USDA =5‘--cUnited States

Department of

Agriculture

Rural BusinessCooperative

Service

RBS Research

Report 155

Decision-Making in

Cooperatives with

Diverse Member

Interests
Agricultural producers establish and support a cooperative when it provides benefits

they would not obtain by individual actions. Cooperatives are distinguished from other

types of organized ventures in that owners are the primary users of services, who benefit in proportion to use.

Members of a cooperative typically have diverse economic interests. These may

encompass size, type and location of farm enterprises, and length of membership.

Maintaining cohesiveness for building incentives to cooperate is becoming more complex as more variations in production practices and technology become available, new

forms of business relationships are developed, and as consumer preferences continue

to become more diverse and demanding.

The objectives of this research are: first, examine the role of member consensus and

policy consistency in a cooperative; second, examine member consensus and policy in

a strategic framework of competition, where competitors offer individualized terms to

selective producers that are difficult for cooperatives to match; and third, develop a

game theory analysis for situations where cooperatives need to attract large-scale producers.

Keywords: cooperatives, cooperate, members, consensus, decision-making, diverse

interests, conflict, strategy, strategic decisions, game theory, long-range planning.

Decision-Making in Cooperatives With Diverse Member Interests

Rural Business-Cooperative Service

RBS Research Report 155

Bruce J. Reynolds

Strategic Management and Planning - Cooperative Services

April 1997

Price: Domestic $4.50; foreign $5.00
Contents Introduction ........................................................ 1

Diverse Agricultural Producers .......................................... 3

Membership Consensus in a Business ................................... 4

Consistent Policy .................................................... 6

Attracting Large-Scale Producers ...................................... 10

Summary and Conclusions ........................................... 17

Glossary .......................................................... 18

i
Decision-Making in Cooperatives

With Diverse Member Interests

Introduction

Agricultural producers have an incentive to form

and support a cooperative when it provides benefits

they would not obtain by acting independently.

Cooperatives can prosper when producer interests and

goals are accomplished more effectively with cooperation than with more individualistic methods of transacting for services.

The term “incentive for cooperation” is used in

this report instead of terms such as “common goals” or

“commonality of interests.” The emphasis throughout

is on the role of individual incentives in making cooperation possible, as well as resulting in conflicting

interests that coexist with those of cooperation.

In a context of individual incentives, organizational cooperation is a process of long-range planning

to develop business projects and services where benefits increase with more uniform quality and regularity

in operations. Programs must be implemented that

minimize member incentives for individualized dealings. This process involves converting potential conflict situations into those where incentives to cooperate

are dominant.

A clear direction and a timely process of decision-making are key ingredients for any successful

business. The more diverse the production enterprises

and the services members need, the greater the challenge for a cooperative to retain those key ingredients.

While cooperatives have been highly successful in U.S.

agriculture, the complexity of group coordination with

diverse producer interests is a perennial, and possibly,

an increasing challenge today.

Competitive adjustment for a cooperative arises

not only in promoting efficient business performance,

but also in ensuring that such performance is created

by and focused on cooperation. Members assume

responsibilities for the latter through consensus governance of their cooperative. Such governance tends to

adopt consistency in policies for guiding economic

relations and dealings with members. This tendency

for consistency in policy and procedure makes the

handling of diverse member interests more challenging for cooperati ves than for business entities where

eath transaction

individual deals

andconsistent policy are general

ativ.es. It also considers their stra

This report

-lY a pplied by coopertegic implications for

coordinating members with diverse interests, when

operating in competitive industries. The first section

gives an overview of diverse economic interests,

“Diverse Agricultural Producers.”

The next section, “Membership Consensus in a

Business,” examines how producers are only willing to

form or belong to a cooperative when there is a general

consensus on certain major decisions. The most basic

decision is that a cooperative should deal consistently

with members and avoid individual favoritism.

Membership consensus sets cooperatives apart from

many of their competitors. This creates special strategic considerations.

The way competing firms react to the situation of

relative uniformity in cooperative dealings with members is examined in the section “Consistent Policy.” It

considers some of the consequences of competing in

markets with substantial oppor tuni t-i.es or demands for

individu.alized dealing, a s compared with markets that

reward

trol.

uniformity in product or service quality conThe issue of attracting large-scale producers to

cooperatives is also addressed. Many cooperative 1eaders and economists advocate major policy changes to

accommodate the interests

establish consistency of sta

of large producers and

ndards for equitable dea

ings. A game-theoretic analysis highlights strategic

decisions in trying to create incentives for large prolducers to join cooperatives. Potential drawbacks to

member cohesiveness from approaching this objective

with a policy of more differentiated member treatment

are also discussed.

Decision-making with diverse member interests

is an important issue, but is only one of many that

cooperatives confront. This report focuses on a single

problem and ignores important considerations, such as

1
the potential divergence of interests between management and members. The focus throughout is that management is trying to maintain as large of a cohesive

membership as possible. Consideration of efficient

membership size is also not examined. Much cooperative theory has addressed the issue of membership

size. However, this report assumes increasing returns

and benefits to all members by expanding, or at least

not shrinking, the membership in a cooperative.

A situation of an expanding membership when

average returns are constant or decreasing is often

handled in economic analysis by identifying gains

from differentiating the terms of membership and

dealings when members have different costs associated with providing services. That type of differentiation

policy is discussed in this report in terms of effects on

consensus decisions and organizational cohesiveness,

but no technical analysis of “how-to” methods for efficient differentiation policy is provided.

Three basic strategies for cooperatives are examined in this report. The first is a strategy of business

development and definition, where cooperatives can

define their essential business around services that do

not involve substantial incentives for individual terms

in transactions. A second strategy is to use more distinctly cooperative marketing and service programs,

and to have them linked to value-added ventures. This

approach can have advantages in situations where

risks to and weaknesses of cooperatives are exposed

when they are replicating some of the methods and

operations of investor-owned firms. A third strategy

emphasizes long-term planning for building performance attributes of cooperatives that attract and retain

members.

This report views handling of diverse member

interests in a strategic framework, as described by the

influence diagram in Figure 1. The process is initiated

by the goals of each individual producer. When proFigure I- Strategic Framework of Cooperatives and Diverse Member Interests

Goals of Individual Producers

Individual

Transacting

\

Incentives for Cooperation Incentives for

Member Consensus

t

I Consistency in Policiest

Achieving Goals

l eeeeeee

l 

l Diverse Member Interests

I

1

l

-I Conflicting Interests

k

Process Flow 1-b

Pressures l eeeeeeeeeeeeeb

2
ducers do not recognize incentives or interests from

working with other producers in a cooperative, they

follow the option of individual transacting.

Figure 1 follows the process of cooperation,

where achieving incentives for membership requires

consensus decisions and consistency in policies and

procedures for member dealings. These requirements

or characteristics of cooperatives coexist with pressures, indicated by the horizontally dotted arrows,

from diverse member interests and from competitors,

who may offer slightly different terms to make individual deals.

If conflicting interests arise from these pressures,

an organization will need to resolve them by rebuilding incentives to cooperate. This can be a continuous

process of redesigning services and their delivery to

rebuild incentives to cooperate. The continuous nature

of this process is depicted by the circular flow of

arrows in Figure 1.

