AgDM newsletter article, January 1999

Value-added cooperatives – Wave of the future?

By Don Hofstrand, Extension Farm Management Specialist, 641.423.0844, dhof@iastate.edu

A value-added cooperative is a type of cooperative designed to add value to agricultural commodities through additional processing.  Farmer-investors own the facilities, commit product to the cooperative, and receive the profits generated by cooperative.  Adding value may be in the form of converting feedgrains to livestock or the processing of farm commodities.

Hypothetical example – Layer hen cooperative

A hypothetical example of a value-added cooperative is shown below.  An equity investment of $5 million is required to build a one million bird facility needing one million bushels of corn as feed per year.  So, farmers invest and commit corn to the cooperative at the rate of $5 per bushel of corn. 

As farmers deliver corn to the cooperative, they receive market price at the time of delivery.  Profits generated during the year are distributed to them as an additional corn price payment at the end of the year.

Facility
Capacity	1 mil birds
Investment	$12.5 million
Equity (40%)	$5 million
Corn Requirement	1 million bu.

Stock
Equity investment per bu. corn	$5.00
Share of stock
Farmer investment	$5,000
Corn commitment	1,000 bu. per year

Corn Delivery – one share
Bushels of Corn	1,000 bu.
Corn Payment per bu. (market price)		$2.25

Year-end profit disbursement
Cooperative profits	$1 million
Profit per bushel of corn	$1.00
Total payment for corn	$3.25
Return on Equity ($1 mil./$5 mil.)	20%

By investing in a value-added cooperative, small and medium sized farmers can participate in large-scale, professionally managed livestock production with only a modest investment.  As shown in the example, a $5,000 investment returns the profits generated from 1,000 birds in the cooperative.  Building a 1,000 bird enterprise on the investor’s farm would probably not be feasible.

Examples of value-added cooperatives

Although value-added cooperatives are relatively new in Iowa, they have existed for some time in Minnesota, North Dakota, and South Dakota.  Below are examples of some of them.  Although there are many examples of financially successful value-added cooperatives, it must be remembered that, like any business ventures, there are also failures.

American Crystal Sugar – Moorehead, Minnesota
American Crystal Sugar is the largest of three sugar beet cooperatives in North Dakota and Minnesota with 2,835 farmer members.

When the cooperative was formed, purchasing a share of stock involved investing $100 and committing the sugar beet production from one acre of land.  Currently, the open-market sale value of a share is from $1,700 to $1,900.

The three Sugar Beet Cooperatives in Minnesota and North Dakota jointly market their sugar through United Sugars Corporation (of which they are also owners).  United Sugars is the number one marketer of beet sugar in the country, the number three marketer of all sugar, and has an 18 percent market share.

South Dakota Soybean Processors – Volga, South Dakota
After years of suffering from low soybean prices and high meal prices, 2,100 South Dakota and Minnesota farmers decided to join together and build their own soybean processing plant.  They started processing in September of 1996.  Today they process about 70,000 bushels of soybeans per day and sell meal as far north as Canada and west to the Pacific coast.

Dakota Growers Pasta – Carrington, North Dakota
Dakota Growers was formed in 1991 and began operation in 1994.  It has a membership of about 1,100 durum wheat growers.  In early 1998 is became the second largest pasta producer in the nation with a capacity of half a billion pounds of pasta.  It had sales of almost $80 million in 1997, up from $22 million in 1996.  Dakota Growers goal is to become the largest provider of private-label pasta in the nation.

Initially, a share of equity stock cost $3.85 and required the delivery of one bushel of durum wheat per year.  Today a share of stock costs $7.50 for current members and $11.00 for new members.  Return on equity hit a high of 31 percent in 1997.

North American Bison Cooperative – New Rockford, North Dakota
Some value-added cooperatives fill specialty or niche markets.  The bison cooperative, formed in 1993, built a processing plant designed especially for bison.  The cooperative has 265 members in 15 states, 4 Canadian provinces, and Belgium.  The cooperative is currently considering an expansion by building another processing facility, possibly in western Canada.

Iowa Turkey Growers Cooperative – West Liberty, Iowa
As the first value-added cooperative in Iowa, West Liberty Foods and the Iowa Turkey Growers Cooperative that owns it were formed in 1996 by 45 turkey growers.  West Liberty Foods can process 3.5 million turkeys a year into meat products for supermarkets, restaurants, and other food outlets.

About 90 percent of West Liberty’s meat products are sold as private labels (processing and packaging turkeys for other companies who sell them under their own brand name).  The other 10 percent are sold under West Liberty Food’s brand name.

