Their Loyalty or Our Value Package

Phil Kenkel
Bill Fitzwater Cooperative Chair
Oklahoma State University

 

At a recent cooperative educational program, a large producer was invited to present his perspective toward his local cooperative. He prefaced his remarks with the comment that he placed no value on cooperative stock since it was unclear when it would be redeemed and its value could be written down. His views were another spin on the familiar desire for deep discounts just above marginal costs. The producer was not interested, or perhaps had not been recruited, to serve on the board or become involved in the cooperative.

A common reaction to these types of expectations is to conclude that the producer has no loyalty to the cooperative and wants benefits without the responsibility of investing. There is validity to those claims but the issues are worth pondering. Loyalty to a cooperative is not an end in itself. It is rather a reflection of the belief (and often fact) that patronizing the cooperative on a long-term basis is in the producer’s best interest. The lack of “loyalty” of the disinterested large producer may be explained by his first statement about cooperative equity. In most situations, the prices of products, services and commodities are similar between a cooperative and its independent competitor. The cooperative value package provides three advantages: cash patronage, stock patronage and the opportunity to be involved in and influence the direction of the business. The net impact of cash patronage is reduced by the tax impacts of the qualified stock. A significant part of the cooperative value package is the fact that the member is building equity without any out-of-pocket investment. If members do not consider themselves an owner, their value package is obviously reduced.

Building loyalty in a cooperative comes down to explaining why patronage is in the member’s long-term best interest. That involves creating the best value package of price, service and investment in infrastructure and communicating the value of ownership and governance. Ownership value is diminished by long revolving periods and eliminated when cooperatives channel member returns to unallocated reserves. Rapid equity revolvement requires high profitability, which may diminish the customer-level returns. Overall, cooperative managers and boards do a great job of balancing those tradeoffs and creating an enviable value package. They often fall short in communicating the entire value package, particularly the value of ownership. Are today’s producers less loyal or do we need new ways to communicate our value?

 

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.

 

Depreciating Fixed Assets

Phil Kenkel
Bill Fitzwater Cooperative Chair
Oklahoma State University

 

Fixed assets are a necessary evil for agricultural cooperatives. Along with fixed assets comes the topic of depreciation.

Depreciation can be thought of in at least three ways. The layman’s concept of depreciation is the decline in market value with use or obsolescence. We all expect a truck to depreciate when we drive if off the lot. While that’s a great example to explain depreciation to teenagers, it doesn’t help us much in agribusiness where the current market value of a grain facility is difficult to determine. The accounting concept of depreciation is the process of allocating the appropriate portion of an asset’s cost to the periods during which the asset generates revenue. The tax concept of depreciation is the process of deducting the cost of an asset over the time period allowed by the IRS.

In most cooperatives, depreciation methods are driven by tax rules. Accelerated depreciation (taking the most rapid depreciation that IRS will allow) increases depreciation expense and thereby reduces net income and patronage distributions while increasing cash flow. This “conservative” approach also impacts the balance sheet. For example, under textbook accounting depreciation, a steel grain bin would have some value for up to 25 years. In practice most cooperatives would depreciate it over 10 years based on IRS class life tables or take more rapid bonus depreciation if it available. The grain bin becomes fully depreciated and has no value reflected on the balance sheet for more than half of its actual useful life.

Depreciation practices are just one reason why financial statements prepared on a book basis will differ from those prepared on a tax basis. Cooperatives should continue to use available strategies to reduce taxable income. However, as your board and your banker strategize over the strength of your balance sheet, it might be useful to consider how it would look if the fixed asset values were more in line with their actual remaining life. That path takes you into some other interesting differences between tax and book values.