Congress of the United States

House of Representatives

Committee on Agriculture

HEARING

Hearing on New Generation Cooperatives

# Statement of Thomas C. Dorr

Under Secretary for Rural Development

United States Department of Agriculture

October 16, 2003

Thank you Mr. Chairman.

Mr. Chairman, Members of the Committee, on behalf of the President and
Secretary Veneman, I appreciate the opportunity to come before this
committee to discuss ways in which the Federal government can help
farmers and other rural residents increase their incomes and improve
their quality of life through more effective cooperative organizations.

It goes without saying that we are living in some of the most
challenging times in our nation's history and foremost \-- next to
homeland security \-- our rural Americans desire increased economic
opportunities and an improved quality of life. Our realization that this
is important to our constituents is critical to succeeding at rural
economic development.

This is the foundation on which President Bush unveiled his Jobs and
Economic Growth Plan. The President understands that a key element to
economic success in rural America is allowing our farmers and ranchers
to retain more of their earnings. By reducing the tax burdens on
Americans \-- farmers and ranchers and their families will have greater
opportunity to invest in their own future.

[USDA Rural Development]{.underline}

At USDA Rural Development, our vision is to serve rural America. The
Rural Development mission area provides financial and technical
assistance to foster growth in existing and new opportunities for
business development, home ownership, and critical community and
technology infrastructure. The return on this assistance is the economic
growth realized through our direct investment and, more importantly,
that stimulated by private market leveraged investment.

It is with this vision in mind that Rural Development's mission has been
designed to deliver programs that will support our two goals: 1)
increasing economic opportunity; and 2) improving the quality of life of
rural residents.

In order to properly address these mission goals, it is important to
recognize the changes that have occurred throughout rural America and
within USDA. With this understanding and a renewed sense of purpose,
Rural Development must utilize the tools and resources at hand to
support new economic growth in rural America.

[Traditional Cooperatives]{.underline}

For over 100 years, cooperatives have organized and operated according
to a relatively static model. Equity financing and control were the
responsibility of the member-patrons. Earnings were allocated to patrons
on the basis of use. It was a corporate vehicle designed to provide
access to beneficial interests generated by members. It was not designed
to be an investment tool. This model has heretofore served rural America
well, and has provided many important benefits to farmers and other
rural residents.

Today, cooperatives, like much of rural America, face serious
challenges. The companies they buy from and sell to are becoming larger,
fewer in number, and more sophisticated at reducing costs and improving
returns within their industry sector, which can impact other
participants in these industries. Sweeping innovations in areas such as
biotechnology, information services, transportation, and global sourcing
have made many cooperative facilities and equipment obsolete. Also,
governance structures and the resulting transparency have helped to make
non-cooperative enterprises more responsive to change.

It is more evident than ever that global economic challenges are here to
stay. Many foreign investors are using technology and lower labor costs
to become lower cost producers of the same products we produce in rural
areas. In many cases, they are becoming competitors rather than
customers. One of our top initiatives at Rural Development is to look at
the effectiveness of the current cooperative model for assisting farmers
and ranchers in this increasingly competitive environment.

The traditional model has had a history of change and responsiveness.
However, cooperatives are presently struggling to convert the equity and
dreams of many rural Americans into the kinds of economic opportunity
they need and desire. As Under Secretary, I am looking at ways to
increase the profitability of producer cooperatives. I am also focusing
our efforts on how the cooperative model can utilize local equity to
stimulate economic stability and growth that will be beneficial to all
rural Americans.

Given the opportunity, Americans will create strength through investment
in their own economic future. I also believe it is our role at Rural
Development to support these efforts in order to maximize the effect on
local economies.

But first we must ask ourselves how we might keep rural America
competitive? How do we ensure a strong rural economy? Agriculture
remains an important component in many rural areas, and I firmly believe
that American agriculture is at a crucial crossroad. When we look at
what drives our local and regional rural economies, along with our
agricultural industry, and in the context of global markets \-- we must
accept that in the future, the agriculture industry will require new
strategies and an openness to adapting to new environments.

