United States

Department of

Agriculture

Rural Development

Rural BusinessCooperative Service

FIBS Research

Report 141

USDA

Shared-Sewices

Cooperatives
Abstract This report describes the general structure and operations of shared-services

cooperatives and discusses some of the benefits accorded to their owners.

This report will provide some insights for business people and public servants

interested in organizing a shared-services cooperative. It discusses how they

are organized and how they operate. This includes corporate structure, governance, and management. It also describes elements that promote the sucess

of shared-services cooperatives.

Key wotis: cooperatives, service, purchasing

Shared-Services Cooperatlves

Anthony C. Crooks

Karen J. Spatz

Marc Warman

RBS Research Report 141

Reviewed and approved for reprinting, May 1997
Executive

Summary

Rural Americans depend on community services provided by their schools,

hospitals, small businesses, churches, local governments, etc. These organizations ‘can often help lower their operating costs by obtaining needed services

and products through shared-services cooperatives. A shared-services cooperative is a business organization owned and controlled by private businesses

or public entities which become members of the cooperative to more economically purchase services and/or products. Members of shared-services cooperatives respond jointly to common problems. l

Purpose

This report describes the general structure and operations of shared-services

cooperatives and discusses some of the benefits accorded to their owners.

This report will provide some insights for business people and public servants

interested in organizing a shared-services cooperative. It discusses how they

are organized and how they operate. This includes corporate structure, governance, and management. It also describes elements that promote the success

of shared-services cooperatives.

Information for this report was gathered from in-depth personal interviews with

the managers of 19 shared-services cooperatives. Most of these associations

were incorporated as cooperative businesses. The rest were organized as

non-profit corporations that operated on a cooperative basis. Those organizations interviewed for this report are not identified, to maintain confidentiality.

Secondary sources of information used in this report were obtained from the

Cooperative Services program of USDA’s Rural Business-Cooperative Service;

National Cooperative Bank; National Cooperative Business Association; and

various cooperative development organizations.

Examples of Shared-Services Cooperatives

Examples of shared-services cooperatives include groups of employers who

formed alliances to buy health care insurance or to purchase health care services directly from hospitals and physicians. Another example is school districts organizing cooperatives to provide special education programs as well as

purchasing products (such as janitorial supplies) for individual school districts.

Hardware stores, restaurants, independent pharmacies, rural electric cooperatives, and natural food stores have formed shared-services cooperatives that

operate as wholesalers. A shared-services cooperative can serve virtually any

business enterprise.

l This report does not represent official policy of the U.S. Department of Agriculture, the

Internal Revenue Service, the U.S. Department of Treasury, or any other Government agency.

This publication is presented only to provide information to persons interested in cooperatives,

including the tax treatment of cooperatives.
Contents Highlights.. ....................................................

i

Purpose of Shared-Services Cooperatives ...........................2

Sructure and Organization ....................................... .3

Cooperative Operations ......................................... .6

Structural Alternatives .......................................... 11

Elements of Success ........................................... 12

Challenges.. ...............................................

..12

Some Additional Thoughts ...................................... .13

References...................................................14

ii
Rural communities are in danger of losing the important services provided by

hospitals, pharmacies, retail stores, utilities, school districts, restaurants, and

other establishments. The loss of services hurts the economic growth and viability of rural communities. Opportunities exist for them to keep or improve existing services. One way is through shared-services cooperatives which provide

services competitively and at a high standard of quality to rural communities.

A shared-services cooperative is a group of private businesses or public entities joining together to form a cooperative corporation. It provides one or more

services to enhance or increase the competitiveness of their operations. In

simplest terms, the shared-services cooperative provides services in response

to the specific needs of its member-owners. This makes the cooperative an

extension of each member’s own operation.

The goal of shared-services cooperatives is to buy or provide products and/or

services for their members at a cost less than if individual members were to

buy those products or services. The goal is not to generate a return on investment, but to capture savings through lower administrative costs, quantity purchasing discounts, and assured levels of business with vendors and suppliers.

By purchasing cooperatively, individual businesses or government entities can

increase the efficiency of their buying activities.

Three characteristics distinguish shared-services cooperatives from other business organizations. First, cooperatives are owned by the private businesses or

public entities that use it. Second, cooperatives are controlled by those who

own and use the business. Third, cooperatives operate to provide benefits to

their members as users, not as investors.

Most of these associations are legally organized as a cooperative or as a nonprofit corporation that operates on a cooperative basis. Each has a distinct

organizational structure. The chosen structure depends on the needs and

structure of its members, and State law. For example, in some States, public

entities or nonprofit corporations cannot form a cooperative business but must

organize jointly as a nonprofit corporation that operates like a cooperative.

Shared-services cooperatives provide a wide variety of services to members.

Some are specific to the business of members, such as providing special education classes for member school districts. Other services are more general,

such as providing management information services. A major function for

many shared-services cooperatives is buying products for members.

A number of factors contribute to the success of shared-services cooperatives.

These include staff; quality management; attention to member needs; and the

ability to be flexible, creative, and innovative.

Shared-services cooperatives also face a number of challenges such as “free

riders,” competition among members, and changing industry practices.

There are other short-term and less formal solutions to the problems facing

rural businesses and municipalities which can lead to the formation of a

shared-services cooperative. These include simple contractual arrangements

and networks.

. . . 111
Shared-Service Cooperatives

Anthony C. Crooks

Karen J. Spatz

Marc Warman*

Many rural communities across the United

States are in danger of losing the important services

provided by hospitals, pharmacies, retail stores,

utilities, school districts, restaurants, and other

establishments. This loss could be compounded by

lost jobs, lower family incomes, out-migration, and

eroded local tax bases.

On the other hand, opportunities abound for

many rural Americans. Towns and counties that

were once economically dependent on outside

industries can look inward to home-grown

resources for development. Rural communities can

empower themselves to keep existing or attract

new services to meet their needs. A growing rural

economy may offer jobs and help stem the exodus

from rural communities, as well as attract new people, new tax revenues, and new services. One measure of a healthy community is the quality and

range of services it provides to its residents.