After going through a period of low prices and losses in the turkey industry, West Liberty Foods is expecting to make a profit in 1998.

Others
Other examples of value added cooperatives include:

How value-added cooperatives differ from traditional cooperatives

Value-added cooperatives are different from traditional input/supply and marketing cooperatives.  Traditional cooperatives are designed to provide services to their farmer patrons.  Value-added cooperatives are designed to generate profits for their farmer investors.

Specifically, value-added cooperatives have the following characteristics:

Substantial investment
Because value-added cooperatives are involved in the processing of agricultural commodities, a substantial investment of money is required by the member investors to build or buy the processing facilities.

Limited membership
Once sufficient shares have been sold to capitalize the cooperative, membership in the cooperative is closed.  Membership to new investors is only available by buying existing shares from current members or through a stock offering to expand the cooperative.

Delivery right/obligation
Investors are required to deliver the raw commodity to the cooperative for further processing.  This is not only a right but also an obligation.

Distribution of profits
Typically, farmer investors are paid approximately market value for the raw commodity delivered to the cooperative.  At the end of the year the cooperative profits are given to the farmer investor as an enhanced price for the raw commodity.

Expansion through the sale of stock
Usually the majority of a value-added cooperative's earnings are returned to the investors each year.  Expansion is usually funded by selling additional stock.

Professionally managed
Successful value-added cooperatives usually hire experienced managers from the industry to manage the facility and the cooperative.  Member investors serve as the cooperative’s board of directors in a policy-making capacity.  

Open-market transfer of shares
Shares of stock can be sold on the open market at any time to willing investors.  The cooperative imposes few restrictions on who can buy shares.

Why should farmers invest in value-added cooperatives?

Value-added cooperatives provide another source of income for the farm without really changing the make-up of the farm.  Farmers invest money in the cooperative but do not provide labor or management.  So the farm business functions in much the same way that it did before.

Livestock production
Value-added cooperatives allow farmers to increase their incomes and reduce risk exposure on their farms by earning livestock income from the cooperative.

Increase income – Traditionally, farms consisted of several enterprises.  In addition to corn and soybeans, the farm often included several livestock enterprises such as hogs, dairy, beef, chickens, etc.  However, to be profitable, farmers found they needed to focus their management skills by specializing in just a few enterprises.  They also found that they needed to increase the size of their operation to take advantage of economies of scale.  So, farms changed from small diversified operations to large specialized ones.  However, farmers can receive income from several sources and continue their specialized farming operations by investing in livestock production cooperatives.

Reduce risk – The traditional farm of the past had less risk exposure because it was diversified with several enterprises. The logic of diversification is that when one enterprise is going through a period of low profitability, other enterprises are going through a period of high profitability, thereby offsetting each other and maintaining income levels on the farm.  However, specialized farming operations receive the risk reducing benefits of diversification by investing in livestock production cooperatives.

Processing farm products
Production agriculture is just one part of the food supply chain that provides food to consumers.  Over the years, the economic returns from processing food products have increased while the returns from producing them have declined.  So, the farmer's share of the consumer’s food dollar has declined. 

Increase income – Processing cooperatives reverse this trend and increase the farmer’s share of the food dollar.  Processing cooperatives increase farm income because farmers receive the profits earned from processing farm products after they leave the farm gate.

Reduce risk – Income volatility in the production segment of the food supply chain is usually greater than the volatility of the entire food chain.  This is because low profits in one segment of the food chain often leads to high profits in another segment.  So, risk exposure may be reduced by participating in more than one segment (production and processing) of the food supply chain.   

Market power
By joining together in a value-added cooperative, farmers increase their market power.  With increased market power comes higher incomes and reduced risk exposure. 

Market power can be increased by either expanding horizontally or vertically.  Market power through horizontal expansion is achieved through large-scale production – larger scale than can be achieved individually. 

Market power through vertical expansion is achieved by participating in more than one segment of the food supply chain.  Value-added cooperatives provide the opportunity for farmers to be integrated into several segments of the food supply chain.  For example, grain farmers move from participating in one segment of the supply chain to participating in three segments by creating value-added livestock production cooperatives that eventually expand into the processing of livestock.

The market power of these vertically integrated systems will increase with the development of biotechnology.  With attribute-specific crops and livestock, the advantages of being able to tailor-make the specific feed traits for maximum livestock efficiency will create a competitive advantage.  Value-added cooperatives will have an advantage by having their farmer/owners produce the attribute-specific feed crop as compared to their competitors who will have to contract for its production or attempt to buy it on the open market.

 

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