Cooperatives Distilled

Cooperatives Distilled

Rick Riehle 206 923-8409 [email protected] [email protected]

President

Founding Member

Pangaea Organica

Northwest Triple Bottom Line

A Cooperative

Chamber of Commerce

www.pangaea.coop

www.nwtbl.org

Copyright © 2006

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Table of Contents 1. Cooperatives Distilled......................................................................................................................................3 1.1. Cooperative Principles..............................................................................................................................3 a) Principle One: Member Governance.....................................................................................................4 b) Principle Two: Member Benefits..........................................................................................................5 c) Principle Three: Member Ownership.....................................................................................................6 1.2. Types of Cooperatives..............................................................................................................................7 a) Consumer Cooperatives..........................................................................................................................7 b) Producer Cooperatives...........................................................................................................................8 c) Employee Cooperatives..........................................................................................................................8 1.3. Cooperative Consequences.....................................................................................................................10 a) Social Conscience.................................................................................................................................10 b) Financing..............................................................................................................................................11 2. Appendix 1: The Evolution of Cooperative Principles...................................................................................12 3. Appendix 2: Corporation, Partnership, Cooperative, Non-profit...................................................................14 4. Appendix 3: Cooperatives In Business Today...............................................................................................15 5. Appendix 5: Resources for Cooperatives.......................................................................................................16

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1. Cooperatives Distilled Cooperatives are businesses that are owned and democratically controlled by their members, and that exist to serve their members' economic interests. While cooperatives are economically self-sustaining and able to generate profits like any other businesses, their purpose is service, not profit. This distinction in purpose, along with the core principles under which they operate, render cooperatives the businesses equivalents of egalitarian states. They are nothing less than the next evolutionary stage in the long march of history toward social, political and economic enfranchisement for all. Purpose and principle are the features of cooperatives that distinguish them structurally from corporations1. Many corporations operate according to principles established by their leaders, or serve social purposes beyond shareholder profit, but this does not render them structurally different from other corporations. As such their ongoing goodwill is dependent on leadership. This essay begins with principles of cooperatives, it proceeds then to descriptions of the basic types of cooperatives, and finally considers some of the consequences of cooperatives.

1.1. Cooperative Principles Many cooperatives include among their principles things like cooperation among cooperatives, concern for community, and promoting an understanding of the cooperative business model. These principles can be traced back to the 1844 founding of the Rochdale Society of Equitable Pioneers, and are outlined herein in an appendix. Every business, cooperative or otherwise, is free to adopt whatever principles it sees as essential to the fulfillment of its mission. The present task, however, is to identify those principles that realign businesses so as to structure them as cooperatives and thereby avoid the pitfalls of corporations.2 There are exactly three principles; each is necessary and together they are sufficient to identify or structure a business as a cooperative. The principles influence one another. Principle Two, for example, guides the disbursal of business proceeds which puts 1 A note on terminology. The term corporation herein applies to non-cooperative companies. The term shareholder or stockholder refers to owners of corporations. Members and member-owners refer to owners of cooperatives. Both cooperatives and corporations are businesses which are legally incorporated according to the laws of an incorporating authority. Both can be incorporated under any of several forms including Corporation, Sub-chapter S Corporation (SCorp), Limited Liability Corporation (LLC), Partnership, Limited Liability Partnership (LLP). For the purposes of this essay the form of incorporation of a business, cooperative or otherwise, is irrelevant. 2 The pitfalls of corporations are discussed in the extended essay “Ecological Economics: An Economic Contract” (Riehle, 2006)

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constraints on how the business is funded in the first place, the subject of Principle Three. Principle Three specifies the responsibilities of each member with regard to funding that lead to the voting rights discussed in Principle One.

a)

Principle One: Member Governance Cooperatives are democratically controlled by their members. Members elect representatives from among the membership, accountable to the membership, on the basis of one member, one vote.