Shared-services cooperatives are one means to

provide these services competitively and at a high

standard of quality to rural communities. Discount

chain stores located at a significant driving distance

can still attract “price-sensitive” customers away

from independent local businesses. But, by allowing independent businesses to purchase supplies at

prices closer to those paid by the discount chains,

shared-service cooperatives can help local businesses remain competitive.

Shared-services cooperatives can also provide

services otherwise unavailable to a community. For

example, certain medical services might not be pro-

* Authors are listed alphabetically. Senior authorship is shared among the three.

vided in an area were it not for the hospital cooperative formed by a group of rural hospitals.3 Office

equipment for the town hall might be too costly

were it not for the community services cooperative

organized by local municipalities to share the purchasing of equipment. The medical services and the

desk are both made available because shared-services cooperatives can purchase products and services for less than the combined costs of individual

businesses or municipalities buying for themselves.

Shared-services businesses organized as cooperatives have several structural and operational

characteristics that make them different from other

business types.

1) A shared-services cooperative is owned by

the private businesses or public entities that use it.

For example, a pharmacy shared-services cooperative is owned by the independent pharmacies that

purchase prescription drugs and/or over-thecounter products through it. An office supply cooperative is owned by the businesses that purchase

office products through it.

As owners of the cooperative, members are

responsible for the payment of fees and assessments, participation in the governance and operation of the cooperative, and use of its services.

Membership support is very important. A sharedservices cooperative cannot succeed without the

members’ continuous patronage.

2) A shared-services cooperative is controlled

by the private businesses or public entities that

own and use the business. The cooperative is con3 The specific examples used throughout this report

are from interviews with 19 shared-service cooperatives.
trolled by its member-owners through a board of

directors (elected democratically from among the

member-owners) and through participation in

membership meetings and committee work. The

board sets the overall operating policies for the

cooperative, approves the annual budget, oversees

its operation, and distributes the benefits derived

from use of the cooperative. The board also hires

professional management to handle the day-to-day

operations of the cooperative. The manager hires

needed staff and implements the policies of the

board.

3) A shared-services cooperative operates to

provide benefits to its members as users, not as

investors. While the goal is not to generate a return

on investment, operating budgets are developed so

expected income exceeds expected operating costs.

A shared-services cooperative, like any other business, needs to cover costs and generate an excess to

cover expansion and unforeseen emergencies.

Operations of shared-services cooperatives are

financed through capital provided by memberowners and debt capital. Ownership capital is

defined as the money a cooperative obtains without

having a legal obligation to repay it. Initial investments by members are part of that ownership caIjital. Debt capital is borrowed from financial institutions and the cooperative is legally liable to repay

it. Shared-services cooperatives generate income

through their fee structure. Part of the earnings

generated when income exceeds costs of operation

can be retained by the cooperative as ownership

capital. The rest is refunded to members based on

their use of, not investment in, the cooperative.

The purpose of this report is to present and

discuss shared-services cooperatives. These cooperatives are defined as a group of private businesses

or public entities that join to form an organization

which provides one or more services to enhance or

increase the competitiveness of members’ operations. The term “cooperative” is defined (for this

report) as an organization legally incorporated as a

cooperative or non-profit corporation that operates

on a cooperative basis (member-owned, membercontrol, and member-service oriented).4

While this report focuses mainly on smaller

shared-services cooperatives, it should be noted

that several large national cooperatives exist. These

cooperatives mostly provide wholesaling services

for retail groceries, hardware stores, and “fastfood” restaurants. There are also opportunities for

some smaller shared-services cooperatives to

expand into national operations. One of the cooperatives interviewed is beginning to move in that

direction.

The report describes the distinctive characteristics of shared-services cooperatives. The next section describes the purpose of these cooperatives.

Their structure and organization, including the

board and staff, are described in section two.

Cooperative operations are described in section

three. Structured alternatives are reviewed in section four. Sections five and six discuss elements of

success and challenges faced by shared-services

cooperatives. The final section presents some additional thoughts on shared-services cooperatives.

PURPOSE OF SHARED-SERVICES

COOPERATIVES

Private businesses and public entities use

shared-services cooperatives to jointly respond to

common problems. For example, cooperatives can

purchase supplies and services in larger quantities

and at lower costs than individual firms or agencies. Members of these cooperatives generally operate similar types of businesses. Common problems

related to their businesses bring them together to

seek a common solution. Cooperatives address a

variety of problems, and in some cases, members

face more than one type of problem. Four types of

problem situations suggest a cooperative solution.

The first is a shortage of materials or services

that motivates individual buyers to consider purchasing jointly. This is particularly true if a product

(service) that meets the specifications required by

its users is not available. Because buyers’ purchasing power is greater through their shared-services

cooperative, members gain an advantage in locating a reliable source for a product (service) that

4 Although not found among the 19 cooperatives

interviewed, cooperatives could include for-profit

corporations that operate “cooperatively.” Bylaws

usually determine if an entity operates as a cooperative”.

2
meets their specific needs. For example, a group of information, collect data, and publish a newsletter

rural utilities formed a cooperative, to purchase for their members. Information provided by the

wire when there was a shortage. cooperative may assist members with their decisionThe second type of problem is the high cost of making and increase their overall competitiveness.

supplies and services. Through joint purchasing, a

shared-services cooperative could enhance the competitiveness of its members by reducing the cost of

STRUCTURE AND ORGANIZATION

supplies and services. In other instances, these

The organizational structure of a shared-sercooperatives serve as a reliable least-cost supplier vices cooperative depends on several factors such

for a specified level of quality. For many small,

as the number of members, the nature of their busiindividually owned businesses, this can be a critical ness, and the programs and services the cooperafactor in remaining competitive. In one example, a tive offers. For example, how the board of directors

group of small retail pharmacy stores formed a

is chosen for a cooperative with 10 members will be

cooperative to jointly purchase products to keep

very different from one with 300 members.

them competitive with discount chains. Their coopSimilarly, the staffing requirements of a cooperative

erative enabled them to offer products to customers

offering one service may differ significantly from

at or below the prices of discounters.

one offering 10 distinct services. The following disResponding to changing government policies cusses some of the organizational elements affectis a third kind of problem that could be addressed

ing shared-services cooperatives.

by a cooperative. Education cooperatives were

organized in response to legislation requiring

Incorporation

schools to provide special education services to all Most shared-services cooperatives are legally

students who need it. Many school districts don’t organized as a cooperative or as a non-profit corpohave enough students with special needs to justify ration which operates on a cooperative basis. The

forming a class. Special education cooperatives can structure chosen depends on the needs of the memorganize classes by combining members’ students. bers, the structure of the members, and State laws.