When cooperatives neglect strategic planning

and rebuilding incentives, relationships gradually

deteriorate into divisiveness. In summary, the pressures coming from within and outside an organization

either get resolved in a kind of circular and continuous

process, or they move a cooperative into eventual

decline. The strategic framework of Figure 1 is applied

throughout the report.

Diverse Agricultural Producers

passing localities with different ethnic populations,

were unified by common economic needs for efficient

services and for coordinated marketing.

Many cooperatives prospered from the volume

and size economies of a larger membership, but there

was also recognition that the more ethnically homogeneous cooperatives of the past possessed certain advantages.2 Those advocating a local basis for cooperation,

versus industry-wide contracting with producers, also

stressed the importance of minimizing diverse economic interests for effective cooperation.3 The reduced local

concentration of the farm population and gradual geographic expansion of cooperatives’ membership has

made internal cohesiveness a major concern for the

modern cooperative. There are many diverse characteristics of American farmers, but two stand out as the

most likely sources of divisiveness.

(1) Large Versus Small

The major example of diverse economic interests

in farmer cooperatives is the size of members’ farming

operations. When a cooperative’s operations are subject to increasing returns to size or scale of operation,

economic interests are more apt to conflict over equitable policies. In some cases, cooperatives distribute

returns in proportion to the economic impact of volume and establish voting power in proportion to

patronage volume. Differences in the size of farm operations have long been a source of disagreement on

member policy.

American agriculture produces a wide variety of

foods and fiber on predominantly family-owned farms

and ranches. The American farm population has

always been highly diverse and independent, originally consisting of immigrant producers from many countries. Early cooperatives often formed around different

immigrant populations.1

Market instability in the late 19th century led to

increased political organization by farmers. Gradually

more relationships and organizations were formed

across ethnic and local lines. Paralleling these political

movements, the growth of a modern agribusiness

economy created an overriding need for the efficiencies and the market power of large cooperatives.

Members from broader geographic regions, encom-

(2) Different Farm Technologies and Practices

Many farm enterprise technologies are increasingly specialized for, and integrated with, specific marketing channels. When that occurs, coordinated marketing or services need to be organized by and for

producers with compatible systems. For example, the

increasing advantages for producing more uniformquality meat can be a more difficult adjustment to

carry out when a traditional cooperative’s membership

has widely varying production systems and differing

views about strict adherence to any specific standardized method.4

* F. E. Parker, The First 125 Years: A History of Distributive and

Service Cooperation in the United States, 1829-1954, The

Cooperative League of the U.S.A., 1956.

* Ibid, p. 321.

3 E.G. Nourse, “Recent Trends of Cooperation Among

Cooperatives,” Proceedings of the National Association of

Marketing Officials, 7th Meeting, 1925.

4 B. J. Reynolds and J. D. Reilly, “Integrators, Innovators,” Farmer

Cooperatives, March 1994.

3
Membership Consensus in a Business

Agricultural cooperatives are controlled and

directed by their members to be financially sound

businesses. Many cooperatives have achieved public

notoriety for entrepreneurial innovation. Rather than

consensus governance and decisions being a limiting

factor, they have helped make many cooperatives

highly competitive and innovative. A consensus

approach can also make organizations vulnerable to

unfocused business objectives, which often prompts

the admonition that cooperatives must “operate as a

business.”

The requirement of consensus in cooperative

decision-making is further discussed along with some

of its potential positive and negative influences on

achieving business objectives. Lastly, member consensus has also had an impact on strategies of organizational structuring of cooperatives. Different approaches have been developed.

Consensus Process

Consensus does not require everyone to be in

perfect agreement. Rather, it involves acknowledgment

and respect for different opinions and economic needs.

The process requires members to exercise judgement

about supporting proposals that build and accomplish

their goals, even when such decisions may not exactly

satisfy individual preferences.5

In consensus-based organizations, members’

views are acknowledged even when not in complete

agreement with a majority of befiefs. This act of having

individual preferences and views communicated and

acknowledged is often called the power to exercise

voice, either by voting or other means.6 Voting in cooperatives occurs in two forms, as in democratic government. Representatives are elected to a governing body

that, in turn, makes group decisions by either implicit

or explicit voting.

Voting by the membership is often required for

certain major decisions, but is primarily for electing

directors to the board. Directors usually serve in staggered terms to maintain continuity and to provide frequent elections. But members need not always present

their views through official channels, i.e., to a member

of the board. Members often have direct access to man5 Reynolds, “It’s Unanimous: Why Cooperative Boards Strive for a

Norm of Unanimity,” Farmer Cooperatives, July 1995.

6 A.O. Hirschman, Exit, Voice, and Loyalty, Harvard University

Press, 1970.

4

agement. Managers regard the process of being “called

on the carpet” by any member as a regular part of their

job.7 Of course, members are likely to take a different

view from management about the effectiveness of control. Surveys of cooperative members often reveal

some disgruntlement about the extent of their control

and influence.*

A board of directors is the primary avenue where

diverse member opinions are brought to a consensus.

The board has both fiduciary responsibilities for overseeing the financial solvency of the cooperative and

representing member interests. The former responsibility comprises the group interest, while the latter

involves individual, often diverse, interests of members that must be reconciled and harmonized.

Because cooperatives are voluntary organizations, members’ final recourse may be to exit the organization? That ultimate threat gives cooperatives an

incentive to practice consensus decision-making. In

many theoretical discussions of governance, unanimity

is established as a logical and efficient criterion for

cooperative policy decisions.1o While directors often

differ on many issues, they usually make a concerted

effort for consensus, if not unanimous, decisionsF

Positive Effects

While cooperatives are built on democratic governance and consensus, these attributes are not displayed in daily business decisions. The consensus

process of cooperatives goes largely unnoticed by the

public. The importance of consensus is subtle but pervasive in how it affects what cooperatives do and how

they do it.

A major advantage is in combining different perspectives and experiences in making decisions. The

pressure from having to consider diverse interests

actually builds new values and innovative ideas for

cooperatives.

7 H.C. Peterson and B. L. Anderson, “Cooperative Strategy: Theory

and Practice,” Agribusiness, Vol. 12, No. 4,1996.

8 R.D. Boynton and H.T. Elitzak, Member Control of Farmer

Cooperatives, USDA/ACS, SR 7,1982.

9 Hirschman, op. cit.

J. Staatz, “A Game-Theoretic Analysis of Decision-making in

Farmer Cooperatives,” note 4, Cooperative Theory, USDA/ACS

Service Report No. 18 1986, p. 141, and R.J. Sexton, “The

Formation of Cooperatives,” American Journal of Agricultural

Economics, 68, May 1986, and I? Zuzman, “Constitutional

Selection of Collective-Choice Rules in a Cooperative Enterprise,”

Journal of Economic Behavior and Organization, Vol. 17,1992.

Reynolds, Ibid, July 1995.
Another advantage is the recognition outside

officials give to the fairness of cooperative dealings

with members, such as in distributing earnings to

members, as challenged in cooperative tax cases. The

courts have upheld these distributions as fair, largely

on the basis of the consensus process as being superior

to the opinions of outside experts in determining fair-

._

ness. IL

Questions about fair dealings are often not easily

resolved when there is no agreement on criteria.

Different justifications can be used to support conflicting approaches. However, democratic institutions give

weight to consensus decisions as providing some validation of policy fairness.

