Journal Entry (Reflection)

 

Journal Entry (week 5)

Please submit your journal entry or short essay for this week here. You should include your thoughts and reflections on this week’s assigned readings, lectures, additional material, personal experiences, ideas regarding your final project, and concerns. Please do not exceed 200 words. This assignment is graded based on effort. If sufficient effort to reflect on this week’s material is detected, you will receive full credit.  

ARE 132: COOPERATIVE
BUSINESS ENTERPRISES

Prof. Kiesel

Midterm Logistics

 On Canvas (as Canvas Quiz)
 Available for a limited time starting at beginning of class time (no

class)

 Looked questions
 Multiple choice and True/False Questions first

 Two short answer questions requiring typing in your answers

 Similar to practice midterm (Question 3 not covered yet)

Competitive versus Monopoly Prices

 With competitive prices, profit is only a result of cost
advantages

 With market power, profit is a result of higher prices and lower
quantities

The Competitive Yardstick

Co-op Objectives

If producing at higher output?

 Move to closed membership(lower
demand)

 Alter the cost structure and
expand physical size

Achieving Minimum Average Total Costs

If producing at lower output?

 IOF (or first objective) would
reduce output and increased
prices as compared to setting
AR=ATC

 Cooperatives could expand to
non-member business, but might
provide no incentives for members

Decision Making in Cooperatives

 Starting a new co-op
What are the steps to starting a new co-op?

 Critical elements of structure of decision making
What are the keys to long-term success?

Nine Steps to Starting A New
Co-op

1. Preliminary exploration

2. Gauge broader interest

3. Form steering committee

4. Clarify purpose of business

5. Conduct feasibility study

6. Hold membership drive

7. Develop business plan

8. Prepare legal documents

9. Early start-up phase

1. Preliminary exploration

Begin with concept of multi-owner
business, not necessarily a co-op

Discuss need for group action
(horizontal coordination) and vertical
integration

 Identify potential products/services &
economic rationale

Conduct preliminary research

What is the economic rationale
for creating a co-op?

Back to economic theory
Response to what type of market failure?

2. Gauge broader interest

 Identify prospective members
Discuss basic concept with them

Participation in Benefits

 Benefits include overall cost efficiency and
bargaining power

 Opportunity to buy from closed supply channel or
to sell to closed marketing channel

 Benefits arising through the role of cooperatives as
competitive yardstick

 Opportunity to share in any distribution of income

(Many cooperative bylaws say that a cooperative must do
not more than 50% of its business with non-members)

3. Form steering committee

Assemble 5-9 interested, dedicated
volunteers

Seek out those with broad experience base

 Identify leader(s)
Draft mission statement
Discuss potential functions/

activities of firm

4. Clarify purpose of business

Discuss needs with potential members
Fine-tune Mission Statement

Can multiple-owner firm offer a solution?
What specific products/services will be

provided?

PACHAMAMA’S MISSION STATEMENT
Our mission is to provide customers with premium
coffee in the most direct manner possible and, in
doing so, improve the lives of family farmers and
their families.

5. Conduct feasibility study

Market analysis
Operations analysis
Financial analysis

6. Hold membership drive

Discuss findings of feasibility study (objectively) with
potential members
Potential obstacles?
Who will be served?
How will members be served?
What are their projected volumes?
How much investment is needed?
How will firm be operating?

Participation in Ownership
and Control

 Customers who use the cooperative are expected to have
ownership:
 The easiest way to think about equity investment is direct

investment through purchase of equity shares.
 Owners participate in control by setting policies (including the

governance structure of the cooperative)
Write bylaws of the organization which include:

1) classes of membership and their qualifications,
2) the governance system, including the role and

responsibilities of the board of directors and how they are
elected, and

3) rules for certain actions such as annual meetings, bylaw
amendments, or dissolution.

7. Develop business plan
Work out details for market, operations

and financial analyses
Review plan with business advisors
Draft equity program
Estimate debt financing needs &

discuss plan with lenders

8. Prepare legal documents

Determine appropriate business
structure (Co-op, LLC, S-Corp)

Work with attorney to draft Articles of
Incorporation & Bylaws

File Articles of Incorporation with
Secretary of State

9. Early start-up phase

Obtain appropriate licenses and
insurance

Hold first official meeting to elect officers
Acquire capital from members
Hire management
Begin operations!

Organization of Co-ops

Members

Board of Directors

President/ C. E. O

Division Vice President

Bylaws
describe the
rights and
obligations

(Same as
other
corporations)

Principal

Agent

Management Issues

 Management incentives in co-ops

Does board have business acumen to perform
oversight function?