Districts save money by avoiding paying private

For example, some States allow local governments

schools or holding low-enrollment classes. Many or other public entities to organize only as nonprofeducation cooperatives also provide training for it corporations.

teachers and specialists to improve the quality of Most corporations, including cooperative or

education.

nonprofit corporations, are formed under a State

In another example, a recycling cooperative law. These statutes grant specific powers (e.g., to

was organized in response to environmental legis- market, purchase, manufacture, etc.) and general

lation. Recycling was required as landfills were ones (all powers necessary and proper to conduct

closed or had use restrictions. The cooperative mar- business).

kets recyclables for its township members and Statutes usually describe the association foroffers technical support services on how to operate mation process, including number of incorporators

a successful recycling program. required, association name, capital structure, and

Information sharing and member education is how long the association may exist. Mandatory and

the fourth problem that cooperative collaboration discretionary provisions of the articles of incorporacan address. Schools, businesses, hospitals, municition and bylaws are described in some detail by

palities, and utilities each share common concerns. most statutes. They may also describe qualification

All recognize the advantages of sharing informa- for membership and documents of membership

tion when operating in separate noncompeting (e.g., stock certificates) and define the rights of

areas. For example, one hospital cooperative began membership (including members’ control of a COOPas a forum to share information and discuss mutual erative).

problems. Most shared-services cooperatives share Incorporation statutes may specify the minimum number of directors required, their qualifica3
tions, and method of selection. Procedures for

director removal, director compensation, board

meetings, and board committees may also be

described. Patronage agreements between user and

cooperative are frequently defined in the statutes, as

are any limitations placed on nonmember business.

Every State has at least one statute that may be

used to form a cooperative and one statute to form

a nonprofit corporation. These statutes vary widely

in topics covered and in specific requirements for

each topic. State business corporation law will

apply to fill in the gaps in coverage if not in conflict

with the cooperative incorporation statute or the

non-profit incorporation statute.

Membership

The purpose of a shared-services cooperative

is to enhance the welfare of its members. Members

design their cooperative to suit their specific needs.

As the needs of members change, the services their

cooperative offers should also change. But, the

cooperative should never change its focus on serving members.

The cooperative’s bylaws generally cover

membership requirements. In most instances, members are in similar businesses such as utilities,

health care, education, retail stores, and municipal

governments. Members of most shared-services

cooperatives are also located in the same region.

However, there are cooperatives with national and

international membership. One cooperative has

members in the United States and Canada.

The number of members in existing sharedservices cooperatives ranges greatly. There is no

ideal membership size and membership changes

over the life of a cooperative. One cooperative’s

membership grew from 4 to 3,000. In contrast,

another’s declined from the initial 21,000 to 560.

School cooperatives tend to have the fewest

changes in the number of members.

Membership may change when members are

dissatisfied with the cooperative, no longer have

the need for it, or the cooperative merges or discontinues operations.5 In one example, a school district

switched membership to another purchasing cooperative to gain access to a particular service.

Another cooperative lost members when it

increased its membership fee. Most cooperatives

have adjusted to changes in membership without

altering their structures.

Member patronage is essential to the success

of a cooperative. To ensure patronage, the cooperative may have a membership agreement that

requires members to conduct a specified amount of

business with the cooperative over a given time

period. However, most shared-services cooperatives do not use membership agreements. Members

are generally free to purchase services and products

elsewhere. Cooperatives without membership

agreements can enhance patronage by providing

quality services and products at the lowest possible

price.

Associate (nonvoting) memberships can be

used to raise revenue, generate awareness and

enthusiasm for services the cooperative provides,

and increase the pool of experience available for

advisory committees. However, few cooperatives

have associate membership programs.

Board of Directors

Cooperatives are controlled by their memberowners through a board of directors. The chief

responsibilities of the board include safeguarding

the cooperative’s assets; distributing the benefits of

the cooperative; planning the cooperative’s future;

hiring, directing, and appraising the cooperative’s

manager; and setting policies.

In cooperatives with a limited number of members (20 or less), all the members may find themselves serving on the board. However, cooperatives

often have too many owners for all to be members

of the board. Then, members elect a trusted few

from among themselves to serve on the board and

guide the business affairs of the cooperative.

5 Some managers indicated that business failures

among their members were lower than industry

averages.
Board Composition and Nature Cooperative

bylaws define the nature and composition of the

board. The bylaws describe director eligibility,

method of selection, term of office, and board

organization. Boards of these cooperatives

generally have 7 to 21 directors who serve a limited

or indefinite number of terms.

Director meetings are usually conducted on a

monthly or every-other-month basis. An agenda is

developed for each meeting and minutes are kept.

Some cooperatives compensate their directors for

expenses incurred in attending board meetings.

Director selection methods may vary with a

cooperative’s size, structure, and function. Usually

a cooperative’s bylaws describe how directors are

selected. State statutes may also contain director

selection provisions. Larger cooperatives may use a

nominating committee of three to five directors to

assist with the selection of board candidates. The

selection of the nominating committee itself is

determined by the bylaws.

Cooperatives have developed various systems

to produce equitable representation of their membership. Many cooperatives elect directors “atlarge,” the entire membership can vote directly to

fill each board position, and each director represents the entire membership. Some divide the cooperative’s territory into geographic districts that contain nearly equal membership numbers. Directors

are then elected by district. Others elect directors

from roughly equal territories based on volume of

member business.

