ARE 132: COOPERATIVE BUSINESS ENTERPRISES

Prof. Kiesel

Logistics

 (Pre-lecture) quizzes tests whether you read the required textbook chapters for each week prior to lectures (not the required articles) Quiz 1 will reopen after this lecture for addition

attempt (for 24 hours)  Format of quizzes is a result of increased cheating

during previous quarters observed in all classes  I will make answers for quizzes available after lecture

Please don’t share material outside this course and hold each other accountable!

Logistics (cont.)

Check group assignment on Canvas and reach out to your group members First due date is Jan 22nd We will continue to talk about logistics

World (European) History Review

 Industrial Revolution (economic hardship and social upheaval) Destruction of Capitalism and ruling of the working class under (Marx)

Idealistic thinkers and social experiment of new communities and management funded by wealthy investors (Owen)

Realistic (religious) thinkers using individual member investments and scripture as foundation for operation (King)

 Rochdale Pioneers (Prototype of cooperative model)

 Cooperative approaches spreading around the World  Contemporary successful models in Europe (e.g. Mondragon)

 Introduction to U.S. Economy

 Widespread application in Developing Countries

American History Review  Driving forces behind American development: (market

failure), economic crisis, new technology, farm organizations and cooperative advocates, favorable public policy Coops follow innovation, expansion and diffusion circle

Two American Cooperative Thinkers

 Sapiro: large-scale, centralized co-ops organized by commodity that create market power

 Nourse: locally organized and controlled cooperatives and the use a federated structure that promote competition

 Horizontal and vertical integration as way to create or counterbalance market power

Why an Economic Theory For Cooperatives?

 Economic theory forces discipline into arguments concerning conduct and performance of cooperatives  Conduct is the range of business methods, strategies and policies that

cooperatives use responding to their business environment

 Performance is the result of cooperative conduct

 Develop realistic, workable relationships between general cooperative principles (ICA, how cooperatives should operate) and policies(User ownership, user control, proportional distribution of benefits)

 Helps to determine price, output, and membership policies logically and consistently

Economic Definition of Cooperatives

 Formal definitions have evolved  Early definitions (1946, Emilanoff) do not perceive cooperatives as

firms because they generate wealth for its members and lack control by a central authority

 Subsequent definitions recognize cooperatives as separate firms having distinct decision making units (1978, Vitaliano)

 Traditional theory of profit-maximizing firm was modified to account for the unique features of cooperatives (expand firm objectives)

A cooperative is a horizontal coordination among independent businesses (members) for the purpose of achieving vertical integration.

Theory of a Firm  The purpose of a firm is to decide what to produce, how to

produce it, and how to distribute what is produced.

 A property right is a legally enforced right to select the uses of economic good or service produced by a firm.  Private property rights are those assigned to an individual

person  Alienable property rights are those that can be transferred

to someone else

Firms exist because there are contracting costs to using markets and these costs may be lowered when internalizing these transactions inside a firms  Firms are a connection of groups of contracts

Type of Contracts  A firm signs contracts with:

1. suppliers to purchase inputs to create something, 2. employees to help provide services with their labor, 3. lenders, bondholders, preferred stockholders, or others

who provide capital to the firm, 4. buyers who agree to purchase the products or

services made by the firms, or 5. any other entity doing some form of business with the

firm.

For cooperatives, some of these contracts exist with owners or employees of the firm

Who Owns the Firm?  The owner of a firm has the right to control the firm and to

any residual earnings after the firm has contracted its expenses (with suppliers, employees, lenders, and others with whom it has a contractual arrangement)

 There are key cost associated with these two rights resulting from risk taking and controlling and managing decision making  Cost of collective decision making might be high

Cooperatives are firms with the same framework and property rights as corporations

Basic Model (of IOFs)  Use a basic firm approach based on the simplifying assumption

that organizations have a predetermined objective (e.g. maximizing profits or earnings)

 Consider fertilizer supply selling to farmers on a per ton basis in perfectly competitive market:

Basic Model (of IOFs)  Consider fertilizer supply selling to farmers on a per ton basis in

monopolistic competition (product differentiated) market:

Margin

Basic Model (of IOFs)

 Selling agricultural Commodity at grocery store

MR D (retail) Q

P

MC AC

Costs

Mark up

Key Concepts: Marketing Margin (Review)