In the nascent United States suffrage was limited to property owners: one vote to each person who owned real estate. Corporate suffrage today, the voting rights associated with stock, is limited to stockholders, one vote to each share of stock. In 1870 the Fifteenth Amendment to the United States Constitution granted voting rights regardless of race. In 1920 the Nineteenth Amendment granted voting rights to women. The Voting Rights Act of 1965 effectively defeated the Jim Crow laws of mostly southern states that had prevented minorities, predominantly black, from voting. In 1971 the Twenty-sixth Amendment lowered the voting age nation wide to eighteen. Political enfranchisement has evolved in fits and starts the world over, but it has consistently moved toward a more inclusive, more widely represented citizenry. In the United States, it has only recently approached one citizen, one vote. The march toward wider enfranchisement in the political arena has not been accompanied by wider or more equal enfranchisement in the corporate arena. Shareholders do not get a single vote each; rather, they get a single vote for each share of stock they own. Had it followed this model, the United States would have become an oligarchy with the largest property holders controlling election outcomes through the superior power or their vote. There is a rational behind the corporate mode of voting rights. Each share of stock represents capital risked by an investor, and greater amounts of risked capital should entail greater influence in how that capital is put to use. Cooperatives are funded differently from corporations. There is a single buy-in price for member-owners and each thus contributes the same amount of capital. The objective of this mode of funding is member democratic control: one member, one vote. Generally speaking cooperatives operate as representative democracies. Members elect a board of directors from within the membership, and the board of directors is responsible for executive oversight and management/principle alignment. They may operate democratically in 23358466

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other contexts as well, but this mode of election of the board of directors applies to all types of cooperatives and forms the key link between member-owners and management.

b)

Principle Two: Member Benefits Surplus revenues, business proceeds remaining after a cooperative performs its service to its membership, are to be distributed to members according to their participation in the cooperative's economic success.

As mentioned earlier, the purpose of a corporation is profit whereas the purpose of a cooperative is service. To underscore this key difference, cooperatives traditionally speak of surplus revenues rather than profits, but both refer to net business proceeds, or income over expenses and funds retained for reinvestment. Cooperatives return surplus revenues to members proportionate to their use of, or economic participation in, the business. In contrast, corporations return profits to investors proportionate to their share of ownership. For a member to benefit from their member-ownership in a cooperative they must be active participants. A shareholder in a corporation can be passive and yet benefit economically from their ownership. What does it mean to distribute surplus revenues based on economic participation in a business? Consumer cooperatives often distribute to their members a dividend at the end of the fiscal year. This dividend is based on the amount of business they conduct with the business as a percentage of surplus revenues. For example, if a member's transactions represent 1% of gross revenues, at the end of the year they receive 1% of net, or surplus revenues. Other cooperatives discount member transactions by a specific percentage of the price charged to nonmembers, and perhaps issue special dividends to members on lucrative years, again based on participation. Employee cooperatives in contrast might distribute surplus funds in a manner similar to that of partnerships: based on a combination of factors such as position and hours worked. This subtle but pivotal shift in reward structure cascades throughout the cooperative business model affecting involvement, motivation and outcomes. Where once profit, the passive income of the rentier3, was the purpose of corporate business, the new purpose, that of cooperative business, is service and involvement. Indeed this may be one of the cultural aspects of cooperatives that prevent their widespread use. Americans, regardless of income, when polled on their future economic prospects report that they expect to be wealthy as they progress in their lives. This belief affects their position 3 rentier – a person living on passive income from property or investments.

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on social issues such as estate taxes. Regardless of whether or not they fully understand the mechanics of cooperatives, no one thinks of cooperatives as a way to become wealthy and enter the class of the rentier. Hence, they do not align with the life expectations of the typical American. Surplus funds in a cooperative explicitly serve the economic interests of member-owners. Surplus revenues do not leach out of the businesses to serve the interests of remote shareholders, but are either retained for businesses development or redistributed to the membership. Cooperatives thereby eliminate the overhead associated with the perpetual repayment of investors for the use of their money and prevent the development of oligarchy. This effect operates at the level of the business, preventing any small group of investors from vastly surpassing the others, and if the cooperative business model were employed more widely, this effect would also be felt in society at large, as fewer citizens would be in a position to vastly surpass the others. The second and third cooperative principles are intimately linked. Surplus revenues are to be distributed to members according to their participation in their cooperative's economic success, not according to their percentage of equity ownership. This is fair because each member owns an equal share of their cooperative. Hence, the third cooperative principle makes the second equitable.

c)

Principle Three: Member Ownership Cooperatives are funded and hence owned by their members. Capital raised from outside the membership must be done so in a manner consistent with self-determination.