Delegation and Guidance Structures Directors

elect from among themselves corporate officers in

the form of a chairman (or president), vice-chair (or

vice president), secretary, and treasurer to help

conduct meetings and other business in an orderly

manner. Some cooperatives will also elect an

executive committee to handle many routine

director responsibilities. Other board committees

may be formed to oversee important aspects of the

cooperative (e.g., finance or member relations).

Some cooperatives pick an outside director to

provide special expertise to the board (e.g., financial experts or lawyers). In addition to a specific

expertise, outside directors may also provide a

fresh (and objective) perspective to help assess the

general business climate that surrounds the cooperative. Raising grant money is sometimes another

responsibility of outside directors.

The board develops and approves policies for

the cooperative. They should also review specific

operating policies recommended by management.

Written policies are important to a board because

they reflect the philosophy of the cooperative and

serve as guidelines for actions the cooperative must

take to meet its goals.

Cooperative boards may establish advisory

committees to seek counsel or special insight on

specific issues or programs outside their range of

expertise. Advisory committees often examine a

particular member or customer need, important

aspects of cooperative operations, program development, and program delivery. Although advisory

committees may not necessarily contain board

members, they always report directly to the board.

Management and Staff

Staffs of existing shared-service cooperatives

are often characterized by considerable enthusiasm

toward their jobs, peers, and managers. This attitude is noteworthy because cooperatives are generally understaffed due to budget constraints.

Consequently, staff members are often asked to

acquire a variety of skills and perform an array of

tasks. Most understand and support the principles

of cooperation and view themselves as working for

the members, not the cooperative.

Some employees may also be members of the

cooperative. Under these circumstances, the

employees may be even more committed to the

cooperative. However, shared ownership among

members and employees may also cause tensions

within the cooperative when goals bf members and

employees conflict. One area of potential conflict is

employee salaries and benefits.

There are relatively few levels, from support

staff to the chief executive officer, in terms of formally defined positions in the cooperative’s organization chart, Each position is defined in terms of its

overall contribution to the mission of the cooperative. In contrast to traditional management where

decisions move down the “chain-of-command”

5
from top management to general staff, many

shared-services cooperatives use a team management concept.

Staff teams are assigned to a project and/or to

resolve a particular problem. While each staff member has an assigned responsibility, the team

approach adds flexibility and employs the skills of

each staff person. This approach also empowers

staff members to make decisions regardless of job

title. Moreover, once a particular responsibility is

satisfied or problem resolved, the team is dissolved

and employees are assigned to other duties.

COOPERATIVE OPERATIONS

Shared-services cooperatives provide services

and programs to meet member needs. The programs and services offered change when the needs

change. In many cooperatives, members help

design programs and services. The only limitation

is the creativity of the cooperative’s staff and its

membership. In a real sense, the cooperative acts as

an extension of each member’s own operation.

Financing and Taxation

To deliver programs and services successfully,

cooperatives must have adequate capital to finance

assets and operations. Cooperatives can accumulate

capital in two basic ways - accumulating net

worth (ownership capital) and borrowing (debt

capital). Ownership capital is money obtained to

purchase assets and to finance operations without

having a legal obligation to repay it. Debt capital is

money borrowed with a legal liability to repay

under specific interest rates, terms, and other conditions.

In general, a shared-services cooperative generates income through its fee structure. Earnings

generated when income exceeds costs of operation

can either be retained by the cooperative as equity

capital or returned to members as a patronage

refund. The major distinction between such associations organized as cooperatives and those formed

as nonprofit corporations is the way each allocates

earnings.

In a cooperative corporation, earnings are allocated to patrons based on the amount of business

each conducts with the cooperative during the year.

Some of these allocated earnings are usually

returned to the members as cash. The remaining

allocated earnings are retained by the cooperative

as member investments. The board of directors

decides what proportion of earnings will be

retained as accumulated equity capital.

Most State nonprofit laws expressly forbid the

distribution of any earnings to members, trustees,

officers, or other private persons. Even upon dissolution, assets of a nonprofit corporation can often

only be distributed to other nonprofits. Earnings

are usually placed in unallocated reserves. State

law may contain further restrictions on the size and

use of these reserves.

Acquiring adequate equity capital can be a

major challenge for shared-services cooperatives.

They frequently depend on fees and debt capital to

cover operating expenses and any asset purchases.

An important consideration for existing and potential cooperatives is the development of a systematic

capitalization plan.

One way cooperative corporations can raise

equity capital is to implement a base capital plan. A

base capital financing plan requires patrons to

maintain a current level of capital in the cooperative based on their degree of use. The plan requires

the cooperative to determine its total equity capital

needs, then allocate its capital requirements among

the member-patrons according to each one’s share

of cooperative business over a base period of time

(3-7 years).

After each operating cycle (or as the board

determines appropriate), the cooperative’s equity

requirements are reviewed. Each patron’s equity

requirements is then adjusted to reflect changes in

the capital needs of the cooperative for the new

base period.

Fee Structure Shared-services cooperatives use a

variety of techniques to generate income to cover

operating costs and acquire assets-initiation, flat

annual, and usage fees; product markups

(margins); rebates; and member assessments. The

goal of a cooperative’s fee structure is to generate

income in a manner that is fair to all members.

Thus, as the number and complexity of programs

6
and services offered by the cooperative increase, so

does the complexity of the fee structure.

Fees are usually set annually by the organization’s board of directors. The board estimates the

cooperative’s budget for the coming year and determines what income is needed to cover operating

costs, working capital, and prudent reserves.

Members are then charged fees based on the level

of income necessary to meet program and service

obligations.

Initiation fees are used by shared-services

cooperatives to recover some of their operating

expenses, but, more importantly, to ensure that

potential members will use and be committed to

the cooperative. Initiation fees may consist of a onetime membership fee, an application fee, or the

price of a share of cooperative (common) stock.

Some health care and educational cooperatives

charge members on a population basis. For example, one cooperative charges new members a flat

amount for one share of stock plus a set fee for each

employee in their firm.

Annualfees are the most common income

source for shared-services cooperatives. There are

two main types-aflatfee charged equally to all

members and a usage fee charged based on a member’s past usage of the cooperative’s programs and

services. The flat fee is charged when the cooperative offers one or two relatively simple programs.

