Rural

COOPERATIVES

The

Nature of the

Cooperative

The

Nature of the

Cooperative

A reprint of 10 articles 

by K. Charles Ling

The

Nature of the

Cooperative

A reprint of 10 articles 

by K. Charles Ling

A reprint of 10 articles 

Rural

COOPERATIVES COOPERATIVES

USDA Rural Development Cooperative Information Report 65
These 10 collected articles by USDA Rural Development agricultural economist Charles Ling were originally printed in

Rural Cooperatives magazine to examine the nature of cooperatives and their place in our free-market economy. “Essential

Economic Roles of Farmer Cooperatives” (Published in the Nov./Dec. 2013 issue) summarizes the essence of this work.

“What Cooperatives Are (and Aren’t)” (Nov./Dec. 2009) and “What Cooperatives Do” (March/April 2010), explain the

economic structure of cooperatives and their role in the marketplace. Together, they examine the economic theory of

cooperation as advanced, respectively, by Ivan V. Emelianoff and Edwin G. Nourse. These writings constitute a

comprehensive framework for understanding cooperatives. The fourth article, “Dairy Cooperatives: What They Are and

What They Do” (March/April 2011) looks at dairy cooperative practices to illustrate how well the theory fits reality, and vice

versa. “How Co-ops Do It” (Nov./Dec. 2011) analyzes marketing operations of dairy cooperatives as a means of

understanding the economics of co-op marketing. The sixth article, “The Nature of Cooperatives” (Jan./Feb. 2012), attempts

to show how cooperatives relate to other market participants through their roles in transaction governance. The seventh

article, “Capital Ideas” (May/June 2012), discusses how cooperatives raise equity capital. The eighth article, “The Many Faces

of Cooperatives” (Nov./Dec. 2012), shows the variation on the uniqueness of the cooperative business model that constitutes a

continuum onto which each type of cooperative falls and is whereby analyzed. The last two articles (Jan./Feb. and Mar./Apr.

2013) exemplify the analysis.

Topics discussed here are examined in greater detail in the following research reports:

Co-op Theory, Practice and Financing: A Dairy Cooperative Case Study (USDA RBS Research Report 221, April 2011);

The Nature of the Cooperative: A Dairy Cooperative Case Study (USDA RBS Research Report 224, April 2012).

Cover photos: sugarbeet grower courtesy American Crystal Sugar; dairy farmer courtesy Dairygold.

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Cooperative Information Report 65

February 2012

Revised November 2014

 

United States

Department of 

Agriculture

Rural Development
The Nature of the Cooperative 3

Contents

04 Essential Economic Roles of Farmer Cooperatives

 What cooperatives are, what they do, and how they interact with other market participants.

9 What Cooperatives Are (and Aren’t) Co-ops are aggregates of economic units.

12 What Cooperatives Do

 Co-ops enable farmers to exercise countervailing power against powerful entities in the 

 marketplace, promoting and maintaining competition.

16 Dairy Co-ops: What They Are and What They Do How well does theory stand up to reality?

22 How Co-ops Do It Dairy co-ops are a prime example of the economics of co-op marketing.

27 The Nature of Cooperatives Economizing transaction cost is a new dimension for understanding value of co-ops.

32 Capital Ideas Lessons offered by dairy co-ops shed light on important equity capital issues.

38 The Many Faces of Cooperatives The cooperative business model has many variations.

44 The Co-op Nature of (the Affordable Care Act) CO-OPs Their similarities with and differences from other types of cooperatives.

48 Worker Cooperatives Another variation on the co-op business model.
By K. Charles Ling, Ag Economist

USDA Rural Development 

e-mail: Charles.ling@wdc.usda.gov

 Editor’s note: This article focuses on the

core points of the author’s presentation,

“Farmer Cooperatives and Value Creation:

the Example of Dairy Farmers in the

United States,” delivered at the 5th

meeting of the Organization for Economic

Cooperation and Development (OECD)

Food Chain Analysis Network, Oct. 30-31,

2013, in Paris. It is also a concise summary

of a recently completed study into the nature

of the cooperative, as reported in two recent

research reports available from USDA

Rural Development (RR 221 and 224) and

a series of nine articles that have appeared

in Rural Cooperatives magazine. 

 This summary addresses four salient

points:

 1. Economic structure of cooperatives —

what are cooperatives?

 2. Market performance of cooperatives

— what do cooperatives do?

 3. Transaction governance roles of

cooperatives — how do cooperatives

interact with other market

participants?

 4. Variations on the cooperative business

model.

Economic structure of cooperatives — what are co-ops?

 In his 1942 book, Economic Theory of

Cooperation: Economic Structure of

Cooperative Organizations, Ivan V.

Emelianoff said that for economic

analysis of cooperatives, the economic

structure of cooperative organizations

should be clearly defined, and the

definition should be free from the

encumbrance of sociological, legal,

technical, social-philosophical and

ethical considerations. 

 His definition: “Cooperative

organizations represent the aggregates

of economic units.”

 “Aggregate” is commonly defined as:

“Any total or whole considered with

reference to its constituent parts; an

assemblage or group of distinct

particulars massed together.”

 As defined by Emelianoff: “An

economic unit, or economic individual,

is an economic body admittedly

complete and sufficiently integrated for

individual existence and independent (in

conditions of an exchange economy —

interdependent) economic functioning.”

 This economic definition of

cooperatives seems to be simple, yet it

is very robust. What naturally flows

from this definition are what people

often call “cooperative principles,” such

as: members own, members control,

members use, and members benefit

from the cooperative.

 Following Emelianoff’s definition,

these are the characteristics of

cooperatives: 

• A cooperative is an agency owned and

controlled by members and through

which they conduct their business.

• Each member-farm fully retains its

economic individuality and

independence.

• The board of directors is elected from

among member-farmers.

• Proportionality and service at-cost are

two basic working principles.

• Members provide advances (i.e.,

equity capital) for financing the

cooperative.

• Patronage refunds are returned to

members who have been underpaid or

overcharged.

• Dividend on capital, if any, is interest

payment for using members’ capital.

• The cooperative is neither a

horizontal integration of its members

nor a vertical integration between the

cooperative and its members. “It is a

third mode of organizing coordination.” (Shaffer)

Market performance of

cooperatives — what do

cooperatives do?

 The first academic paper on the

theory of cooperation, “Economic

Philosophy of Co-operation,” by Edwin

G. Nourse, was published in 1922 in

the American Economic Review. His ideas

still have relevance to the reality of

market performance of cooperatives

today.

 Several examples from the paper

illustrate how farmers organized in

agricultural cooperatives can jointly

perform certain market functions

efficiently — functions which usually

cannot be satisfactorily carried out

alone by individual farmers. These

include:

• Cooperation to gain market access for

producers who otherwise do not have

a market outlet. 

• Local and regional coordination of

cooperatives to compete with private

competitors that have grown to great

sizes.

• Formation of region-wide associations of

Essential economic roles

of farmer co-ops

4 The Nature of the Cooperative
growers, often in horticultural

regions, to assemble, process and

distribute their products.

 These examples show how

cooperatives are organized and grow to

enable farmers to exercise countervailing power and compete. Although

Nourse did not directly use the term

“countervailing power” (the term was

coined later, by Galbraith in 1956), he

did state that the keynote of the

philosophy of cooperation was for

agriculture to have a type of

organization of the size that has an

effective bargaining position in dealing

with commercial organizations. 

 Another term in the cooperative

lexicon that is attributable to Nourse is

“competitive yardstick,” following his

“brief remark” in 1945, in which he said

the place for the agricultural

cooperative in the nation’s business “is

primarily that of ‘pilot plant’ and

‘yardstick’ operation. Its objective is not

to supersede other forms of business,

but to see that they are kept truly

competitive.” 

 This is the summary of Nourse’s

ideas regarding the roles cooperatives

play in the marketplace:

• Cooperatives are organized for

efficiently carrying out specific

business functions.

• Cooperatives can be of any size and

geographical scope that allows them

to function efficiently in the

marketplace.

• Cooperatives afford farmers the

organizational sizes for exercising

countervailing power.

• Cooperatives are pro-market; they let

the market supply-and-demand price

be the guidance for producers.

• Cooperatives are a means for farmers

to promote and maintain competition

― as the competitive yardstick of

efficient operations.

• In those fields where the market has

become truly competitive and farmers

can be well served by other firms,

cooperatives may want to cede the

field and assume only a stand-by

position (to preserve members’

capital, time and efforts for use on the

farm), while maintaining the legal

institutions and organizational

capacity to step in if there is a relapse

of market inadequacy.

[Author’s note: Whether the market could

ever be truly competitive is debatable.]

Transaction governance 

roles of cooperatives — how 

do cooperatives interact with

other market participants?

 Cooperatives interact with other

market participants through their roles

in transaction governance, or “in

aligning incentives and crafting

Figure 1 — A simple contractual schema

Adapted from Williamson, 2005, Figure 1: Simple Contractual Schema.

credible contracting

administrative

k = 0

k > 0

D (Hierarchy)

B (Unrelieved hazard)

C (Hybrid)

A (Unassisted market)

s > 0

s = 0

“Each member farm fully retains its economic

individuality and independence,” according to

the co-op attributes outlined by economist

Ivan V. Emelianoff. Seen here is the Hepler

Homestead dairy farm, near Pitman, Pa., a

member of the Dairylea Cooperative. Photo by

Mitch Wojnarowicz, courtesy Dairylea 

The Nature of the Cooperative 5
governance structures that are better

attuned to their exchange needs.”

(Williamson, 2002, p. 172). 

 In marketing milk and milk products

(for example), farmers and their

cooperatives may engage in the

following transaction scenarios.

 Scenario I. In a subsistence

agricultural economy, farm production

in excess of family consumption may be

sold off farm. There could be many

sellers and buyers. The transactions are

incidental to subsistence farming, do

not require specific assets, and primarily

belong to a bygone era. 

 Scenario II. Commercial milk

production requires capital investment

in specialized assets that cannot be

easily employed for alternative uses.

Asset specificity, product perishability

and market volatility cause uncertainty

and pose hazards to the investment of

dairy farmers. They are vulnerable

when dealing with a small number of

milk buyers (processors). They may

organize cooperatives to gain

countervailing power. However,

contracts that spell out the terms of

trade as legal rules may not relieve the

hazard. It is impossible to foresee and

encompass all contingencies in a

contract due to human limitations;

relying on courts for relief is timeconsuming and costly.

 Scenario III. Cooperatives are

organizations of farmers and have

comparative advantages of working

closely with members for assembling

milk, providing field services and

performing farm-related functions.

Many processors have chosen to rely on

cooperatives for milk supplies that are

tailored to their requirements for

volume, quality, composition and/or

delivery schedule. Under such an

arrangement, the transactions are

assisted with what is called credible

contracting and supported by inter-firm

contractual safeguards. Instead of a set

of legal rules with court enforcement,

the contract here is a framework or a

set of guidelines for interactions

between the firms. Discrepancies in

performance are resolved through

amicable consultation or negotiation or

by arbitration.

 Scenario IV. In addition to selling

members’ milk, it may be necessary for

a dairy cooperative to forward-integrate

into processing dairy products to

balance milk supply or to generate

higher margins from the market for

members’ milk. These processing

enterprises are under the cooperative’s

hierarchical administrative control .

 The roles of a cooperative in the

above scenarios fit with the analysis of

the roles of a firm in transaction

governance that constitute the core of

transaction-cost economics (Williamson,

2010, 2007, 2005 and 2002). The four

scenarios correspond to the four

transaction modes in table 1 that is

adapted from Williamson’s Simple

Contractual Schema (figure 1).

 The transaction governance

structure Mode A is the unassisted

market. The governance structure

Mode B is the market where asset

specificity exposes transacting parties to

uncertainties and, without safeguards,

to unrelieved contractual hazards to

their investments. Mode C is where the

market is assisted with credible

contracting. All successive production

stages are integrated under hierarchical

control in transaction governance Mode

D. 

 The attributes of a market mode are

high-incentive intensity, little

administrative control, and a legal-rules

contract regime. On the other hand,

attributes of hierarchy are low-incentive

intensity (where pricing for the

successive stages is at cost-plus),

considerable administrative control (by

Table 1 — Transaction governance modes and attributes

Transaction

governance mode

A: Unassisted market

B: Unrelieved hazard

C: Hybrid

(Credible contracting)

D: Hierarchy

(Administrative)

Asset 

specificity 

(k)

0

>

>

>

Investment hazard

safeguard 

(s)

0

0

>

>

Incentive 

intensity

High

<

<

Low 

(pricing for

successive stages is

cost plus)

Administrative

control

Little

>

>

Considerable 

(by fiat)

Contract

law regime

Competitive norm

Legal rules contract

regime

Credible contracting

Internal implicit

contract law

(Forbearance)

Source: Adapted from Williamson, 2005, Figure 1: Simple Contractual Schema.

Note: “>” indicates a mode having a higher intensity of the particular attribute than the mode above it.

“<” indicates a mode having a lower intensity of the particular attribute than the mode above it.

6 The Nature of the Cooperative
Table 2 — Variations on the cooperative business model

Types of cooperatives

Dairy cooperatives1

Agricultural marketing

cooperatives

New-generation

cooperatives

Purchasing

cooperatives2

Affordable Care Act

CO-OPs3

Multi-stakeholder

cooperatives4

Farm production

cooperatives

Cooperatives with

non-patronage

members

Structure

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units (health

insurance subscribers)

Aggregates of

economic units

Aggregates of

economic units that are

not independent in

production operation

Mixture of patron and

non-patron members

Organization

Centralized member

organizations

Mostly centralized

member organizations;

some are federated

Centralized member

organizations

Local (retail) cooperatives are centralized;

many federated with

other locals; federated

cooperatives may have

direct members

Organized by sponsors;

then become local (inState) centralized

member organizations

Centralized member

organization

Centralized member

organization

Defined by state laws

Governance

Member-governed

Member-governed

Member-governed

Member-governed

Initially formation

board; then membergoverned

Member-governed

Member-governed

Defined by state laws

Source of equity

Members

Members

Members; tied to

delivery rights

Members

Sponsors and

supporters;

accumulated surpluses

Members

Members

Defined by state law

Operation

Members' exclusive

marketing agent―unique

economics

Unique economics if

exclusive marketing

agent; otherwise, like

other firms

Business volume defined

by delivery rights

Sourcing supplies or

services for sale to

members and patrons

Operations are the same

as other insurance

issuers in the relevant

markets; must meet COOP Program standards

and requirements 

A framework for multiparty, multi-stage

credible contracting

among members

A vertical integration

between members and

the cooperative in

production

Defined by state laws;

most likely memberpatrons’ business

fiat) and forbearance is the implicit

contract law of internal organization

(the parties must resolve their

differences internally).

 Cooperatives are transaction

governance structures, as are noncooperative firms. Depending on the

lines of business, transactions can occur

under all possible governance modes.

Cooperatives adapt to various

governance modes for economizing on

the transaction cost.

 For entering into credible

contractual relationships with buyers,

the cooperative’s functions of providing

market access and exercising

countervailing power put its members,

collectively through the cooperative, on

a relatively more equal footing with

buyers. This should make credible

contractual relationships between sellers

and buyers more attainable and stable.

 Furthermore, as its members’

collective marketing agency, the

cooperative serves as a single

transaction entity for credible

contracting with buyers. Therefore, it

introduces order and eliminates

conflicts among members who would

otherwise be competing individually for

customers. All these should contribute

to lower the transaction cost. 

1Separately listed and used as the standard bearers of traditional cooperative business model.

2Include farm supply cooperatives, utility cooperatives, service cooperatives, consumer cooperatives, credit unions, etc.

3Qualified Nonprofit Health Insurance Issuers under the Consumer Operated and Oriented Plan (CO-OP) Program.

4Defined as cooperatives having, for example, farmers, final customers and intermediaries in the supply chain as members.

The Nature of the Cooperative 7
 A cooperative does not own the

assets for producing the milk that the

cooperative markets for its members;

the assets and the investment hazard

associated with asset specificity belong

to member-farms. By pooling members’

milk in its marketing efforts, the

cooperative, in essence, also pools

members’ investment hazard. 

 As a result, each member’s share of

the hazard conceivably is less than if

they individually market their products.

The fact that asset specificity and the

associated investment hazard belong to

individual members reaffirms the

cooperative’s unique economic structure

of being an aggregate of its memberfarms.

Variations on the 

cooperative business model

 Cooperative organizations represent

the aggregates of economic units. The

intrinsic cooperative structure entails

the uniqueness of the cooperative’s

Rural Cooperatives : Expand your members’ horizons

Steer them to USDA’s Rural Cooperatives

magazine – now in its 81st year of helping 

build stronger co-ops. Each bi-monthly issue 

is packed with information on successful and 

innovative cooperatives. Simply post a link to 

the magazine on your home page: 

www.rurdev.usda.gov/rbs/pub/openmag.ht

m. For an electronic subscription: 

www.rdlist.sc.egov.usda.gov/listserve/mains

ervlet.

Are your members

It’s a Big World 

Out There

 in the dark?

organization, governance, equity

financing and operation. Different

commodities have their own

characteristics and different types of

cooperatives have their own special

attributes. 

 Laying out each type of

cooperative (or each cooperative) in

the format of table 2 (page 23)

provides a compre-hensive view of

their similarities and differences.

Most variations occur in the area of

operation, where the cooperative’s

commodities, lines of business and

transaction governance modes

determine how it operates.

References

• Emelianoff, Ivan V. Economic Theory of Cooperation:

Economic Structure of Cooperative Organizations,

Washington, D.C. 1942 (litho-printed by Edwards

Brothers, Inc., Ann Arbor, Michigan), 269 pages.

• Galbraith, John K. American Capitalism: The Concept

of Countervailing Power, revised edition, Houghton

Mifflin Company, Boston, 1956; esp. Chapter XI,

The Case of Agriculture, pp. 154-165.