Where the second principle governs the mode of distribution of business revenues, funds that come out of the business, this principle governs the mode in which funds flow into the business. In this respect these principles are reciprocal, the conditions of one affecting the conditions of the other. Since according to the second principle surplus revenues are to be distributed to members rather than external investors, investment capital must come from the members themselves, or they must be raised in a manner consistent with the self-determination of the cooperative. Self-determination is the right of members to control the business; it is conveyed exclusively to them by way of ownership. In this respect this principle, Member Ownership, is the reciprocal of the first principle, Member Governance. In order to retain rights of self23358466

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determination, investment capital when raised from outside the membership must not confer voting rights. This prohibits cooperatives from offering common stock, stock with voting rights, to non-members and encourages instead financial instruments such as preferred stock which confer no voting rights and specify a rate of return. Member ownership as a cooperative principle has a specific lineage back to the 1844 principles of the Rochdale Society. The original principle was “Payment of limited interest on capital.” In 1966 it was modified to “Limited return on equity” and then to “Autonomy and independence” in 1995. (See Appendix 1) The objective, then as today, was to promote a human centered mode of production: labor using capital rather than capital, or its owners, using labor.

1.2. Types of Cooperatives There are three types of business cooperatives: consumer owned, producer owned and employee owned. They are defined by the relationship of their member-owners to the cooperative. Consumer cooperatives are owned by the consumers of their products or services. Producer cooperatives are owned by producers who jointly market, distribute and sell their products through them. Employee cooperatives are owned by their employees. Each has a characteristic influence in the way it aligns the interests of its constituents. Cooperative literature commonly lists additional types of cooperatives including financial or service cooperatives; however, these can be distilled into one of the types mentioned above. Financial cooperatives—credit unions—are consumer owned cooperative banks. Service cooperatives are categorized, like all business cooperatives, according to whether its owners are its consumers, its employees, or producers of the products that it in turn markets and sells. There is a fourth type of cooperative which is not a business, but rather a legal construct for the joint ownership of property. They are called property or housing cooperatives. They account for indivisible property in the same manner as business cooperatives, and operate according to many of the same principles, including self-determination and democratic member control, but since they are not businesses they are not discussed in this essay.

a) Consumer Cooperatives Consumer cooperatives are started and owned by groups of individuals for any of several purposes. One is to provide for themselves a service or product which would otherwise be

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wholly unavailable or available under less than advantageous conditions. Examples include grocery cooperatives and utility cooperatives which provide electricity or gas service. Consumer cooperatives often get their start when groups of individuals seek better prices on a specific product or product category. Recreational Equipment Incorporated, the largest consumer owned cooperative in the United States, was founded in 1938 by mountaineers in the Northwest looking for reasonable prices on quality gear. Control over sourcing is another motivator behind consumer cooperatives. Grocery and produce cooperatives focus on organic, natural and local foods. Where large chain grocers relegate this category to a back corner of the store and where they are unwilling to commit to sourcing fresh, seasonal and local produce, natural grocery cooperatives thrive.

b) Producer Cooperatives Producer cooperatives are owned by producers who unite to co-market, co-brand and distribute their products, which might otherwise be generic commodity products indistinguishable from their competitors'. Land-O-Lakes and Organic Valley are examples of well known producer cooperatives. Organic Valley by blending the high-quality products of many separate dairy operations produces a consistently high-quality product which, because of its consistency and large scale quality control, sets its product apart even from other organic dairy producers. Members tend also to pool purchases through the cooperative, thus producer owned cooperatives tend to also serve their members in a manner similar to that of consumer cooperatives. Members of producer cooperatives may not be individuals, but rather other businesses. Each member company exercises a single vote in the cooperative which thus remains true to the first principle, Member Governance. Family farmers who have incorporated themselves for the usual purposes associated with liability protection and taxes, and then combine to form a producer cooperative, are an example of a cooperative of incorporated businesses rather than individuals. Likewise, True Value Hardware is a cooperative composed of retailers, each of which is independently incorporated and owned.