Management might not be inclined to run
cooperative in members interest
No simple barometers of management

performance such as stock prices (IOF)
No stock option incentives

Key to success: Presence of full-time professional
manager that jointly optimizes performance of
cooperative and members;
Management knowledge of cooperative culture
is needed Board oversight needs to be supported
on business knowledge

Control or Principal-Agent
problem in Cooperatives

Control or principal agent problem: is induced by
the divergence of interests between the
membership, their representative board of
directors (principal) and management (agent).

 Decision making can be costly
Information asymmetries exist
monitoring of performance is incomplete
Little external pressure is exerted on

management performance due to the
cooperative structure

The Logic of Collective Action

 Developed by Olson (1965)

 Challenges optimism of group theory: individuals with common
interests voluntarily act so as to try to further those interests
(Bentley 1949, Truman 1958)

 “Unless the number of individuals is quite small, or unless there
is coercion or some other special device to individuals act in
their common interest, rational, self-interested individuals will
not act to achieve their common or group interest” (Olson,
1965, p. 2)

 Ostrom’s work addresses: How can individuals jointly using a
common-pool resource be able to achieve an effective form
of governing and managing their own commons?
 Evolving rather than completed theory

Public v. Private Goods

Rival?
Yes

No

Excludable?
Yes

Pure private
goods:

•Candy bars
•Computer chips
•Congested toll roads

Club goods:

•Country clubs
•Cable TV
•Uncongested toll roads

No

Open-access
goods:

•Deep ocean fisheries
•Groundwater aquifers
•Congested freeways

Pure public goods:

•Biodiversity
•Public radio
•Uncongested freeways
•Public parks

Prisoners Dilemma

 E.g. Players in a game as herders and define a “cooperate” and

“defect” strategy

 Classic example:

 Each player has a dominant strategy in the sense that the player
is always better off choosing that strategy—to defect—no matter
what the other player does

 Solution?

u1=1; u2=1 u1=3; u2=0

u1=0; u2=3 u1=2; u2=2

Suspect 2 (u2)
talk silent

Su
sp

ec
t 1

(u
1)

sil
en

t

ta
lk

“cooperative” strategy

A Blueprint for Cooperatives

Bylaws are the rules or policies that explain how any
organization, including a cooperative, operates.

The articles of incorporation lay out the basic framework of
the firm and are broader than its bylaws. They describe:

 Type of organization (non-stock cooperative, stock
cooperative, cooperative association, etc.),

 Purpose of the business, number of shares of common stock
and any preferred stock that might be issued,

 Structure including number of directors and how a member
votes on those directors,

 Legal definition of membership

 Location of the headquarters (legal address)

 Asset disposal upon liquidation

Cooperative Bylaws

Cooperative Bylaws should address:
Membership requirements, rights


Voting

Procedures
Election of Directors
Meetings of Directors

Patronage allocation & distribution
Board-management relations
Membership termination
Co-op dissolution

Voting
A. One person, one vote (pure democracy)
B. Patronage or proportional voting

Which is attracting large suppliers?
Why is attracting large suppliers important?

 Possible Solution: Mixed voting strategies

𝑣𝑣𝑖𝑖 = 1 + 𝛼𝛼(𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝) 𝑖𝑖 s.t. 𝑣𝑣𝑖𝑖≤ 𝑣𝑣∗

Especially important when large size of diversity

Two main functions: Vote on Bylaws and Board of Directors

Board of Directors
 Status of directors

Member of co-op or representative of co-op
Outside directors

 Number of directors
2/3 of coops have 6-15 directors
Large regional (federated) coops often have

more
 Election of directors

Procedure specified in Bylaws
At large vs. district elections

 Time limits

How Are Directors Selected?

 Manner in which corporate directors are chosen is straight-forward:

 Potential directors are assumed to have some core of
knowledge( e.g. accounting or finance, governance, human
resources, or strategy)

 Desire for broad background in core areas of knowledge plus
additional attributes such as diversity

 Usually two members of management (which include the CEO
and another senior leader)

 Nominating committees identify directors with certain skill sets
(directors are chosen at-large subject to meeting the needs
identified by the board)

 Shareholders in the firm vote for the board based on their
proportion of shares with number of votes linked with their share
of equity.

 Stakeholder cast vote for the entire slate of directors as opposed to
each director separately

How Are Directors Selected?
(cont.)