• Hess, Jerry N. Oral History Interview with Dr. Edwin

G. Nourse, Washington, D. C., March 7, 1972,

Harry S. Truman Library, Independence, Missouri.

http://www.trumanlibrary.org/oralhist/nourseeg.htm.

• Nourse, Edwin G. “The Economic Philosophy of CoOperation,” American Economic Review, Volume XII,

No. 4, December 1922, pp. 577-597.

• Nourse, Edwin G. “The Place of the Cooperative in

Our National Economy,” American Cooperation 1942 to

1945, American Institute of Cooperation, 1945, pp.

33-39.

• Shaffer, James D. “Thinking about Farmers'

Cooperatives, Contracts, and Economic

Coordination,” Cooperative Theory: New Approaches,

ACS Service Report Number 18, U.S. Department of

Agriculture, Agricultural Cooperative Service. July

1987, pp. 61-86.

• Williamson, Oliver E. “The Theory of the Firm as

Governance Structure: From Choice to Contract,”

Journal of Economic Perspectives, Volume 16, number 3,

summer 2002, pp. 171-195.

• Williamson, Oliver E. “The Economics of

Governance,” American Economic Review, 95 (May

2005), 1-18.

• Williamson, Oliver E. “Transaction Cost Economics:

An Introduction,” Economic Discussion Papers,

Discussion Paper No. 2007-3, March 1, 2007.

http://www.economics-ejournal.org/

economics/discussionpapers/2007-3.

• Williamson, Oliver E. “Transaction Cost Economics:

The Natural Progression,” American Economic Review,

100 (June 2010): 673-690. (Prize Lecture, the Sveriges

Riksbank Prize in Economic Sciences in Memory of

Alfred Nobel 2009, Stockholm University, Sweden,

December 8, 2009).

• American Heritage Dictionary of the English

Language, New College Edition, Houghton Mifflin

Company, Boston, 1976. n
The Nature of the Cooperative 9

By Charles Ling, Ag Economist

Cooperative Programs 

USDA Rural Development 

any factors are converging to bring new

attention to the cooperative business model.

Discussions about a possible role for co-ops

as part of national health-care reform and an

explosion of interest in local foods, farmers

markets and community-supported agriculture and fisheries

— which often employ co-op business models — have added

to this attention. 

 During the past 10 or 15 years, we’ve also seen many

experiments with variations on the traditional co-op business

model, as have occurred with some new-generation

processing co-ops and producer-owned limited liability

companies (LLCs), including those involved in renewable

energy production. As such, it is timely to take a fresh look at

what a cooperative is and how it differs from an investorowned business. 

Emelianoff’s definition

 A concise definition of a cooperative by Ivan V. Emelianoff

— in explaining the economic structure of cooperative

What Cooperatives Are (and Aren’t)

Economist says co-ops represent the aggregates of economic units

Graphic by Stephen Thompson

M
associations about 70 years ago — remains refreshingly clear

and applicable today. His work marked the beginning of a

new era in the development and evolution of cooperative

theory. The narrative of ideas presented in this article is

primarily drawn from Emelianoff’s book, and will hopefully

shed light on the nature of cooperatives. 

 In Economic Theory of Cooperation, Emelianoff carefully

reviewed the worldwide literature on cooperative theory from

the late 19th century until 1939. He came to the conclusion

that for economic analysis of cooperatives, the economic

structure of cooperative organizations should be clearly

defined, and that the definition should be free from the

encumbrance of sociological, legal, technical, socialphilosophical and ethical considerations. 

 Against this backdrop, Emelianoff established this

definition: “Cooperative organizations represent the

aggregates of economic units.” While that is more “bare

bones” than many definitions of cooperative, it crystallizes

the essence of what cooperatives should have in common. 

 “Aggregate” is commonly defined as: “Any total or whole

considered with reference to its constituent parts; an

assemblage or group of distinct particulars massed together.”

Further, as defined by Emelianoff: “An economic unit, or

economic individual, is an economic body admittedly

complete and sufficiently integrated for individual existence

and independent (in conditions of an exchange economy —

interdependent) economic functioning.”

Co-ops as aggregates of farms

 In the agricultural context, farms are such economic units.

The nature of cooperative associations as aggregates of

member-farms is clearly discernible in the embryonic forms

of such associations. For example, a buying club of farmers

may want to purchase certain goods together, such as

fertilizer.

 The buying club would have someone take orders from

member-farmers and place orders with a vendor, as well as

perform other related chores. If the vendor requires a

deposit, members may advance money to the buying club for

the deposit requirement in proportion to their respective

buying volume. 

 There may be an elected committee to facilitate decisionmaking if the number of members is large. Members may

each have one vote if their purchasing volumes are about the

same. Otherwise, some form of proportional voting may be

adopted to conciliate large-volume members.

 When the fertilizer (for example) is delivered, members

pay the balance of their obligations. After the transactions

have been completed, payment to the vendor and other

expenses are subtracted from the sum of money paid by

members. Any surplus is returned to members in proportion

to the volume of fertilizer they have purchased. 

 This buying service is conducted at cost; every aspect of a

member’s transaction through the buying club is in

proportion to their patronage (buying) volume. The buying

club may be disbanded after fulfilling its joint-buying

purpose.

 This scenario shows that the buying club represents the

aggregate of its member-farms, through which they purchase

fertilizer. If the buying club metamorphoses into a permanent

purchasing cooperative association, the picture may look

more complicated. However, the underlying nature of the

cooperative as an aggregate of member-farms remains the

same.

Making it permanent

 In this new scenario, the person who manages buying

orders and other chores will be the manager of the

cooperative (usually a hired professional). The committee of

members becomes the board of directors. Advanced

payments by members to the cooperative become equity

capital for financing the operation and for carrying

inventories and owning facilities. 

 Year-end surplus is returned to members as refunds in

proportion to patronage volume, but a portion may be

retained as revolving capital. The principles of

proportionality and service at-cost remain intact, but their

practices may be less evident because the operation has

become more complex.

 Although the above example is based on purchasing

cooperatives, the same line of reasoning also applies to

marketing cooperatives. The difference between purchasing

and marketing cooperatives is: instead of procuring goods, a

marketing cooperative markets products produced by

member-farms.

 In either case, the member-farms coordinate their

activities through the cooperative, but each fully retains its

economic individuality and independence. 

 A cooperative may be described as a center of memberpatrons’ coordinated activities, or as an agency owned and

controlled by members through which they conduct their

business. In this respect, it is identical with the special

departments or branches of single member-farms. 

 For example, a dairy cooperative is the collective

marketing arm of its member dairy farms; a farm supply

cooperative is their supply purchasing department; and a

livestock-genetics cooperative is the breeding service branch

for its members. As some would say: a cooperative is an offfarm extension of the farming business.

Characteristics of co-ops

 Being aggregates of member-farms, cooperative

associations have these characteristics in common:

a) The equity capital of a cooperative is the sum of

advances needed for financing anticipated

transactions of individual members of the

cooperative; it is not the same as the entrepreneurial

capital of an investor-owned corporation.

10 The Nature of the Cooperative
b) The member-owners of a cooperative are

independent farmers who have chosen to coordinate

certain activities via a cooperative. They are not the

same as the stockholders of an investor-owned

corporation, who are a diverse set of shareholders

joined solely by common investment.

c) The surplus or deficit of a cooperative is the account

payable to, or receivable from, the member-patrons

of the cooperative on their current transactions; this

is not the same as the profit or loss of an investorowned corporation.

d) The sum for patronage refunds to members is the

sum either underpaid (overcharged) to the members,

or — in case of a deficit — overpaid (undercharged)

to members on their transactions through the

marketing (or purchasing) cooperative; the sum for

patronage refunds is not the profit of the cooperative

or its income.

e) The dividend on capital, if any, does not represent a

profit or any income of the cooperative; it is the

interest payment for using capital advanced by

members. By contrast, investor-owned corporations

pay dividends to shareholders out of earnings.

f) All the economic functions of a cooperative are

ultimately the economic functions of the memberfarms performed through the cooperative as their

collective branch or collective department.

Therefore, all economic services of cooperative

associations are performed at cost.

 Emelianoff emphasizes: “None of such traits can be

unreservedly used as an unerring test of a truly cooperative

organization, since these traits only indirectly disclose the

economic character of the cooperative aggregate....The only

comprehensive and indisputable test of the cooperative

character of organizations is their aggregate structure.”

Unique aspects of co-ops

 The unique aspects of cooperative character, however, are

often not readily apparent. There are many reasons for this,

some examples being:

• Cooperatives only reflect the characters and aspirations of

their membership, which are diverse and manifest the

diversity of the population, the geographical regions and

the commodities involved. Such differences directly, or

indirectly, have a certain bearing on the character of an

association and its cooperative ideals. The variability of the

external characteristics of cooperatives is kaleidoscopic and

infinite. Differences in their external and superficial

features obscure cooperatives’ ultimate economic character

of being aggregates of their member-farms.

• Most cooperatives are incorporated. The legal vestments of

incorporated cooperative associations also cloak their

economic structure as aggregates of member-farms to such

a degree that they are often mistaken to be the same as

investor-owned corporations. This is one of the principal

sources of confusion in understanding cooperative

organizations.

• A lack of distinction between the concept of an investorowned corporation as a profit-seeking economic unit and

the concept of a cooperative as an agency of its member

farms is another factor that confuses many. Use of common

accounting terminology for both business models adds to

this confusion. As the above list of co-op characteristics

shows, such conventional terms as “profit,” “capital,”

“shareholders,” “dividends,” etc., should be used with

reservations when describing cooperatives.

• In governance, a cooperative board of directors —

including its board election rules, composition, function,

responsibilities and interaction with management — is not

the same as the board of an investor-owned corporation

(especially the publicly traded ones). Consequently, the role

of the top manager of a cooperative is also somewhat

different from that of an investor-owned corporation (even

if they have the same title).

 Emelianoff’s conclusion that cooperative organizations

represent the aggregates of associated economic units

provides a clear insight into how cooperatives organize and

function. This insight is not limited to agricultural

cooperatives. 

A unique mode of organizing coordination

 In a paper dealing with the issue of economic coordination

some 45 years later, James Shaffer echoed (though without

citing) Emelianoff’s definition of cooperatives as aggregates

of member-farms. Because member-farms are independent

entities, represent independent profit centers and act

independently, except that they jointly own the cooperative,

the cooperative association is neither a horizontal integration

of its member-farms nor a vertical integration between

member-farms and the cooperative. He asserted that “the

cooperative is a third mode of organizing coordination.”

References:

 Emelianoff, Ivan V. Economic Theory of Cooperation:

Economic Structure of Cooperative Organizations, Washington,

D.C. 1942 (litho-printed by Edwards Brothers, Inc., Ann

Arbor, Michigan), 269 pages. (A reprint by the Center for

Cooperatives, University of California, 1995, may be accessed

at: http://cooperatives.ucdavis.edu/reports/index.htm.)

 Shaffer, James D. “Thinking About Farmers’

Cooperatives, Contracts, and Economic Coordination,”

Cooperative Theory: New Approaches, ACS Service Report

Number 18, U.S. Department of Agriculture, Agricultural

Cooperative Service. July 1987, pp. 61-86.

 American Heritage Dictionary of the English Language,

New College Edition, Houghton Mifflin Company, Boston,

1976. ■

The Nature of the Cooperative 11
By Charles Ling, Ag Economist

Cooperative Programs

USDA Rural Development 

charles.ling@wdc.usda.gov

Editor’s note: This article is a sequel to

“What Cooperatives Are (and Aren’t),”

Rural Cooperatives, Volume 76, Number

6, November/December 2009.

he year 2012 has been

declared by the United

Nations General

Assembly as the

International Year of

Cooperatives in order to highlight the

contribution of cooperatives to socioeconomic development worldwide.

That same year also will be the 90th

anniversary of the publication of

“Economic Philosophy of Cooperation,” the first academic paper on

the theory of cooperation, published in

the American Economic Review (Nourse,

1922; Hess). The piece was written by

Edwin G. Nourse, who later became

the first chairman of the Council of

Economic Advisers, Executive Office of

the President, 1946-49.

 This may be an opportune time to

review Nourse’s ideas on cooperation

and see if they have relevance to the

reality of the market performance of

cooperatives today and, therefore, if

they deserve to be relearned.

 Nourse’s primary focus, along with

the oft-quoted “brief remarks” he made

years later (Nourse, 1945), was on the

role agricultural cooperatives played in

the marketplace. This arose from his

observation that the attempt to apply

the cooperative form of organization to

economic needs and problems in

agriculture was critically important.

Purposes of cooperation

 The following examples are taken

from Nourse’s paper to illustrate how

farmers organize cooperatives to

perform various market functions

jointly and efficiently in various market

situations — functions that cannot be

satisfactorily carried out alone by

individual farmers:

 1) Cooperation for market access — An

example is a small fruit-producing area

far from any large market. The product

is perishable, hence both risk and

marketing expense are high. Volume is

not large enough to attract a private

distributor. Facing this situation,

producers have the option of organizing

a cooperative association to market

their products. These cooperatives have

frequently demonstrated the ability to

achieve successful results where private

outside entrepreneurship fails to

perform.

 2) Local to regional coordination — A

local cooperative creamery may initially

be effective in meeting the competition

of other small, private creamery

operations. However, when competing

creameries have grown to be entities of

great size, the competition must be met

by a distributing organization of equal

scope. This will often be achieved

through federation of the cooperative

creameries across a region which may

embrace an entire state, several states or

parts of a state. 

 3) Region-wide associations — In many

instances, growers in horticultural

regions have organized and integrated

highly efficient businesses that serve

producers across an entire production

region by assembling, processing and

12 The Nature of the Cooperative
distributing their products. These

agencies have eliminated wasteful

competition both at the local shipping

point and at the central markets.

Further-more, they are the instruments

of the producer and owner of the

goods, and hence are likely to be more

aggressive in the effort to reduce

expense and wastage in the handling

process and to improve quality and

enlarge outlets.

 (Author’s note: Cooperative

organizations covering entire

production regions have been most

prevalent in California because of the

characteristics of the state’s economic

geography. This type of cooperative

organization was called “the California

plan” and was promoted on a national

scale in the 1920s by Aaron Sapiro, with

varying degree of successes and failures

(Sapiro; Larsen, et al).)

Countervailing power

 The above examples show how

cooperatives are organized and grow to

enable farmers to exercise “countervailing power” in the market-place,

although the term was not coined until

the 1950s when economist John

Kenneth Galbraith cited the type of

cooperatives made famous by Sapiro as

an example for his explanation.

 Nourse certainly recognized the

importance of countervailing power if

cooperatives are to have a strong

market position. As he stated: “Possibly

the keynote of the philosophy lies in the

idea that a means must be found for

giving agriculture a type of organization

whose productive and bargaining units

respectively will expand in step with the

growing needs of the agricultural

techniques (and its accompanying

capital demands) and of the size

requisite to an effective bargaining

position in contact with the units of

commercial organization with which

they must deal.”

Pro-market

 Nourse said that the theoretical

implication of agricultural cooperation

“is preeminently that of functional

reorganization rather than

comprehensive economic regeneration.”

In other words, the farmer takes the

essential facts of the market as given

and, working together with other

producers through the cooperative,

seeks to be in the most effective market

position to compete. Thus, the

distinctive economic philosophy of this

business form is viewed “as a means to

improve the lot of both farmer and

consumer by improving the efficiency

of the economic machine.”

 Cooperatives enable farmers to

effectively compete in the marketplace

and garner market signals that put them

in a position of prompt and sensitive

response to the reaction of the

consuming public and guide their

farming business decisions. According

to Nourse, the cooperative objective is

twofold (Nourse, 1945):

 1) “It is to make the most

economical and efficient market

channel by which whatever volume of

product farmers see fit to produce gains

access to the attention and the

purchasing power of all who might use

such a product. (For supply-buying coops, most economical access to the best

sources of the goods they need.) Thus,

a true supply-and-demand price is

allowed (and aided) to express itself for

the guidance of producers.”

 2) “It aims to reflect these market

conditions back most promptly and

fully to producers in ways that will both

guide and, so far as possible, assist them

in changing their methods so as to

continue production and to prosper or

to shift to more suitable lines of

production.”

Competitive yardstick

 In Nourse’s view, the cooperative is a

means for promoting and maintaining

competition in the marketplace. The

supply-demand-price dynamic

“provides a powerful stimulus to the

association to devise further economies

of method which will enable them to

maintain the level of net returns to the

grower. Such competition also spurs the

private agency to outdo the cooperative

in its efficiency in order to hold its

business.”

 He used the term “yardstick” years

Market access, countervailing power and yardstick roles enhance economic efficiency

The Nature of the Cooperative 13
later (Nourse, 1945), when he said the

place for the agricultural cooperative in

the nation’s business “is primarily that

of ‘pilot plant’ and ‘yardstick’ operation.

Its objective is not to supersede other

forms of business but to see that they

are kept truly competitive.” 

 The cooperative is to “occupy

certain strategic points, and there to set

a plane or pace of competition which

will assure for the farmer efficient

service at true long-run cost.” When

such services (manufacturing,

distributing, transporting, financing,

etc.) are furnished efficiently and

economically (which means in a truly

competitive manner), “there is no

occasion for the farmer to occupy the

field and divert some of his capital and

some of his managerial time and effort

to these tasks and away from his main

enterprise of farm production.”

 Farmers should remain vigilant.

Nourse cautioned: “It is of the upmost

importance, however, that farmers shall

have both the legal institutions and the

organizational ‘know-how’ to step into

these fields when and to the extent that

service is inadequate or unduly high in

cost. It is important also that they

remain in each of these fields with an

organization sufficiently large to attain

high efficiency so that farmers shall be

protected against any subsequent lapse

in the quality of service or temptation

to profiteer in charges by the

noncooperative service agencies.

