Non-member contracts expose cooperatives

New Zealand cooperatives are creating a dangerous precedent when they offer contracts that allow non-members to participate. The situation often arises where a cooperative perceives a threat to...

New Zealand cooperatives are creating a dangerous precedent when they offer contracts that allow non-members to participate. The situation often arises where a cooperative perceives a threat to its membership by investor-owned organisations providing the same amenity.

Investor-owned organisations of course don’t require contributions of capital from parties they trade with.

Hence offering non-member contracts is one way for cooperatives to compete directly for business, and also perhaps to fully utilise the cooperative’s assets. Indeed it is often deemed a pragmatic response.

However, the essential point is that these non-member contract arrangements do not require a contribution of capital as for normal cooperative members.

The issue is how this practice exposes the cooperative, and whether in the end this is a constructive strategy.

Some of the same cooperative organisations offering non-member contracts have also moved away from nominal value shares. Instead, they reflect the value of the cooperative in the value of member shares. This too has been a move designed to “modernise” the cooperative, and in some cases to reflect the value of additional investment in activities beyond the core business of the cooperative.

The underlying principle in valuing any investment is that it should somehow reflect the expected dividends to investors. Cooperative members should be most interested in what part of their payout or rebate is actually a dividend from the cooperative’s investment in various non-core activities, versus what they would receive as members of a cooperative without that additional complexity.

By offering contracts to non-members those cooperatives following this strategy essentially tell members that the actual dividend on their whole cooperative share value is the difference between the contract price and the payout (or rebate) to members. It is this ready comparison which exposes the cooperative to criticism in the first instance.

For supplier cooperatives, such as dairy companies, if the gap between members’ payout and contract price is high (i.e. a less competitive contract price), it suggests a large dividend to members – which would tend to justify members having contributed capital. However, that same poor contract price then probably won’t be competitive with what investor-owned organisations are offering.

BALANCE TO BE STRUCK
Hence there’s a balance to be struck between keeping members happy and still competing against other firms in the contract market.

In very rough terms, take for example a difference between non-member contract price and cooperative member price of $0.20 per unit. Assuming the cooperative member could achieve a return on their invested capital of 12%, this difference is equivalent to a $0.20 dividend on a $2.40 investment. Hence this would suggest it would be sensible to remain a cooperative member only if the required cooperative share price were less than $2.40 per unit.

Yet even if a cooperative is successful in contracting business from non-members who would otherwise have gone to a competitor, what then? It will likely also have lost some of its own membership to non-member contracts.

Part of the problem is that by its very nature, a cooperative can’t afford too high a proportion of non-member business without undermining its own access to member capital.

Practically, cooperatives therefore have to limit the proportion of non-member contracts available. But even with those limits, the existence of non-member contracts complicates the attribution of value between members and non-members, which is generally to the disadvantage of members.

There is also an increased risk of non-member contracts facilitating wealth transfer between cooperative members, particularly in modern cooperatives. The recent devaluation of one New Zealand cooperative’s share price has highlighted this. Those members who took advantage of the non-member contract opportunity and took their capital out of the cooperative at a high share value are now able to buy back into the cooperative at its current low value.

The success of that share price devaluation in terms of returning membership might be hailed as a success by some, but it is most definitely a failure for the loyal cooperative members.

In the end, what determines the outcome for a cooperative is whether the cooperative is actually efficient in its use of members’ capital. If the cooperative is efficient, then this must be self-evident in its ability to consistently return a higher payout or rebate to members, relative to competitors, above and beyond the cost of the capital contributed by members.

In this context, it is difficult to justify a cooperative strategy that involves offering contracts to non-members. Its inherent contradictions, and its basic failure to address the core purpose of a cooperative in providing an efficient amenity for members should be reason enough to dismiss it.

Ultimately, it is up to the members to demand that management remain focused on the underlying efficiency of the core cooperative business.

— from the August 2008 Cooperatives News

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