c) Employee Cooperatives Employee cooperatives are started by individuals who unite to build a business. In this case, the service provided by the cooperative is its members' livelihood. Hence, as the purpose of any cooperative is service to its members, and as employees' purpose in work is to earn a 23358466

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living, employee cooperatives are motivated by the profitable operation of the business. In an employee owned cooperative, members' interests as employees are aligned with their interests as owners by virtue of the relationship between members, employees, and owners: they are all three one in the same. For-profit businesses strive to align the interests of their employees with the interests of their investors through, for example, employee stock option grants and employee stock purchase programs. Management gurus and human resource managers alike consider these strategies among the best for management and workforce motivation. However, they come at a real bottom-line cost to non-cooperative, for-profit businesses: they dilute stock values. While the investing public purchases stock and options at market prices, employees and executives purchase at a discount through these programs, or receive stock and options without paying as a reward for achieving goals. Consequently, employees benefiting from these programs become equal owners on a per share basis after having contributed an unequal amount of capital. The more extensive the stock giveaway, the greater the number of shares with a claim on the company's assets and profits. Thus, efforts to align the interests of employees and owners ultimately and ironically generate tension. To underscore this point, consider the high-flying dot-com era at the turn of the twenty-first century when these programs were generous and ubiquitous. During the run up in the stock market, few complained because everyone made money, at least on paper. Once the market broke, however, criticism from investors and others became widespread. Economists and large institutional investors continue to warn against excessive executive compensation via stock and options grants. A great deal of business literature is devoted to the topic of business success through motivating employees to act as if they were owners of businesses. This literature speaks of engendering an entrepreneurial spirit; it encourages management to be open to the ideas of front line staff. Some of it is useful and inspiring, the rest is manipulative and base. One way to motivate employees to act as if they were owners—the most direct and straightforward way—is to make them owners. Moreover, employee owned cooperatives render unions redundant. Like all cooperatives, employee cooperatives are equally owned by their members: employees. Initial capital investments to start any business are often substantial, thus employee cooperatives often start as a partnerships between a few individuals with available financial resources who invite those they hire to buy into the business over time according to a specified schedule and set of policies. The objective is for all owners to be at investment parity with reference to each other, so that they can equally and equitably share in decisions and surplus 23358466

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revenues. When vested employee owner-members leave the cooperative they are likewise bought out by the remaining members according to a specified schedule and set of policies. Employee cooperatives share some features with professional partnerships such as law or accounting practices. As with partnerships, employee cooperatives use accounting techniques to determine the buy-in price for new employee-members. As with cooperatives, partners share in the governance of their partnership. In most cases both partners and employee-members are compensated according to their contribution to the company's success and its overall performance. Yet partnerships and cooperatives are not the same. In a cooperative any employee is eligible to become a member-owner, whereas in a partnership the only individuals eligible to become partners are the professionals, not those who are considered support staff. Cooperatives adhere to the one member, one vote principle, whereas partnerships are free to allocate executive power as they see fit, thus senior partners often maintain control.

1.3. Cooperative Consequences Cooperatives are defined by their purpose of service rather than profit, and by the three cooperative principles of Member Governance, Member Benefits and Member Ownership. This alignment of purpose and principle necessarily and structurally make cooperatives more equitable for their constituents than corporations. The following is a brief, non-exhaustive survey of consequences of this alignment.

a) Social Conscience Cooperatives tend to operate with a social conscience as a consequence of several factors: they eliminate investors who have no other interest in the company other than investment returns, they align the interests of their constituents, and they operate from a paradigm of multiple bottom lines. This is a substantive, structural difference between cooperatives and corporations. Power utility cooperatives, for example, avoid polluting the communities they serve whereas profit-motivated power utilities subject the environment to their bottom line when they are able to avoid legal and financial liability. Grocery cooperatives, partly as an extension of their typical focus on organic foods, endorse ecologically sound agricultural practices. The idea of multiple bottom lines, an idea which has its roots in ecological economics,4 in which a businesses recognizes more than the imperative to return profits to 4 http://en.wikipedia.org/wiki/Ecological_economics

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investors, is not unique to cooperatives, yet it is served better by cooperatives than other modes of businesses.