 “But it is just as important that the

cooperatives recognize when they have

in fact attained their real objective by

demonstrating a superior method of

processing or distribution or by

breaking a monopolistic bottleneck, and

that they should then be content merely

to maintain ‘stand-by’ capacity or a

‘yardstick’ operational position rather

than try to occupy the whole field or a

dominating position within it. In some

cases, they may be well advised in

entirely terminating operations once

they have stimulated regular

commercial or manufacturing agencies

to competition amongst themselves.”

 Nourse’s economic philosophy of

cooperation may be summed up in a

nutshell: Cooperatives make it feasible

for farmers to jointly market their

products. The cooperative may evolve

to a scale large enough to effectively

bargain with other market participants

and/or to avail itself of scale economies

in processing and marketing operations.

Subject to the same market disciplines

and supply-demand-price dynamics as

any business, the presence of the

cooperative challenges other market

participants to operate efficiently and

thus strengthens the competitive market

mechanism. When the market for

members’ products has become truly

competitive, the cooperative may want

to assume only a stand-by position but

maintain the legal institutions and

organizational capacity to reenter the

field, if necessary. Table 1 summarizes

all these points in the left column.

 Examples in real life show that

Nourse’s ideas on cooperatives are still

very relevant today. Consider dairy

cooperatives, which as a group are the

most prominent U.S. agricultural

marketing cooperatives. A point-bypoint comparison of dairy cooperative

practices to Nourse’s theory is

summarized on the right column of

table 1. It shows that market

performance of dairy cooperatives

coincides with the basic principles

posited by Nourse’s economic

philosophy of cooperation. 

 With current renewed interest in the

cooperative form of doing business, it

may be worthwhile for the new

generation of cooperators to relearn

Nourse’s ideas and fully understand the

roles cooperatives play in the

marketplace.

 Editors note: More details on cooperative

theory and practice using dairy cooperatives

as a case study will be available in a

forthcoming research report from the

Cooperative Programs office of USDA

Rural Development. ■

“The cooperative is a means for promoting and

maintaining competition in the marketplace...Its

objective is not to supersede other forms of

business, but to see that they are kept truly

competitive.”

14 The Nature of the Cooperative
References

Galbraith, John K. “American Capitalism: The Concept of Countervailing

Power,” revised edition, Houghton Mifflin Company, Boston, 1956; esp.

Chapter XI, The Case of Agriculture, pp. 154-165.

Hess, Jerry N. Oral History Interview with Dr. Edwin G. Nourse,

Washington, D. C., March 7, 1972, Harry S. Truman Library,

Independence, Missouri.

http://www.trumanlibrary.org/oralhist/nourseeg.htm. 

Larsen, Grace H. and Henry E. Erdman. “Aaron Sapiro: Genius of Farm

Co-operative Promotion,” The Mississippi Valley Historical Review, Vol.

49, No. 2, 1962, pp. 242-268.

Nourse, Edwin G. “The Economic Philosophy of Co-Operation,”

American Economic Review, Volume XII, No. 4, December 1922, pp. 577-

597.

Nourse, Edwin G. “The Place of the Cooperative in Our National

Economy,” American Cooperation 1942 to 1945, American Institute of

Cooperation, 1945, pp. 33-39.

Sapiro, Aaron. “True Farmer Cooperation,” Journal of Agricultural

Cooperation, Volume 8, 1993, pp. 81-93, reprinted from the World’s Work,

May 1923, pp. 84-96.

United Nations. “United Nations Declares 2012 International Year of

Cooperatives,” Press Release DEV/2784, December 21, 2009, New York.

Economic philosophy of cooperation

Cooperatives are organized for efficiently carrying

out specific business functions.

Cooperatives can be of any size (and can be local,

regional or national in scope) that allows them to

function efficiently in the marketplace.

Cooperatives afford farmers the organizational sizes

for exercising countervailing power.

Cooperatives are pro-market; they let the market

supply-and-demand price be the guidance for

producers.

Cooperatives are a means for farmers to promote

and maintain competition — as the competitive

yardstick.

In those fields where the market has become truly

competitive and farmers can be well served by

other firms, cooperatives may want to cede the field

and assume only a stand-by position (to preserve

members’ capital, time and efforts for use on the

farm), while maintaining the legal institutions and

organizational capacity to step in if there is a

relapse of market inadequacy.

Market performance of dairy cooperatives

49,675 dairy farmers in 155 cooperatives marketed

83 percent of U.S. milk in 2007.

The smallest local cooperative has a few members

marketing less than 1 million pounds of milk per

year; the largest one has more than 10,000

members in the 48 contiguous states and markets

tens of billions of pounds of milk.

Collective bargaining for better prices and terms of

trade is the exercise of countervailing power.

Dairy cooperatives and their member-farmers are

subject to the disciplines of the market in a free

economy.

To be competitive, processors must match the

effectiveness and efficiency of dairy cooperatives.

Dairy cooperatives have comparative advantages

in procuring milk and have major shares in making

hard products (71 percent of butter, 96 percent of

nonfat and skim milk powder, and 26 percent of

cheese — the latter decreased from 34 percent in

2002). Their shares are less significant in sectors

that are capital-, technology- and service-intensive

and that carry high product and market risks (7

percent of fluid milk, 4 percent of ice cream, 11

percent of yogurt, 14 percent of sour cream. Their

share of cheese has also declined in recent years).

However, dairy cooperatives have the wherewithal

to take up the slack if the market fails to perform

well.

Table 1 — Comparison of Nourse’s cooperative theory and dairy cooperative practice

Note: Data from “Marketing Operations of Dairy

Cooperatives, 2007,” USDA/RD Research Report

No. 218, 2009.

The Nature of the Cooperative 15
What they are and what they do
By Charles Ling, Ag Economist

Co-op Programs/ USDA Rural Development 

e-mail: charles.ling@wdc.usda.gov

 

Editor’s note: Two previous articles in Rural Cooperatives —

“What Cooperatives Are (and Aren’t)” (Nov./Dec. 2009) and

“What Cooperatives Do,” (March/April 2010) — explain the

economic structure of cooperatives and their role in the

marketplace. Together, these two narratives examine the

economic theory of cooperation as advanced, respectively, by

Ivan V. Emelianoff and Edwin G. Nourse. These writings

constitute a comprehensive framework for understanding

cooperatives (summarized in tables 1 and 2, left column). This

third article examines dairy cooperative practices to illustrate

how well the theory fits the reality, and vice versa. It is

excerpted from the author’s research report: “Co-op Theory,

Practice and Financing,” available from USDA. 

airy cooperatives, as a group, represent

the most prominent of all agricultural

marketing co-op sectors. Co-op milk and

dairy product sales represented 42

percent of total commodity marketing by

all U.S. agricultural cooperatives in 2007 (Deville, et al.).

Dairy cooperatives account for a majority of milk sold in

the United States, especially at the first-handler level and

in the manufacture of “hard” dairy products (butter,

cheese and milk powders). 

 In 2007, there were 155 dairy cooperatives in the

nation owned by 49,675 member-producers, or 84

percent of the nation’s licensed dairy farms. They

delivered 152.5 billion pounds of milk, or 83 percent of

all milk marketed (Ling).

 Cooperatives marketed 71 percent of the nation’s

butter, 96 percent of nonfat and skim milk powders, 26

percent of natural cheese and 42 percent of dry whey

products. Their shares of “soft” and cultured products

were less significant: 4 percent of ice cream, 13 percent

of ice cream mix, 11 percent of yogurt and 14 percent of

sour cream. Co-ops processed 7 percent of the nation’s

packaged fluid milk products in 2007.

Mission and functions

 There is no mystery as to why so many dairy farmers

organize in cooperatives: they seek to jointly and

efficiently market their milk far better than they could as

individuals. Milk is a “flow” product (cows are milked

twice or thrice daily) and is highly perishable; it must be

picked up from the farm and delivered to the market

(milk plants) soon after it is produced. By working

together through their cooperatives, farmers strive for

better control over the movement of the milk through

the marketing channel and to attain higher value for

their milk.

 The functions and services the farmers demand of

their respective cooperatives vary, depending on the

specific market situation the members of a cooperative

face and their particular needs. Dairy cooperatives may

be charged by members with the responsibility of

performing one or more (or all) of the following

marketing functions:

• Provide an assured market; typically there is a written,

or tacit, agreement between a member and the

cooperative that the cooperative is the exclusive

marketing agent of the member’s milk.

• Negotiate milk pay price and terms of trade with milk

buyers (investors-owned processors).

• Collect and ensure payment from milk buyers.

• Check weights and tests; this helps to ensure that the

milk payment a member receives is accurate and

commensurate with the quantity and quality of the

milk delivered to milk buyers. 

• Arrange for milk hauling; milk obviously must be

picked up from the farm in a timely fashion and

delivered to the plant of first-receipt. This can be

performed by the cooperative’s own haulers, by

contract haulers or by haulers retained by members.

The cooperative may also be responsible for setting or

negotiating hauling rates.

• Provide field services; cooperatives typically have field

service personnel to assist with on-farm production

problems and regulatory and inspection issues for the

farm to achieve quality-milk production.

• Disseminate market information about the situation

and outlook of the milk market; this is provided to

members for use in making dairy farming business

decisions.

• Other marketing-related services that help members

deal with all the minutiae related to producing and

marketing quality milk.

 In addition, dairy farmers may ask their cooperative to

leverage its group strength to procure various other

services to help sustain their farming operations and farm

life. Some of the services may include providing:

• Insurance products, such as disaster insurance for the

D

These MMPA family farm members were featured in a “June Is Dairy Month” ad produced with Kroger grocery stores,

one of the co-op’s major customers. Kroger wanted to emphasize to shoppers that milk in the dairy case came from

home-state farms. Photo courtesy Kroger and MMPA

The Nature of the Cooperative 17
farm, health and/or life insurance (for farmers and their

families and farm employees) and farm workers’

compensation.

• Retirement programs.

• Risk management services to deal with market

uncertainties.

• Farm business consulting services, such as farm expansion

feasibility studies and business plans.

• Operating capital and facility capital financing.

• Financial planning services.

• Livestock marketing services (mainly for culled cows and

calves).

• Other services that may help members’ farming operations.

Organization

 Dairy cooperatives can be of any size (and can be local,

regional or national in scope), depending on whatever scale

the membership considers to be the most appropriate for

marketing their milk.

 A small local cooperative may have a few member-farms

and market less than 1 million pounds of milk a year. A

regional co-op may have hundreds or thousands of members

in more than one state and handle millions, or even billions,

of pounds of milk. The nation’s largest dairy cooperative has

about 10,000 member-farms in all of the 48 contiguous states

who deliver tens of billions of pounds of milk annually to

their co-op.

 All dairy cooperatives are known to be centralized

organizations with direct membership. A limited number may

have other dairy cooperatives as association members, but the

practice is usually for accommodating the fact that the

cooperative is the marketing agent of all or part of the milk,

dairy products or services of these association members.

 Dairy cooperatives operating in the same market may

form marketing agencies in-common to rationalize milk

hauling and shipment for reducing transportation costs, to

share market information, or to collectively bargain with

buyers for higher prices for milk or dairy products marketed.

Governance

 Members of dairy cooperatives exercise ownership and

business controls through a board of directors that is elected

from among member-farmers. Candidates for the board are

typically nominated by a committee of elected members who

are not directors. Elections of the directors are usually done

at the annual membership meeting.

 If a cooperative is large, in terms of membership or

geographical area, members may be grouped into districts (or

areas/regions/divisions/locals). Directors then may be

nominated from the district and elected at the cooperative’s

annual meeting. Districts are usually drawn such that

members in the same district are more or less homogeneous.

Voting at the district level is typically by one member/one

vote. The number of directors each district is entitled to may

be different due to proportionality considerations based on

milk volume. Some boards may have at-large members.

 In a large cooperative, a delegate body elected by members

may be needed to channel information and make decisions on

behalf of the membership. The delegate body may be

empowered to represent the membership in all decisions,

except for matters that specifically require votes by the entire

membership.

 A limited number of dairy cooperatives have non-member

directors, typically in the states where they are required by

law. Non-member directors usually play an advisory, nonvoting role on the board.

 An executive committee of elected officers and selected

board members may be constituted to facilitate decisionmaking when the board is not in session. The board may also

appoint several committees to carry out specific board

functions, such as audit, finance, membership and marketing

committees.

 The board controls the cooperative’s business on behalf of

members and makes major decisions; it also sets the policy

and determines the overall direction of the cooperative.

Management carries out the co-op’s day-to-day operations.

Another very important function of cooperative board

members is serving as a conduit of communication between

the management and the rank-and-file members.

Operations

 Dairy cooperatives perform various marketing functions to

carry out the most important task of providing an assured

market for members’ milk. They may engage in one or more

of these activities:

• Bargaining — Find a market for members’ milk and

bargain/negotiate with milk buyers for milk prices and

terms of trade.

• Fluid processing — Own or retain plant capacity to

process some or all member milk into fluid products. Fluid

plants may also process soft and cultured products.

• Niche marketing — Own or retain plant capacity to

process some or all member milk into specialty (niche)

products.

• Making hard products — Own or retain plant capacity to

manufacture hard dairy products (such as cheese).

Manufacturing plants also provide a home for milk when it

is in excess of market demand and transform the milk into

storable products for further processing or later

distribution.

 Of the 155 U.S. dairy cooperatives, 108 may be classified

as bargaining cooperatives because bargaining is their only, or

main, marketing activity. Four co-ops are fluid processing

operations that do business primarily in processing and

distributing fluid products. Another 19 of these businesses are

niche marketing cooperatives. The remaining 24 may be

called diversified cooperatives, having bargaining and one or

more processing/manufacturing functions as their main

operations.

 Besides assuring a market for members’ milk, dairy

18 The Nature of the Cooperative
cooperatives may also perform some or all of the other milk

marketing functions listed in the mission and functions

section above. In addition, they may procure farm supplies or

provide other services for members.

 Dairy cooperatives also provide services to milk buyers in

accordance with the terms of trade negotiated, such as

delivering milk on schedule, maintaining quality control and

related laboratory services, preconditioning or standardizing

milk and/or fulfilling full-supply contracts.

Market performance

 A cooperative affords dairy farmers the organizational size

that is necessary for exercising countervailing power to

effectively bargain and deal with milk buyers and other

market participants.

 The dairy industry has evolved in a way that dairy

cooperatives and processors have developed a high degree of

bilateral dependency.

 Because dairy cooperatives are organizations of farmers,

they have the comparative advantages of working closely with

members for assembling milk, providing field services and

performing farm-related functions. It is these advantages that

accord them the predominant market share at the firsthandler level.

 In additon to this dominance in milk procurement, co-ops

have the responsibility of balancing milk supply. Many dairy

cooperatives maintain plant capacity to manufacture reserve

and surplus milk into storable products such as butter, milk

powders and cheese. Consequently, they have major market

shares of these hard products. Like a reservoir, these

cooperative plants absorb milk in excess of demand and

provide supplemental milk to the market when it is needed.

 Many processors rely on dairy cooperatives for milk

supplies that are tailored to their requirements for volume,

quality, composition and delivery schedule, so they can focus

their attention on the sectors where they are dominant:

making fluid, cultured and soft products (and lately cheese)

and further processing and packaging dairy products for the

consumer market. These sectors tend to be capital-,

technology- and service-intensive and are exposed to high

product and market risks.

 Farmers, who are generally risk-averse and have many

Table 1 — Comparison of Theory and Dairy Cooperative Practice: What Cooperatives Are

Theory: Economic Structure of Cooperatives

Cooperative organizations represent the aggregates of economic

units.

A cooperative is an agency owned and controlled by members

through which they conduct their business.

Each member-farm fully retains its economic individuality and

independence.

The board of directors is elected from among member-farmers.

Proportionality and service at-cost are two basic principles.

Members provide advances (i.e., equity capital) for financing the

cooperative.

Patronage refunds are returned to members who have been

underpaid or overcharged.

Dividend on capital, if any, is interest payment for using members’

capital.

Being an aggregate of member-farms, the cooperative is neither a

horizontal integration of its members nor a vertical integration

between the cooperative and its members. It is a third mode of

organizing coordination.

Economic Structure of Dairy Cooperatives

A dairy cooperative is the aggregate of dairy member-farms.

A dairy cooperative is owned, controlled and used by members as

the milk marketing arm of their dairy farming business.

Member dairy farms are independent economic units, each making

its own business decisions.

Directors are members; they may have non-member directors who

usually are non-voting advisors and may be mandated by state laws.

These principles are applied in every facet of operations that relate

to member business.

Almost all equities are member capital; ownership of a fraction (a

portion of preferred stock) is not discernable from the financial

statements.

Patronage refunds are net savings returned to members.

Dividends, if paid, are usually on preferred stock, and typically at less

than 8 percent.

There may be some degree of coordination among members as they

voluntarily and collectively adapt to market situations. However, this

is not the same as vertical or horizontal integration.

The Nature of the Cooperative 19
demands on their financial resources on the farm, probably

prefer to stay out of these sectors rather than compete headon with processors (their milk customers), as long as the

market performs well and their farming business can be

sustained.

 Still, there are a substantial number of dairy cooperatives

operating in these sectors, although as a whole their market

share is not high. The upshot is that though dairy

cooperatives are generally less active in these sectors, they

have the size, organization and wherewithal to enter the

market if the situation calls for it.

 

Financing

 Based on the complete financial data of 94 dairy

cooperatives for the fiscal year ending in 2007, total assets of

these cooperatives were $12 billion (or $8.41 per

hundredweight/cwt of milk). Current assets accounted for

60.4 percent ($7.3 billion or $5.08/cwt) and fixed and other

assets accounted for the other 39.6 percent ($4.8 billion or

$3.34/cwt). These 94 businesses represented 61 percent of all

dairy cooperatives and marketed 142.9 billion pounds of

milk, or 94 percent of cooperative milk volume (Ling, table

12).