Negative Effects

Cooperatives have to guard against negative

effects that pressures for consensus can have on business capability and acumen. A consensus-based organization may be more prone to fall into certain traps

than a business with more concentrated and top-down

decision-making.

‘Business As Usual’ Trap

Cooperatives have to guard against preserving

cohesiveness at the cost of avoiding timely and controversial decisions. New business directions often have

uneven or selective benefits among the membership,

so the safest option is to avoid rocking the boat or

“business as usual.” There can be a tendency to avoid

initiatives because then it is harder to find fault should

business decline. Such thinking can be reenforced by

consensus pressures.

Changes in agriculture are undermining the

“business as usual” approach as a sure route to member consensus. Producers who have adopted new technologies or production practices want linkage to

value-added processing or marketing systems to maximize the benefits of the on-farm adjustments they are

making. Special programs can be developed for some

producers, as long as these selective actions do not

jeopardize the joint gains of cooperation.

Unremunerative Services Trap

The agency status of cooperatives(see

Glossary)often involves developing or providing services that are under or inadequately provided by

Investor-Owned Firms (IOFs) or other non-cooperative

alternatives. These services may have a limited-earnings potential, but are valuable to at least some of the

members. Demand is often extremely influenced by

price cycles in farm product markets. This complicates

the process of consistently supplying such services on

a remunerative basis. In these cases, producers have to

take initiatives to establish and control off-farm businesses, usually cooperatives, to ensure availability of

special services.

Special services are likely to supplement core

functions of a cooperative. An example is providing

tire repair service at field locations. This service is not

always feasible to offer as the core service of a business, but with coordinated support of a membership, it

can be provided. Other examples include new specialty crops or livestock that do not have highly developed markets. Market development is an extreme

example of valuable services not easily provided in a

remunerative way. It usually requires producer initiative in a cooperative to develop a generic product market* A cooperative may get trapped into providing

certain services without full remuneration or extending their supply beyond a point where variable costs

are covered. A recent survey of 31 local cooperatives in

Oklahoma showed that 65 percent provided services

with negative margins. Only 35 percent of that group

indicated that discontinuing them was under consideration. The top three money-losing services are service

stations, feed mills, and tire repairs?

Consensus pressures for nonremunerative services often arise from diverse member interests.

Management and board may feel pressured to placate

certain highly vocal members with services that do not

contribute to the cooperative’s margins.

Organizational Structuring

Organizational structure and restructuring strategies are influenced in several ways by the role of member consensus in a cooperative. Consensus has often

been an obstacle for implementing mergers and consolidations. The advantages of producer access and

control of large-scale and capital-intensive facilities for

food and fiber processing have in many cases been

gained by organizing federations of several locally

organized cooperatives.

12 R.E. Lee, “Expense Allocation

Accountant, Fall 1989, p. 25.

and Apportionment,” Cooperative

13 l? Kenkel, “Survey of Cooperative Managers and Boards of

Directors, 1991,” Unpublished, Oklahoma State University, 1992,

p. 45.

5
Cooperatives have also been able to facilitate

many types of large-scale coordinated marketing that

would otherwise not be feasible from a member consensus standpoint if access to such capabilities were

only possible by consolidating multiple organizations.

A recent alternative to federation that may have more

application to agricultural cooperatives in the future is

the use of specialization networks.

Some local cooperatives in contiguous regions are

capturing economies of size by having each organization specialize in a particular service. All members

throughout the network region have access to one

cooperative that can provide each service with more

efficiency. By offering specialization in a single service

they also might avoid potential problems of diverse

member interests when cooperatives offer multiple

services.

Recent organizational innovations have emerged

in so-called New Generation Cooperatives. Although

they have developed for a wide range of reasons and

objectives, an indirect and supplementry advantage is

the ability to form cooperatives with minimal member

diversity of economic interests. By requiring advance

commitment to an already developed plan for valueadded operations, consensus and planning and decision-making are effectively secured.

Furthermore, equity investments and patronage

volume needs are estimated. Memberships are closed

when they reach the specified target. The defined

membership of these cooperatives have a powerful

incentive for consensus that many open membership

organizations lack. This capability of building consensus is an important advantage that tends to be overlooked or understated in promoting these new organiza tional forms.

Making Consensus an Advantage

Membership consensus in a business is challenging and is a complex attribute of traditional cooperatives with diverse member interests. Maintaining a

consensus among a large number of diverse members

need not inhibit sound business decisions. The board

and management of most cooperatives handle the

pressures of consensus building by being strategically

aware about the process. This involves taking advantage of potential strengths in consensus decision-making and avoiding its potential traps.

Consistent Policy

Economic transactions for similar agricultural

products or services can often be negotiated on a multitude of different terms or arrangements. Financing

methods, timing, quality variations in product or service delivery, and informal promises about future

deals are a few of the dimensions on which buyers and

sellers may transact with distinctive or individualized

terms. Furthermore, planning and policy for transacting can only provide general guidance for addressing

individual opportunities and contingencies.

One characteristic of cooperatives that stems

from consensus is adherence to consistent procedures

and policies for member dealings. Cooperatives differentiate their prices or service fees according to established criteria on quality or cost standards. Some members regard the policies of their cooperatives as being

fairly uniform, and occasionally inflexible in not

adjusting policies to market contingencies.14

This section examines some implications for competitive strategy of consistency and adherence to policy in a cooperative’s dealings with members.

Cooperatives handle the combined demands of meeting individual member needs while maintaining balanced and consistent quality of services to all members. They must also compete with firms that do not

operate within a structure of member governance and

consensus.

Consistent Policy and Procedure

Consistent policy is needed to prevent arbitrariness or uneven quality in member dealings. This characteristic is initially established in a membership

agreement. Marketing cooperative agreements may

contain substantial details on mutual rights and

responsibilities for a cooperative and its members?

Most cooperatives are committed to receive

members’ entire output and to provide services to all

members, and to report their financial and operating

information to members and to directors. IOFs operate

without the same kind of pressures for consistent dealings with customers, although they may have incentives to make their customer dealings consistent. But

they differ with cooperatives in having more flexibility

I4 Ibid, p. 72, and L.D. Sanders, I?Kenkel, and E. Smith, Summary of

Survey of Critical Issues for Cooperative Survival, Oklahoma

State University, AE# 92-131,1992.

I5 Reilly, Cooperative Marketing Agreements, USDA/ACS RR 124,

1993
to selectively differentiate customers. In the general

theory of cooperation, this distinction is critical. In

products or offer services, knowing the general limits

that a cooperative must follow. Cooperatives must also

face the fact that any differentiated deals that they

might make, or are suspected of making, may create

ethical conflicts and erode trust.18 IOFs are more insulated from such criticism.

A third consideration is for an IOF to offer pricing arrangements that would be both highly remunerative and risky if offered to all customers who might

cooperation, services must be provided to all members

of the group if provided to any, which sets it apart

from other forms of OrganizationP

Most cooperatives are highly responsive to members’ differing needs, while also adequately safeguarding interests of the entire membership. Access to ma

agement and the power of voice, menti.oned in the

nprevious section, keep cooperatives relatively well

informed about, and responsive to, members’ diverse

needs and interests. In fact, many cooperatives tend to

err more on the side of insufficient safeguarding of the

group interest, than on inflexible adherence to

policiesJ7 Never theless, coopera tives are generally

consistent in their dealings with members, and comwant such terms. The

fferi

1 strategic approa.ch for an IOF is

one of portfolio 0 ngs that balance the risks. An

IOF can selectively offer a range of terms, easily controlling its financial position. An IOF competitor is also

aware that such individualized pricing is difficult, and

possibly more risky for a cooperative to match. A high

risk/return marketi ng method can eventually become

petitors strategically react to this orientation of cooper- a service that members want from their local cooperaatives. tive. When such individualized high risk/return terms

are offered by a cooperative, the stage is set for losses

Strategic Considerations that may spill over to the entire membership.