The usage fee can be based on the use of an individual program or service or on the use of all of

them. Some cooperatives use a combination of both.

Some education cooperatives use this type of fee

structure, charging a flat fee plus tuition based on

the number of students.

Fees-fir-Service is a common income source

because members pay only for the services used.

For example, if a member receives technical services from the cooperative, its fee is based on the

resources used by the cooperative. Those who do

not use this service are not charged for it.

Nonmembers who use the cooperative’s service are

normally charged a higher fee than members.

Product markups are used by cooperatives that

act as wholesalers. These cooperatives buy products from manufacturers or distributors and resell

them to members. Cooperatives often have a minimum markup policy. When setting the price for

members, the cooperative will add to the cost of the

product a minimum fee to cover its operating costs,

working capital, and a contribution to ownership

capital.

Rebates from manufacturers and distributors,

usually based on the volumes purchased, is another

income source for cooperatives that buy and resell

products. Rebates can also be included in the price

of products negotiated with various vendors. For

example, a cooperative can negotiate a price of 61

cents per gallon for No. 2 fuel oil with 1 cent rebated to the cooperative for administrative costs. The

cooperative must be careful to fully inform its

members about this rebate procedure.

Member assessments are usually used in special

cases when the cooperative needs additional capital. The most common usage of special assessments

is to initiate a new program. Members who plan to

use the program are assessed a fee to pay startup

costs. This fee is usually the same for all participating members. Other members who later decide to

use the program must also pay the assessment fee.

Member assessments can also be used in cases of

financial emergencies when cooperatives need

additional operating cash.

Taxation The income tax treatment of sharedservices cooperatives and their members depends

on whether they are organized as cooperative or

nonprofit corporations.

The rules for taxing cooperative corporations

are found in Subchapter T of the U.S. Internal

Revenue Code (I.R. Code). Subchapter T defines

how cooperatives calculate their taxable income,

the time period within which patronage refunds

must be paid, patron taxation, and other rules

unique to cooperatives.

The general principle of cooperative income

taxation is that of single tax liability, usually

assumed by the patrons. Single tax treatment is

achieved by allowing a cooperative to deduct from

its taxable income distributions of earnings from

business with or for patrons, that are made to

patrons on a patronage basis. These distributions,

called patronage refunds, are deductible whether

paid in cash or an equity allocation.

7
However, this single tax principle applies only

to business income that is “cooperative” in nature.

Earnings from sources other than patronage (e.g.,

income from activities not directly related to the

cooperative’s business) and income from cooperative activities not distributed in the manner specified by the I. R. Code are generally not eligible for

single tax treatment.

Generally, a surplus placed in reserves by nonprofit corporations are totally tax exempt. No tax

liability accrues at the member level because,

unlike the cooperative member-patron, members of

nonprofits never have access to any of the funds

retained by the organization. Like cooperatives,

nonprofits lose their favorable tax status with

regard to income generated by activities unrelated

to their principal purpose.

Shared Services

Services provided by shared-services cooperatives are developed and designed as needed by the

board, committees, and members themselves. Most

cooperatives begin by offering one service.

Additional and more complex programs may then

be added as the cooperative matures.

For example, a cooperative may start by purchasing an item members need but that is in short

supply. However, as members voice a need for

more items, the cooperative responds by purchasing a full line for its members. At the same time, the

cooperative may begin to offer accounting services

to its members.

Shared-services cooperatives can offer industry-specific or general services. For example, a marketing program for recyclables would be specific to

solid waste management cooperatives. Advocacy,

on the other hand, is a service that may be provided

to any industry.

Specific Shared Services Special education

classes are a shared service provided by education

cooperatives. Most education cooperatives employ

teachers, rent or.own classrooms, and often provide

transportation for students attending their classes.

They may also employ specialists such as physical

therapists and speech therapists, if needed.

Another example of industry-specific services

is the hiring or contracting of health care professionals by hospital cooperatives. Member hospitals

may have limited resources to recruit and pay professionals, especially when that service is needed

only part time. The cooperative could hire a fulltime doctor whose services could be shared among

member hospitals. Each member then pays the

cooperative for a specified period of service.

Genera/ Shared Services Cooperatives may

offer services of a general nature to assist members

with their management and operations.

Management information is an example of a service

that assists members by providing recordkeeping,

billing, personnel and payroll management,

insurance processing, inventory, and other types of

data processing. Many small enterprises must

contract outside for these services. Having the

services provided by their cooperative can offer

savings for the member.

Equipment maintenance is a similar type of

shared service that benefits members in many

industries. In each case, members save by sharing

the costs of a general service contract with other

members of the cooperative.

Casualty and surety is another general service

offered by many cooperatives. Insurance coverage

varies with member. Some examples are workmen’s

compensation, health, liability, and life insurance.

By pooling resources and risk, cooperatives can

access more attractive insurance rates. The savings

can then be passed on to members in the form of

lower premiums. In one example, a cooperative

saved members 25 percent in annual insurance

expenses.

Some cooperatives also provide technical

assistance to members. It may be in the form of feasibility studies for new services, strategic planning

assistance, and management training. The exact

type of technical assistance offered to members will

depend upon the type of industry and member

needs.

Advocacy and education are also services

offered by cooperatives. Advocacy includes lobbying efforts. In one cooperative, the president’s chief

duty is to promote cooperatives as a way of solving

8
industry-specific problems. A cooperative can be

more effective than individual members in lobbying activities. The cooperative speaks with a louder

voice than each member separately.

Consumer education is similar to advocacy in

that the ability to communicate is greater when the

members speak with one voice. Members save by

having the cooperative conduct this activity rather

than each member acting alone. All members benefit if the demand for their product increases.

Members also use their cooperative as a vehicle to exchange information. They often gain a competitive edge over nonmembers because of their

ability to share solutions. Information exchange can

be formal or informal. Formal information sharing

includes publications such as newsletters.

Information is shared informally via member networks and conferences.

Cooperatives can also provide professional

development and training opportunities.