 Total liabilities of these co-ops were $8.7 billion. Of this

amount, 72.3 percent were current liabilities ($6.3 billion or

$4.40/cwt) while 27.7 percent ($2.4 billion or $1.69/cwt)

were long-term debts. Equities, the balance of assets and

liabilities, were $3.3 billion ($2.32/cwt).

 Dairy cooperatives typically pay members for their milk

twice a month. A large proportion of the current assets and

the current liabilities are for such pending periodic cash

payments to members.

 This is a unique characteristic of the balance sheet of dairy

cooperatives. Therefore, it is important to focus on the ratio

of long-term debts to equity in evaluating financial strength,

which was 72.6 percent for the 94 cooperatives.

 Equities can be grouped into four categories: common

stock, preferred stock, retained earnings and allocated

equities.

 Common stock — In 2007, common stock only

accounted for 0.1 percent of total equities. This is because

common stock of cooperatives is usually issued for witnessing

membership and carries minimal nominal value.

 Preferred stock — Preferred stock, as reported, was 7

percent of total equities. A substantial portion of the

preferred stock was issued by some cooperatives to members

for witnessing retained patronage refunds or for witnessing

members’ additional investment in the cooperative and may

be considered as allocated equities. It is not clear who holds

the remaining preferred stock (probably representing less

than 5 percent of total equities); the holders could be nonmembers as well as members.

 Retained earnings — Retained earnings could be

earnings derived from non-member businesses, but may also

include allocated equities that some cooperatives choose not

to separately specify in the financial reports, retained net

savings that are going to be allocated later, or earnings that

are difficult to attribute to specific member transactions. 

 Therefore, retained earnings that are not likely to be

subject to allocations (or considered by some to be

“permanent” equity) should be less than the reported 10.8

percent of total equities. In any case, retained earnings

belong to the cooperative and therefore are owned by

members.

 In most cases, non-member businesses of dairy cooperatives are incidental to the dairy operation. These may include:

• Processing into storable products other firms’ surplus

(distressed) milk that needs to find a home.

• Sales of goods sourced from other firms in dairy stores or

other sales outlets.

• Sales of dairy or farm supplies that may include customers

who are non-members.

 In a limited number of cases, retained earnings are profits

from investment activities that may or may not be related to

the core business of serving members’ marketing and farming

needs.

 Allocated equities — The 94 cooperatives reported that

82.1 percent of their equities ($1.91/cwt) were allocated to

members. Allocated equities are members’ capital from one

or more of these sources:

 Retained patronage refunds — Retained patronage refunds

are net savings that are allocated to members based on

patronage but are retained to finance the cooperative’s

operations after a cash portion has been paid to members.

Members must treat the entire patronage refund (retained as

well as cash payment) as income for tax purposes.

Cooperatives usually revolve retained patronage back to

members after a certain period of time.

 Capital retains — Some cooperatives use capital retains to

finance the operations or, more often, for special projects

such as building new plants. Money is withheld from milk

payment at a certain rate per hundredweight of milk.

Members must treat capital retains as income for tax

purposes. Capital retains are also revolved back to members

after a certain period of time.

 Base capital plan — Some larger diversified dairy

cooperatives have adopted base capital plans to establish a

more stable equity pool. Under such a plan, a target base

capital level is established at a rate per hundredweight of milk

marketed during a representative period. The base capital

may be funded by retained patronage and/or capital retains,

or by other means of member contribution. Once a member

attains the prescribed base capital level, future patronage

earnings allocated to the member are paid in cash.

 Members provide almost all equity capital. Counting

common stock, preferred stock (that are issued to members),

retained earnings and allocated equities, almost all equities

(probably more than 95 percent) of dairy cooperatives are

supplied and owned by members.

20 The Nature of the Cooperative
Table 2 — Comparison of Theory and Dairy Cooperative Practice: What Cooperatives Do

Market Performance of Dairy Cooperatives

49,675 dairy farmers in 155 cooperatives marketed 83 percent of U.S.

milk in 2007.

The smallest local cooperative has a few members marketing less

than 1 million pounds of milk per year; the largest one has about

10,000 members in the 48 contiguous states and markets tens of

billions of pounds of milk.

Dairy cooperatives may grow, or have grown, to the size necessary

for effectively bargaining with milk buyers for better prices and terms

of trade. 

Dairy cooperatives and their member-farmers are subject to the

disciplines of the market in a free economy.

To be competitive, processors must match the effectiveness and

efficiency of dairy cooperatives.

Dairy cooperatives have comparative advantages in procuring milk

and have major shares in making hard products (71 percent of butter,

96 percent of nonfat and skim milk powder, and 26 percent of cheese,

although the latter decreased from 34 percent in 2002). Their shares

are less significant in sectors that are capital-, technology- and

service-intensive and that carry high product and market risks (7

percent of fluid milk, 4 percent of ice cream, 11 percent of yogurt, 14

percent of sour cream. Their share of cheese has also declined in

recent years). However, dairy cooperatives have the wherewithal to

take up the slack if the market fails to perform well.

Theory: Market Performance of Cooperatives

Cooperatives are organized for efficiently carrying out specific

business functions.

Cooperatives can be of any size (and can be local, regional or

national in scope) that allows them to function efficiently in the

marketplace.

Cooperatives afford farmers the organizational size for exercising

countervailing power.

Cooperatives are pro-market; they let the market supply-and-demand

price be the guidance for producers.

Cooperatives are a means for farmers to promote and maintain

competition; they serve as a “competitive yardstick.”

In those fields where the market has become truly competitive and

farmers can be well served by other firms, cooperatives may want to

cede the field and assume only a stand-by position (to preserve

members’ capital, time and efforts for use on the farm), while

maintaining the legal institutions and organizational capacity to step

in if there is a relapse of market inadequacy.

Theory and reality fit

 Considering all of the above, it is clear that the economic

structure and market performance of dairy cooperatives are

in full accord with the economic theory of cooperation as

expounded by Emelianoff and Nourse. Dairy cooperatives’

mission, functions, organization, governance, operations,

market performance, financing, etc., all conform to the

theoretical prescriptions, as tables 1 and 2 show. Cooperation

as practiced by dairy farmers in marketing milk is an

enduring business model that is in full agreement with the

economic theory of what cooperatives are and what

cooperatives do.

 The dairy market has seen some extreme highs and lows in

the past few years. While co-ops tend to be a stabilizing

influence on ag markets, they cannot prevent such market

shifts. Still, the cooperative form of a business remains the

overwhelming choice of dairy farmers for marketing,

processing and many related services. ■

References

• DeVille, Katherine C., Jacqueline E. Penn, and E. Eldon

Eversull. Cooperative Statistics, 2008, U.S. Department of

Agriculture, Rural Development, Service Report 69,

November 2009.

• Emelianoff, Ivan V. Economic Theory of Cooperation: Economic

Structure of Cooperative Organizations, Washington, D.C.

1942 (litho-printed by Edwards Brothers., Inc., Ann Arbor,

Michigan), 269 pages. (A reprint by the Center for

Cooperatives, University of California, 1995, may be

accessed at: http://cooperatives.ucdavis.edu/reports/

index.htm.)

• Ling, K. Charles. Marketing Operations of Dairy Cooperatives,

2007, USDA Rural Development, Research Report 218,

July 2009.

• Nourse, Edwin G. “The Economic Philosophy of CoOperation,” American Economic Review, Volume XII, No. 4,

December 1922, pp. 577-597.

• Nourse, Edwin G. “The Place of the Cooperative in Our

National Economy,” American Cooperation 1942 to 1945,

American Institute of Cooperation, 1945, pp. 33-39.

• Rural Cooperatives, USDA Rural Development, Volume 76,

Number 6, November/December 2009 and Volume 77,

Number 2, March/April 2010.

The Nature of the Cooperative 21
By K. Charles Ling, Ag Economist

USDA Co-op Program

Note: This article is a sequel to “What

Cooperatives Are (and Aren’t),” “What

Cooperatives Do,” and “Dairy Co-ops:

What They Are and What They Do,”

Rural Cooperatives, Volume 76, Number 6,

November/December 2009; Volume 77,

Number 2, March/April 2010; and

Volume 78, Number 2, March/April 2011,

respectively. Past issues are posted on the

USDA Rural Development website:

www.rurdev.usda.gov. 

n our free-market

economy, the

cooperative is a unique

business model in that

it is an aggregate of

individual economic units. In the

agricultural sector, a cooperative is an

aggregate of member-farms.

 Using the dairy sector as an example

for this article, the cooperative takes

whatever milk volume is produced by

members and then acts as their

exclusive marketing agent. Members’

farming operations are not under the

cooperative’s administrative control, and

the cooperative cannot dictate how

members operate their dairy farms. 

 This operating mode entails its own

unique economics that comprises the

following elements:

• When milk price goes up or down,

the milk volume a farm may produce

depends on the financial objective of

the farm: whether it wants to attain

maximum total profit (minimum loss

in a loss situation), maximum total

revenue (up to the break-even point),

or minimum average cost.

I

How co-ops do it

Dairy co-ops are a prime example of

the economics of co-op marketing

Photos courtesy Darigold

22 The Nature of the Cooperative
• Production input cost changes do not

change a farm’s rated capacity, but

instead shift the farm’s cost curves

straight up or down. The milk volume

that the farm produces, again,

depends on the financial objective of

the farm. (Cost curves refer to a

typical, simple diagram showing how

milk production costs vary in relation

to production volume. See figure 1.)

• Depending on how farmers respond

to milk price and input cost changes,

the milk volume the cooperative has

to handle may continually fluctuate. 

• Likewise, milk production is a

biological process and is subject to

daily and seasonal fluctuations.

• The seasonality of milk production

generally does not match the

seasonality of fluid milk demand. This

mismatch requires cooperatives that

supply milk to the fluid market to

balance seasonal supply with seasonal

demand and handle the inevitable

seasonal surplus milk volume at a

substantial supply-balancing cost.

 A fuller explanation of the unique

economics of dairy cooperative

operation is facilitated by the focusing

on a model dairy farm.

Model dairy farm

 A farm is constructed with its

dairying infrastructure to accommodate

a dairy herd of a certain size. It has a

rated capacity of producing a certain

number of pounds of milk per day.

When the farm produces milk at the

capacity volume, the average cost of

milk production per hundredweight

(cwt) should be at a minimum. If milk

price for the month is the same as the

minimum average cost, then the farm’s

milk production for the month is at

capacity and the farm is said to be in

“equilibrium.”

Milk price variation

 If milk price is lower than the

minimum average cost, the farm will

incur a loss for every cwt of milk it

produces. According to textbook

optimization theory, the farm would

minimize its total losses by producing

milk at a volume where milk price

(marginal revenue) equals marginal

cost. 

 However, although marginal cost is a

useful concept, its “real-life calculation”

has many complications and, therefore,

it is not readily available for practical

day-to-day operational decision-making

(This also applies to other concepts

related to marginal productivity). For

such decisions, the time-honored

business practice is to use average cost

in the profit-and-loss estimation. 

 In the present case, it is very likely

that the dairy farm will still strive to

attain the lowest average cost by

producing milk up to its rated capacity,

even though doing so would incur a

higher loss. So, depending on which

cost concept a farmer uses, milk volume

produced by the dairy farm may be

somewhere between the two amounts

just mentioned.

 When milk price is higher than the

minimum average cost, the farm will

enjoy a profit. The farmer may decide

to attain the lowest average cost by

producing at its rated capacity. Or, the

farmer may want to achieve maximum

total profit by producing a milk volume

where milk price (marginal revenue)

equals marginal cost, if the latter is

actually known. 

 Alternatively, the farmer may strive

for maximum total revenue and increase

its production up to the volume where

the farm will break even. Thus, when

milk price is higher than the minimum

average cost, the amount of milk

produced by the dairy farm may be

somewhere in the range framed by the

three possible milk volumes just given.

 Replicating the model dairy farm

ten, a hundred or even a thousand

times, depending on the size of a

cooperative, the aggregate milk volume

produced by its members is certain to

fluctuate. The cooperative may know

with certainty the aggregate volume of

members’ rated capacity, which would

logically be the basis for planning its

milk handling capacity. 

 However, the uncertain volume of

actual delivery means on some days the

cooperative will have slack capacity,

while on other days it may have to

scramble to make sure every drop of

milk has a home. Also in response to

the fluctuating volume, milk hauling

may have to be rerouted for most

economical coordination.

 It should be noted that because a

cooperative is formed to market

whatever the aggregate volume of milk

produced by its members, it does not

have its own milk production functions,

milk production cost curves or milk

supply curves.

Milk production 

input cost variation

 Suppose milk price remains the same

as the minimum average cost given at

the rated capacity volume, but the cost

of production input, such as feed or

fuel, has increased. Because the

infrastructure and the size of the dairy

herd do not change, the rated capacity

of the farm will stay the same.

 However, the average cost curve and

its associated marginal cost curve will

shift upward. The farm will suffer a

loss, and it may want to minimize its

total losses by producing milk at a

volume where milk price (marginal

V

P

Pounds/day

$/cwt

MC AC

Figure 1: Average cost (AC) and marginal cost

(MC) vs. milk production volume

The Nature of the Cooperative 23
24 The Nature of the Cooperative

revenue) equals marginal cost. 

 Short of knowing the marginal cost,

it is very likely that the dairy farm will

work to attain the lowest average cost

by still producing milk at its rated

capacity. When production input cost

increases, milk volume produced by the

dairy farm may be somewhere between

the two milk volumes just referred to.

 On the other hand, if production

input cost decreases, the average cost

curve and the associated marginal cost

curve will shift downward and the farm

will reap a profit. The farm may still

decide to produce milk at its rated

capacity. Or it may increase its

production up to the break-even point

that will return the highest total

revenue. 

 Alternatively, the farm may want to

achieve maximum total profit by

producing at the milk volume where

milk price (marginal revenue) meets

marginal cost. When production input

cost decreases, milk volume produced

by the dairy farm may be somewhere in

the range framed by the three volumes

just articulated.

 Again, the aggregate volume of

member milk faced by the cooperative

is rather uncertain, depending on how

members make their day-to-day

production decisions in reaction to

production input cost changes.

 The discussion thus far shows the

challenges a dairy cooperative faces in

handling fluctuating milk volume when

either milk price or production input

cost changes. When both price and cost

changes are considered at the same

time, the picture is even more

complicated.

 Still, this is a highly simplified

scenario. In real life, not every farm is

like the model dairy farm; in fact, no

two farms are alike. They are not likely

to be of the same size and make the

same production decision. That means

the volume variation may be even more

uncertain than what has been described.

In addition, the seasonality of milk

production further aggravates milk

volume uncertainties.

Seasonal production variation

 Milk production is affected by a

cow’s physiological condition, which is

subject to seasonal changes. The

seasonal nature of milk production is

best portrayed by the index of

seasonality, such as shown in table 1,

which is based on milk deliveries to the

Northeast regional market and

documented in an earlier USDA

research report. The table shows that

the first six months of the year is a

period of higher-than-average milk

deliveries, with May being the peak. 

 The index of 106 indicates that May

is 6 percent higher than annual average

daily deliveries. Milk deliveries decline

sharply from June to July and stay

relatively low throughout summer and

fall. Deliveries are usually lowest in

November. 

 With an index of 95, November is 5

percent below annual average daily

deliveries. Deliveries recover in

December and increase steadily through

winter and spring. The drop from May

to November is 11 percentage points.

 Seasonality of milk production, in

essence, shifts a farm’s cost curves

downward to the right during a

seasonally high production month or

upward to the left during a seasonally

low production month. During a

seasonally high production month

(seasonality index is more than 100),

since the same infrastructure and the

same herd size will produce more milk,

the farm’s capacity should be higher

than originally rated. 

 Also because the same fixed cost is

spread over a higher milk volume, the

average cost of producing milk should

be lower. The combined effect would

shift the cost curves rightward and

downward. 

 On the other hand, during a

seasonally low production month

(seasonality index is less than 100), since

---------------Percent---------------

January 100.1 101.9

February 101.8 100.6

March 103.7 100.9

April 105.4 98.2

May 106.0 98.1

June 103.4 94.0

July 97.8 94.2

August 97.0 98.1

September 96.3 105.2

October 95.4 104.6

November 95.0 102.8

December 98.1 101.4

Annual average 100.0 100.0

Source: Ling, K. Charles. Cost of Balancing Milk Supplies:

Northeast Regional Market, U.S. Department of Agriculture,

RBS Research Report No. 188, October 2001.

Note: Different regions of the country may experience

different seasonality, and seasonality may change over time.

Producer milk

Month deliveries

Fluid

demand

Table 1 Indices of seasonality of producer milk

deliveries and fluid demand
the same infrastructure and herd size

will produce less milk, the farm’s

capacity should be less than originally

rated. And because the same fixed cost

is spread over a smaller milk volume,

the average cost of producing milk

should be higher. The combined effect

would shift the cost curves leftward and

upward.

 The net effect of shifting seasonal

capacity and cost curves means that the

members’ milk volume the cooperative

has to handle will fluctuate seasonally

throughout the year. This further

compounds the challenges of marketing

members’ milk.

Seasonal demand variation

 On the milk demand side, seasonal

variation is mainly caused by fluid

(beverage) uses. This is because the

milk volume required by fluid

processing plants is directly and

instantaneously derived from

consumers’ demand of fluid products,

which is highly seasonal. Manufacturing

plants that make storable products such

as cheese are different. They tend to

maintain a throughput volume at or

near plant capacity in order to achieve

least-cost operations.

 The example in table 1 shows that

fluid demand is highest in September

and maintains a higher-than-average,

though declining, level through fall and

winter until March; fluid demand is

lower-than-average from April through

August. The peak in September

(seasonality index = 105) is 5 percent

above annual average daily

consumption. 

 The lowest fluid consumption month

is June, with an index of 94, or 6

percent below the annual daily average.

The June low is a drop of 11 percentage

points compared with the September

peak.