A cooperative’s consensus policies and procedures for market dealings have several strategic Competitor Specialization

dimensions and ramifications. The term “strategic”

refers to making decisions in light of information on

the expected actions and responses of others. A strategic framework involves making assumptions about

each side’s perspectives and decisions. Those used in

this report demonstrate implications of agricultural

producers’ diverse interests.

One strategic effect of policy consistency is to

make information about cooperative terms of trade

more available and predictable than the same kind of

information from IOFs. When cooperative managers

refer to “operating in a fish bowl,” they are referring

not only to the burden of public reporting but also to

the consequences of uniform and consistent policy.

Members know their cooperative’s terms in transacting business, but lack reliable access to comparable

information about IOF dealings with different customers.

A second strategic consideration is that IOFs are

more likely to customize services or selectively offer

special pricing when competing with cooperatives

than with other IOFs. A competitor is aware that a

cooperative has constraints in responding to certain

individual customer needs. IOFs can selecti vely bid on

A fourth strategic consideration involves the

opposite of individualized and differentiated dealing.

When customers are economically diverse, a competitor may

a segme

have1 more incen

the market.

tive to specialize and expand

nt of In elffect, a firm selects its

market to conform to a uniform service it provides. In

addition, the incentive to specialize is affected by the

extent to which the competition accommodates diverse

customer needs. Examples of such situations are common in many local feed milling businesses.

Suppose a cooperative feed mill serv‘es a variety

of Ii vestock producer members, in&ding some largescale hog finishing enterprises. The cooperative will

try to provide its service at prices

its entire livestock membership.

that are feasible for

A compe titor may derive advantages by opera

feed mill dedicated to and integrated with an

ting a

expanding hog finishing business. Their advantage in

specialization may come from several sources, not the

least of which would be in not having to supply feed

at prices that help maintain a varied customer base. In

sum, diverse interests create opportunities for strategic

positioning.

The key elements of strategic positioning can be

visualized in a game-tree diagram. Figure 2 shows a

cooperative having to make decisions that move i t in

either a direction of accommodative or restrictive . pollI6 M. Olson, The Logic of Collective Action, Harvard University

Press, 1965, p. 14.

l7 P. Lasley, C. P. Baumel, R. Deiter, and P. Hipple, Strengthening

Ethics Within Agricultural Cooperatives, USDA/RBS RR 151,1997 18 Ibid.
Figure 2- Strategy Under Conditions of Diverse Producers

co-op /OF Competitor

Specialize for a customer segment

Selectively Accommodate

Specialize for a customer segment

Selectively Accommodate

cy to meet the diverse interests of members. An IOF

competitor can modify its operations to take advantage of consistent policy and business decisions of a

cooperative.

Along the top branch of Figure 2, in italics, the

competitor will specialize or focus its services if the

cooperative decides to follow an accomodative policy

in serving diverse customers.

Along the bottom branch, the competitor will selectively accommodate diverse customer needs, when

faced with a cooperative that chooses a restrictive policy on the kinds of services it will offer and limits the

extent of customizing services.

Figure 2 demonstrates a strategic framework, one

of many possible actions and responses. Specialization

decisions are based on many considerations. When a

competitor specializes, opportunities might improve

either by providing more general services or by specializing in some other service. Although actual decisions involve many more considerations, cooperatives

have to guard against giving too little weight to strategic factors and too much to service demands of members. Any new service or business venture must consider the extent of diverse interests, risks to the group,

the impact on member cohesiveness, and the efficiency

of how it fits in with, or complements, the cooperative’s resources and capabilities.

Defining a Cooperative Business

Most cooperatives operate in similar fashion to

other firms in a given industry, but also act as agents

for members in trying to improve earnings for their

farm enterprises. Selection of services to be offered is

usually determined by member interests.

Nevertheless, not all services or business operations

that can benefit members are economically feasible.

Even services that have been profitable for some IOFs

may draw heavily on resources and situations that are

disadvantageous for cooperatives.

Competitive strategy for cooperatives begins

with selecting and defining a business that coalesces

member goals and economic interests, and minimizes

incentives for individual members to defect from cooperation. Some agricultural industries and farm services

vary in regard to how united members feel about the

value and effectiveness of what their cooperative provides. Here are three examples of agricultural services

that differ in how conducive they are for cooperative

organization. The first two are relatively conducive,

while the third is more challenging for cooperatives.
Value-Added Processing dealerships closed at a faster pace. There were 101

Many cooperatives have developed successful cooperative dealerships in 1970,56 by 1980.** They

value-added businesses from processing raw products. number only about 12 in the U.S. today.

For perishable farm products, such as milk, coopera- Some of the remaining cooperative tractor dealertive processing has been especially prevalent. As many ships and repair service businesses serve wide geofarm products have encountered a transition from graphic areas with multiple locations. Cooperatives

actively traded commodity markets to integrated systerns, opportunities for comparative pricing and individualized dealing are narrowing.

that have tried or are successfully maintaining tractor

retailing dealerships, have reported a considerable

dearth of these services. Members have regarded their

Producers can potentially capture added value by cooperative’s involvement as meeting an under-supparticipating in integrated systems through coopera- plied need .*I

tives. Although there are many competitive dimen- Cooperatives have historically been competitive

sions to the new systems of integration, uniform dealings with producers and efficient management of

processing are strong points for cooperatives, in contrast to the individualized deal making of traditional

farm-commodity trading.

Market Development

of products that were new to many consumers in the

Market development involves substantial comU.S. Cooperatives took a lead role in developing those

monality of interests among producers, and there is

usually no direct competition in providing this type of

markets. In recent years, economic growth in several

service. This situation is demonstrated in the history of

cooperatives that have developed markets for specialty

foreign countries has renewed the task of market

farm products. Cranberries and almonds are examples

development, and cooperatives have played an active

role. Some of the producers of new varieties of crops

and animals are organizing cooperatives with a market

development orientation.

in managing marketing and farm service tasks that are

relatively uniform for the membership. In addition, as

farm populations become smaller, more geographically

dispersed, and composed of more economically

diverse producers, cooperatives may want to avoid

increasing membership when it creates a multitude of

disparate member needs. Rather, they can help set up

new cooperatives to meet specialized needs, and work

together for lowering costs by establishing network

relationships.**

Cooperative Forms of Marketing

extent they coalesce member interests, or as to the

extent of exposure to losses from individual member

decisions. In very general terms, marketing cooperatives have followed two basic approaches. One provides a competitive market price for member reference

and gains member patronage by bettering or at least

matching the offerings of competitors. The other, distinctly “cooperative” marketing, serves individual

member interests by coordinating with other members.