I believe the key for farmers, cooperative businesses, and rural areas
to remain competitive is our ability to grasp and utilize the power of
technology. The Internet, and the technology that has flowed from it,
has resulted in a freer flow of capital and easy access to knowledge
across borders. It has made it possible for competition to develop and
build production and value-added systems unconstrained by yesterday's
foundations. It has served to create international and non-traditional
competitive pressures.

Embracing the benefits of technology will not alone provide our
producers and business ventures the competitive edge needed in today's
markets. We need to look at agriculture as a business, and in America
that is often easier said than done.

The global economic realities that we face force us to understand and
accept that while we hold dear the attributes of the traditional ways of
life -- we have a responsibility to our farm families and the future of
American agriculture to paint a new picture \-- one that allows us to
respect our traditions and expand our tolerance and acceptance of new
and innovative approaches to support our farmers and ranchers and the
rural communities in which they live. It is time we paint a new portrait
for the 21^st^ Century.

Many suggest that the limited off-farm investment of farmers and
ranchers means they don't have enough capital to invest. I don't agree.

Farmers have an enormous asset base -- their land -- that can provide
investment capital. Instead of just rolling land assets into the
relatively low returns from farming, producers could move some of that
capital to other areas. If done effectively, this would simultaneously
raise farm incomes, enable more farmers to stay on the farm, and promote
rural growth.

Many farmers and ranchers have assets that can be used to make major
investments in businesses that ultimately can exact a strong return on
their investment. If the business plan is sound and convincing --
[and]{.underline} if farmers understand the untapped potential of their
capital, I suspect they will invest.

We are challenged today to develop strategies for rural America that are
effective and programs that make sense. We, in the public sector, simply
have to do a better job. We have bound ourselves up with procedures,
regulations, and approaches that reflect a rural America of the 1950s,
using concepts from the 1930s.

We must work with our farmers and ranchers to help identify
opportunities to use the untapped equity in their land to make serious
investments in their local communities. This approach doesn't mean
encouraging producers to leave farming or to take senseless risks. It's
just the opposite. By increasing their return on investment -- the value
of their land -- their ability to stay in farming and ranching can be
enhanced, not lessened. That age-old solution of how to protect the
family farm comes, as we have always known, in diversification.

But utilization of land equity as a form of capital investment must be
accompanied by an evolution in how cooperatives support producers and
value-added ventures. Cooperatives must be prepared to sail in
relatively unchartered waters to bring the maximum benefit to producers
who look to them for economic opportunities and security.

Patron cooperatives were designed to provide members a beneficial
interest. The benefit they received as a patron member was either a
cheaper price if they bought something from or through the cooperative,
or a better price if they sold something to the cooperative. Any
earnings derived from patron cooperative operations had to be returned
to the members as cash patronage dividends or additional equity retained
by the cooperative.

The effect was two-fold. Cooperatives had to commit most of their earned
income to patronage dividends. Second, they have never been able to
become investment vehicles. The result was that the primary way for
either patron or federated coops to grow their business was through the
use of debt. That worked reasonably well when competition for
traditional U.S. agricultural commodities was limited and U.S.
production agriculture was in a substantial growth mode.

There were occasions when local patron cooperatives, even in good times,
made poor business decisions and were unable to sustain themselves.
Usually these resulted in mergers with neighboring patron cooperatives.
As a federated cooperative, Farmland went through these difficulties at
least twice before their present bankruptcy.

As a cooperative business venture, the patron cooperative is the
traditional institutional vehicle. Its purpose is well intended. The
cooperative, as an institution, however, is struggling to convert the
equity and dreams of many rural Americans and agricultural producers
into the kinds of economic opportunity they need and desire.

We must change that. Rural Development should be at the focal point of
this discussion and we intend to be.

To diversify farmer investment in businesses that add value to the
products that rural Americans produce through processing, distribution,
and perhaps even branding is paramount. This will allow producers to
capture some of the dollars now going to the middlemen between producers
and consumers. It creates jobs, payrolls, and tax revenues that support
the entire community.