 Thus, seasonality of fluid demand

usually runs counter to the seasonality

of milk production. Fluid demand tends

to be high during those months when

milk production is low, and tends to be

low when milk production is high. The

mismatch of supply and demand is a

major challenge the cooperative has to

handle, as shown in the following

example.

 Suppose that on an annual daily

average basis, the cooperative’s

members deliver 10 million pounds of

milk a day, and the cooperative markets

4 million pounds to fluid milk

processors and a constant 2.5 million

pounds to dairy product manufacturing

processors. 

 Suppose further that milk production

and fluid demand follow the seasonal

patterns given in table 1. In May, the

cooperative’s members will produce

10.6 million pounds of milk a day, while

fluid plants will use 3.9 million pounds

and the manufacturing processors will

---------------Million pounds/day---------------

January 10.0 4.1 2.5 3.4

February 10.2 4.0 2.5 3.7

March 10.4 4.0 2.5 3.8

April 10.5 3.9 2.5 4.1

May 10.6 3.9 2.5 4.2

June 10.3 3.8 2.5 4.1

July 9.8 3.8 2.5 3.5

August 9.7 3.9 2.5 3.3

September 9.6 4.2 2.5 2.9

October 9.5 4.2 2.5 2.9

November 9.5 4.1 2.5 2.9

December 9.8 4.1 2.5 3.3

Annual average 10.0 4.0 2.5 3.5

1

Items may not add to totals due to rounding.

Member

milk

Month deliveries

To fluid

milk

processors

Table 2 An example of a cooperative's milk in excess of demand by fluid milk

and manufacturing processors1

To

manufacturing

processors

Co-op milk in

excess of

sales

The Nature of the Cooperative 25
use 2.5 million pounds. The cooperative will have 4.2 million

pounds of milk a day in excess of demand by fluid plants and

manufacturing processors (table 2). 

 On the other extreme, the same calculation will show that

the daily excess volume will be 2.9 million pounds in the fall

months (September through November); a reduction of 1.3

million pounds a day from May. 

 If the cooperative has its own manufacturing plants to use

a constant volume of 2.9 million pounds of milk a day, then

the cooperative still needs to have facilities to handle a

seasonal surplus of 1.3 million pounds of milk a day in May.

During other months, the seasonal surplus balancing facilities

will be under-utilized and will run dry in the fall months,

resulting in costly plant operations.

 If a cooperative does not have enough surplus balancing

capacity (or in the case of bargaining cooperatives that do not

have any plant capacity), there are two ways for them to

dispose of surplus milk. They can sell the surplus milk in the

spot market, usually at a price discount, or they can pay a

“tolling fee” to have the milk manufactured into storable

dairy products at plants owned by others. 

 The price discount and the tolling fee are charges for

defraying the costs of owning and operating surplus handling

plant facilities.

Other marketing cooperatives

 The unique economics of cooperative marketing operation

is applicable in the situation where the cooperative is the

exclusive marketing agent of the milk produced by members.

Other agricultural commodities (such as fruits, vegetables,

nuts, poultry, sugar, etc.) that exclusively rely on the

cooperative to market members’ products would have unique

economics of cooperative operation similar to that of dairy

cooperatives. 

 However, they differ from milk in some important aspects.

The main difference is that milk is a “flow” product — day in

and day out — while other farm commodities are harvested

in lumps toward the end of the growing season of several

weeks or months. 

 In the analysis of the economics of cooperative marketing

of milk, the unit of time used is on a per day basis. The same

analysis of other commodities has to use a unit of time that is

appropriate for a particular commodity.

 Some producers of commodities that are storable and have

a long marketing season (such as grains and oilseeds) may

view the cooperative as but one of multiple outlets and

market through it only if the cooperative offers the best

terms and services among all alternatives. In such a case, the

cooperative may still maintain its uniqueness in its cooperative structure, organization, governance and equity financing.

Its marketing operation, however, is not different from other

marketing firms (firms other than cooperatives). ■
his series of articles has attempted to clarify the nature of the

cooperative business model in our free-market economy by explaining

the cooperative’s unique economic structure as an aggregate of

independent economic units (member-farms). Co-ops are organized

to achieve a common goal(s) using organization, governance, equity

financing, operations and economics that are unique to cooperatives. Cooperatives

have been shown to be pro-market, helping farmers gain market access and exercise

countervailing market power, and serving as a competitive yardstick for their industry.

 

 This article attempts to show how cooperatives relate to other market participants

through their roles in transaction governance, or “in aligning incentives and crafting

governance structures that are better attuned to their exchange needs” (Williamson,

2002, p. 172). 

 As it has been in some of the previous articles, the dairy industry will again be used

as an example to demonstrate the role of the co-op. In marketing milk and milk

products, farmers and their cooperatives may engage in the following transaction

scenarios.

T

The Nature

of Cooperatives

By K. Charles Ling, Ag Economist

USDA Rural Development 

Cooperative Programs

Editor’s note: This completes a

series of five articles that examine

the characteristics that make

agricultural cooperative businesses

unique and valuable in our economy.

The previous articles in the series

were: “What Cooperatives Are (and

Aren’t)” (November/December

2009 issue); “What Cooperatives

Do” (March/April 2010); “Dairy

Co-ops: What They Are and What

They Do” (March/April 2011); and

“How Co-ops Do It: Dairy Co-ops

Are a Prime Example of the

Economics of Co-op Marketing,”

(November/December 2011). Past

issues of Rural Cooperatives are

posted on the USDA Rural

Development website:

www.rurdev.usda.gov. Hard copies

can be obtained by e-mailing

requests to: coopinfo@wdc.usda.gov,

or by calling (202) 720-8381. 

Roles in economizing transaction cost is a new

dimension for understanding value of co-ops

A worker prepares to pull milk samples

from co-op tankers. The samples are

checked before a tanker is cleared for

unloading. USDA photo by Lance Cheung

The Nature of the Cooperative 27
 Scenario I. — In a subsistence agricultural economy, farm

production in excess of family consumption may be sold off

farm. For example, a farm family may have one or two cows

for producing milk to satisfy the family’s food needs. If there

is surplus milk, it may be sold to neighbors (food safety

regulations permitting). The transactions are incidental to

subsistence farming, do not require specific assets, and are

primarily operations of a bygone era in the United States.

 Scenario II. — Commercial milk production requires

substantial capital investment in specialized assets: milk cows;

barns, milking parlors and other buildings; machinery and

equipment; skilled labor and management, etc. Most of these

assets are specifically for producing milk and cannot be easily

employed for alternative uses. Furthermore, milk is a “flow”

product and is highly perishable. Its market is inherently

volatile due to daily, as well as seasonal, variations of milk

production and fluid milk demand. Supply and demand

variations are not coordinated. 

 Asset specificity, high product perishability and market

volatility make dairy farmers vulnerable when dealing with

milk buyers (usually dairy food processors). There are many

dairy farmers, but a small number of milk processors.

Processors also must deal with “asset specificity” — they own

dairy plants that are capital- and technology-intensive and

require large size to take advantage of the economies of scale.

But they are in a dominant bargaining position vis-a-vis

individual dairy farmers.

 Farmers organize cooperatives to gain bargaining and

countervailing power. However, asset specificity still causes

uncertainty and poses hazards to the investment of the dairy

farmers and the processors if there is no credible contractual

safeguard. Contracts that spell out the terms of trade as legal

rules may be formulated in an effort to relieve the hazard. 

 But it is impossible to foresee and encompass all

contingencies in a contract, due to human limitations.

Relying on courts for relief is time-consuming and costly.

This is a scenario of transaction without credible contracting,

and the transaction does not have safeguards to relieve the

investment hazard and protect the investment.

 Scenario III. — For a highly perishable commodity such

as milk, it is vitally important for both producers and

processors to work together to make sure milk flow is smooth

and without interruption. Producers need to have an assured

outlet for the milk once it is produced, while processors

require a steady supply of fresh milk to manufacture highquality dairy products and efficiently utilize plant capacity. 

 The dairy industry has evolved in such a way that many

dairy cooperatives and processors have developed a high

degree of bilateral dependency. Because dairy cooperatives

are organizations of farmers, they have the comparative

advantages of working closely with members for assembling

milk, providing field services and performing farm-related

functions (84 percent of U.S. dairy farmers marketed milk

through cooperatives in 2007, the year of USDA’s latest dairy

cooperatives survey). 

 Many processors rely on dairy cooperatives for milk

supplies that are tailored to their requirements for volume,

quality, composition and/or delivery schedule, so they can

focus their attention on processing and packaging dairy

products. Under such an arrangement, the transactions

between cooperatives and processors are assisted with what is

called credible contracting and supported by inter-firm

contractual safeguards. Instead of a set of legal rules with

court enforcement, the contract here is a framework or a set

of guidelines for interactions between the firms. 

 Discrepancies in performance are resolved through

amicable consultation or negotiations or by arbitration. The

court is only used as a last resort remedy. 

 Scenario IV. — Besides selling members’ milk to buyers

(processors), it may be necessary for a dairy cooperative to

forward-integrate into processing some or all of its members’

milk into various dairy products. Being marketers of

members’ milk, many cooperatives have to maintain plant

capacity to balance milk supply and manufacture reserve and

surplus milk into storable products. Otherwise, the surplus

milk will be at the mercy of the market and lead to depressed

milk prices. In order to generate higher margins from the

market for members’ milk, some cooperatives also may

choose to integrate into processing fluid products or specialty

dairy products, or further processing hard products. These

processing enterprises are under the cooperative’s hierarchical

administrative control.

Transaction governance structures

 The roles of a cooperative in the above scenarios fit with

the analysis of the roles of a firm in transaction governance

that constitute the core of transaction-cost economics

(Williamson, 2010, 2007, 2005, and 2002).

 In Scenario I, transactions between numerous suppliers

and buyers are for an undifferentiated product. The product

is made with a general purpose technology and does not

require assets that are specific for its production (asset

specificity is zero). Transaction governance is accomplished

through market competition. The transaction governance

mode is unassisted market.

 When the product uses special purpose technology that

requires specific assets for its production, as described in

Scenario II, asset specificity is greater than zero. Asset

specificity causes uncertainty and poses hazards to the

investments of the suppliers and the buyers. Contracts that

are formulated as legal rules may provide no safeguards to

protect against investment hazards. Here, transaction

governance is still the market, and the transaction governance

mode is unrelieved contractual hazard.

 In Scenario III, firms seek out reputable, trustworthy

counterparts to reduce investment hazards. Such transactions

give rise to bilateral dependencies, and the parties have

28 The Nature of the Cooperative
incentives to promote a continuous, long-term relationship,

thus safeguarding specific investments. Transactions are

supported by inter-firm contractual safeguards; the contract

here is a set of guidelines for mutual adaptations. The

transaction governance mode is credible contracting, a hybrid

mode between (unrelieved hazard) market and full

integration.

 Successive, technologically separable stages are brought

under unified ownership and vertically integrated and

controlled in Scenario IV. In this scenario, the transaction

governance mode is hierarchical administrative control. This

mode occurs when a higher degree of asset specificity and

added uncertainty pose greater needs for cooperation in

mutual adaptations between successive stages.

 The transaction governance modes are summarized in

table 1. Each mode in the table represents a generic mode of

governance, and each generic mode of governance embodies

its own internally consistent attributes of incentive intensity

(reward for effort), administrative control, and contract law

regime – and, therefore, has its own strengths and

weaknesses.

 The governance structure Mode A is the unassisted

market. The governance structure Mode B is the market

where asset specificity exposes transacting parties to

uncertainties and, without safeguards, to unrelieved

contractual hazards to their investments. Mode C is where

the market is assisted with credible contracting. All successive

production stages are integrated under hierarchical control in

transaction governance Mode D. 

 The attributes of a market mode are high incentive

intensity, little administrative control, and a legal rules

contract regime. On the other hand, attributes of hierarchy

are low incentive intensity (where pricing for the successive

stages is cost-plus), considerable administrative control (by

fiat), and forbearance is the implicit contract law of internal

organization (the parties must resolve their differences

internally).

Transaction governance in practice

 Dairy cooperatives may be classified into one of four

categories, based on the main marketing function(s) they

perform (table 2). Their transaction governance roles

depend on their lines of business.

 All four categories of dairy cooperatives may have joint

ventures with other cooperatives or firms to process and

market certain dairy products. The cooperative supplies dairy

inputs and the partner(s) provide technical or marketing

know-how to the joint venture.

 This is one way of bringing product processing under the

cooperative’s partial control. In this case, transaction

governance mode may be viewed to fall somewhere between

Mode C and Mode D.

Conclusions

 Cooperatives are transaction governance structures, as are

non-cooperative firms. Depending on the lines of business of

a cooperative or other type of a firm, transactions can occur

under all possible governance modes. Cooperatives adapt to

various governance modes for economizing on the

transaction cost, just as other firms do.

 For entering into credible contractual relationships with

buyers (processors), the cooperative’s functions of providing

market access and exercising countervailing power put its

members, collectively through the cooperative, on a relatively

more equal footing with buyers. This should make credible

contractual relationships between sellers and buyers more

attainable and stable.

 Furthermore, as its members’ collective marketing agency,

 

A: Unassisted market 0 0 High Little Competitive norm

B: Unrelieved hazard > 0 < > Legal rules contract regime

C: Hybrid (Credible contracting) > > < > Credible contracting

D: Hierarchy (Administrative) > > Low (Pricing Considerable Internal implicit contract law

 for successive (by fiat) (Forbearance)

 stages is 

 cost-plus) 

Source: Adopted from Williamson, 2005, Figure 1: Simple Contractual Schema.

Note: ">" indicates a mode having a higher intensity of the particular attribute than the mode above it.

"<" indicates a mode having a lower intensity of the particular attribute than the mode above it.

Asset

specificity

Transaction

governance mode

Investment

hazard

safeguard

Table 1 Transaction governance modes and attributes

Incentive

intensity

Admin.

control

Contract

law regime

The Nature of the Cooperative 29
the cooperative serves as a single transaction entity for

credible contracting with buyers. It also introduces order and

eliminates conflicts among members who would otherwise be

competing individually for customers. As a result, transaction

costs should be reduced. 

 A cooperative does not own the assets for producing the

milk (for example) that the cooperative markets for its

members; the assets and the investment hazard associated

with asset specificity belong to member-farms. By pooling

members’ milk in its marketing efforts, the cooperative, in

essence, also pools the investment hazard. As a result, each

member’s share of the hazard conceivably is less than if they

individually market their products. The fact that asset

specificity and the associated investment hazard belong to

individual members reaffirms the cooperative’s unique

economic structure of being an aggregate of its memberfarms.

 These analyses show how cooperatives relate to other

market participants through their roles in transaction

governance and will hopefully broaden understanding of the

cooperative’s place in the market economy. Together with the

earlier work on cooperative basics, they should clarify the

nature of the cooperative.

References

• Ling, K. Charles. The Nature of the Cooperative: A Dairy Cooperative Case

Study, USDA Rural Development, Research Report 224, April 2012.

• Williamson, Oliver E. “The Theory of the Firm as Governance Structure:

From Choice to Contract,” Journal of Economic Perspectives, Volume 16,

number 3, summer 2002, pp. 171-195.

• Williamson, Oliver E. “The Economics of Governance,” American

Economic Review, 95 (May 2005), 1-18.

• Williamson, Oliver E. “Transaction Cost Economics: An Introduction,”

Economic Discussion Papers, Discussion Paper No. 2007-3, March 1, 2007.

http://www.economics-ejournal.org/economics/discussionpapers/2007-3.

• Williamson, Oliver E. “Transaction Cost Economics: The Natural

Progression,” American Economic Review, 100 (June 2010): 673-690. (Prize

Lecture, the Sveriges Riksbank Prize in Economic Sciences in Memory of

Alfred Nobel 2009, Stockholm University, Sweden, December 8, 2009). ■

Table 2 Category of dairy cooperatives by marketing function(s) and their transaction governance roles

Category of cooperatives

Bargaining

Niche marketing

Fluid processing

Diversified

Main function

Negotiate with milk buyers for

milk prices and terms of trade; a

few may operate milk handling

facilities but not milk plants.

Own or retain plant capacity to

process members’ milk into

specialty/niche products.

Own or retain plant capacity to

process members’ milk into fluid

products. May also process soft

and cultured products.

Perform bargaining and all or

most other marketing functions.

As a group, sold 53 percent of

milk to other handlers

(bargaining), while

manufactured the remaining 47

percent into various products.

Dimension

108 cooperatives (out of 155

U.S. total, or 70 percent).

Together handled 23 percent of

the 155.8 billion pounds U.S.

cooperative milk volume, but

few handled more than 1 billion

pounds of milk each.

19 cooperatives. Most handled

less than 50 million pounds of

milk each. Together handled

less than 1 percent of U.S.

cooperative milk volume.

Four cooperatives. Milk volume

processed was moderate.

Together handled less than 1

percent of U.S. cooperative milk

volume.

24 cooperatives. Three out of

four cooperatives in this group

handled 1 billion or more

pounds of milk and none

handled less than 50 million

pounds. Together handled 75

percent of the U.S. cooperative

milk volume.

Transaction governance mode

Regular milk sale is usually

Mode C (hybrid); may be Mode B

(unrelieved hazard) for spot milk

sales.

Product processing stages are

Mode D (hierarchy); wholesale

distribution of products is

usually Mode C and may be

Mode B; and retail sales are

usually Mode B.

Product processing stages are

Mode D; wholesale distribution

of products is usually Mode C.

Bargaining function is usually

Mode C; product manufacturing

and further processing stages

are Mode D; wholesale

distribution of products is

usually Mode C and may be

Mode B; and spot milk sales may

be Mode B.

Table source: All dairy cooperative statistics cited are 2007 data, the year of USDA Cooperative Programs’ most recent dairy survey.

30 The Nature of the Cooperative

By Charles Ling, Ag Economist

Cooperative Programs

USDA Rural Development

charles.ling@wdc.usda.gov

cooperative faces many challenges in

sourcing and maintaining an adequate level

of capital for financing its operations. Being a

cooperative, its equity capital is provided by

members and is therefore dependent on

members’ willingness to support the cooperative’s

undertakings. 