b) Financing In raising capital cooperatives are limited to methods that do not jeopardize the the first and third principles, Member Governance and Member Ownership. This prohibits cooperatives from offering stock with voting rights (common stock) to non-members. Cooperatives typically raise capital from members directly and through borrowing externally. Cooperatives have issued preferred stock to non-members, since it does not jeopardize cooperative principles: preferred shares confer no voting rights. Preferred stock is so called because it carries certain rights before those of common stock. In the event of a business liquidation, preferred shares receive proceeds from the liquidation before common shares. Also, preferred shares are paid dividends before common shares, and at a specified rate. Note, incidentally, the lineage of the principle of Member Ownership: its original formulation was “payment of limited interest on capital.” This is a property of preferred shares which pay dividends at a specified rate. Common shares on the other hand are not limited in this regard. This aspect of cooperatives often make them inappropriate for starting risky, large-scale business ventures that require a great deal of start-up capital. There are large cooperatives that operate nationally and internationally, but they have typically grown incrementally from modest beginnings. Energy cooperatives, another example, while substantial business ventures, are able to raise large amounts of initial capital through issuing bonds, since energy utilities, cooperative or otherwise, are considered low-risk undertakings.

Cooperatives seek to increase and diversify ownership, specifically the ownership of the means of production, and to make it more widespread on a more equitable basis within a context of ecological economics and the capitalist system.

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2. Appendix 1: The Evolution of Cooperative Principles There are seven cooperative principles which can be traced back to the principles of the Rochdale Society of Equitable Pioneers, founded in 1844 in Rochdale, England. Contemporary cooperatives often adopt the cooperative principles defined by the International Cooperative Alliance (ICA), which are based on the Rochdale principles. With Principle One, Member Governance, I deliberately reintroduce the qualifier of one vote to each member to clearly break with the corporate practice of one vote to each share of stock. Principle Two, Member Benefits, invokes the provision that the economic benefits of the business should accrue to the members in accordance with their participation. Principle Three, Member Ownership, links Principles One and Two together, establishing the right of governance and self-determination, and the privileges of member benefits. Some of the principles I leave out can be assumed to apply in all situations. Political and religious neutrality, for instance, were codified into law in the United States by the Civil Rights Act of 1964, and are now commonly accepted social mores. Cooperation among cooperatives is perhaps a laudable goal, yet the lack of its effective practice should not be cause for denying a company its status as a cooperative. Moreover, as the cooperative business model becomes more common, it is easy to envision a time when some degree of competition among cooperatives is the norm. Already today consumers often have a choice, for example, between grocery cooperatives. Concern for community should perhaps be a universal goal, but without knowledge of the situation in which a cooperative finds itself, it is difficult to specify what it should mean in practice; better to leave its manifestation to natural outcomes resulting from the alignment of the interests of constituents. As cooperatives and the larger economy evolve, it is preferable to identify only those things as principles that will remain essential and withstand the test of time. The table is ordered so that the lineage of each principle can be seen at a glance.

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Original Rochdale Principles (1844)

International Cooperative Alliance (1937)

International Cooperative Alliance (1966)

International Cooperative Alliance (1995)

1 Democratic control: one man, one vote

Democratic control: one man, one vote

Democratic governance

Democratic member control

Member Governance

2 Distribution of surpluses in proportion to trade

Distribution of the Surplus belongs to surplus to the members members in proportion to their transactions

Member economic participation

Member Benefits

3 Payment of limited interest on capital

Limited interest on capital

Limited return on equity

Autonomy and independence

Member Ownership

4 Open membership

Open membership

Open, voluntary membership

Voluntary and open membership

5 Promotion of education

Promotion of education

Education of members Education, training and public in and information cooperative principles

6

Cooperation between cooperatives

7

Core Cooperative Principles (2006, Riehle)

