Ag cooperatives consolidating, too*
The agribusiness landscape is in transition locally and globally. In the Midwest, a segment of traditional row-crop operations are growing at break-neck speed, fueled by recent years of high commodity prices, built-up working capital, favorable borrowing conditions, and technology. Yet an equally viable segment of farmers are remaining relatively small, by choice.
This diversity is mirrored at the ag retail level, too. An uptick in consolidation activity among the grain marketing and input supply firms has emerged in the last four years, and yet some are choosing to stay small, successfully so. The dual-role firms and also specialized dealers and retailers face significant pressures in their own upstream and downstream environments, negotiating and transacting in increasingly concentrated and complex fertilizer and seed markets while also managing grain movements and margins with processors and end users that dwarf them in size.
The changing landscape of agribusiness raises questions about the role and relevance agricultural cooperatives. Consolidation and the challenges it imposes are not unique to co-ops, but their effects within the co-op system are remarkable, and the current environment differs from past periods of consolidation.
Growth mirrors producers
The consolidation trend in co-ops starts with producers. According to USDA's National Agricultural Statistics Service (NASS), Iowa had approximately 121,000 farms at the end of the 1970s, with an average farm size of 275 acres. By 2015 that profile shifted dramatically: NASS estimates there were 87,500 farms with an average size of 349 acres.
In 2005, about 6.9 million acres of Iowa's farmland was held by farms with over $500,000 in sales. By 2015, that number nearly tripled to 18.2 million acres. Mid-sized and large farms grew during this time while the smaller farms remained relatively consistent, perhaps growing modestly. The result is a significant change in the diversity of farms in Iowa by size, by operational enterprises, and in their needs.
As farms grow, the agri-businesses that serve them must grow to remain relevant to the farmers' needs, or be outgrown. Figure 1 shows that from 1979 through 2016, the number of co- ops headquartered and doing business in Iowa fell from 350 local grain and farm supply co-ops to approximately 55. Interestingly, the number of locations maintained by co-ops in Iowa increased, primarily due to acquisition of non-cooperative firms. Instead of each co-op being a one- or two-location company, as in 1980, the average is now approximately 10 locations per co-op. Nearly every rural town in Iowa still has a co-op close by, but is now the same as that in the neighboring town.
Drivers of consolidation
Consolidation – growth via acquisition or merger – is not new. A constant force driving consolidation is growth in size and scope of member-producers' operations, but periodically other factors accelerate the activity. Two notable periods of consolidation activity occurred in the last four decades. The first was the farm financial crisis in the 1980s. Co-ops financially susceptible to the losses generated from farm failures and tight commodity margins were absorbed by surviving co-ops. Non-cooperative assets were part of that, too. The second period was in the mid- and late-1990s when many co-ops found themselves in speculative (and losing) positions due to multi-year hedge- to-arrive contracts. Financial weakness in this period was the catalyst for consolidation and surviving co-ops acquired assets from co-ops and non-cooperative firms.
Today's catalyst is different. Even with tightening grain margins, little commodity price movement in a relatively low-price environment, and pressure from private retailers and wholesalers on the input side, co-ops in Iowa maintain fairly strong balance sheets, with sufficient working capital and good leverage positions. The co-ops are merging as part of an offensive growth strategy, citing the need to service producers whose operations are growing, enhanced efficiencies and access to strategic resources.
The gains-in-efficiency argument is common among consolidating firms, including the "mega-merger" firms like Bayer/Monsanto and Dow/DuPont. Despite the fact that these integrations are horizontal rather than vertical in nature, the companies identify the potential for significant savings in R&D, personnel expenditures, and streamlined contracting and negotiations. Co-ops in Iowa that have consolidated or have contemplated the move also look to the potential efficiency gains. Cases are made for economies of scale the ability to capitalize on technical production factors -and economies of size-reduction in long run average costs. Co-op boards and executive teams see an opportunity for cost efficiency in administration and operations, including eliminating redundancies in personnel and opportunities for upgrades in systems related to HR, accounting, and IT.
Besides the potential for efficiency gains, co-ops view consolidation as a growth path via access to two strategic resources, not necessarily mutually exclusive: human capital and assets that create value for producers. By becoming a larger company, they can offer employees and potential new employees a more defined career path, thus improving the co-op's ability to recruit and retain talent. They are not wrong about this: young talent is attracted to growing companies, to state-of-the-art facilities and to upward mobility. Human capital is a critical strategic resource and driver of consolidation today.
The second type of strategic resource held up as a reason to merge is assets, particularly those with some form of assets specificity, whether it be location- based or use-based. Acquiring access to assets that open up new markets (e.g., soy processing, ethanol) for the co-op and its members creates value without, in most cases, taking on significant new construction, investments, and additional debt.
Value creation for members is the name of the game in the cooperative world, and in an increasingly competitive environment with tightening on-farm situations, co-op members value strategic movements that open the door for greater firm profitability without sacrificing on-farm profitability.
Co-ops came from defensive origins. Iowa’s producers in the late 1800s and early 1900s organized cooperative associations to gain bargaining power and enhance their prices and negotiating ability in an era where there was otherwise little protection or representation. It was push- back against the dominating trusts and "big business." Even consolidation historically has been defensive or reactive in nature. However, the current wave of co-op consolidations is primarily driven by offensive posturing and a desire to capitalize on strategic opportunities to benefit member producers, thus making it a fundamentally different period of consolidation than witnessed in the last half a century.
A game changer?