 Marketing margin will typically include the costs of the following:  Assembly of the raw products from the farm  Processing  Distribution  Retailing

 Alternatively, break margin down into costs for inputs (e.g. labor, capital, energy, materials, etc.) and mark up

𝑃𝑃𝑡𝑡∗ = (𝑃𝑃𝑟𝑟 -M)/K 𝑃𝑃𝑡𝑡∗ as maximum farm price

𝑃𝑃𝑟𝑟 as retail price

M as margin

K as conversion factor

1. Margin Reduction

2. Market Power Avoidance Opportunistic behavior results in trading

partners attempting to exercise short-term market power (over farms) • Monopsony power (retail) • Monopoly power (fertilizer supplier) • Oligopoly power(fertilizer supplier) • Price discrimination(fertilizer supplier)

 Cooperative might face lower prices for some inputs used in marketing

 Cooperative might market the product more efficiently than presently done

3. Influence Consumer Prices

 Two possible avenues: 1. Cooperative might be able to restrict flow of farm

product to the market 2. Cooperative might be able to improve quality of the

finished product or offer value-added products

Oversupply(relative to demand) at heart of American agriculture’s financial dilemma in many markets

Example: Fair Trade and Co-ops  Earliest roots after World War II in attempt to provide markets

for handicrafts (produced by eastern European refugees) as a poverty alleviation project

 During the mid-70s as a new wave of businesses in Europe, called Alternative Trade Organizations (ATOs)  ATOs realized that the partnerships they were looking for

could be found in the small farmer co-operative movement

 Since then, cooperatives have been the heart and soul of the Fair Trade movement.  Not just “suppliers” or “buyers”; cooperatives as true,

equal partners operating within a global family of traders and activists working to change food, agriculture and trade systems.

Fair Trade and Co-ops (cont.)  Farmer Cooperatives sell products (and educate and

train their members in production, quality, environmental management, democratic organization)  Support their communities, and achieve economic

and political empowerment.  Worker cooperatives(in the North) have also been

instrumental in building Fair Trade.  Equal Exchange, the largest Fair Trade cooperative in

the United States, brought Fair Trade food and coffee to market

 Food co-ops are the third link in the Fair Trade supply chain  Early supporters of Fair Trade, promoted Fair Trade

products

Basic Model of (Supply) Cooperative

 Several possible objectives: 1) Maximize total returns as a group 2) Minimize net price paid by patrons 3) Set average revenue equal to average costs

(business at cost)

Does that change the outcome?

Who establishes objectives?

Optimal Size or Achieving Minimum Average Total Costs

 Why?  Most efficient (lowest cost production)

 What if producing at higher output?  Can move to closed membership

 Alter the cost structure and expand physical size

 Why?  Most efficient (lowest cost production)

 What if producing at lower output (excess capacity)?  IOF objectives would result in reducing output and increasing

prices

 Cooperatives might require ATC=AR  Cooperatives could expand to non-member business

Optimal Size or Achieving Minimum Average Total Costs

Hueth: Missing Markets and the Cooperative Firm

 Refers to other approaches that: Focus on imperfect competition, and on its

potential pro-competitive effect (Nourse, Sexton) Focus on potential barriers to the formation and

operation of cooperative enterprise, in particular collective decision making costs (Ostrom, Hausman)

Considers informational advantages associated with cooperative operation, usually restricted to the banking sector (Banerjee et al.,Guinnane)

Hueth: Missing Markets and the Cooperative Firm (cont.)

 Hueth argues that commitment is the key function of institutions that enables the expansion of markets and trade.

 Consumer banking and insurance, retail grocery, news collection, farm credit supply, rural utility service, etc. are settings where economic agents in the economy have used the cooperative firm structure to provide for themselves goods and services not available in market prior

Hueth: Missing Markets and the Cooperative Firm (cont.)

 His examples illustrate that patrons make significant up-front contributions (commitment) to initiate enterprise Can be viewed as non-linear pricing (Patrons contribute a

portion of their expected surplus up front)

Sexton: Cooperatives as Entrants  Focuses on entry and entry deterrence into a market

characterized by monopoly power (single producer)  Compares differences between IOF firm and Cooperative

(Consumer coalitions) as potential entrants