Co-operative, corporate or hybrid not just a question of structure

The moves by Fonterra and Silver Fern Farms to find new ways of accessing capital to develop their businesses suggest they have both found the co-operative model insufficiently flexible. On the other hand there are several examples of agricultural co-operatives which don’t seem to have the same trouble, notably Alliance, Tatua and Ravensdown.


This suggests there is nothing inherently more difficult about running a co-operative than any other type of business. It’s got everything to do with how well a business is run, not its capital structure. There are many things in favour of the co-operative model, not least the commitment of members and their common interest, size of shareholding notwithstanding.


Two further examples of successful co-operatives familiar to New Zealanders are Rabobank, the largest rural bank in the world, and Foodstuffs, the country’s biggest grocery chain. Despite its dominance in Australia Woolworths has found it impossible to gain market share from its competitor which still holds 55% of the grocery market. Access to capital is not the problem.


None of these examples has had any difficulty expanding their business, upgrading fixed assets or building a strong brand identity with their customer base. So there must be something else which makes the difference. The first issue is retention of profits, because if a company pays too much to its shareholders, whether suppliers or customers, it won’t have enough to reinvest in its future growth. If it has to pay out a disproportionate amount of profit to compete, it must by definition have an inefficient business structure – this is nothing to do with its capital structure, but all about board, management and strategic direction.


Fonterra and SFF have made much about redemption risk which, in Fonterra’s case, is a consequence of its fair value shares, either because production falls in drought conditions or suppliers decide to send their increased output to a competitor to avoid being compelled to buy more shares. That is quite simply a scheme design flaw, not a shortcoming of co-operatives.


In contrast, since buying out the banks and corporates in 1997, Alliance has done everything it wanted within its co-operative structure: it has been consistently competitive in livestock procurement, including an end of year pool payment and a yield grading bonus, it has upgraded its plants, implementing yield grading at them all and investing at 130% of depreciation, it has paid an average of 7.5% dividend on its suppliers’ shares in all but one year, it has $45 million invested in overseas markets (including NZ Farmers in London and NZ Lamb Company in Canada), and it has been one of the two most profitable meat companies throughout the period. Furthermore shareholders since 1997 have almost doubled their shareholding through bonus issues.


This comparison suggests Alliance has done better than the other two companies without loading up its debt levels or paying its shareholders more than it could afford for raw material supply. SFF has suffered from the combined effects of the Richmond takeover, arrogance and incompetence, lack of investment in its ageing plants and inadequate market presence, until the last two years when board and management concluded a whole new approach was necessary. The only snag is this has to be done against a backdrop of declining market share, lower stock numbers and high debt.


Fonterra appears to be struggling with the conflicting objectives of meeting New Zealand dairy farmers’ payout expectations in adverse market conditions and building a value added global business, while having to confront more domestic competition and the impact of climate on milk volumes. The main questions are whether Fonterra has paid out too much of its returns to suppliers and how many dairy farmers are interested in investing significantly beyond the farm gate to build a higher risk global business. The answer to the last question will depend on future returns from the commodity business which has invariably produced over 90% of the annual payout.


When meat prices are hit by volatile world markets and exchange rates, suppliers always complain meat companies are failing to invest in value added products, not recognising the high investment required and the higher risk of failure. SFF is in the process of transferring the funding risk of market investment to its suppliers through conversion to tradeable shares, because it didn’t believe its members would invest sufficiently in co-operative shares for it to pursue this strategy.


It doesn’t take too much to work out which of the three co-operatives has done the best job of looking after its suppliers’ interests.

One Response to “Co-operative, corporate or hybrid not just a question of structure”

  1. Otc Stocks Says:

    i have been reading your blog for a bit now, just wanted to say thanks for this. and i have am subscribed to your RSS feed. look forward to reading more from you

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