 Members’ equity retained by the cooperative represents a

substantial sum of their money and competes with the capital

needed for operating their farms. Most members therefore

prefer to have as little of their equity retained by the co-op as

possible, and for a short equity-revolving period. Co-ops use

a variety of means to redeem member equity in ways that

meet both the needs of the co-op and its members. 

 When a cooperative’s business is doing well, some

members may perceive that its market valuation is higher

than the book value and want to have access to the gain. This

may stoke the pressure to “sell off” the cooperative or

convert it to a public corporation.

 To overcome these challenges and shore up an adequate

equity level, alternative capital financing methods have been

used by some cooperatives. These methods include: issuing

preferred stock; accumulating (unallocated) retained earnings;

capitalization using a “new-generation” cooperative model;

and allowing non-member capital to be invested in cooperatives (which usually requires a change in state co-op laws).

Capital

A

Lessons offered by dairy co-ops shed light on important equity capital issues

Ideas 

continued on page 34

32 The Nature of the Cooperative
 The experience of dairy cooperatives can serve as an

example for answering some frequently asked questions

(FAQs) regarding cooperative equity financing, including the

following, grouped by specific financing alternatives.

Member equities

 Question: Cooperative equities are furnished by

members and therefore are limited. How does a cooperative

gain access to capital without incurring long-term debt,

without selling off the cooperative, or without going public in

these situations:

• When the cooperative needs more capital?

• When members agitate to gain access to the perceived

high market value of the business?

• When pressure mounts to shorten the equity-revolving

period?

 Answer: Members organize or join a cooperative to

market their farm production. They should provide the

cooperative with capital at a level that is commensurate with

the functions they want the cooperative to perform and the

benefits they want to derive from it.

 If market value of the cooperative is higher than the book

value, it means the cooperative’s earnings and potential

future earnings are higher than can be expected, given its

level of equity capital. Members gain access to this higher

earning ability by receiving higher pay prices, premiums and

patronage refunds. Selling off the cooperative to gain the

value of the business is tantamount to “killing the goose that

lays the golden egg.”

 Eventually, it is up to members to decide if they want the

cooperative to be viable or if they prefer other alternatives.

Preferred Stock

 Question: What effects might issuing preferred stock

have on a cooperative’s practice?

 Answer: Preferred stock may specify nearly any

conceivable right for shareholders. What effects preferred

stock may have on a cooperative’s practice depend on what

rights are specified. Preferred stock that pays dividends and

has preference in assets over common stock in the event of

the dissolution of the cooperative — the most common type

of preferred stock — probably would not have any impact. If

the preferred stock confers certain voting rights, the effect

would depend on what specific issues the preferred stockholders are entitled to vote on.

Retained earnings

 Question: Many cooperatives expand non-member

businesses to accumulate retained earnings as permanent

equity. What might be the long-term effects of this practice

on governance?

 Answer: Cooperatives may have non-member business

for various reasons. In any case, retained earnings belong

to the cooperative and thus are jointly owned by members.

Disposition of retained earnings is at the discretion of the

board of directors.

 However, a marketing cooperative would not be

conforming to the Capper-Volstead Act requirements if its

non-member business were to exceed 50 percent of total

sales. Moreover, by accumulating permanent capital, the

cooperative may actually increase incentives for members

to sell off the cooperative or convert it to a public

corporation.

New-generation cooperatives 

 Question: Are new-generation cooperatives the answer

to co-op financing issues?

 Answer: A new-generation cooperative requires

members to pay equity up front to acquire the delivery

rights. While this attribute may address the issue of raising

capital, the cooperative model introduces new issues,

mainly relating to delivery rights and property rights

(Torgerson).

 Furthermore, many new-generation cooperatives are

organized for business opportunities that resemble venturecapital investment. They tend to process one product or a

narrow range of products. This presents additional risks as

compared with a cooperative that is organized to market

members’ product(s) through a variety of marketing

channels.

Outside (non-member) capital

 Question: What changes in governance, organizational

structure and practice may be brought about by the new

cooperative laws enacted by some states that allow outside

equity capital?

 Answer: There is a large variation regarding voting

power and earning distribution, etc., among the few state

laws that allow cooperatives to have investors. Differences

in governance and earning distribution rules will influence

cooperative organizational structure and practice

differently. It is better to analyze them on a case-by-case

basis. Furthermore, not every cooperative newly

incorporated under these state laws has outside (nonmember) investors. n

Equity financing issues:

F A Q s

The Nature of the Cooperative 33
 This article focuses on the equity financing practices of

dairy cooperatives in the hope that it can help all types of coops better understand capital financing issues.

Dairy co-op equity capital

 Just as for any other type of business, dairy cooperatives

require an adequate level of capital to market members’ milk.

Besides bargaining (negotiating for milk prices and terms of

trade), co-ops may have diversified operations, including:

owning and operating milk-handling facilities, performing

value-added processing, and/or providing milk marketingrelated and other member services. Member equities are the

source of capital to support these operations.

 The four basic categories of dairy cooperative equity are: 

• Common stock — Common stock of cooperatives is

usually issued to prove membership, although it typically

has only nominal value. Based on the complete financial

data of 94 dairy cooperatives for the fiscal year ending in

2007, common stock only accounted for 0.1 percent of

total equities. (All numbers cited in this article are 2007

data, the year of USDA Cooperative Programs most recent

dairy survey (Ling, 2009). The survey is done every five

years; new statistics will be available after data collection on

dairy cooperatives’ 2012 operations is completed.)

• Preferred stock — Some dairy cooperatives issue

preferred stock, mostly to members to document retained

patronage refunds or their additional investment in the

cooperative. Preferred stock owned by members may be

considered as allocated equities. In 2007, preferred stock

was reported to be 7 percent of total equities.

• Retained earnings — Retained earnings can be derived

from non-member businesses which, in most cases, are

incidental to a cooperative’s dairy operation. Retained

earnings may also include allocated equities that are not

separately specified in the financial reports, net savings that

are yet to be allocated, or earnings that are difficult to

attribute to specific member transactions. Therefore,

retained earnings that are not likely to be subject to

allocation (or considered by some to be “permanent”

equity) should be less than the 10.8 percent of total equities

reported for 2007. In any case, retained earnings belong to

the cooperative and thus are owned by members.

• Allocated equities — The 94 cooperatives surveyed

reported that 82.1 percent of their equities were allocated

to members. Allocated equities are members’ capital from

one or more of these sources:

 Retained patronage refunds — Retained patronage

refunds are net savings that are allocated to members based

on patronage, but which are retained to finance the

cooperative’s operations after a cash portion has been paid to

members. 

 Capital retains — Some cooperatives use capital retains to

finance the operations or, more often, for special projects,

such as building new plants. Money is withheld from 

milk payment at a certain rate per hundredweight of milk.

 Members must treat patronage refunds (both cash and

retained) and capital retains as income for tax purposes.

Cooperatives usually revolve retained patronage refunds and

capital retains back to members after a certain period of time. 

 Base capital plan — Some larger dairy cooperatives with

diversified operations have adopted base capital plans to

establish a more stable equity pool. Under such a plan, a

target base capital level is set at a rate per hundredweight of

milk marketed during a representative period. The base

capital may be funded by retained patronage refunds and/or

capital retains, or by other means of member contribution.

Bags of dehydrated milk powder fill a co-op warehouse. USDA photos by Lance Cheung

34 The Nature of the Cooperative
Once a member attains the prescribed base capital level,

future patronage earnings allocated to the member are paid

in cash.

 In summary, almost all equity capital of dairy cooperatives

is supplied and owned by members, including: common

stock, preferred stock, retained earnings and allocated

equities. By obtaining equity financing internally from

members, cooperatives do not incur the cost of soliciting

investment capital in the capital market.

Member loyalty is key

 For an average member-producer delivering 3.1 million

pounds of milk in 2007, total allocated equity retained by the

cooperative was estimated at $59,000 per member

($1.91/cwt), quite a large sum of capital committed by

individual members. (Because retained equities also include

those yet to be revolved back to retired members and inactive

(former) members, equities actually retained for active

members should be somewhat less than this estimated

amount).

 Members must treat retained capital, when allocated, as

income for tax purposes and pay taxes out of their own funds.

Although the retains are revolved back to members as

permitted by the cooperative’s earnings after a few years, the

present value of the retained capital is diminished because

taxes on them have to be paid upfront and the revolving

funds to be received in the future are discounted.

 Members’ perceptions and attitudes towards retained

equities may vary with their respective membership status —

active members, retired members or inactive (former)

members — even though they all usually receive the revolved

equities on the same revolving schedule, which is determined

by the board of directors. These perceptions may include: 

 Active members — Active members may realize the

necessity to adequately capitalize the cooperative’s operations

to ensure that their milk is effectively and efficiently

marketed. Still, retained equities compete with capital needed

for members’ dairy farming operations, which is very

substantial because of the type of inputs used and assets

owned.

 Members are usually supportive of a co-op’s need for

financing if the capital requirement is for the cooperative to

carry out basic milk marketing functions. A cooperative may

face some dissension if it attempts to invest in what some

members consider to be extraneous businesses, unless they

are convinced that the new ventures will:

• solidify the market for members’ milk, or

• help market members’ milk, or

• add value to members’ milk, and

• benefit members the most among all available alternatives

of investing the capital.

 Retired members — Retired members may be content

with receiving retained equities that are revolved on a steady,

regular basis. They may consider such payments as

something akin to retirement annuities. However, some may

express dissatisfaction that no dividend is paid on the retained

equities and the cooperative uses their capital free of charge

— especially if the revolving period is long. If equity

revolving becomes erratic — usually due to the cooperative

encountering certain financial difficulties — they may

become disgruntled.

 Inactive (former) members — Inactive members may be

farmers who have discontinued membership in the

cooperative and made other milk marketing arrangements, or

who have exited from dairy farming and transitioned into

other farming enterprises or have discontinued farming

The Nature of the Cooperative 35
altogether. Conceivably, they are the least satisfied with

equities being retained, because they may need the capital for

use in other endeavors. As their loyalty to the cooperative has

waned or becomes nonexistent, they may deem it

meaningless to have the retained equity sitting idly (from

their perspective) in the cooperative.

Equity financing alternatives

 Some dairy cooperatives have tried alternative financing

methods to leverage members’ capital. Examples include:

structuring subsidiaries as public stock corporations or as

limited liability companies, entering into joint ventures with

other firms, or organizing as a new-generation cooperative. A

few have issued preferred stock, mostly to members.

 Public stock corporation — There is one known case of

a dairy cooperative converting its fluid business subsidiary

into a publicly traded stock company. The idea was to use

investor financing and stock as tools for expansion and

growth, while members maintained the majority ownership

of the business. However, in less than three years, the

cooperative bought back all outstanding stock from minority

shareholders.

 It can be difficult for a cooperative to operate a public

stock corporation subsidiary because there are fundamental

conflicts between benefits for member-producers and

investors’ focus on returns on investment. In the dairy

business, the conflict between producer milk pay price and

profit for investors may be difficult to reconcile.

Furthermore, with investor capital, the subsidiary and even

the cooperative may lose Capper-Volstead status in inter-state

commerce.

 Preferred stock — A cooperative may issue preferred

stock to raise more funds from members or to tap nonmember capital. The most common type of preferred stock

pays dividend and has preference in assets over common

stock in the event of the dissolution of the cooperative. Some

preferred stock may be considered as equity capital while

others may look more like debt capital, depending on how

the rights of the shareholders are specified.

 Limited liability company (LLC) — An LLC is a stateapproved, unincorporated association, just like a partnership

except that it protects its owners and agents from personal

liability for debts and other obligations of the LLC. Earnings

pass through to the owners (there are no non-qualified

retains) and enjoy single-tax treatment. An LLC may operate

on a cooperative basis or it may allocate earnings and assign

votes among its owners any way they want. Some producers

believe that an LLC provides greater flexibility for tapping

investor capital. However, the combination of producers and

investors in an LLC would result in the same conflicting

benefit issues as in a publicly traded subsidiary operated by a

cooperative.

 Joint venture — An LLC may be a useful model for

established cooperatives to form joint ventures with other

cooperatives or firms. On the marketing side, a joint venture

LLC may be used by a cooperative and its partner to develop

and market certain dairy products. The cooperative supplies

dairy inputs and the partner provides technical or marketing

know-how to the LLC.

 The joint-venture partners share the financing and the risk

of the business activities of the LLC. This organizational

model reduces the cooperative’s capital requirement and risk

exposure, while a market outlet for milk is secured. Many

recent joint ventures formed by cooperatives with other

business entities are organized as LLCs.

 New-generation cooperative — Interest in the newgeneration cooperative model surged in the 1980s and 1990s,

largely in response to the market condition prevailing during

that time. It was believed that this form of cooperative

organization would solve the problem of depressed farm

income by engaging in value-added processing. 

 However, the attributes of the new-generation cooperative

model also have created some problems, mainly related to

delivery-right and property-right issues (Torgerson). After the

turn of the 21st century, interest in forming new-generation

cooperatives has cooled down substantially.

 A distinct feature of the new-generation cooperative is its

equity financing method. It is unique even among

cooperatives:

• It requires significant equity investment as a prerequisite to

membership and delivery rights to ensure that an adequate

level of capital is raised.

• The delivery right is in the form of equity shares that can

be sold to other eligible producers at prices agreed to by

the buyer and the seller, subject to the approval of the

board of directors to satisfy members’ desire of having the

freedom to “cash in” on the hoped-for increases in the

value of the cooperative.

 Only one dairy cooperative is known to have been

organized using the new-generation model. In 1995, a

cooperative in South Dakota was established to make

specialty cheese. But its remote location, the investment

needed to renovate its plant and the skill required to make

and market specialty cheese posed major problems. The newgeneration model proved no help. It suffered the same fate as

the struggling cooperative it was formed to replace and

ceased operation four years later.

Purpose and Means

 Dairy cooperatives are prime examples of the traditional

model of a cooperative that is owned, controlled, financed

and used by members. Focusing on the business of marketing

members’ milk, dairy cooperatives benefit members by

enhancing returns to their milk production efforts; members

supply equity capital needed for the cooperative to carry out

its function as their collective milk marketing arm. 

 The cohesiveness between member purposes and

cooperative functions makes dairy cooperatives, as a group,

perhaps the most prominent agricultural marketing

cooperatives. This is because milk is highly perishable and its

36 The Nature of the Cooperative
daily production must have an assured, ready market.

 Most dairy farmers (84 percent of U.S. total in 2007) rely

on marketing services provided by their cooperatives. It is for

this reason that equity capital financing, in general, is not a

contentious issue for dairy cooperatives if the funds are used

for the core business of marketing members’ milk. Dairy

cooperatives are seldom used as a vehicle for investing in

ventures that are unrelated to member business (Ling, 2011).

 The close bond between producers and their dairy

cooperatives may or may not be replicated in other

agricultural commodity sectors, depending on the

characteristics of the commodity and its market. Because no

two commodities are the same, the needs of respective

producers in marketing them also vary. 

 Cooperatives may be more essential to producers of

commodities that have to be marketed shortly after being

produced (such as vegetables, fruits and, of course, milk), or

that have no ready market outlet other than the cooperative,

than they are to producers of commodities that are storable

and have a longer marketing season (such as grains and oil

seeds) or that have multiple market outlets.

 It stands to reason that raising or retaining equity capital is

more challenging for a cooperative that is regarded by its

members as but one of the competing market outlets for their

products than for a cooperative that is indispensible to

members.

 It can be even more challenging for a farm supply

cooperative that has to compete with other supply stores in

the local market. There are hundreds, or even thousands, of

supply items, and it is unlikely that the cooperative can be the

best-value provider of every piece of merchandise. “Cherrypicking” by members in making purchases is inevitable.

However, it is difficult to raise equity capital from members

in this circumstance. (A food cooperative competing with

other stores may encounter the same issue.)

 Regional farm supply cooperatives may have economies of

scale in product sourcing or in operating manufacturing

facilities, especially for major supply items such as seeds, feed,

fertilizer, chemicals, and petroleum products. They could

pass along cost-savings derived from scale economies to

members and thus better meet competition. 

 However, operating upstream manufacturing plants has its

own risks (such as volatile raw material prices) that require

the cooperative to have ample capital to cushion the shocks.

The challenge for these cooperatives is to have a solid and

broad membership base that sees the value of supporting the

cooperatives with adequate equity capital.

 All these factors point to the fact that the cooperative

capital financing issue is really a reflection of a certain gap, or

disconnect, between member purposes and cooperative

functions. If this gap is narrow, it tends to be less of an issue;

if the gap is wide, it becomes a more serious issue. 

 The solution to the issue lies in assessing what members

want the cooperative to do and whether they are willing to

finance it with equity capital in the amount commensurate

with the benefits they expect to receive from a cooperative

that operates for members’ best interests. In some cases,

members may have to decide whether the cooperative is the

most suitable business model for what they want to

accomplish.

 In recent years, the cooperative model has gained new

attention from social entrepreneurs and economic

development practitioners. Being owned, controlled and used

by members for mutual benefits, cooperatives are an

appealing tool to empower people to work toward their own

economic destiny. They can be adapted to be communitybased organizations to serve economic opportunity-deprived

or service-deprived areas. 

 Because such cooperative organizations are formed to

address public policy or social issues, it is appropriate to have

initial capital funding assistance from public or philanthropic

sources. Over the long term, however, they must be selfsustainable in order to be economically viable. Some

exemplary precedents are rural electric cooperatives and the

Farm Credit System.

References

• Farm Credit Administration. History of the FCA and the

FCS,

http://www.fca.gov/about/history/historyFCA_FCS.html.

• Ling, K. Charles. Marketing Operations of Dairy

Cooperatives, 2007, USDA Rural Development, Research

Report 218, July 2009.