Cooperation among cooperatives Concern for community

6 Political and religious Political and religious neutrality neutrality 7 Cash trading: no extended credit

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3. Appendix 2: Corporation, Partnership, Cooperative, Nonprofit This table provides a comparative overview of the main types of private sector enterprises. As a high-level overview, and for the sake of brevity, it in some cases merely indicates tendencies and does not try to exhaustively account for differences within a category. In other words, not all corporations or partnerships would agree, for instance, that their only or even primary purpose is profit. Further, due to issue complexities the table makes no reference to differences between cooperatives and for-profit corporations in the context of, for example, ownership/management linkage. Non-profit organizations are private-sector organizations such as universities or hospitals which operate to preform a service. Non-profits may engage in commerce, but they are not businesses, and they are legally restricted in their business activities and in their handling of business proceeds. Without an income-generating endowment, non-profits are often dependent organizations that rely on the generosity of benefactors to donate capital and operating funds. While cooperatives, like non-profits, exist to perform a service to their members, and sometimes also to the public at large, unlike non-profits they are self-sustaining businesses without outside benefactors. corporation

purpose: investor profit sustenance: self-sustaining ownership: investors management: hired professionals governance model: dictocratic hierarchy source of capital: shareholders basis of distribution percent of equity of proceeds: ownership target consumers: external consumers sector: private

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partnership

cooperative

non-profit

partner profit

member service

community service

self-sustaining

self-sustaining

external benefactors; endowment

partners

members

(not applicable)

partners

members or hired professionals

hired professionals

contractual democracy

constitutional democracy

constitutional hierarchy

partner-owners

member-owners

external benefactors

contribution

participation

(not applicable)

external consumers

members; external consumers

charter dependent; community at large

private

private

private, i.e., non-governmental

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4. Appendix 3: Cooperatives In Business Today The chard below is a sampling of cooperatives operating today. It is by no means an exhaustive list. Some of these business emphasize the cooperative aspect of their operation, others are widely recognized business icons whose status as cooperatives are little known. name

type of co-op

primary business

web site

Agriliance

producer

agricultural/food

http://www.agriliance.com/

AlaskaUSA

consumer

banking

http://www.alaskausa.org/

BECU

consumer

banking

http://www.becu.org/

Cenex

producer

energy

http://www.cenex.com/

CHS

producer

energy/agricultural

http://www.chsinc.com/

Co-opportunity

consumer

grocer

http://www.coopportunity.com/

Croplan Genetics

producer

agricultural/food

http://www.croplangenetics.com/

CUNA Mutual Group

consumer

insurance

http://www.cunamutual.com/

First Tech

consumer

banking

http://firsttechcu.com/

Group Health Cooperative

consumer

healthcare

http://www.ghc.org/

Land O'Lakes

producer

agricultural/food

http://landolakesinc.com/

Madison Market

consumer

grocer

http://madisonmarket.coop/

Mondragon

employee

conglomerate

http://www.mcc.es/

books & coffee

http://mondragon.ca/

Mondragon Bookstore & Coffeehouse employee Mountain Equipment Co-op

consumer

recreational equipment http://www.mec.ca/

National Cooperative Bank

consumer

banking

http://www.ncb.coop/

Nationwide Mutual Insurance

consumer

insurance

http://www.nationwide.com/

Ocean Spray

producer

agricultural/food

http://www.oceanspray.com/

Organic Valley

producer

agricultural/food

http://organicvalley.coop/

Pangaea Organica

hybrid

food & drink

http://pangaea.coop/

PCC Natural Markets

consumer

grocer

http://www.pccnaturalmarkets.com/

REI

consumer

recreational equipment http://rei.com/

Seminary Co-op Bookstores

consumer

books

http://semcoop.booksense.com/

South Mountain Company

employee

builders

http://www.somoco.com/

Sunkist

producer

agricultural/food

http://www.sunkist.com/

Tech

consumer

technology

http://tech.coop/

True Value Hardware

producer

hardware

http://www.truevaluecompany.com /

Web Collective, Inc.

employee

technology

http://www.webcollective.coop/

Welch’s

producer

agricultural/food

http://welchs.com/

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5. Appendix 5: Resources for Cooperatives Co-op America http://coopamerica.org/ Euro Coop http://www.eurocoop.org/ International Cooperative Alliance http://www.ica.coop/ National Cooperative Business Association http://ncba.coop/ National Society of Accountants for Cooperatives http://www.nsacoop.org/ Northwest Cooperative Development Center http://www.nwcdc.coop/ University of Wisconsin Center for Cooperatives http://www.uwcc.wisc.edu/

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