## 

## New Generation Cooperatives

If we begin to look at cooperatives with the idea that they can serve
not only as a form of security, an outlet for farm production, but also
as investment vehicles that pay dividends to their members \-- one that
is focused on creating an acceptable return on investment \-- we will
have gone a long way to strengthening rural America. The "new
generation" cooperative model is a step forward toward meeting this
objective.

Let me make it clear what we at Rural Development mean by a "new
generation" cooperative. Some people use the term to include virtually
any cooperative that adds value to agricultural production through
processing and merchandising. We expand the term to refer to
cooperatives that not only engage in value-added processing and
merchandising, but also adhere to a fairly specific set of
characteristics that provide producer-owners with economic incentives to
patronize and invest in them.

A "new generation\" cooperative will usually have several organizational
and operational traits that include:

a.  The membership is closed.

b.  The amount of product it will accept from a producer is limited.

c.  The investment of a member is tied to patronage rights. (I.e., in a
    traditional cooperative, each new member usually makes the same,
    relatively small, initial investment.)

d.  The patronage rights are transferable at market value. (I.e., in a
    traditional cooperative, equity is only redeemed at the discretion
    of the board of directors. It is usually redeemed years after it is
    issued and rarely for more than face value.)

"New generation" cooperatives link producer equity contributions and
product delivery rights. The delivery arrangement is more than a right,
it is also an obligation. So if the member doesn't raise enough corn,
for example, to meet the delivery commitment, he or she must purchase
product on the open market to fulfill the contract. The risks of
fluctuations in production are borne by the individual producer-members,
not the cooperative.

In a "new generation" cooperative, the members are free to sell their
interest in the cooperative and the linked delivery rights to other
producers at whatever price another producer is willing to pay.

[Building on Today's New Generation Cooperatives]{.underline}

While USDA Rural Development encourages and works with "new generation"
cooperatives, we aren't convinced that they are the only improvement on
the traditional model that can and should be developed. We must build on
today's "new generation" cooperative model by developing strategies and
structures that will overcome obstacles, such as tax law and governance
structures, still limiting cooperative success, most notably the
difficulty cooperatives have in attracting sufficient equity capital.
These approaches should be directed at encouraging greater investment by
producers and opening avenues for investment by non-producers.

Farmers also have the resources to make these investments. *Agricultural
Statistics 2003*, published by USDA's National Agricultural Statistics
Service, reports that farm real estate in this country has an aggregate
value of approximately \$1.1 trillion (p. IX-8). Outstanding debt on
that farm real estate totals only about \$110 billion (p. X-9), only 10
percent of its value.

Our challenge is to help producers develop cooperative structures that
will generate a return on the untapped value of their real estate
sufficiently large and safe enough to entice them to invest in off-farm
operations.

There is nothing magical about organizing a business on a cooperative
basis. But if the business plan is strong and the implementation of that
plan is focused and visionary, farmers and other rural Americans can
expect a strong return on their investment.

There is another consideration. While many producers have substantial
assets that are minimally leveraged, their numbers are declining. The
amount of funds needed to finance a potentially lucrative
agriculture-related business may be more than potential member-patrons
can, or should prudently, invest. Steps should be taken to make
investing in a cooperative attractive to local non-producers, and, when
advantageous to the producers and the community, non-producer outside
investing interests.

Impediments to non-producer equity are found in Federal and State laws
enacted several decades ago. If non-producer outsiders are to invest in
a cooperative, they may well expect to have a voice in its affairs and
the opportunity to earn a return on their investment commensurate with
the success of the cooperative. Good governance and increased
transparency could also help improve the cooperative model.

Modifying rules could give cooperatives some of the flexibility enjoyed
by limited liability companies. Cooperatives could be provided some
options to pursue outside equity if the producer members believe doing
so would strengthen their association. Such legislative reform must be
done carefully and with much thought.

Non-producer outside investors will also not want to have their money
locked up in a cooperative. Easy transferability of investment vehicles
will need to be included in any package of incentives aimed at
non-producer equity.

[USDA Rural Development's Role]{.underline}

The public sector, and those of us in Rural Development at USDA in
particular, must adopt new approaches in providing our services to rural
America. Today, Rural Development is developing a multi-dimensional
program to strengthen cooperatives as part of a bigger overall
initiative to revitalize our rural economy and improve the quality of
life for our rural residents.