• Ling, K. Charles. Cooperative Theory, Practice, and

Financing: A Dairy Cooperative Case Study, RBS Research

Report 221, April 2011.

• National Rural Electric Cooperative Association. History of

Electric Co-ops, http://www.nreca.coop/

members/History/Pages/default.aspx.

• Torgerson, Randall E. “A Critical Look at NewGeneration Cooperatives,” Rural Cooperatives, United States

Department of Agriculture, January/February 2001, pp.15-

19.

• U.S. Department of Agriculture. Rural Development,

Business and Cooperative Programs Public Meeting on

Research Transcript: September 27, 2005, http://www.

rurdev.usda.gov/rbs/pub/ResearchPublicMeetingTranscript.

pdf n

The Nature of the Cooperative 37
The Many Faces

of Cooperatives

38 The Nature of the Cooperative
By Charles Ling, Ag Economist

Cooperative Programs

USDA Rural Development 

ooperatives are a model of business that are

owned, controlled and used by members and

that accrue benefits to members. Outwardly,

cooperatives may seem to be all alike, except

in the products (commodities, supplies or

services) handled or provided. In reality, the cooperative

business model has many variations.

 This article briefly describes dairy cooperatives to

showcase the cooperative business model; other types of

cooperatives are then shown to be variations of the model.

Dairy cooperatives have been previously demonstrated to

exemplify the attributes that are prescribed by classic

cooperative theories.

Uniqueness of cooperative model

 Cooperative organizations represent the aggregates of

economic units (Emelianoff). In the agricultural sector,

cooperative associations are aggregates of member-farms.

The intrinsic cooperative structure entails the uniqueness of

the cooperative’s organization, governance, equity financing

and operation.

Unique cooperative structure — Dairy

cooperatives represent aggregates of dairy

farms, organized to market milk produced by

members. Members’ farming operations are

not under the cooperative’s administrative

control. Therefore, the cooperative is neither

a horizontal integration of its member-farms

nor a vertical integration between memberfarms and the cooperative. It is a third mode

of organizing coordination (Shaffer).

 Unique cooperative organization — Cooperatives are

business organizations of member-patrons. They can be of

any size and can be local, regional or national in scope. All

dairy cooperatives in the United States are known to be

centralized organizations with direct members.

 Unique cooperative governance — Members of dairy

cooperatives exercise ownership and business controls

through a board of directors that is elected from among

member-farmers. The board makes major decisions, sets the

policy and determines the overall direction of the cooperative

for the management to follow in its day-to-day operations.

Effective communication with members to foster sound

governance is emphasized.

 Unique cooperative equity financing — Equity for dairy

cooperatives is supplied and owned by members. It can be

grouped into four categories (percentages are averages as

reported by 94 cooperatives (Ling, 2009)): common stock (0.1

percent of total equities) is for witnessing membership and

carries nominal value; preferred stock (7 percent) is mostly

for witnessing retained patronage refunds; retained earnings

(10.8 percent) could be earnings from incidental nonmember businesses and net savings yet to be allocated; and

allocated equities (82.1 percent) include retained patronage

refunds, capital retains and/or base capital.

Unique cooperative operation — Being an

aggregate of member-farms usually requires the

cooperative to be the exclusive marketing agent of

members’ milk. This operating mode entails its own

unique economics that comprises the following

elements: (1) the milk volume the cooperative has to

handle continually fluctuates; (2) the cooperative does

not have its own milk production functions, milk

production cost curves, or milk supply curves; and (3)

the mismatch between seasonal milk supply and

demand requires cooperatives to handle the

inevitable seasonal surplus milk volume at a

substantial supply-balancing cost.

Cooperative roles in transaction

governance

 In marketing members’ milk, dairy cooperatives interact

with other market participants to bring about mutual

adaptation so that transactions can take place in the most

economical and mutually advantageous way; the transactions

are under all possible governance modes listed in table 1.

 Spot milk sales and retail dairy product sales are most

likely under transaction governance Mode B — where a

competitive market without credible contractual safeguards

may expose members’ investments to unrelieved hazards.

Regular milk marketing is usually conducted under the

credible contracting mode (Mode C) in order to stabilize the

C

The Nature of the Cooperative 39
relations between the cooperative and the milk buyers

(processors) and to protect members’ investments. If a dairy

cooperative forward-integrates into processing dairy

products, the processing enterprises are under the

cooperative’s hierarchical administrative control (Mode D).

Most wholesale dairy product sales are under credible

contracting, but some may be under Mode B (unrelieved

hazards).

Variations on the cooperative model

 Different commodities have their own characteristics, and

different types of cooperatives have their own special

features. They all represent variations on the cooperative

business model.

 Marketing cooperatives — Marketing cooperatives share

the uniqueness of dairy cooperatives in structure,

organization, governance and equity financing that stems

from their being aggregates of member-farms. The unique

economics of dairy cooperative operation is applicable in the

situation where the cooperative is the exclusive marketing

agent of the milk produced by members.

 Other agricultural commodities (such as fruits, vegetables,

nuts, poultry, sugar, etc.) that exclusively rely on a

cooperative to market members’ products would have unique

cooperative operations similar to that of dairy cooperatives.

However, they differ from dairy cooperatives in some

important aspects.

 For example, milk is produced every day while other farm

commodities are harvested in concentrated time spans of

several weeks or months toward the end of the growing

season. In the economic analysis of the supply and demand

situation of milk marketing operation, the unit of time used is

per-day (cwt/day). The same analysis of other commodities

has to use a unit of time that is appropriate for a particular

commodity.

 Some producers of commodities that are storable and have

a long marketing season (such as grains and oilseeds) may

view the cooperative as but one of multiple outlets and

market through it only if the cooperative offers the best

terms and services among all alternatives. In such a case, the

cooperative may still maintain its uniqueness in its

cooperative structure, organization, governance and equity

financing. Its marketing operation, however, is not different

from other (non-cooperative) marketing firms.

 New-generation cooperatives — Many new-generation

cooperatives were formed in the 1980s and 1990s in the

belief that this form of cooperative organization would solve

the problem of depressed farm income by engaging in valueadded processing and capturing processor margins.

 A distinct feature of the new-generation cooperative is its

equity financing method. It is unique even among

cooperatives:

• It requires significant equity investment as a prerequisite

to membership and delivery rights to ensure that an

adequate level of capital is raised.

• The delivery right is in the form of equity shares that can

be sold to other eligible producers at prices agreed to by

the buyer and the seller, subject to the approval of the

board of directors — to satisfy members’ desire of having

the freedom to cash in on the hoped-for increases in the

value of the cooperative.

 A new-generation cooperative is organized to market

members’ commodities through its main function of valueadded processing. By bringing processing functions under

internal administrative control, the cooperative’s transaction

governance mode is Mode D (table 1). For wholesale

distribution of finished products, transaction governance is

usually Mode C (credible contracting) but some may be

Mode B (unrelieved hazard).

 The delivery right is instituted to ensure that the capacity

of the processing plant is fully utilized. A member delivers to

the cooperative according to the volume conferred by such

right, which may be more or less than the volume the

member produces. Under such terms, the cooperative is not

an exclusive marketing agent of members’ total production.

 Though the cooperative is still an aggregate jointly owned

and operated by members to process and market their farm

production, the volume the cooperative handles is

predetermined. This should minimize the cooperative’s

volume variation uncertainties.

 Purchasing cooperatives — Farm supply cooperatives

are organized to procure production supplies and services for

sales (mainly) to members. Many also handle farm and home

items, such as heating oil, lawn and garden supplies and

equipment, and food. Most supply sales to farmers are at the

retail level by local cooperatives that are centralized

organizations with direct members.

 Many local cooperatives also federate with other

cooperatives to form regional cooperatives to achieve

economies of scale in sourcing major supply items, such as

40 The Nature of the Cooperative
seed, feed, fertilizer and petroleum products. Some federated

cooperatives also have individual farmers as members and are,

therefore, a hybrid organization of centralized and federated

forms.

 Many supply cooperatives also market members’ crop and

livestock production, just as marketing cooperatives may also

have supply and service businesses. Supply cooperatives share

marketing cooperatives’ unique structure, organization,

governance and equity financing. However, their operations

are unique in their own way, because supply cooperatives’

main business of procuring supplies for members operates on

the buying side of market transaction. Transaction

governance mode for sourcing products is most likely under

credible contracting (Mode C).

 Here, they serve as focal points for credible contracting

with suppliers and economizing on transaction costs on

behalf of individual members. If they integrate upstream and

bring the business of producing supply items under the

cooperative’s administrative control, then the mode of

transaction governance for this part of the operation is Mode

D.

 Their transaction governance mode in selling products to

members depends on the degree of member loyalty. If

members are loyal patrons, or if the cooperative is the only

Transaction

governance mode

A: Unassisted market

B: Unrelieved hazard

C: Hybrid

(Credible contracting)

D: Hierarchy

(Administrative)

Asset specificity

0

>

>

>

Investment hazard

safeguard

0

0

>

>

Incentive intensity

High

<

<

Low (Pricing for

successive stages is

cost plus)

Administrative control

Little

>

>

Considerable (by fiat)

Contract law regime

Competitive norm

Legal rules contract

regime

Credible contracting

Internal implicit

contract law

(Forbearance)

Table 1 Transaction governance modes and attributes

Source: Adopted from Williamson, 2005, Figure 1: Simple Contractual Schema.

Note: ">" indicates a mode having a higher intensity of the particular attribute than the mode above it.

"<" indicates a mode having a lower intensity of the particular attribute than the mode above it.

The Nature of the Cooperative 41
store in the relevant market area, the cooperative would

resemble a buying club. Utility cooperatives and many service

cooperatives are also in this category.

 If member loyalty is low, then the cooperative would

operate as any other firm in selling supplies, although it may

still maintain its uniqueness in its cooperative structure,

organization, governance and equity financing.

 Consumer cooperatives and credit unions are similar to

supply cooperatives, except that consumer cooperatives’ main

business is in consumer products: foods, groceries, etc., while

the business of credit unions is satisfying members’ credit

needs. There are many more types of purchasing

cooperatives.

 Local-food cooperatives — In recent years, consumers

have shown increasing interest in locally produced food.

Because production of locally marketed food is more likely to

occur on small farms located in rural regions near

metropolitan areas, local-food cooperatives may have a

limited geographical scope. However, they should be

classified as marketing cooperatives.

 Multi-stakeholder cooperatives — Along with local

food demand, some multi-stakeholder cooperatives have been

formed that comprise everyone who has a stake in the local

food chain, including farmers, processors, distributors,

truckers, buyers, etc.

 On the surface, this brings together the successive stages

of the transaction into the organization and appears to be

Mode D transaction governance. In reality, members are

economic units that independently operate their respective

business. The importance of their stakes in the cooperative to

their economic well-being may vary widely.

 By organizing all stakeholders in the successive stages of

the supply chain under one roof, the cooperative becomes a

framework for mutual adaptation and for multi-party, multistage credible contracting among members (Mode C) only

when they deal with each other in attending to the

cooperative’s business of moving products from farmermembers to buyer-members. The durability of the

cooperative is dependent on the stability of the collective

credible contracting relationships.

 Farm production cooperatives — Several farmers can

form a co-op and pool resources to operate a farm. This is

one way of organizing and managing inputs for production at

a larger scale than the members could as individuals. 

 The structure, organization, governance and financing

may be the same as a cooperative. Its operation, however,

needs to have overall coordination for it to be a coherent and

efficient production entity. Management oversight and

administrative control over members’ participation in the

farming operation is necessary, although the management

and administrative rules may be determined by members

themselves.

 Members cannot make farming decisions independent of

the farm, and they do not represent independent profit

centers. In essence, the production operation is a vertical

integration between producer-members and the cooperative.

 Cooperatives with non-patronage members — Some

states have enacted new cooperative laws in recent years that

allow cooperatives to have non-patron members (investors) as

well as patron members. These laws vary from reserving the

voting power only for member-patrons to setting a minimum

level of voting power for member-patrons. Requirements

regarding earning distribution between patron members and

non-patron members also differ substantially.

 Differences in governance and earning distribution rules

and the type of non-patron members involved (for example,

for-profit investors, nonprofit economic development

organizations, community supporters, etc.) will cause the

cooperative’s structure, organization, governance, equity

financing and operation to deviate in various ways from the

uniqueness of the cooperative model that was described

earlier in the article. These organizations have to be analyzed

case by case because of the variety of state laws.

Conclusions

 Variations on the uniqueness of the cooperative business

model are summarized in table 2, using dairy cooperatives as

the reference “point” for the model.

 Laying out each type of cooperatives (or, for that matter,

each cooperative) in the format of table 2 provides a

comprehensive view of their respective structure,

organization, governance, equity, and operation, and their

similarities and differences from one another:

• Structure: Cooperatives are aggregates of economic units.

However, the economic units can come in many “stripes.”

Also, the coordination between the economic units

(members) and the cooperative and between members

through the cooperative can vary substantially.

• Organization: Cooperatives are organized by members to

serve some specific purposes, and the purposes can be very

different from one cooperative to another. Cooperatives

may have different sizes and geographical scopes. They

may be centralized, federated or hybrid organizations.

• Governance: The directors of cooperative boards are

supposed to be elected from among members, although

different cooperatives may have different election

procedures. Each cooperative may also see the

responsibilities of the board and the roles of management

somewhat differently. The degree of transparency and

accountability of the board and management to

membership may also vary. 

• Equity: The composition (categories) of the equities, the

proportion of equities that is owned by members, the

rights that are bestowed on equity ownership and the

mechanisms that are employed to ensure that ownership is

in the hands of current members can vary among

cooperatives.

42 The Nature of the Cooperative
Type of cooperatives

Dairy

cooperatives1

Marketing cooperatives2

New-generation

cooperatives

Purchasing

cooperatives3

Multi-stakeholder

cooperatives4

Farm production

cooperatives

Cooperatives with nonpatronage members

Structure

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units that are

not independent in

production operation

Mixture of patron and

non-patron members

Organization

Centralized member

organizations

Mostly centralized

member organizations;

some are federated

Centralized member

organizations

Local (retail)

cooperatives are

centralized; many

federated with other

locals; federated

cooperatives may have

direct members

Centralized member

organization

Centralized member

organization

Defined by state laws

Governance

Member- governed

Member- governed 

Member- governed

Member- governed

Member- governed

Member- governed

Defined by state laws

Source of equity

Members

Members

Members; tied to

delivery rights

Members

Members

Members

Defined by state laws

Operation

Members' exclusive

marketing agent

unique economics

Unique economics if

exclusive marketing

agent; otherwise, like

other firms

Business volume

defined by delivery

rights

Sourcing supplies or

services for sale to

members and patrons

A framework for multiparty, multi-stage

credible contracting

among members

A vertical integration

between members and

the cooperative in

production

Defined by state laws;

most likely memberpatrons’ business

Table 2 Variations on the uniqueness of the cooperative business model

• Operation: The products handled or provided by various

cooperatives are very different and, therefore, the

cooperatives’ operations can vary widely. They source their

products differently, prepare the products for the market

differently, and adapt to their respective market differently.

The variety of cooperative operations can be discerned

through the lens of transaction governance (the transaction

cost economics approach advanced by Williamson and

schematically adopted in table 1). n

References

• Emelianoff, Ivan V. Economic Theory of Cooperation: Economic

Structure of Cooperative Organizations, Washington, D.C.

1942 (litho-printed by Edwards Brothers., Inc., Ann Arbor,

Michigan), 269 pages. (A reprint by the Center for

Cooperatives, University of California, 1995, may be

accessed at: http://cooperatives.ucdavis.edu/reports/

index.htm.)

• Ling, K. Charles. Marketing Operations of Dairy Cooperatives,

2007, U.S. Department of Agriculture, RBS Research

Report No. 218, July 2009.

• Ling, K. Charles. The Nature of the Cooperative: A Dairy

Cooperative Case Study, USDA Rural Development, RBS

Research Report No. 224, April 2012.

• Shaffer, James D. “Thinking about Farmers' Cooperatives,

Contracts, and Economic Coordination,” Cooperative

Theory: New Approaches, ACS Service Report Number 18,

U.S. Department of Agriculture, Agricultural Cooperative

Service. July 1987, pp. 61-86.

• Williamson, Oliver E. “The Economics of Governance,”

American Economic Review, 95 (May 2005), pp. 1-18.

1 Separately listed due to dairy cooperatives’ role in explaining the cooperative business model.

2 Include local-food cooperatives.

3 Include farm supply cooperatives, utility cooperatives, service cooperatives, consumer cooperatives, credit unions, etc.

4 As defined in this article.

The Nature of the Cooperative 43
By Charles Ling, Ag Economist

Cooperative Programs

USDA Rural Development 

he Affordable

Care Act (section

1322) created the

Consumer Operated and Oriented

Plan Program (CO-OP Program) to foster

the creation of new, consumer-governed, private, nonprofit

health insurance issuers (referred to as CO-OPs). These COOPs will promote integrated care and improve health plan

accountability. 

 Through the loans authorized by the Act, the goal of the

Program is to create at least one new CO-OP in every state

to enhance competition in the Affordable Insurance

Exchanges (also established under the Act) and provide

additional plan choices in the individual and small group

markets. The Program is administered by the U.S.

Department of Health and Human Services (HHS). The

statute and the rules and regulations implementing the

Program can be found at http://www.healthcare.

gov/law/features/choices/co-op/.

 The Program-qualified CO-OPs are supposedly modeled

on existing health insurance cooperatives and other business

cooperatives. The acronym “CO-OP” (note: all letters

capitalized) has the same spelling as “co-op,” the abbreviation

of the term “cooperative” in common usage. 

 There is strong interest in the co-op community (and

doubtless outside of it as well) to see where these new health

CO-OPs lay in the continuum of cooperative business model

variations (Ling). Based on the Program’s CO-OP standards

and related requirements, this article looks into the structure,

organization, governance, equity financing, and operation of

the CO-OPs to shed some light on their similarities with and

differences

from other types of

cooperatives. The economic

analysis is through the lens of

industrial organization, taking the law

and regulations governing the Program as

given. It is not intended to be an interpretation

of the Program, which is under the purview of

HHS Centers for Medicare and Medicaid

Services (CMS).

