a Cooperative

Phil Kenkel
Bill Fitzwater Cooperative Chair
Oklahoma State University

 

Establishing the strategic direction for a cooperative is a key role of the board of directors. A board that is not actively engaged in strategic planning is abdicating one of its key responsibilities.

While the board is responsible for strategic direction, the role of the CEO and the interaction between the board and CEO during the planning process is seldom discussed. The CEO has an in-depth understanding of both the performance of the cooperative and emerging issues in the business environment. For this reason, the CEO is often in the best position to propose strategic alternatives. The strategy can then be developed (or rejected) through an interactive dialogue with the board of directors. This goes back to the old adage “the manager proposes and the board disposes.” In other cases, the board proposes strategy and the CEO leads an interactive discussion as to whether the cooperative has the financial and human resources to implement the strategy.

In an aligned cooperative, the board should develop the strategic plan and be the strategic advisor to the CEO on a continual basis. The CEO is charged with implementing the strategic plan. That plan is being rolled out in a constantly changing environment. In challenging years, the CEO discusses the short-term issues facing the firm, and the board shifts their advice toward those choices. In more favorable times, the CEO cautiously alerts the board about the possibility of above average cash flow, and the board shifts advice toward infrastructure re-investment decisions. Strategy is a board function but strategy development and implementation is a team effort.

 

Would Members Ever Sell Your Cooperative?

By Phil Kenkel
Bill Fitzwater Cooperative Chair
Oklahoma State University

 

Unlike investor-owned firms, cooperatives are not generally for sale to the highest bidder. However cooperative memberships do have the option of liquidating the firm. This is not a scenario that most boards and managers spend much time worrying about. They conclude, probably correctly, that their best defense is to ensure that the cooperative operates efficiently and adds value for its member owners. However there are practices that enhance or diminish the likelihood of voluntary dissolution by the membership.

Retaining member-based profits in the form of unallocated reserves is a practice that has long troubled cooperative scholars. Cooperatives need reasonable amount of unallocated reserves to cover an unexpected loss or regional stock write down. However, unlike allocated retained patronage, profits retained as unallocated reserves are only distributed to members upon dissolution. If you recall the movie “It’s a Wonderful Life,” you might remember the scene where Jimmy Stewart examined the terms of his life insurance policy and concluded he was worth more dead than alive. Members are unlikely to liquidate a cooperative just because the ratio of unallocated to allocated equity is too high. When other factors tempt them to liquidate, excessive unallocated reserves create the scenario where they discover that their equity is worth more dead than alive.

While excessive unallocated reserves enhance liquidation potential by violating the “user benefits” principle, other practices create issues by violating the “user control” principle. A cooperative’s membership role determines the individuals that are eligible to vote on dissolution or any other major issue. Keeping membership rolls current by removing inactive members keeps decisions in the hands of members who are actively using and actively benefiting from the cooperative. Achieving this is a topic in and of itself and is likely to require a bylaw change along with advice from your legal counsel and auditor. However, under a one-member, one-vote system, an inactive member with a small equity balance has the same influence as your largest producer.

A final practice that diminishes the likelihood of a dissolution vote is keeping the asset base aligned with member needs. This also relates to the “user benefits” principle. A number of studies have examined why producers patronize a cooperative. Patronage refunds are usually not one of the highest ranked factors and equity retirement payments rate even farther down. Service, which includes access to the right mix of equipment and infrastructure, generally tops the list. A cooperative that exits unprofitable business areas and reinvests in the areas where it can add value for the membership is unlikely to face a dissolution vote.

The best defense against dissolution? Manage the cooperative to be an efficient business and adhere to principles to be a good cooperative. It’s a wonderful life and you are part of a wonderful cooperative industry!

Myth Buster: Cooperative Stock is Debt

By Phil Kenkel
Bill Fitzwater Cooperative Chair
Oklahoma State University

 

The revolving stock in a traditional cooperative is an interesting instrument. Unlike stock in a publicly traded corporation, it has no market value. This absence of a market value necessitates that it be eventually redeemed by the cooperative firm. This creates the unique structure of the cooperative where equity is continually being destroyed and replenished. Even the national accounting standards board has at times been concerned, or perhaps confused, about cooperative equity. This generated proposals that cooperative equity be treated as instruments with properties of debt. Cooperative accountants were quick to point out that this structure would leave cooperatives without owners.

I have heard both members and cooperative leaders proclaim that a cooperative’s revolving equity is debt. The member’s statement is usually made as part of an argument that the cooperative must redeem their equity at a given age. Cooperative managers sometimes describe revolving equity as debt as part of a rationale for retaining funds as unallocated reserves (retained earnings) rather than as allocated equity. Managers and board members in a cooperative struggling to reduce revolving periods are often particularly hesitant to issue new equity.

Despite the unique characteristics of cooperative equity, it is not debt. Unlike a debt instrument, the cooperative board has discretion as to when it is redeemed. When required by financial circumstances, cooperative equity can be written down in value. A cooperative that has experienced losses obviously doesn’t have the unilateral ability to write down its debt. Cooperative stock has value to members only when it is redeemed. The principle of distributing patronage in proportion to business volume is only ultimately fulfilled when the distributed stock has been redeemed. While it is essential that cooperatives redeem stock, the member is the owner of the firm. Unlike lenders, owners receive the residual claim. The board’s first priority should be to manage the cooperative’s balance sheet. The equity redemption budget should be determined by the cooperative’s financial resources, not as an implication of the redemption system.

Profitable cooperatives absolutely can issue equity and redeem it on an acceptable cycle. There is clear evidence of this from some of Oklahoma’s cotton ginning cooperatives that have very short revolving cycles. Providing your cooperative has adequate levels of unallocated equity, you should have no hesitation in retaining funds as allocated equity. In fact, it is the only vehicle of retaining funds that provides an ultimate benefit to the member. Retained patronage is the primary vehicle for members to build ownership in their cooperative. Issuing stock is not creating debt but rather creating owners.

Myth:  Cooperative Stock is Debt

Status: Busted!

 

12-21-2011