Cooperative marketing techniques vary as to the

Tractor Services

Tractor retailing and repair is a diverse service

that often requires significant customization. Until

about 40 years ago, cooperatives were expected to play

a significant role in the retail and repair industry. In

the 193Os, numerous cooperatives were formed for

farm machinery leasing and repair servicesJ9 They

rapidly went out of business during the 195Os, but

some remained by establishing dealership franchises.

In recent decades, the number of these dealerships

have significantly declined, but cooperative tractor

is most effective when integrated with value-added

operations and risk management for members.

This type of marketing pools member production, and

Many producers, particularly in the grain industry, are more accustomed to monitoring market prices

and receiving individualized pricing services. In such

cases, a distinctive program that is not comparable to

competitive b

to producers.

ids may

In these

not a

situa

.ppear to offer advantages

tions it is especially critical

2o L. Biser, Cooperative Farm Machinery Operations, 1970-80,1983.

21 Interview with Larry Crook, AG West Supply, Aug. 15,1996.

22 J. R. Fulton, M. P. Popp, and C. Gray, “Strategic Alliance and Joint

Venture Agreements in Grain Marketing Cooperatives,” Journal

of Cooperatives, Vol. 11,1996, and A. Borst, “Network Movement

Presents challenges and Opportunities for Farmer Cooperatives,”

Farmer Cooperatives, January 1995.

I9 W.W. Fetrow and R.H. Elsworth, Agricultural Cooperation in the

United States, USDA, Bulletin 54,1947.

9
to integrate pooling with value-added functions.

Limiting membership may also be necessary to prevent dissipation of potentially higher earnings.

Individualized dealings in producer markets by

non-cooperatives can draw cooperatives into involvement with terms and situations that may impose costs

on other members. The seriousness of unanticipated

hazards from cooperatives pursuing individualized

member dealing is demonstrated by the recent problems with hedge-to-arrive contracts. This form of contract benefited individual growers prior to 1996. But

that year incentives existed for members to not honor

their contracts. Those who defaulted imposed losses

on other members of their cooperatives.

The defaulting on hedge-to-arrive contracts is

being criticized as a breakdown of trust and ethical

behavior.*3 However, this problem can be approached

strategically as well as ethically Hedge-to-arrive contracts are an outgrowth of pressures for cooperatives

to pursue individualized dealings. Competitors might

be aware that such contracts are likely to impose more

dilemmas and conflicts for cooperatives than for their

own firms. By strategic framing of the issue, cooperatives avoid or circumvent ethical crises by using cooperative marketing techniques. The approach of circumventing ethical dilemmas by making precommitments

is examined by many theorists of strategy.24

Pooling programs generally offer advantages in

marketing large volumes and in providing market risk

management. Cooperatives face a special kind of risk

when independent decisions of individuals can impose

losses on the group. Pooling addresses such hazards

by avoiding individualized pricing contracts.

Nevertheless, techniques like pooling will not be more

widely adopted if advocated as merely a safeguard.

Pooling must be framed in a value-added context to

become more widely adopted in commodity industries

such as grain.

Attracting Large-Scale Producers

Many cooperatives need to attract large-scale

producers to achieve efficient operating size. Pressures

to retain and gain their patronage is particularly critical in the bulk commodity industries, such as grain

23 Lasley, op. cit., and Rural Cooperatives, July-August 1996.

24 T. C. Schelling, “Ethics, Law, and the Exercise of Self-Command,”

chapter 4, Choice and Consequence, Harvard University Press,

1984.

10

and the related farm services.*5 Cooperatives usually

review their economic performance, streamline their

services into those with critical volume support, and

make their services more effective for the needs of

large producers.

An alternative and more consequential approach

for addressing problems of inadequate membership of

large producers is to provide differential treatment in

cooperative policies. Many cooperative leaders and

economists advocate policies for differential treatment

of members in proportion to their patronage volume or

use.26 Such policies provide more efficient and equitable dealings when increasing returns justify compensating large patronage members above the average

return.27 Some proponents point out that providing

such compensation would also create more incentives

for large producers to join or to remain as members of

cooperatives.

This discussion focuses on strategic issues of

gaining patronage from large producers in situations

where a cooperative’s earnings are being impaired by

insufficient volume. In this framework, cooperatives

evaluate the use of policy instruments or new services

to determine the most effective ways to increase incentives for patronage from large producers. This discussion is in three parts.

Before presenting a game theoretic analysis, it is

important to avoid any misunderstandings about

cooperative policies as being strictly uniform and

designed for equalizing all dealings with members.

Therefore, the first part of this discussion reviews how

most cooperatives apply proportionality and differential treatment of members.

Part two analyzes the large-scale producer problem by using game-theoretic payoff matrices. These

matrices describe incentives and relevant choices in

concrete situations, but this analytical technique leaves

out many details in order to clearly define strategic

moves and decisions.

The third part discusses some of the institutional

details and social contexts left out of payoff matrices

that help make cooperation feasible and sustainable. It

incorporates some of the game results and institutional

Kenkel, op. cit.

H. Swarm, American Institute of Cooperation Yearbook, 1985, and

R. D. Knutson. “Cooperative Principles and Practices,” Farmer

Cooperatives for the Future, 1985, and J. B. Royer, “Cooperative

Principles and Equity Financing,” Journal of Agricultural

Cooperation, Vol. 7,1992.

M. Fulton and J. Vercammen, “Distributional Impacts of NonUniform Pricing,” Journal of Cooperatives, Vol. 10,1995.
aspects of cooperative governance and decisions into a

long-term planning approach to the problem of retaining and gaining membership of large-scale producers.

Proportionality and Differentiation

In their early years U.S. cooperatives tended to

strictly apply equal treatment, but over time they have

increasingly incorporated more differentiation of terms

according to quality or cost differences in member

dealings.** In today’s economy, cooperatives usually

combine elements of both proportionality and equality

in member dealings. The three basic principles of

cooperation - (1) user ownership, (2) user control,

and (3) user benefits - are compatible with differentiated treatment of members and a wide range of policies or practices for member dealings? Member dealings in proportion to use is inherent in the traditional

principle of service at cost.

The emphasis on member size or patronage volume differences is often called the proportionality

principle or policy. 30 It refers to equitable policies in

the sense of maintaining parity in the relationship

between benefits and contributions across all members. In contrast, the traditional member policy of

cooperatives in the U.S. has tended to apply aspects of

both proportionality and equality. In general, cooperatives distribute benefits and share burdens in proportion to use, while member voting has predominantly

been on an equal or one-member, one-vote basis?

In the two operational areas of member payments

and finance, allocations are intended to be in proportion to use or volume, but many cooperatives fall short

of strict proportionality in several aspects.

The distribution of benefits in proportion to use

or volume is usually on an average value or per-unit

basis. This approach is labeled “equal” because the

average or same price for like qualities of product or

services is applied. Although this approach falls short

of strict proportionality, cooperatives have often been

diligent in communicating value or quality-price differential information to members.

In many commodity industries, cooperative marketing captures quality premiums for members. They

have been pioneers for improving producer incentives

by passing these differentials on to individual members. At the same time, cooperatives may exercise discretion in the interests of lower transactions costs, or

for risk management or for member cohesiveness, by

not always fully differentiating earnings across all

commodities .32 To some extent the risk management

aspects of cooperative pooling, by smoothing out price

fluctuations over time, involves equalizing potential

earnings differences of the membership.

Member financing in proportion to use by cooperatives is reflected in the method of per-unit retains.