Economic structure

 A CO-OP is an organization of health insurance

policy subscribers who are individuals or individuals with

dependants. All insurance-covered persons are counted

as members of the CO-OP.

 The CO-OP makes decisions regarding how to

maintain and improve the quality of health care delivered to

members, while keeping insurance premiums affordable.

Subscribers are free to choose whether to join a particular

CO-OP, or how — and how much — they may use the

services provided by the CO-OP as members. 

 Therefore, the CO-OP fits the economic definition that a

cooperative is an aggregate of economic units, which are

capable of independent economic functioning (Emelianoff). It

is also useful to note that a dictionary defines aggregate as:

T

The Co-op Nature of 

(the Affordable Care Act) 

CO-OPs 

44 The Nature of the Cooperative
“Any

total or

whole

considered with

reference to its

constituent parts; an

assemblage or group of

distinct particulars massed

together.”

Organization

A CO-OP is a Program-qualified, nonprofit

health insurance issuer organized under state

law as a private, nonprofit, member

corporation.

The creation of a CO-OP relies on the

effort of its sponsors. A sponsor may be an

organization or individual that is involved in

the development, creation or organization of the

CO-OP or provides 40 percent or more to the

CO-OP’s total funding (excluding funds from

Program loans). However, no state or local

government or political subdivision (or their

instrumentalities) can be a sponsor of the

organization or contribute 40 percent or more

to its total funding. Furthermore, no

organization excluded by CMS can be a sponsor

or contribute 25 percent or more to the COOP’s total funding.

After the CO-OP is organized, it will sign

up health insurance subscribers and they and

their covered dependents will be members of

the CO-OP. The CO-OP will become a

centralized member organization when its

operational board of directors elected by

members is in place.

The CO-OP Program has the goal of

having at least one CO-OP in each state and

gives priority to CO-OPs that offer qualified

health plans on a state-wide basis. Therefore, COOPs are most likely local (in-state) organizations that

do not cross state lines. When circumstances warrant it, a

CO-OP may cover more than one state. States may have

more than one CO-OP if Program funds are available. 

 CO-OPs are to remain nonprofit, consumer-operated and

-oriented insurance issuers after they have received Program

loans and even after they have fully repaid their loans. They

are not permitted to convert or sell to a for-profit or nonconsumer-operated entity at any time, undertake any

transaction that would result in the CO-OP implementing a

governance structure that does not meet the stipulated COOP standards, or do things to harm its consumer orientation.

 CO-OPs may join together to establish a private

purchasing council to enter into collective purchasing

arrangements for items and services that increase

administrative and other cost efficiencies, including claims

administration, administrative services, health information

technology and actuarial services. But the private purchasing

council is not allowed to set payment rates for health care

facilities or providers participating in health insurance

coverage provided by the CO-OPs. Further, the antitrust

laws continue to apply to any private purchasing council.

Governance

 A CO-OP is required to be governed by an operational

board with all of its directors elected by a majority vote of a

quorum of the CO-OP’s members who are age 18 or older.

Elections of the directors on the CO-OP’s operational board

are contested: the total number of candidates for vacant

positions on the operational board exceeds the number of

vacant positions. In the case of resignation, death, or

removal, the CO-OP may fill vacant director positions for

the remainder of the relevant term without conducting a

contested election.

 Positions on the board of directors may be designated for

individuals with specialized expertise, experience or

affiliation. But the designated directors cannot constitute a

majority of the operational board.

The Nature of the Cooperative 45
 No government (federal, state, local, political subdivision

or instrumentality) representative or representative of an

organization excluded by CMS can be a board member.

 The majority of the voting directors on the operational

board must be members of the CO-OP (not counting

designated directors who are also members). Each director

has one vote unless he or she is a non-voting director.

 However, in the initial stage of forming the CO-OP and

before it has begun

accepting enrollment

of insurance

subscribers and has an

election by the

members of the

organization to the

board of directors, a

formation board is to

steer its development.

The first elected

directors of the

organization’s

operational board must be elected no later than one year

after the effective date on which the organization provides

coverage to its first member; the entire operational board

must be elected no later than two years after the same date.

Equity financing

 The initial funding of a CO-OP is supplied by its sponsors

and supporters. To help overcome the difficulty of obtaining

adequate capitalization for start-up costs and state insurance

reserve requirements, CO-OPs may borrow two kinds of

low-interest loans offered by the CO-OP Program

specifically for these critical activities:

• Start-up loan to provide assistance in meeting the costs of

establishing a CO-OP. The repayment period of the loan is

five years following each drawdown of loan funds.

• Solvency loan in meeting state insurer solvency and reserve

requirements. The repayment period of the loan is 15 years

following each drawdown of loan funds.

 A CO-OP may borrow joint start-up and solvency loans,

or only borrow a solvency loan. By receiving the loans, the

CO-OP must adhere to the standards and fulfill all

requirements established by the CO-OP Program. It must

meet the required CO-OP standards no later than five years

following initial drawdown of the start-up loan or three years

following the initial drawdown of the solvency loan.

 Net savings or surplus funds (revenue in excess of expenses

or “profit”) of the CO-OP must be used to lower premiums,

to improve benefits or for other programs intended to

improve the quality of health care delivered to its members.

In addition, net savings may be used to conduct marketing,

repay Program loans, and meet state solvency requirements.

They may also be used to provide for enrollment growth,

financial stability and stable coverage for members.

 CO-OPs are forbidden to ever convert or sell to for-profit

or non-consumer operated entities.

Operations

 CO-OPs develop healthcare provider networks to provide

services that meet members’ healthcare needs. They have to

compete for health insurance subscribers in the relevant

markets. Therefore, their operations are the same as any

other health insurance issuers in the relevant markets.

 CO-OPs are required to meet certain standards and

requirements for the issuance of health insurance plans to

achieve Program objectives.

 For example:

• At least two-thirds of qualified health insurance policies or

contracts for health insurance coverage issued by a COOP in each state in which it is licensed must be in the

individual and small group markets.

• In every market where the CO-OP operates, it must offer

a qualified health plan at the Silver Level (defined as the

level of coverage that is equivalent to 70 percent of the

full actuarial value of benefits provided) and at the Gold

Level (equivalent to 80 percent of full benefits).

• Meet certification requirements in order to participate in

the Affordable Insurance Exchanges.

 The incentive (trade-off) for CO-OPs to meet these and

other plan standards and requirements is the privilege to use

start-up loans and solvency loans at below-market interest

rates to achieve the goals of the organizations.

Conclusions

 The impetus for creating CO-OPs is by Congressional

mandate to address certain public policy healthcare issues. A

major portion of initial funding of CO-OPs is low-interest

government loans to help overcome the difficulty of

obtaining adequate capitalization. Legislative mandates

effected with government loans have precedents such as the

initial organizations of rural electric cooperatives and the

Farm Credit System. As exemplified by these precedents,

CO-OPs must be self-sustainable in order to be economically

viable over the long term.

 To ensure the CO-OPs created under the Program are

viable, sustainable and stable, and to make certain they can

repay the loans and thereby protect federal investment in the

Program, they are required to meet CO-OP standards and

health plan standards and fulfill many other requirements. As

a result, CO-OPs are somewhat unique in the spectrum of

cooperative business model variations as shown in table 1

(adopted and modified from Ling, table 2). n

CO-OPs are forbidden

to ever convert or sell

to for-profit or 

non-consumer 

operated entities.

46 The Nature of the Cooperative
Type of cooperatives

Dairy

cooperatives1

Agricultural marketing

cooperatives

New-generation

cooperatives

Purchasing

cooperatives2

Affordable Care Act

CO-OPs3

Multi-stakeholder

cooperatives4

Farm production

cooperatives

Cooperatives with nonpatronage members

Structure

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

Aggregates of

economic units

(health insurance

subscribers)

Aggregates of

economic units

Aggregates of

economic units that are

not independent in

production operation

Mixture of patron and

non-patron members

Organization

Centralized member

organizations

Mostly centralized

member organizations;

some are federated

Centralized member

organizations

Local (retail)

cooperatives are

centralized; many

federated with other

locals; federated

cooperatives may have

direct members

Organized by sponsors;

then become local (instate) centralized

member organization

Centralized member

organization

Centralized member

organization

Defined by state laws

Governance

Member-governed

Member-governed 

Member-governed

Member-governed

Initially formation

board; then membergoverned

Member-governed

Member-governed

Defined by state laws

Source of equity

Members

Members

Members; tied to

delivery rights

Members

Sponsors and

supporters;

accumulated surpluses

Members

Members

Defined by state laws

Operation

Members' exclusive

market agent — unique

economics

Unique economics if

exclusive marketing

agent; otherwise, like

other firms

Business volume

defined by delivery

rights

Sourcing supplies or

services for sale to

members and patrons

Operations are the

same as other

insurance issuers in the

relevant markets; must

meet CO-OP Program

standards and

requirements 

A framework for multiparty, multi-stage

credible contracting

among members

A vertical integration

between members and

the cooperative in

production

Defined by state laws;

most likely memberpatrons’ business

Table 1 — Variations on the cooperative business model

1 Separately listed and used as the standard bearers of traditional cooperative business model.

2 Include farm supply cooperatives, utility cooperatives, service cooperatives, consumer cooperatives, credit unions, etc.

3 Qualified Nonprofit Health Insurance Issuers under the Consumer Operated and Oriented Plan (CO-OP) Program.

4 Defined as cooperatives having, for example, farmers, final customers and intermediaries in the supply chain as members.

References

• Emelianoff, Ivan V. Economic Theory of Cooperation: Economic Structure of Cooperative Organizations, Washington,

D.C. 1942 (litho-printed by Edwards Brothers., Inc., Ann Arbor, Michigan), 269 pages. (A reprint by the Center

for Cooperatives, University of California, 1995, may be accessed at:

http://cooperatives.ucdavis.edu/reports/index.htm.)

• Ling, K. Charles. “The Many Faces of Cooperatives,” Rural Cooperatives, Volume 79, Number 6, November/

December 2012, pp.24-29.

• American Heritage Dictionary of the English Language, New College Edition, Houghton Mifflin Company,

Boston, 1976.

The Nature of the Cooperative 47
Worker Cooperatives:

Another variation on the co-op business model

Members of worker-owned co-ops democratically own, govern and manage their businesses. This solar-power co-op and a commercial laundry 

co-op (facing page) are both part of the Evergreen family of worker co-ops in Cleveland, Ohio.

48 The Nature of the Cooperative
By Charles Ling, Ag Economist

Cooperative Programs

USDA Rural Development

worker cooperative is

organized by workermembers to pool their

labor and other

resources together for

the business of producing certain goods

and (or) services for the market. It is a

business entity that is democratically

owned, financed, governed and

managed by its worker-members and

accrues to them the benefits of their

labor and efforts. This category of

cooperatives represents yet another

variation on the cooperative business

model.

Economic structure

 The economic structure of a

cooperative is defined as representing

an aggregate of economic units. It is

neither a vertical nor a horizontal

integration between the cooperative and

its constituent economic units, but a

third mode of coordination. However, a

worker cooperative is integrated with its

member-workers in at least one aspect:

its production operation. That’s because

the labor of worker-members is a factor

of producing its goods and services. 

 The production operation needs to

have overall coordination for the

cooperative to be a coherent and

efficient production entity. Management oversight and administrative

control over members’ work is

necessary, although the management

and administrative rules may be

determined by worker-members

themselves.

Organization

 The basic form of a worker

cooperative is a centralized organization

with all its workers as direct members.

Governance

 Governance is exercised directly by

worker-members or indirectly through

the board of directors (and other

designated bodies of representatives)

who are democratically elected from

among worker-members. In a worker

cooperative, governance usually extends

into managing every aspect of the

cooperative’s operation — beyond the

usual domain of overseeing corporate

affairs, making policies and setting

guidelines.

Equity capital

 Like all other cooperatives, workermembers should furnish the

cooperative’s equity capital. In some

cases, initial capital funding assistance

may come from economic development

agencies or social entrepreneurs to help

meet shortfalls. For long-term

economic viability, however, a

cooperative must be self-sustaining.

One way of accumulating worker

capital over time is by retaining a

portion of year-end net savings

(earnings or profits) after distribution to

members, based on the value of labor

contribution to the cooperative’s

business or on other agreed-upon

criteria.

Operation

 Worker-members democratically

own, govern and manage the

cooperative and are meant to have total

control over the operation of the

business. They integrate their skill and

labor with the cooperative’s production

process. In addition, the membership

must possess entrepreneurship,

managerial ability, technological

knowhow and knowledge of the market

in order to help manage a successful

cooperative.

 Entrepreneurship is the ability of

perceiving business

opportunities and setting out

to organize capital, labor and

other inputs to produce goods

and services to exploit

opportunities. Such ability is

essential not only for starting a

cooperative or other business,

but also for adapting to a

potential changing market

environment once the business

is running. Entrepreneurship

also entails shouldering the

risk of business gains or losses

and success or failure.

Management is responsible

for smooth and efficient

operations in order to carry

out the cooperative’s business plan. In a

worker cooperative, manager(s) are

democratically selected and

management decisions and

administrative rules are democratically

determined, from the ground up. This

is in contrast to most other firms, where

administrative control is usually by fiat

and workers have little say about

management.

 Worker-members may know all the

technical processes of their industry, but

technology advances over time. To stay

A

 A worker-member plays the dual role 

 of being a worker and an entrepreneur.

The Nature of the Cooperative 49
competitive, worker-members have to

keep abreast of technology development

and have sufficient alacrity in changing

production processes.

 Foremost in marketing, the

cooperative must ascertain consumers’

tastes and preferences and their

changing nature so that products

produced can meet consumers’

expectation and satisfy their needs and

wants. Knowledge of the market also

includes knowing competitors’

strengths and weaknesses.

Special attributes

 The equity of a worker cooperative

is provided by member-workers.

Therefore, the cooperative’s ability to

raise capital is constrained by members’

financial resources. If there is not an

adequate level of equity to strengthen

the balance sheet, it would also be

difficult to obtain debt capital.

 The manager of a worker

cooperative is usually democratically

promoted from among workermembers and is, therefore, one among

equals. This could cause management

to be ineffective if the manager is not

accorded adequate authority to manage. 

 Because worker-members play the

dual role of being a worker and an

entrepreneur, their rewards should be

twofold: (1) a wage income for

supplying production labor; and (2) a

distribution of the cooperative’s net

savings for being a part-owner who

participates in managing the

cooperative’s business. 

 By organizing the worker

cooperative, worker-members may

expect to have a higher wage income

compared to their counterparts in the

competing firms. However, to make this

possible, the productivity of the workermembers would have to be higher than

their counterpart workers. As for

rewarding their capital investment and

management time as part-owners, the

level of net savings is dependent on the

profitability of the cooperative.

 With workers as members, if the

cooperative’s business is below its

capacity, the likely solution is to have a

shared reduction of working hours

instead of laying-off workers, as is the

common practice of non-cooperative

firms. If the cooperative’s business

expands beyond its capacity, new

worker-members would have to be

recruited. To build teamwork, many

worker cooperatives hire new

employees for a trial period or

apprenticeship before offering them

membership.

 Issues may arise from these attributes

from time to time, but they should not

be difficult to resolve when the

cooperative is small with a limited

number of employees and its business

lines are relatively simple. (The vast

majority of worker cooperatives in the

United States are small businesses,

having fewer than a dozen employees

on average (United States Federation of

Worker Cooperatives; Deller, et al).)

Business model modifications

 When a cooperative’s business

thrives and grows in its scale and

complexity, it may have to make some

modifications to its basic business

model. For example:

• The cooperative may have to obtain

capital infusion from outside its

membership if the financial resources

of its members are not sufficient to

finance its expansion. Members’

ownership stake, along with their

voice in governance, may then be

diluted.

• The cooperative may have to hire

management expertise from outside

its membership. This may entail

changes in the dynamism of membermanagement relations, especially if

the new manager is not a member and

seeks to exert management authority.

• If the cooperative has to hire a large

number of new workers to staff a fastexpanding business, it may have to

waive membership requirement of the

new recruits, especially if competing

in a tight labor market. Convincing

the uninitiated to be worker-members

and assume the dual role of being a

worker and an entrepreneur may be a

time-consuming process.

 In the United States, modifications

to the basic worker-cooperative

business model may take the form of

worker-owned businesses organized as

Employee Stock Ownership Plans

(ESOPs).

References

• Deller, Steven, Ann Hoyt, Brent Hueth and

Reka Sundaram-Stukel. Research on the

Economic Impact of Cooperatives, University

of Wisconsin Center for Cooperatives, revised

June 19, 2009, table 2-2, p. 11.

• Emelianoff, Ivan V. Economic Theory of

Cooperation: Economic Structure of Cooperative

Organizations, Washington, D.C. 1942 (lithoprinted by Edwards Brothers., Inc., Ann Arbor,

Michigan). (A reprint by the Center for

Cooperatives, University of California, 1995,

may be accessed at: http://cooperatives.ucdavis.

edu/reports/index.htm, pp. 230-244.)

• Ling, K. Charles. “The Many Faces of the

Cooperative,” Rural Cooperatives, Volume 79,

Number 6, November/December 2012, pp. 24-

29, especially table 2.

• Nourse, Edwin G. “The Economic Philosophy

of Co-Operation,” American Economic Review,

Volume XII, No. 4, December 1922, pp. 577-

597.

• United States Federation of Worker

Cooperatives. “About Worker Cooperatives,”

http://usworker.coop/aboutworkercoops.

(Accessed July 31, 2012). n

 Worker-members democratically own, govern

and manage the co-op and are meant to have

total control over the business.

50 The Nature of the Cooperative