 Important difference in selecting directors over non-
cooperative corporations:
 Directors are selected from their customers who are members

 Many cooperatives use similar tools to identify directors in an
effort to identify suitable candidates for the board, however:
 Because of their unique nature, directors are often chosen based

on geography and districts based on the population of its
members are created

 Nominating committees consider the pool of directors in that
geographical district only

 Board elections in a cooperative ask each member to vote
for each director individually rather than a slate of directors in
IOF

 Terms of directors
¾ have 3 year term
Most stager terms to provide continuity

 Power of directors
 Bylaws outline power

Board is responsible for full oversight of co-op affairs
Members often only indirectly responsible

Member participation in nominating and voting for
Board of Directors is key

Board of Directors (cont.)

Performance Evaluation

 Key Question: Are you better off with a co-op structure?
Compare net prices (after payment of discounted

refunds) to net prices being offered through alternative
sources

 Yardstick dimension of co-ops; Does co-op make rival
non-co-ops perform better?

 Use financial statement comparisons
Must evaluate relative to the performance of joint

entity
Don’t use common measures such as return on equity

(ROI or ROE)

Engage members and measure member satisfaction

Membership Issues

Membership upon inception

Organizing co-ops involves free rider problem
Why?

 Entrepreneurship not directly rewarded

Membership Issues (cont.)

 Membership upon inception

Organizing co-ops involves free rider problem
Why?

 Entrepreneurship not directly rewarded
 Access to goods and services to everyone once

established

 Free-rider problem: arises when members or non-
member can use a resource (Co-op) for their
individual benefit but property rights are not well
defined to ensure that they bear the costs of their
actions.
(Particularly an open-membership problem)

Solutions: Develop a Broad Initial
Coalition and Common Values

1. Appeal to sense of civic responsibility (e.g.
define common cause).

2. Involve as many people as possible to spread
entrepreneurial costs.

Membership Issues (Cont.)

 Membership upon inception

 The larger the membership, the better
Why?
Physical benefits (economies of size)
Pecuniary economies (discounts and price premiums)
Reliability of supply (marketing) and demand

(purchasing)
Discourage ‘wait and see’ behavior

Why?
 Need to exploit economies from the outset

Short-run versus long-run costs (important to get members
to join initially)

Reasons for (Physical) Economies of
Size

Membership Issues (cont.)
Membership long term commitment

Encourage long-term commitment
Penalties to failure to meet obligations

Forfeiture of membership
Forfeiture of equity

“Tragedy of the Commons”

 Hardin (1968) symbolizes expected degradation of the
environment when many individuals use a scare resource
in common:
 Uses pasture as an example:
1. Each herder receives direct benefit from letting hi
sherds graze
2. Each herder suffers delayed costs from overgrazing
 Each herder is motivated to add more and more

animals because he/she/they receive direct benefits
and only bear a share of the (delayed) costs resulting
from overgrazing

“What is common to the greatest number has the least
care bestowed upon it” (Aristotle)

Membership Issues (cont.)
Membership long term

Encourage long-term commitment
Penalties to failure to meet obligations

Forfeiture of membership
Forfeiture of equity

 Horizon problem: arises when members
focus on short-term constraints and
benefits returns and might not adequately
retain commitment, involvement and
equity to ensure longer-term viability.

• ARE 132: COOPERATIVE BUSINESS ENTERPRISES�

Midterm Logistics
Competitive versus Monopoly Prices
The Competitive Yardstick
Co-op Objectives
Achieving Minimum Average Total Costs

• Slide Number 7

Decision Making in Cooperatives

• Nine Steps to Starting A New Co-op

1. Preliminary exploration

• What is the economic rationale for creating a co-op?��
• Slide Number 12

2. Gauge broader interest
Participation in Benefits
3. Form steering committee
4. Clarify purpose of business

• �5. Conduct feasibility study
• �6. Hold membership drive�
• Participation in Ownership and Control
• �7. Develop business plan�
• �8. Prepare legal documents�
• �9. Early start-up phase�

Organization of Co-ops
Management Issues

• Control or Principal-Agent problem in Cooperatives

The Logic of Collective Action
Public v. Private Goods
Prisoners Dilemma
A Blueprint for Cooperatives
Cooperative Bylaws
Voting
Board of Directors
How Are Directors Selected?

• How Are Directors Selected? (cont.)

Board of Directors (cont.)
Performance Evaluation
Membership Issues
Membership Issues (cont.)

• Solutions: Develop a Broad Initial Coalition and Common Values

Membership Issues (Cont.)

• Reasons for (Physical) Economies of Size

Membership Issues (cont.)
“Tragedy of the Commons”
Membership Issues (cont.)