Controlling the Cooperative

The key difference between a cooperative and an investor-owned company is that a cooperative is a business owned and operated by its members for their mutual benefit.  An investor-owned company’s only owner focus is financial. 

Because a cooperative is operated for the mutual benefit of its members by its members, member control beyond the levels usually accepted in an investor-owned company is imperative to achieving successful outcomes for members, both financial and in services.  Control by cooperative members is important because in cooperatives, purpose includes how the cooperative interacts with its members’ businesses and this can vary and change over time. By contrast in investor-owned companies, purpose is always clear, to make money through shares and dividends.

The types of controls members have over the decision making of cooperatives are:

1. Redemption of membership – Ultimate form of control, very dissatisfied, Rarely used.
2. Voting rights at AGM – Official level of control. Used annually, more frequently with concern.
3. Engagement with the co-operative – co-operative level of control and is directive or interactive only. Used regularly/daily.  Used in a variety of mediums. NB: Increases in reciprocal engagement decreases the dependence on other forms of control by improving outcomes for members.

Redemption of membership (ownership) – Exercised Anytime

1. Remove capital and cease trading with the co-op. 

• Personal risk to own business as trading security reduced.
• Galvanises remaining members to direct the board

Voting rights at AGM: - Exercised Annually

1. Election of Board members
2. Changes to constitution – changes are to the parameters of the business (not on how the business is run)
3. Passing the annual report
4. Appointment of Auditor
5. Winding up the organisation

Engagement with co-op: - Varied and ongoing

1. Directive remits at AGM/SGM
2. Speaking rights at AGM/SGM
3. Access to co-op communications and publications
4. Access to Directors
5. Access to member representatives
6. Invitation to member update meetings
7. Access to member only areas on co-op website
8. Participation in focus groups or local forums
9. Clear complaints procedures on operational or governance issues
10. Information-sharing networks
11. Member/management working parties
12. Cooperative training and education
13. Advocacy
14. Other forms of formal and informal communication through-out the co-op

Improving member participation is the key to a successful, member controlled, member focused cooperative.  It all starts with the constitution. Having a constitution that clearly defines the parameters of how the cooperative operates, how membership is defined and the rights and responsibilities of members is important in setting the framework for a successful cooperative. 

Unlike investor-owned businesses, reciprocal engagement with members is a key component to the success of co-operatives.  Having a Board that works to develop strong member engagement directly with members will strengthen outcomes for members.  There needs to be a clear pathway from the Board to the members and back again.  The use of external PR firms in communicating with members is extremely damaging to this process and actively destroys value for members.

Member control of a co-operative is vastly different from owner control in an investor-owned business.  It needs to be protected through the constitution and actively encouraged by a member-focused Board.  Lack of co-operatively focused professional development training by the Board, the use of outside PR firms to communicate with members, an overly complicated constitution that does not focus on the important issues, and no clear lines of open communication are all warning signs of poor co-operative health.  The use of reciprocal engagement methods that promote strong lines of formal and in-formal communication by the Board and member representatives is one of the key ways of helping members exercise control over their co-operative. Strong member control creates strong outcomes for the co-operative. 

Does the treatment of the Organic suppliers herald the introduction of Farmgate Pricing?

My concerns about the Fonterra decision to axe Organic milk from New Zealand are not so much the decision, but rather the way it was handled, and that this behaviour could this be an ominous preface on how Fonterra could treat other farmers under less cooperatively focused capital structures in the future.

Telling Organic farmers twenty minutes before the national media that their world was about to change can never be argued was genuine consultation.  It was nothing short of tyranny.  Organic farmers are still shareholders, they still have put the same capital in as every other supplier.  This does not bode well for the future of some regional supply groups that may be less profitable to pick-up and process than other regions. 

If Fonterra decides at some time in the future, that it was no longer economical to pick up from a certain region, what will stop them dis-incentivising them from producing.  The Chairman, Henry van der Hayden, has never made any secret of his desire to introduce farm-gate pricing.  He knows this can never happen under the traditional co-operative model, so has spent the entire time at the helm of the Board, trying to actively change the capital structure.  To this end, you will note that every capital structure option put forward has involved a trading platform of some kind.  If you don’t take the thinking that a form of share trading is the best model to transition Fonterra in to an investor owned company, you will concede that any form of share trading will all but remove redemption from the control mechanisms members have over their Board.  By doing this, the Board will be free to treat different groups of farmers as they chose, because although shareholders will still be free to leave, any mass exudes will not be felt on their balance sheet like it has in the past.  Farm-gate pricing will always be in the best financial interests of Fonterra, but not the best interest of all the members.  

The Role of Redemption

Redemption risk. Two very dangerous words if you believe the rhetoric from Fonterra. But what is redemption risk and what function does it play in co-operatives?

Redemption comes from the co-operative principle of voluntary and open membership. This principle has been set in place to ensure that individuals and businesses wishing to transact with a co-operative are able to do so if they are prepared to put in the required investment. But equally, if we choose to stop interacting with a co-operative, we are able to have our investment returned under the rules in that co-op’s constitution.

Redemption is the favoured method worldwide for managing member capital. In an investor-owned firm, shares only benefit their owners either through dividend payments or by increases in the share price. Co-operatives, on the other hand, primarily support their members through guaranteed access and maximised return for products. This means that redemption from a co-operative is not driven solely by lack of profit, but rather by dissatisfaction with the co-op.