The acquisition of equity capital and its redemption in

the future, coupled with changes in member patronage

and composition, often make financing disproportionate to use.33 However, some cooperatives that have

encountered this shortcoming use base capital plans to

place financial responsibility more in proportion to

members’ current and future use.34

In regard to voting, studies of methods used by

cooperatives in 1978 and in 1995 indicate about 93 percent have a policy of equal or one-member, one-vote.35

In followup questions to survey participants who used

proportional voting, many did not extend proportionality terms to product or service pricing or to provisions for investment returns on equity.

An important consideration when making pricing or financial differentiations is that they communicate incentives on factors that are adjustable or capable

of improvement by at least a large percentage of members, rather than on factors that may not easily be

changed or improved. Payment differentiation according to product quality criteria can create incentives for

all members to make improvements that will expand a

cooperative’s future earnings. The scale of agricultural

production has possibly been one factor that cooperatives have traditionally regarded as not easily adjusted

by many of their members. In sum, cooperatives have

tended to combine elements of both proportionality

I.W. Rust, Providing Equitable Treatment for Large and Small

Members, USDA, Farmer Cooperative Service, Information 21,

1961, p. 3-5.

J. Dunn, “Basic Cooperative Principles,” Journal of Agricultural

Cooperation, Vol. 3,1988.

D. Barton, “Principles,” chapter 2, Cooperatives in Agriculture, D.

Cobia (editor), Prentice Hall, 1989, and Royer, op. cit.

B.J. Reynolds, T.W. Gray, and C.K. Kraenzle, Voting and

Representation Systems in Agricultural Cooperatives,

USDA/RBS RR 156,1997.

S.T. Buccola, J.C. Cornelius, and R.R. Meyersick, “Pool Payment

Equity in Agricultural Marketing Cooperatives,” Journal of

Agricultural Cooperation, Vol. 4,1989.

D. Cobia, J.S. Royer, R.A. Wissman, D.P. Smith,, S.D. Lurya, J.W.

Mather, and P.F. Brown, Equity Redemption, USDA/ACS RR 23,

1982.

R.C. Rathbone and R.A. Wissman, Equity Redemption and

Member Allocation Practices of Agricultural Cooperatives,

USDA/ACS RR 124,1993.

Reynolds, Gray and Kraenzle, op. cit.

11
and equality in member dealings, and have traditionally applied differentiated treatment when it can influence economic growth.

Two Games With Strategic Moves

When diverse economic interests of members

come into conflict, it is usually because of differences

in stand-alone or outside opportunities of some members, especially large-scale producers. Conflicting

interests of members have been modeled for agricultural cooperatives by using game-theoretic techniques.

In developing a theory of agricultural cooperatives,

some economists have used a branch of game theory

known as coalition analysis.36 A game-theoretic

approach, but with a more applied orientation, is used

here to examine the structure of incentives in dealing

with problems of defections by large-scale members.

An important difference in this report with the

approach taken in other game-theoretic analyses of

cooperatives is the use of incentive structures that

involve contingent choices. Theoretical work in game

theory often employs dominated choice situations, like

the prisoners’ dilemma. In dominated choice games,

what the other side or player chooses does not influence a player’s decision. By contrast, contingent choices provide opportunities for influencing the decisions

of the other side by demonstrating various types of

commitment.

Schelling specified two general ways or “strategic

moves” for a decision maker to influence the choice of

the other side or player, either as “promises” or as

“threats.“37 However, these two types of moves are not

necessarily made in literal or face-to-face confrontations. Rather, they are labels for actions that alter

incentives for others to make different choices than

they otherwise would make. In game theory, a promise

is an action that improves the payoff for the other side.

A threat is a move that reduces the other side’s payoff

enough to change its decision from what would otherwise be chosen.

The following two game-theoretic situations

involve fairly extreme, but not unrealistic, situations.

In both cases, there is a hypothetical cooperative that

operates far more efficiently when it receives patronage from large members. A competitor offers individualized deals that have bid large members away from

the cooperative.

36 J. Staatz, “Cooperative as a Coalition,” American Journal of

Agricultural Economics, 65, Dec. 1983, and Sexton, op. cit.

37 Schelling, The Strategy of Conflict, Harvard University Press, 2nd

edition, 1980, p. 122-134.

12

(1) The Promise

Many cooperatives can create incentives for

member patronage from large producers by revising

policies in accordance with a strict proportionality

agenda. Policy provisions most applicable for this purpose are differential pricing and proportional voting.

Applying differential pricing would be relevant to

redistributing marginal gains when a cooperative’s

operations have increasing returns.38 Both provisions

change the way earnings and governance are shared in

a cooperative, but do not change the total efficiency or

earnings from what the cooperative achieves when it is

operating at full capacity with support from its entire

membership.

The two choices (columns) in Figure 3 for large

producers are cooperation and defection. The cooperative operates initially in the lower left cell, (4,3), but in

a subsequent season, large producers chose to defect

from cooperation, (1,4), the lower right cell. In other

words, the game starts in the lower two cells of Figure

3, until an alternative can be offered to “business as

usua1.“39 When large producers choose defection, the

low volume results in a payoff of 1 for the cooperative,

indicating an industry with significant increasing

returns.

The cooperative would prefer to operate in the

lower left cell, (4,3). It used to work at one time but it

is no longer feasible because of the lower payoff of 3

for large producers. The fact that its lower, and not

equal for all members accords with the views

espoused by advocates of the proportionality principle. However, the higher payoff for smaller members

in the lower left cell creates an opportunity for an

alternative.

The lower left cell enables the cooperative to

transfer from smaller scale members, a part of the payoff, 1, to large producers. That would produce a cell

with pay-offs of (3,4). In game theory, when a player

transfers part of its payoff in a cell to the other player

in order to induce a decision solution in that cell, such

moves are called a promise.40 This type of promise

move is the basis of the policy provisions alternative to

business as usual, with its payoffs in the top two cells

of Figure 3.

Management and board consider offering a new

policy of differential pricing in proportion to product

volume delivered and proportional voting. Several

38

39

M. Fulton, op. cit. /S. Brams, The Theory of Moves, Cambridge University Press,

1994, p. 24-34.

40 Schelling, op. cit., 1980, p. 131-134.
Figure s-- Large Producer Game-Attract with Policy Provisions

Policy Provisions

I Cooperative I

Business as Usual

I Large Producers I

Cooperation Defection

directors want to add a “kicker” to this policy. If

implemented and large members continue to defect,

their sizeable volume of equity in the cooperative

would be expropriated or, at the very least, retained

for as long as possible.

Figure 3 shows a situation that game theorists

call the “mixed motive game.” Incentives for conflict

and cooperation are combined.4* The cooperative

implements policy provisions in an attempt to lure

large producers back to cooperation. However, the

smaller producers would prefer a cooperative that

operates in the lower left cell. But, knowing how the

large producers make decisions, they will accept and

implement the policy provisions. In the upper left cell,

smaller producer-members incur a loss of value from

transfers to large members by means of patronage volume premiums and from a relative reduction in their

voting power.