Professional training is offered to teachers, managers, facilities maintenance personnel, health professionals, and others. This service benefits all

members, but is designed to meet specific staff or

professional needs. In some cases, the cost of training is included in the membership fee.

Purchasing Activities

The primary function of shared-services cooperatives is to buy products and/or services for

members at less cost than individual members

could obtain for themselves. The idea is to capture

the savings associated with lower administrative

costs, quantity purchasing discounts, and assured

levels of business with vendors and suppliers. By

purchasing cooperatively, individual businesses or

governmental entities can increase the efficiency of

their buying activities.

In purchasing, the cooperative’s goal may not

necessarily be to obtain the lowest price possible. A

vendor’s reputation for reliability is another important consideration. The lowest price will not benefit

the cooperative’s members if the vendor misses

deliveries, is often out of stock, or goes out of business. Reliable past performance is, therefore, an

important factor when choosing a vendor.

Cooperatives must also develop and maintain

good relations with vendors. Prompt payment,

quick and fair resolution of problems, and a consistent, honest approach in dealing with vendors help

build strong relationships. This leads to better and

more responsive service from vendors.

There are three basic purchasing techniques:

competitive bids, contract negotiation, and

buy/resell. Each procedure can have elements of

the other procedures. For example, a cooperative

that buys products for resale to its members may

have negotiated contracts with various vendors

concerning the purchase price and/or the quality of

the products.

The technique adopted by a cooperative buying for its members depends on several factors. The

most important factor is industry convention.

Successful cooperatives tend to purchase products

and/or services using the same methods as other

businesses in that industry. If the normal way of

conducting business is to request bids from numerous vendors, shared-services cooperatives will generally follow that practice.

Other factors influencing the choice of buying

techniques include the size of the purchasing organization, number of members, frequency of purchases, and the types of products or services being

purchased.

Competitive Bids Competitive bidding at its

simplest works as follows. The cooperative collects

a list of items and quantities that members wish to

purchase. This list is sent to various vendors who

market those items. After the vendors submit bids,

the cooperative selects a particular vendor or

vendors based on price, product (or service)

quality, and other considerations. Members are

notified of the selected vendor and the prices of

items to be purchased. Members then deal directly

with the vendor when ordering, taking deliveries,

and billing. The cooperative’s remaining

responsibility is to handle any problems that cannot

be resolved between the member and the vendor.

Cooperatives can identify potential vendors in

various ways. The easiest method is to continue

with vendors previously used by the cooperative’s

members before they joined the organization. A

9
second method is to use resources such as trade

journals, trade associations, and contacts with other

businesses in the industry. The cooperative also

may invite bids by advertising in newspapers,

trade journals, and state procurement publications.

Cooperatives with public entities as members

may be required to follow State buying regulations.

For example, Massachusetts law has specific

requirements when requesting bids from vendors.

For purchases under $1,000, the cooperative can

buy from anyone; for purchases from $1,000 to

$10,000, the cooperative must obtain three quotes;

for purchases of more than $10,000, the cooperative

must advertise for bids.

Once vendors have been identified or have

contacted the cooperative, they should be sent a bid

package inviting them to participate. The bid package should include:

1. An explanation of the cooperative’s process

for awarding a contract.

2. Explicit instructions on what materials the

vendor must submit to the cooperative.

3. A list of the products the cooperative

wants, including quality specifications.

4. Terms of the contract such as the time period covered and procedures for ordering, delivering,

and paying.

There are many variations to operating a competitive bidding system. These variations are additional services the cooperative could provide its

members. For example, a cooperative can provide a

list of available items to members rather than having them develop their own lists. The cooperative’s

list would include a description of the item, quality

specifications, packaged quantities, estimated

prices, and other relevant information. Members

would only indicate the quantity of items they wish

to purchase.

Another variation concerns selecting a vendor.

An advisory committee composed of individuals

from member organizations could review bids. For

example, a committee of custodians would review

the bids for janitorial products. In some cases, the

cooperative may require bidding vendors to submit

product samples which can be tested by those who

will use the product. The committee then recommends its selection (or selections) to the board for

approval.

Negotiated Contracts Negotiated contracts may

be used independently or in conjunction with the

bidding process. For example, a cooperative may

negotiate with a vendor for only part of its set of

services to be provided at a lower cost. In other

cases, a cooperative may negotiate contracts

without using the bidding process. Health care

cooperatives negotiate contracts with a variety of

health care providers. Each hospital, clinic, and

individual provider would have a separate

contract.

A contract formalizes commitments by both

parties on how to conduct their relationship. The

contract specifies the products and services to be provided; the terms and conditions such as price, quality, and delivery schedules; recourse for non-performance; and the method for voiding the contract. In

the process of negotiating a contract, it is important

for the cooperative to be totally honest with the other

party. Aside from being the best way to conduct business, it helps to avoid future confusion. Formal written contracts between the cooperative and the organization providing the product or service legally

protect the cooperative and its members from problems associated with failure to perform.

Buy/Resell (Wholesaling) Another purchasing

technique is wholesaling or buying product from

manufacturers and distributors and then reselling

to members. Members benefit from group

purchases by capturing volume discounts and

rebates offered by vendors. Members also benefit

through coordinated product deliveries.

Wholesaling cooperatives are cqmmon among food

and hardware stores and other independent

consumer retail operations.

Wholesale cooperatives frequently operate on

a larger scale than other types of purchasing cooperatives. Their larger staffs include buyers who

make the purchases, sales representatives who service members’ needs, and logistics persons who

coordinate deliveries. These cooperatives also use a

more sophisticated data processing system for

tracking members’ purchases and inventory man10
agement. Warehouse facilities, either owned or

rented, are needed to store products.

STRUCTURAL ALTERNATIVES

Shared-services cooperatives may consider

several structural alternatives to improve their own

operations and to increase the level of services to

their members. These include nonprofit social welfare units (501(c)3 organizations), subsidiaries, joint

ventures, and licensees. Normally, these are associated with established cooperatives that offer a wide

variety of services to their members. However,

businesses that are considering the formation of a

new shared-services cooperative may wish to

include one of these structural alternatives.