Essentially, when members ask for their investment to be refunded they are not just withdrawing capital, they are withdrawing support and product. This is why redemption is so important to a co-operative. When members start redeeming their membership, they are sending a very strong message to the Board that their decisions are no longer meeting their needs as members. A strong co-operatively minded board should look on the risk of redemption as the flame under them to keep them agile and member focused. Redemption is the ultimate form of control for members.

This is all well and good in theory, but does the principle stack up in reality? In 2008, Fonterra suffered a major redemption crisis, and this is one of the most persistent arguments for the “Trading Amongst Farmers” proposal.

At the end of that season, Fonterra members were capitalising on the significant change in share price by cashing in any excess shares caused by the nationwide drought or by going to a capital-free competitor for one or more seasons. Like most New Zealand businesses, Fonterra was struggling to access debt to fund this due to the GFC. This put enormous strain on the balance sheet and would have been unbelievably stressful. On the face of it, much of this situation appears to be the result of circumstance, but look a little deeper any you will see that the Board had set themselves up for this fall.

Over the previous eight years, Fonterra had taken no retentions, choosing instead to pay everything out to members. This meant that a sudden need for capital had to be met entirely by debt during the GFC. At the time, the Board was also incentivising management to grow “Total Shareholder Returns,” of which the share price was a major component. On top of this, Fonterra was not discussing the non-financial benefits of belonging to a co-operative with members, which could be argued was because, less than 12 months earlier, the Board had proposed a partial listing. So when investor-owned competitors came knocking, the promise of accessing tied-up capital was all that was needed to win some farmers over.

Things have now improved due to more co-operatively focused governance. Fonterra has begun taking retentions and this has strengthened the financial position. The share price is now far more stable. Changes to the constitution allow farmers to hold shares well above their production, milk-price penalties for production above the season-opening shareholding have been introduced, and capacity adjustment all work to discourage gaming of shares. And most importantly Fonterra is beginning to talk the co-operative talk to its members. All these changes have been driven by Redemption Risk.

A death by a thousand cuts?

IS TRADING Among Farmers (TAF) the first step towards a public listing, and the demutualisation of Fonterra? This is the key question dairy farmers have been battling with, both at the time of the June 2010 vote and again now.

While practically every dairy farmer wants to retain the co-operative status of our company, we are aware that the economic world is rapidly changing and we believe our leaders when they tell us the business needs more capital to grow. So how do we take the steps towards trying something so far removed from a traditional co-operative, without risking it all?

For me, the argument that TAF is a step in the direction of public listing is very compelling. The previous Shareholders Council was very clever in building into the June 2010 vote a longer timeframe for the roll out of the changes. This has allowed dairy farmers to be sure that we really do need TAF for the long term. It has also allowed farmers to see how the investor community has been behaving in the lead-up to its introduction. 15 months on, I have serious doubts with what I am seeing.

My main concern stems from the fact that there has been very little communication between the Shareholders Council and members regarding TAF. We are being told there is very little happening, so nothing to communicate. I don’t dispute this. Perhaps the changes were so insignificant on a piece by piece basis that it would have looked silly discussing them all with members.

But when the Chairman, Simon Couper, finally did come out and update farmers, what we saw was that the small changes over the 15 month period actually amount to significant change around control of the shares within the proposed fund. Although Couper dismisses this as evolution, farmers need to see that this process, if applied to the whole concept, as exactly how our co-operative could “evolve” into an investor-owned business without us being aware of where it began to unravel.

So exactly how significant is this evolution of control of the shares within the fund? Any farmer who uses the fund through either design or need, will have already taken that first step towards letting go of the cooperative ethos. This group of farmers, who will receive the full benefits of being a cooperative member without the full financial commitment, will be able to vote to increase both the percentage of shares an individual farmer can put into the fund and the percentage of total Fonterra shares held by the fund. Given the relatively low percentage of shares that will initially go into the fund, it is highly likely that the fund in its current form may not fulfil the purpose for which it was set up for. Although it could be argued that this group, who will not receive a dividend payment, would work to protect the milk payment through their voting rights, they won’t protect the co-operative ethos and the non-financial benefits of being a co-operative. Now mix this with the far more sinister threat on the horizon – the Fonterra “guardian” controlled shares in the fund.

We were originally told that control of the shares within the fund would remain with the farmer. This small evolution has meant that control of these shares will be blocked together under a single body.

So now there would be a group of farmers, with full voting rights, that no longer links in practice why full shareholding should be the only way to access full cooperative member benefits. After all, the only penalty so far has been the loss of the dividend. This will not have been of major concern as this group primarily cares about the milk price, and this has been protected by the constitution through their voting rights – which they may, or may not, be using. It would not be too difficult to convince the majority of this group to give up these shares entirely, especially if the price was high enough.

This means there would be a nicely packaged chunk of Fonterra shares with their farmer owners wondering if they actually need them. Controlled by a single entity, this bloc of shares is highly marketable and very valuable.

When small details evolve, they mark the first steps to change. The real risk now is that the Shareholders Council fails to see the wood for the trees. Because it was voted on, the Council may now be convinced that TAF is the only capital structure option available, so they tweak it to fit until it’s no longer of value to anyone.

Fonterra was set up as a consolidated co-operative to provide the best returns to New Zealand dairy farmers. Reducing export competition, sharing resources and being the largest processor all help make this happen because co-operatives are always the price setters at the farm gate. This comes about because co-operatives return their profits, after retentions for growth, back to their member/suppliers. Without the profits being returned to suppliers, are we still a true co-operative or will we be seeing the death of our cooperative by a thousand cuts?