The large producers, essentially, let the cooperative make the first move with regard to implementing

an alternative to business as usual. Once the policy

41 Ibid, p. 89, and J. Friedman, “Introduction and Overview,”

Problems of Coordination in Economic Activity, Friedman

(editor), Kluwer Academic Publishers, 1994, p. 4.

provisions are announced, they must evaluate a choice

between cooperation and defection. Cooperation, in

the upper left cell is (3,4), consisting of the cooperative’s payment, plus the volume premium and their

additional share of voting power. In the defection

choice, (2,3), the kicker provision on retaining equity

of defectors explains why the payoff is lower for large

producers than if they could maintain the conditions

in the lower right cell of defection and business as

usual. Once the policy provisions are announced,

defection is no longer the best choice.

The equilibrium solution for the game in Figure 3

is, therefore, in the upper left cell. The two groups of

players are likely to coordinate their expectations in

that cell. The pattern of combined decisions is mapped

by the broken line that ends in the upper left cell of

Figure 3.

This game may seem to be a determinant choice

in having an obvious equilibrium solution in the upper

left cell. Yet, it is a game of contingent choices in that

how each player chooses depends on the incentive

payoffs for each counterpart player. The steps in getting to a solution, like that of the upper right cell,

13
Figure 4-- Large Producer Game-Contract with Competition

Marketing Services

Contract

I I

Business as Usual

1 Large Producers 1

Cooperation Defection

demonstrate a process that, in practice, might be slow

and involve uncertainties that may derail any decisions about making a change.

(2) The Threat

Figure 4 demonstrates the use of communicating

a “threat” in an attempt to change the choices that others would make.42 In this game, the previous season of

defection is likely to be repeated with the same lopsided payoffs in the lower right cell as in Figure 3.

The opportunities for a joint maximum exist in the

lower left cell, as in Figure 3, but market conditions

have deteriorated in Figure 4. Any performance gain

from receiving the high volume of products from large

members, which would benefit the membership as a

whole, is lost under severe market conditions. Its payoff

in Figure 4, lower left cell, is (3,3). As a result, there is a

diminished opportunity to use the policy provisions

alternative to business as usual in order to regain the

cooperation of large producers who have chosen defec42 Schelling, 1980, p. 123-134.

14

tion. Recall that in Figure 3, the cooperative could transfer part of its payoff to loyal members by implementing

favorable policy provisions for large producers.

In the game of Figure 4, the cooperative’s alternative is to consider a major reduction in the scope of its

operations. Such a strategic move has some power to

influence large-scale producers to choose cooperation

if they perceive the cooperative as taking actions that

would reduce their opportunities if they defected. The

alternative to status quo in this situation is to terminate its independent marketing program and obtain

marketing services from its former competitor. The

cooperative would provide storage and product

assembly for shipment, as well as negotiate the marketing service contract. In order to function as a threat,

defectors must be made aware of the plan and its consequences.

An important assumption in the game presented

in Figure 4 is that the availability of the large producers’ outside advantage, the payoff in the lower right

cell, depends on the existence of the cooperative. This

assumption represents the “Nourse yardstick effect” of

cooperatives upon competition (see Glossary). Both

large producers and the membership as a whole are

aware of this dependency
As a practical matter, some cooperatives resort to

marketing service contracts with outside firms in an

effort to improve earnings. Such decisions are made

under circumstances where announcements of preliminary plans would have little if any threat value. In

actual cases of cooperatives that contract outside for

marketing services, their go-ahead decision is probably

made as if it were a dominated choice. It is dominated

in the game theory sense that they perceive no better

alternative and are not expecting the contingency of

winning new member support. That would allow them

to withdraw from having to terminate an autonomous

marketing program. Even though the game in Figure 4

is selectively designed to highlight the use of a threat,

the conditions and alternatives are not too far removed

from the kinds of choices that some cooperatives confront.

The Figure 4 payoff matrix, like Figure 3, is a

game of contingent choices. Neither of the two rows or

columns is dominated. Under the usual game theory

assumption for contingent choices, each player makes

an inference about the choice that the other player will

make. Finding an equilibrium solution to the game in

Figure 4 depends upon how credible the cooperative’s

threat of a marketing service contract is perceived to

be by the large producers.

If the threat is not considered credible, but is subsequently implemented, larger producers would

switch from defection to cooperation. The solution

would be in the upper left cell. The reason for this outcome is that the aggregate volume of the cooperative’s

loyal membership is larger than the separate volume

of each large producer. If they continue to defect, the

payoff is higher for the cooperative in the upper right

cell because it has much more volume and power

when negotiating the marketing service contract than

the individual large producers, who have lost the

leverage they had when the cooperative was that

firm’s marketing competitor.

If the threat is credible, there is opportunity for

the cooperative and large producers to achieve the outcome of the lower left cell. It is not the preferred solution of large producers at the start of the game, before

they perceived the threat as credible, but it is better

than the solution of the upper left cell43

The arrow lines in Figure 4 show possible

sequences of decisions. At the start, only the lower row

is available, and large-scale producers have an incentive to choose defection. The top row is a potential

a3 Ibid, and Brams, op. cit., p. 138-148.

response or strategic move by the cooperative that, if

implemented, would remove the bottom row alternatives for large producers. If this “threat” is not considered credible, but is implemented, decisions converge

along the broken line. They make a transition in the

upper right and eventually settle in the upper left cell.

The movement from upper right to upper left is likely

to occur as large producers gradually discover their

loss of marketing leverage. The upper left cell has

lower transaction costs than the upper right by consolidating all producer transactions and giving the cooperative a quasi-bargaining role.

If the threat of a marketing service contract is

credible, the dotted line is followed. After decisions

move to the lower right cell, a credible threat returns

the decision game back to the starting point. The joint

maximum solution for producers is the cell with highest total payoff. In this game, decisions return to the

cell of business as usual cooperative marketing with

cooperation from large producers.

Insights From Game Theory

Most situations encountered by cooperatives are

neither pure conflict, nor pure cooperative gain. Most

strategic decisions involve mixed incentives of conflict

and cooperation. The mixed incentive game in cooperatives develops from the circumstances of consistent

policy in member dealings and individual differences

in outside opportunities. The games of Figures 3 and 4

highlight some extreme mixed incentive choices. The

usual situation for these kinds of strategic choices is

depicted in Figure 1, where cooperation and conflict

unfold as a gradual process of adjustments, with the

potential for a cooperative to rebuild its strengths and

mission.

A second insight from contingent choice game

theory is in demonstrating how easily decision makers

can be drawn into lower- value joint outcomes. In

Figure 4, movement to the highest joint gain, the lower

left cell, implies that information on the consequences

of ending a cooperative marketing program have been

adequately communicated to producers who have

defected. Incomplete information or misunderstandings of complex market situations create a potential for

ending up in lower-value joint outcomes, such as the

upper cells of Figure 4.

Sustainable Cooperation

Large-scale members often have leverage in

obtaining policy provisions that exclusively meet their

needs. Such initiatives may involve some type of nonuniform sharing of earnings or may only include pro15
portional voting. Under these circumstances, cooperatives should evaluate impacts on future conditions for

member consensus and sustained cooperation. Some

cooperatives may find a natural and appropriate consensus with non-uniform distribution and proportional voting. In other circumstances, when policy provisions are implemented under economic duress, as in

the game in Figure 3, they undermine a foundation for

member cohesiveness. An analogous problem may

occur when mergers of cooperatives lack adequate

melding of different cooperative business and political

cultures.