501 (c)3 Organizations

Organizations incorporated as nonprofit corporations and operating exclusively for the promotion of social welfare may qualify under I.R. code

501(c)3 as tax-exempt associations. Nonprofit

shared-services organizations that operate cooperatively may qualify for this exemption and cooperatives may form subsidiaries that qualify. This

exemption makes it easier for these organizations to

receive grants from public and private sources.

Subsidiaries

A subsidiary is a business organization that is

owned and controlled by another firm.6

Cooperatives can use subsidiaries to conduct nonmember business. By diverting all nonmember

business through a subsidiary, a cooperative can

have a more efficient accounting of its activities.

The subsidiary pays all corporate income taxes and

any remaining profits go to the cooperative.

A subsidiary can also be organized as a 501(c)3

organization. The subsidiary can then solicit grants

from various foundations and Government agencies to fund specific activities. There are cases

where a cooperative was initially organized as a

6 A subsidiary is often called “wholly owned” if

the controlling firm owns all of the voting interest

in the subsidiary and “majority owned” if the controlling firm has more than 50 percent but less than

all of the voting interest.

nonprofit corporation with a 501(c)3 designation

and later reorganized as a cooperative with a

5Ol(c)3 subsidiary.

Joint Ventures

Joint ventures are separate legal entities

owned and controlled by a small number of participants to carry on a specific and limited economic

endeavor. Participants agree to share expenses,

earnings, losses, risks, and control of the venture.

These ventures facilitate collaborative business

activities more efficiently than if tried separately.

Furthermore, venture activities require less capital

investment than if each participant had invested

separately.

A joint venture should be implemented with a

binding written agreement that sets forth specific

information on these issues: legal structure, venture

purposes, finance, distribution of earnings, control

of the joint venture, employees, raw materials

acquisition, marketing responsibility, nonparticipant business, rights to compete, structural reorganization, and agreement amendments. Joint ventures can also be separate legal organizations

organized as a partnership or corporation.

Joint ventures are appropriate for many activities including value-added manufacturing, research

and development, and distribution. For example,

wholesale cooperatives have formed a joint venture

to own and operate retail stores. This provides an

additional market for the cooperatives’ products.

Licensees

Licensees are organizations authorized to market a product or service owned by another organization. Sole distributorships of a product are one

example. As a sole distributor, the cooperative has

the exclusive right to market a product in a specified geographic area. In this case, the cooperative

must sell to nonmembers as well as members.

Shared-services cooperatives may also hold licenses

to sell and/or carry property and casualty insurance and other risk management instruments for

their members.

11
ELEMENTS OF SUCCESS

Many factors contribute to the successful operation of a shared-services cooperative. Not all need

to be present for a cooperative to be successful, but

the more elements present, the better the chances

for success.

Membership

Member loyalty or commitment is a major

contributing factor to the success of shared-services

cooperatives. Members must be supportive and

maintain a high level of patronage of cooperative

programs and services. In turn, cooperatives should

involve their members directly in program design

and oversight.

Board

Successful cooperatives have boards of directors that possess expertise and commitment, and

that pay close attention to the overall direction of

the cooperative. Boards also provide a “sense of

history” or an awareness of member circumstances

and the business environment before the cooperative existed.

Staff

Successful cooperatives, like most businesses,

require a talented and dedicated staff to run daily

operations. Staff that have a full understanding of

the cooperative method of business are an additional asset.

Management

Quality management is a crucial factor in the

success of any cooperative. Shared-services cooperatives, like any business, are managed to benefit

their owners. However, a cooperative conducts

business primarily with patrons who are also its

owners. As a result, cooperative decisionmaking is

quite different from other businesses. Shared-services cooperatives, for example, focus on obtaining

quality products that their members need, rather

than searching for products that maximize the

cooperative’s profits. Members of a shared-services

cooperative invest to acquire services and not for

monetary returns on their investment. Managers of

successful cooperatives pursue this goal in their

decisions.

Flexibility, Creativity, and Innovation

Shared-services cooperatives must be flexible

and creative in service to their members. These

cooperatives are often required to redesign or abandon programs and to add or eliminate services in

response to members’ changing needs.

Service to Members

Beyond these factors, the success of a cooperative may be attributed to the quality of service it

provides members. Successful cooperatives stress

the importance of focusing on member needs, then

satisfying them through the services they provide.

CHALLENGES

Shared-services cooperatives face both internal

and external challenges. Internal challenges are

structural and operational. External challenges are

usually specific to an industry.

Internal

“Free riders” can be a major internal challenge

to cooperatives if all members do not participate in

a program. For example, the purchasing program of

one cooperative required members to pay a fee to

participate. However, vendors often would sell to

participating and nonparticipating members at the

same price. These nonparticipants were “free riders” who took advantage of other members’ investments.

Financial problems are another internal challenge many cooperatives face. Some cooperatives

lack the capital to develop and implement new programs when needed. Furthermore, when a cooperative depends upon grants as a source of income,

financial stress may result when the funding ends

and no other source is available.

Cooperation among members is a vital element in a successful cooperative. However, competition among members is somewhat common.

Overall, competition among members could be perceived as a greater problem than it is, given that

members are typically in the same area of business.

12
The need to cooperate and share services in a cooperative business structure can minimize competition.

The need to innovate is a final example of an

internal (operational) challenge. For example, an

insurance provider recognized the need to provide

innovative policies and services to dissuade members from going back to previous suppliers.

External

External challenges originate from factors outside the control of the members and the cooperative

which serves them, such as industry competition

where a cooperative competes with other suppliers. If

a private supplier can provide a similar product or service at a better price or quality, members will often

purchase outside of the cooperative to acquire the service. This erodes the viability of the cooperative.

Changes in industry practices and technology

are other external challenges. These changes challenge cooperatives to continue providing the best

possible product or service at the lowest cost to

keep members competitive in their industry For

example, hospital cooperatives and their members

constantly work to adopt changing medical practices and technologies.

