The strength of the co-op business model

The strength of the co-op business model

In recent weeks I have been reading various debates in the media about the cooperative business model and, in particular, capital raising. This is essentially about the inherent tension between investment in operations and market development on the one hand and competitive payments to the shareholder suppliers on the other. A lot of the debate seems to involve our dairy industry.

I thought I would provide some context and then offer my thoughts.

 

Background

Co-ops emerged in the 19th century as an important business structure designed to protect the interests of a group of members, based on the principle of equitable distribution of benefits related to use or supply. The first New Zealand co-op that still exists today was SBS Bank, established way back in 1869 while Fonterra was essentially formed two years later when eight cheese-making settlers on the Otago Peninsula decided to combine their milk volumes in order to better meet local demand. The co-op model has continued to flourish globally and locally with 1.2 billion people now belonging to a member-based organization (co-op, mutual or society) while, in NZ,  the largest 40 cooperatives currently generate 16% of our GDP and serve over 1.5 million Kiwis as members.

From small beginnings, cooperatives have expanded to much larger groups of buyers and suppliers to take advantage of scale. Here in NZ, Fonterra’s turnover outstrips the rest by a wide margin, its revenue equal to the combined turnover of the other co-ops that make up the top 10. The rest of this group consisted of grocery retailers, Foodstuffs North Island and Foodstuffs South Island, Zespri, Farmlands, Silver Fern Farms, Alliance, Southern Cross Health Society, Market Gardeners and Mitre 10.

 

Co-op Business Model

The co-op movement, which essentially involves member ownership of businesses and organisations, goes back to the mid-1700’s in Scotland. However, the movement really began its escalation in 1844 in Rochdale, England when 7 key principles were agreed upon by a group of locals, these remaining relevant today. Members of co-ops are either suppliers of product and services (eg. milk or livestock), customers (eg. health insurance, banks or credit unions), purchasers within a buying group (eg. groceries or building supplies), or staff.

The model is all about endurance and sustainability – economic, social and environmental. This is clearly evident here in NZ with each of our largest 40 co-ops now more than 20 years old, five of these over 100 years old (SBS Bank, Fonterra, Tatua Dairy, FMG and LIC) and with another two close by – Foodstuffs North Island (97 years old) and Market Gardeners (96 years old). These businesses have been providing New Zealanders, and those overseas, with trusted brands, products and services for decades and, in some cases,centuries. This has led to consumer trust and confidence while helping build NZ’s economy along with our international reputation as a supplier of quality products and services, agricultural products in particular.

 

Benefits of Co-ops to NZ’ers and NZ as a Country

·         Economic sustainability

Members (shareholders) own and control the company, not investors who could be here today and gone tomorrow. Members that are here for the longer term and with “skin in the game” often by way of their requirement to purchase shares and, therefore, provide capital funds to the business. Many of these members are inter-generational farmers of the land within our agri-producer sector. Profits are retained locally and not transferred offshore. This is a business model that provides financial returns to members each year based on the volume of supply or the amount of business transacted (Rochdale Principle No. 3).

·         Environmental sustainability

Our co-ops are contributing significantly in terms of driving environmental sustainability locally. This includes: fencing to keep livestock out of rivers and waterways; improved on-farm systems in the treatment and discharge of effluent; reduction in on-farm carbon emissions; reduction in the burning of fossil fuels; more efficient use of energy; the emergence of “clean” energy in the form of solar and wind power; introduction of electric delivery vehicles; recycling and reduction in the use of plastic packaging; banning of single-use plastic bags; and more responsible consumption, including educating consumers on how best to reduce food wastage.

·         Social sustainability

Our co-ops give back generously to local communities and NZ’ers nationally, Fonterra’s Milk for Schools programme (now in its eighth year) being a prime example. They offer stable employment with fair and decent work conditions, quality education, gender equality, and good health and well-being, these being four of the UN’s 17 Sustainable Development Goals. It is widely recognized that the co-op business model is the most closely aligned towards the UN’s 17 SDG’s, all to be met by 2030.

 

Lessons from the past

Look at what has happened overseas when single desk exporters have been deregulated – Israeli citrus, Australian pip-fruit, South African multiple fruits. Returns have lowered as the single desk seller model has become one of multiple sellers who have often been traded off by overseas buyers on price, resulting in lower returns. Conversely, look at the NZ kiwifruit industry’s fortunes under Zespri – from an almost bankrupt industry in the mid-90s to what it is now, booming along in terms of volumes, revenues and payouts. A key strength of NZ’s dairy industry up until 2001 had been the single desk seller model that NZ Dairy Board provided, resulting in overseas customers being given one price for our dairy products and not able to trade our dairy companies off against each other as was happening in Australia at the time. Look at the Australian dairy industry now, only one substantial dairy co-op left (NORCO), the rest nearly all foreign-owned.

Our dairy industry currently has around 86% of its milk supplied to co-ops (Fonterra with 82%, Westland Milk Products 3% and Tatua Dairy 1%) although this has been reducing since 2001 as new privately-owned dairy companies have emerged, most of these being foreign-owned. In addition, Westland MP will soon be voting on 100% foreign ownership whereby Chinese investor Yili has offered to match Fonterra’s payout for the first 10 years, but what will happen beyond that? In addition, where will any profits be sent – back to China or re-invested back into the business and local West Coast communities?

Of note, Tatua Dairy has consistently headed our dairy company payouts (co-op and non-coop) since 2001, $8.10/kg milk solids paid out in 2017/18 after 62c was retained for capital expenditure and future investments, the next highest being Oceania Dairy at $6.84 and Fonterra at $6.79 ($6.69 plus a 10c dividend).

 

Capital Raising by Co-ops

Firstly, any poor performance from co-ops due to capital investments made, abandonment of retained earnings policies and poor market investment decisions have no relationship with the co-op business model, more to do with wise decision making, good governance and effective leadership. Capital raising appears to be more of an issue with agri co-ops as processing capacities have needed in increase to match rising volumes, milk and kiwifruit being two good examples. One could also argue that dairy plants cost a lot more to build and commission than retail stores, banks and offices.

The issue is balancing capital retentions with annual payouts, while also investing in capital projects and market investments very carefully. Clearly, Tatua Dairy has excelled here over the past 20 years or so, and most likely for much longer. Some key questions:

  • Have our dairy companies paid out too much in annual payouts and retained too little for capital projects and market investments in the past?
  • Has the cost of entry for our dairy farmers been too low when seeking to supply milk ie. should the shares have been valued at higher prices, Westland MP being a good example?
  • How has Tatua Dairy consistently excelled for so long given its lack of scale (large milk volumes processed via large plants resulting in favourable milk processing efficiencies) and global network relative to Fonterra?

 

Summary

The co-op business model has been well-proven since the 19th century, and provides endurance and sustainability. The co-op sector globally is both huge and diverse. In NZ, we have one of the most cooperative economies in the world (16% of GDP generated by our co-ops) while our co-ops have provided Kiwis and those overseas with trusted brands, products and services for decades and even centuries. In more recent times, however, some co-ops within NZ’s agri-producer sector, notably dairy and red meat, have had trouble raising capital either from their members (shareholders), or banks. Three key factors here are balancing annual payouts with capital retentions, valuing shares appropriately, and investing capital funds very wisely.

 

 

Craig Presland

CEO, Cooperative Business NZ

8th May 2019