KRWG

The Cooperative Business Model

Aug 10, 2019

Credit Dr. Chris Erickson

Commentary:  The co-op has often been touted as an alternative to the traditional for-profit corporation that allows for softer capitalism. Rather than simply maximizing profits, the coop works to maximize the benefit that accrue to members, who are often customers or employee, but also other stake holders. But in setting up a coop, care needs to be taken to create the correct incentives.

While co-ops are established to provide benefits beyond simply making a profit, any enterprise that pursues goals ignoring profits is asking for trouble, even coops. This is especially true in a competitive industry, like groceries, where margins are tin. Failure to focus on the bottom line will result in losses as highly efficient for-profit competitors use their cost advantage to underprice the coop to gain market share. Persistent losses mean a deteriorating financial position and a lack of access to resources.

The problem is that the co-op corporate form can create conflicts of interest. The interests of the members are not necessarily consistent with profit maximization.

I worked when in college at a plywood mill run as a co-op—the permanent employees were also the owners. One of the summers I worked there, a major controversy arose. The plant manager urged the adoption of new technology to reduce costs and keep the plant competitive. Without the investment, the mill would likely close in five years the manger warned. The shareholders, who remember were employees, weren’t as interested in cutting cost as in saving jobs. They voted against the new technology. 

The plywood mill’s problem was that the shareholders/workers had a fundamental conflict of interest. They personally benefited from maintaining their jobs, but at the cost of the long run stainability of the business. Ignoring profits to maximize jobs is not a business model for success. Maximizing jobs subject to at least zero profits can be one. The co-op went bust in after a few years.

Other co-ops have been more successful. The more than 100-year-old Tillamook County Creamery Association is an example. The coop is owned by approximately 100 farmers located primarily in Tillamook County, Oregon. The farmers are hard core businessmen, meaning that profit maximization is their goal. And the co-op has prospered for many years.

Historically, many American financial companies have been organized as co-ops, although the term used is “mutual”. Mutual of Omaha, for example, is owned by its policy holders. However, the mutual form of organization has become less popular in recent years, with former mutual reorganizing as for-profit corporations.

For example, subsequent to the S&L crisis of the late 1980s and early 1990s, many S&L reorganized as for-profits. The idea being that a for-profit could pursue business opportunities more nimbly than mutual, a mutual, by definition, having to account for the interest of the owner/customer in making decisions.

In a cutthroat competitive market like banking, a mutual could not compete with a for-profit when margins were as thin as they were.

Christopher A. Erickson, Ph.D., is a professor of economics at NMSU. He has taught money and banking for more than 35 years. The opinions expressed may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.