*Financial investment*. In Fiscal Year 2003, USDA Rural Development
placed nearly \$16 billion into rural America at a cost of only \$2.9
billion of discretionary budget authority. We invest in rural America
through a variety of direct loan, loan guarantee, and grant programs in
our 3 primary service areas \-- housing, utilities, and businesses and
cooperatives. I believe we do a good job of identifying worthy
recipients and distributing the funds. These programs play a major role
in sustaining our rural economy.

One area where Rural Development can do better than we have in the past
is in monitoring and evaluating the effectiveness of these various
efforts. We are developing tools to measure the return rural America
gets for each dollar expended under these programs and to identify
strengths and weaknesses in each initiative. In the future, we will be
in a better position to work with this Committee and others in the
Congress to explore possible changes in these programs that maximize the
impact of the moneys we administer.

*Financial assistance*. We have some exciting new tools to use in this
effort. For example, the Value-Added Producer Grant Program provides
planning money and working capital for independent producers and
producer groups to develop new value-added agricultural products. In
2001 and 2002, grants totaling \$57.5 million were awarded to 291
recipients in 43 states. An additional \$40 million is anticipated to be
awarded this year.

The 2002 Farm Bill added a new dimension to our value-added efforts, by
authorizing grants to establish Agricultural Innovation Centers. These
centers will provide technical and business development assistance to
producers and groups of producers, including cooperatives, who want to
develop and market value-added agricultural products. The centers will
be controlled by a board consisting primarily of representatives of the
largest general farm organizations and highest grossing commodities in
the State where the center is located.

On September 26, 2003, Secretary Veneman announced the awarding of
grants totaling \$10 million as start-up funding for 10 Agricultural
Innovation Centers. We have high expectations that these centers will
serve as incubators for new ideas, new products, and new strategies that
stimulate economic growth in rural America.

*Education and technical assistance*. Rural Development is more than a
source of funding, especially where cooperatives are involved. Our
technical assistance and research efforts are used throughout the
country by producers interested in developing new cooperatives and
making existing cooperatives better able to serve the needs of their
members.

We will be working harder to help improve business knowledge and skills
in rural America. Serious education on business strategies, finance,
marketing, and decision making will enable farmers, and business and
community leaders, to lead dynamic, creative cooperative businesses that
can succeed.

We in Rural Development need to make sure our efforts are focused on
recognizing challenges and using techniques that look to the future and
not the past. To achieve this goal, I am in the process of creating an
Outside Program Review to study the research and technical assistance
provided by our Cooperative Services area. Its purpose will be to
identify steps we can take to make sure our support of cooperatives is
provided as efficiently and effectively as possible.

[Conclusion]{.underline}

Mr. Chairman, let me offer a few concluding thoughts on where I think,
and hope, we are headed with regard to cooperatives in rural America.

I'm concerned about the long-term health of an agricultural system that
focuses only on production, especially the production of basic
commodities that are being grown at less cost in an increasing number of
countries around the world. Cooperatives offer a vehicle to allow
producers to turn their production into food, clothing, energy,
pharmaceuticals, and, in the future, other value-added products that may
not have even been imagined as yet.

To take advantage of these opportunities will require substantial new
investments of equity capital. Farmers can, and should be expected to,
invest in their own future. But steps should also be taken to facilitate
and encourage non-producer outside investors to be part of the
farmer-based cooperative businesses.

Creating new ways to invest equity capital in cooperatives may offer
more flexibility in the organization and operation of cooperatives.
While accomplishing this, these changes should not subvert the basic
cooperative principle that they exist primarily for the benefit of their
member-patrons and not non-producer outside investors.

Rural Development continues to work to ensure that both funding programs
and research and technical assistance efforts that meet the challenges
and seize the opportunities that lie ahead.

In addition, we look forward to working with Congress to encourage the
changes and new initiatives that are needed for cooperatives and other
rural entities to meet the challenges of the 21st Century.

Thank you for inviting me to be here today and I look forward to
answering any questions you may have.