SOME ADDITIONAL THOUGHTS

Shared-services cooperatives are one way to

increase the quality of life for rural Americans, but

are not necessarily a solution to all of rural

America’s problems. The formation of a shared-services cooperative requires a major commitment of

time, energy, and capital. Potential cooperative

members need to devote significant effort to move

from a concept to an operating cooperative.

Some initial capital investment is also required

to organize potential members, conduct feasibility

studies, hire an attorney experienced with cooperatives, etc. In some rural communities, potential

member commitment may exist, but sufficient capital may not. Also, further assistance will be

required if a cooperative is to be formed.

Other short-term and less formal solutions exist

for problems facing businesses and municipalities.

Some of these could lead to the formation of a cooperative. The simplest alternative is to join an existing

shared-services cooperative. This presumes that the

type of cooperative needed conducts business in the

area and is willing to accept new members.

A second alternative is a contractual arrangement among several businesses or municipalities to

purchase products or services. Such an arrangement will work well for one-time purchases, or the

purchase of a major item to be shared among buyers. Through contractual arrangements, businesses

can learn about the benefits of cooperation. It is

also a way for a group to become more comfortable

in a combined operation.

A third alternative is an informal network of

businesses facing similar problems. Networks are

not incorporated organizations, but rather ad hoc

gatherings of like businesses or municipalities

which discuss mutual problems and possible solutions. These discussions can result in joint activities

such as purchasing one or two products.

One drawback to contractual arrangements

and networks is instability. These alternatives do

not require a considerable commitment from participants. Once the contract expires, the parties can go

their separate ways. A network is even more unstable in that a participant can withdraw at any time.

At the same time, the second two alternatives

can lead to the formation of a shared-services cooperative. By learning to work together and becoming

more comfortable with each other, participants may

wish to formalize the relationship. This is especially

true if they believe there is a need for additional

and/or continued services. Under these circumstances, the idea of a stable organization may

encourage participants to commit to a cooperative.

A shared-services cooperative can provide a

group of private businesses or public entities one or

more services that enhance or increase the competitiveness of their operations. The role of these cooperatives is to provide services in response to the

specific needs of member-owners. They can offer a

wide array of services including purchasing of

products or support services such as accounting,

management information, staff education, insurance, and legal assistance.

Services are developed and designed based on

the needs of members by the board, committees,

and often, by the members themselves. Most cooperatives begin by offering a single service. New and

13
more complex services may be added as members’

needs change and as the cooperative matures. With

a committed membership, a conscientious board,

and a dedicated management and staff who are

flexible, creative, innovative, and member oriented,

a shared-services cooperative can benefit all its

members. The only limitation is the creativity of the

cooperative’s staff and members.

REFERENCES

Baarda, J.R. State Incorporation Statutes@ Farmer

Cooperatives, Washington, D.C.: U.S. Dept. of

Agriculture, Agric. Cooperative Service,

Cooperative Information Report 30, May 1987.

Frederick, D.A. Successful Joint Ventures Among

Cooperatives, Washington, D.C.: U.S. Dept. of

Agriculture, Agric. Cooperative Service,

Research Report 62, April 1987.

Frederick, D.A. and J.D. Reilly. Income Tax Treatment

of Cooperatives: Background. Washington, D.C.:

U.S. Dept. of Agriculture, Agric. Cooperative

Service, Cooperative Information Report 44,

Part 1; November 1993.

Marshall, F. and L. Godwin. Cooperatives and Rural

Poverty in the South, Baltimore: Johns Hopkins

Press, 1971, reprinted 1991, University

Microfilms Int, Ann Arbor, MI.

President’s Council on Rural America. Revitalizing

Rural America Through Collaboration, Washington,

D.C.: USGPO, August 1992.

Thompson, D. ed. A Day in the Life of Cooperative

America, Washington, D.C.: National

Cooperative Bank, June 1994.

U.S. Dept. of Agriculture. Sample Policies for

Cooperatives, Washington, D.C.: U.S. Dept. of

Agriculture, Agric. Cooperative Service,

Cooperative Information Report 39, May 1990.

U.S. Dept. of Agriculture. Cooperative Financing and

Taxation, Washington, D.C.: U.S. Dept. of

Agriculture, Agric. Cooperative Service,

Cooperative Information Report 1, Section 9,

September 1991.

U.S. Dept. of Agriculture. What Co-op Directors Do,

Washington, D.C.: U.S. Dept. of Agriculture,

Agric. Cooperative Service, Cooperative

Information Report 14, October 1992.

U.S. Dept. of Agriculture. What the Co-op Manager

Does, Washington, D.C.: U.S. Dept. of

Agriculture, Agric. Cooperative Service,

Cooperative Information Report 16, April 1993.

14
U.S. Department of Agriculture

Rural Business-Cooperative Service

Stop 3250

Washington, D.C. 20250-3250

Rural Business-Cooperative Service (FIBS) provides research, management, and

educational assistance to cooperatives to strengthen the economic position of farmers and

other rural residents. It works directly with cooperative leaders and Federal and State

agencies to improve organization, leadership, and operation of cooperatives and to give

guidance to further development.

The cooperative segment of RBS (1) helps farmers and other rural residents develop

cooperatives to obtain supplies and services at lower cost and to get better prices for

products they sell; (2) advises rural residents on developing existing resources through

cooperative action to enhance rural living; (3) helps cooperatives improve services and

operating efficiency; (4) informs members, directors, employees, and the public on how

cooperatives work and benefit their members and their communities; and (5) encourages

international cooperative programs. RBS also publishes research and educational

materials and issues Rural Cooperatives magazine.

The United States Department of Agriculture (USDA) prohibits discrimination in its

programs on the basis of race, color, national origin, sex, religion, age, disability, political

beliefs and marital or familial status. (Not all prohibited bases apply to all programs.)

Persons with disabilities who require alternative means for communication of program

information (Braille, large print, audiotape, etc.) should contact the USDA Office of

Communications at (202) 720-2791.

To file a complaint, write the Secretary of Agriculture, U.S. Department of Agriculture,

Washington, D.C. 20250, or call l-800-245-6340 (voice) or (202) 720-l 127 (TDD). USDA

is an equal employment opportunity employer.