Many economists point out that differential pricing in accordance with marginal contribution of volume would likely be a complicated and costly process,

although various multipart pricing schemes are relatively feasible. Although economic analysis of distribution on an equal price basis reveals inefficiencies

from inaccurate pricing of resources, finding alternative allocation methods that are superior for all purposes and that remain valid under changing economic

conditions usually proves to be impossible.44

A critical consideration for implementing nonuniform distribution is that the program obtains consensus in a reasonable and low-cost time frame.

Controversies over distribution methods distract cooperative management from a business and value-added

orientation. The role of cooperatives, particularly managers, is to lead efficient and competitive businesses,

rather than debate and dispense economic justice. Fair

division of an economic pie is a traditional image for

cooperatives, 45 but as recent theorists of strategy have

noted, the time costs of battles over shares, rapidly

diminish net-present values for all claimants.46

An important feature of voting methods, either

one-member, one-vote or proportional voting, is that

they do not lead to significant departures from consensus decisions by a board of directors. Consensus is not

relevant or measured by the margins of victory in

director elections, but only in the governance process

of directors. However, proportional voting allocates

more voting power to some members, and might influ44 T. Groves, “The Impossibility of Incentive-Compatible and

Efficient Full Cost Allocation Schemes,” Cost Allocation, P.H.

Young (editor), North Holland, 1985, and P.H. Young, Equity in

Theory and Practice, especially see chapters 4 and 9, Princeton

University Press, 1994.

45 R. Phillips, “The Economic Nature of the Cooperative

Association,” Journal of Farm Economics, 35,1953.

46 A. Dixit and B. Nalebuff, Thinking Strategically, W.W. Norton,

1991, p. 45-48.

16

ence a board of directors to exercise decisions with

near majority winning coalitions, rather than on the

basis of cooperative consensus. Proportional voting

would seem to more likely lead in this direction if

adopted to attract large producers. If adopted, proportional voting should reflect member consensus and

their social conventions. This point was made in

debates during the 1950s on the strict proportionality

approach.47

A lack of services that adequately meet the needs

of large producers is the more basic problem which, if

addressed, may help avoid situations of having to

offer policy concessions as a form of compensation.

Many cooperatives address the development of outside opportunities for their large-scale members by

innovating new or more effective services for them.

Long-range planning enables these cooperatives to be

positioned to prevent diverse member interests from

becoming conflicting interests. Services are identified

and developed to meet the special and different needs

of members.

When cooperatives address the interests of large

producers with expedient measures, or outside the

context of planning, they are likely to erode trust and

support from the membership as a whole.48 In addition, a broader spectrum of alternative approaches in

meeting the needs of large producers are likely to be

overlooked if this objective were to be handled either

by management discretion in dealing with producers

or by adopting policy provisions of the strict proportionality agenda.

Coordinated action and decision-making, when

cooperative membership is composed of diverse economic interests, involves an incentive structure of both

conflict and cooperation. The lessons that can be clarified by structuring decisions in game-theoretic payoffs

are the importance of continuously developing and

improving business services that provide a joint or

cooperative gain. With long-term planning of this

kind, cooperatives improve their prospects for avoiding the traps of equilibrium outcomes with lower performance and weaker incentives for cooperation.

47 J. Savage, “Comment on, Economic Nature of the Cooperative

Association,” Journal of Farm Economics, 36,1954.

48 Lasley, op. cit.
strategic moves for attracting large producers to a

Summary and Conclusions cooperative are analyzed in a game theoretic framework.

Producers organize and support an agricultural The framework of these games helps clarify the

cooperative when it helps accomplish their goals better incentives for conflict and cooperation that emerge,

or more completely than if they transacted in the mar- even when cooperatives address diverse interests of

ketplace as separate individuals. Cooperatives are vol- members that are less extreme than problems in

untary organizations and operate under the principles attracting large-scale members. This framework identiof democratic governance. These features establish fies interdependencies of decisions and the impacts of

cooperatives as consensus-based organizations. mixed-incentive structures. It provides a starting point

Members typically have diverse economic inter- for long-range planning in developing alternatives for

ests. Consensus is a process of building cohesiveness favorably changing the decision game. Many cooperaand incentives for member support. Cooperatives are tives attract large-scale producers by continuously

established to serve member interests, but consensus is innovating and developing new marketing programs

achieved with policies for consistency in member deal- and services that build on cooperative strengths and

ings and relationships. Policy consistency has the char- incentives for producers to choose cooperation.

acteristic of a local public good in that any services or

special terms offered to one member must be available

to all members.

Diverse economic interests of members and policy consistency have strategic dimensions in the way

non-cooperative firms compete with cooperatives and

in the corresponding response by cooperatives. Noncooperative firms or IOFs have an incentive to compete by offering more individualized and customized

services than is feasible for cooperatives, or to pursue

more narrowly defined business services that avoid

higher transactions costs of serving diverse producer

needs.

Cooperatives are most effective in responding to

the competitive pressures of individualized dealings

by identifying services that prosper from substantial

coordination and application of consistent quality handling. In the area of marketing, this approach involves

programs for value-added earnings that provide individual incentives for member commitment in delivering product to their cooperative. Cooperatives are

implementing a variety of these kinds of value-added

commitment programs, either in the newer form of

new-generation cooperatives or in traditional methods

of pooling.

Large-scale producers are a focal point for individualized dealings by firms that compete with cooperatives. Cooperatives can address the problem of losing some of their largest patrons by offering

differential terms in distributing earnings and voting

power in proportion to member patronage volume or

patronage-generated equity. There are other justifications for adopting policies of this kind, but this report

solely addressed potential strategic uses and implications. The use of these policy provisions and other

17
Glossary

Agency - An individual or organizational entity that

represents or works on behalf of another individual

or organization.

Contingent - In game theory decisions, what the

other party, counterpart, or competitor chooses will

influence the choice to be made. In such games, it is

possible to influence the choice made by the other

party. It makes a difference whether one has the first

or second move, or whether or not communication

is possible.

The test for contingent choices is when payoffs in

each cell along a column or row are not larger than

the payoffs in every cell in adjacent columns or

rows.

Dominated - In game theory decisions, what the

other party, counterpart, or competitor chooses will

influence the payoffs, but neither party can influence the choices the other will make. In such games,

it makes no difference whether one has the first or

second move, or whether communication is possible

or not. The prisoners’ dilemma is an example of a

game with dominated choices.

The test for domianted choices is a column or row

with payoffs in every cell that are larger than those

in adjacent columns or rows.

Mixed incentives - Game theory decisions that

involve competition (conflict) in priorities within

choices for mutual gains from cooperation. Mixed

incentives are a third type of game theory situation

between pure conflict (zero-sum) and pure cooperation. In many studies and discussions of game theory,

mixed incentive games are subsumed into the general category of noncooperative games, with the only

other type identified as cooperative game theory.

Payoff matrix - Payoffs are represented in an

indexed form or in their minimum relative value in

order to show comparative gains or losses from

making different choices in a context of influence

from the choices made by another party.

Proportionality - Equitable treatment of members by

bringing the economic contributions and burdens of

every individual into a parity or equal relationship.

ourse Yardstick - Part of a theory of cooperatives,

developed by E.G. Nourse. The presence of cooperatives in a market provides a measure, “yardstick,”

of how other firms are performing. In these market

situations, a cooperative has an effect of establishing

competitive prices.

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