Quite undeniably, consolidation is a game-changer for co-ops. Recent consolidation efforts are impressive, and they are changing the way co-ops are perceived, forcing co-op boards and managers to rethink strategy, and quite frankly, making producers nervous. Importantly, it has not changed fundamentally the co-op's main purposes that drive decisions: producer interest and benefits remain at the core of co-ops' decisions. The significance of producer heterogeneity, though, cannot be overstated.
A question posed, and naturally so, is whether getting bigger will make the company "better" - more profitable, presumably. If there are truly efficiencies to consolidating then it should be the case that larger companies are more profitable. Figure 2 illustrates the relationship between size and performance for 18 co-op companies in Iowa and bordering states, based on CoMetrics data. The data have been arranged from smallest to largest by total asset value in the third quarter of 2016 (right vertical axis). The blue bars represent performance as measured by the ratio of local savings to net fixed assets, which is one indication of the cooperative's efficiency in the use of fixed assets to generate gross margins from operations and manage expenses.
There is no discernible correlation between size and overall financial performance, except perhaps in the variability of the performance, which is not captured here. The same perspective emerges when alternative financial performance metrics are used, and this is robust back to 2010 and in any quarter. Admittedly, these data cannot show how a single co-op's performance is different pre- and post-merger, and financial improvement due to efficiency gains may take years to recognize.
Regardless, it is not the case in these data that the bigger co-ops achieve superior financial performance. Further, while it can be informative to compare financial performance of co-ops, evaluating co-ops by profitability - and consolidation by its effect on profitability - is a narrow perspective because co-ops do not have profit maximization as their objective. Profitability is a means to an end.
The true metric by which co-ops should be judged is value-creation, and this is particularly true in the case of consolidation. The value proposition of a co-op is much broader than any pecuniary measure. It is the provision of products and services to meet members' needs and operational practices by the co-op that help members achieve enhanced on-farm profitability. It is market stability, existence value, risk pooling, community development, and education. In this sense, promoting consolidation as a mechanism for greater profitability may actually be counterproductive.
This is particularly true now. Members observe that as the co-op gets bigger and as members become more diverse, "benefits," defined more broadly, that accrue to individual members are not equal. Measuring and conveying whether and to what extent growth via consolidation improves the value to any one member is much harder today than in the past. Value is in the eyes of the beholder, which gets at the heart of why consolidation may not achieve the efficiencies desired by boards and managers.
Member diversity matters
Fifty years ago or more, the membership for any given co-op was remarkably homogenous, with similar crop rotations and enterprise mixes, likely even the same religious background and cultural origins. As co-ops have grown into neighboring counties, merged with other co-ops and gained locations on the opposite side of the state, their membership demographics have changed drastically. And this is true on some degree even without consolidation: producers within a local area are more diverse. Co-ops today, including smaller ones, do not have an "average" producer demographic and there exists a tangible challenge to be "the co-op" for every member or local producer.
As members become more diverse, as how they derive value from the co-op changes, and as the co-op grows and becomes more diverse, frictions are created. A co-op cannot be all things to all members; it must make decisions about how to best serve the entire memberships' needs in a time when those are changing rapidly, and diverging. Importantly, it must be able to convey that message. Member-level and even employee-level frictions from consolidation, erode loyalty, cohesiveness and ultimately, cooperation among members. This erosion deserves the attention of boards and management.
Members of larger or recently merged co-ops say things like, "It's not my co-op anymore" and "It is just another big business." These statements are evidence of the member-based frictions associated with growth, and they create a significant potential for drag on a firm's performance. They may be a reason the co-op is unable to obtain efficiencies from consolidation. Perhaps more important, they are telling of what the members say they value in the cooperative: small, local and probably also high-touch. But that sentiment is missing a perspective about the number one reason the co-op exists: market place protection for producers.
Most agricultural co-ops’ histories in Iowa date back to the late 1800s. Producers formed co-ops to have a collective voice in the market for their goods and in dealing with upstream and downstream partners. Producer associations made it possible for their member-owners to gain a larger share of the value of their outputs. Producers are leery of bigger companies as trading partners, and as their co-ops have grown, members are questioning whether it is just another big company operating with less regard for them and their needs. This is a natural response, but false in most cases.
The wave of consolidation today represents precisely the ideals and normative pursuits with which producers charged their early co-ops: market access and power, risk pooling and enhanced bargaining effectiveness on behalf of its members. The "big six" corporations that control the inputs to production ag are merging in some fashion, and even before merger, dwarf any co-op in the Midwest. Producers absolutely need their cooperatives – individually or collectively – to be big enough to negotiate effectively on their behalf. How big is that? Time will tell, and it will be different for each co-op.
A new era
Co-ops exist to protect their members' interests. Education about this is needed to help producer members understand how and why the value proposition of their co-op shifts as a result of consolidation. Given what is transpiring at all levels in the ag supply chain, consolidation may be the best chance producers have to ensure the provision and protection of a competitive and value-added market place for their input needs and outputs.
It is a new era. Consolidation does not signal an identity crisis of the co-op business model except perhaps in their members' eyes. Members' expectations of the co-op are competing: maintain local assets, be sufficiently diverse to service big and small producers whose diversity is increasing rapidly, and still protect the local marketplace on members' behalf in the concentrated and integrated agricultural supply chain. These interests are at odds and create a catch-22 for some co-ops. How co-op leaders manage their members' expectations about the role and value of the co-op will determine the systems' success.
*This article originally appeared in AgriMarketing, April 2017 issue.
Keri Jacobs, associate professor, University of Missouri, email@example.com