mh = —_ batia! wal) exal — c Y U tebe F THE N 9 Py SE and JOSEPH M ERATIVE SERVICE NT OF AGRICULTURE The Farmer Cooperative Service conducts research studies and serv- ice activities of assistance to farmers in connection with cooperatives engaged in marketing farm products, purchasing farm supphes, and supplying business services. The work of the Service relates to prob- lems of management, organization, policies, merchandising, product quality, costs, efficiency, financing, and membership. The Service publishes the results of such studies; confers and advises with officials of farmer cooperatives; and works with educational agencies, cooperatives, and others in the dissemination of information relating to cooperative principles and practices. FCS Bulletin 14 Joseph G. Knapp Administrator Farmer Cooperative Service U.S. Department of Agriculture September 1962 PREFACE Babin of dairy cooperatives, educational and advisory work- ers, and administrators of Govern- ment programs long have needed a basis for distinguishing between a real (bona fide) and an imitation (pseudo) cooperative. This need culminated in a specific request to Farmer Cooperative Service to con- duct research and develop criteria for identifying farmers’ dairy co- operatives. This report provides a set of cri- teria designed for use in appraising dairy organizations to determine IT whether they meet acceptable stand: ards as cooperatives. It is not dli- rectly concerned with physical facilities or operating procedures in milk assembly, processing, and dis- tribution. The criteria look to the future in terms of appraising the competence of the associations to represent and serve the interests of dairy farmers under anticipated market conditions. We searched several sources to de- termine the identifying character- istics of genuine dairy cooperatives. We reviewed laws and legislative 334 Ji — A. “w (ahaa of cooperatives. are wy 5“! wx} j2J hearings for the legal standards that apply to cooperatives, and to under- stand the thinking of legislators who drew up the laws. We studied a large body of research reports, periodicals, and other statements concerning the economic and legal character as well as the history and We iscussed with administrative offi- cials the problems of identifying co- operatives. Finally, in sifting and evaluating this material, we were guided by our experience and that of others in working with dairy and other cooperatives nationally. We realized at the outset of our research that we could not develop a single, terse definition which would identify a cooperative; that discrimination and judgment on the part of the appraiser would be required. The accuracy and sig- nificance of this premise became clearer as research progressed. Many of our attempts to provide categorical and completely objec- tive statements were reduced to gen- eralties that did not suffice to iden- tify marketing organizations that serve and directly benefit farmers. The first section of this report re- views the current position of dairy cooperatives in the industry and the changing technical and economic environment in which they operate. The section “What Is a Coopera- tive ?” includes basic legal standards and general statements by qualified observers concerning the legal and economic character of cooperatives. It identifies three “hard core” prin- iples—service to members at cost, emocratic control by member- patrons, and limited returns on capital—and_ also supplementary characteristics. The section “Determining Coop- erative Character of Dairy Organi- zations” provides a set of standards for identifying a dairy cooperative. These standards fall under three headings: (1) Marketing Service for Members, (2) Control by Mem- ber-Patrons, and (3) Sound Busi- ness Practices. Each of these stand- ards is discussed and explained. The standards may be condensed into questionnaire form for use with. a specific cooperative. However, effective appraisal is complex, call- ing on judgment and insight rather than principally clerical skills, We believe the fundamental and initial need is for standards that may be applied by rank-and-file producer-members and _ leaders themselves. An alert and informed membership can do more than any reasonable amount of outside ad- ministrative interpretations or regulations to assure and maintain the cooperative character of an organization. Because of differences in the pur- poses and provisions of laws appli- cable to individual programs, State or Federal agencies seeking admin- istrative standards for identifying dairy cooperatives may need to adapt or supplement those pre- sented here to suit their specific needs. For example, the purposes and needs of the Federal milk order program and the Farm Credit Ad- ministration are different. In some cases, agencies may require clarifi- cation of their legislative authori- zations before they are able to tighten their current standards. We again emphasize that dis- crimination and judgment are of the utmost importance in applying the criteria in every case. Other- wise, they will be no more than a bare skeleton and their use will not assure dairy farmers of an organi- zation that serves them in a unique _ way because it meets the true stand- ards of a cooperative. III CONTENTS The current sItuation 2 .a5 te ese ee ee Changing: environient] oe ee ee ee Dairy cooperatives are changing] 22 eee ee ee As identified by statutess=2) 22a. 2 eee Basic:principles =: 7. Sp Re ee Determining cooperative character of dairy organizations____- Marketing service for: membersic--0 ee ee ee Control by mem ber-patrons ss. 2 ae oe ee Sound, business practices ==... Determinations by public administrators______________- No: permanent criteria. 20) 2 ee ee ee Cooperatives and Federal orders____-__-___ 22-1 _ 2 Early:development 2 22225 = aa een eee Role’ of cooperatives) = 22 eee ee ee Qualifications under Federal milk orders__________-____- Conclusions IV Criteria for Evaluating Dairy Cooperatives by Stanley F. Krause and Joseph M. Cowden Dairy Branch, Marketing Division HIS report considers the ade- Tews of organization and ad- ministration of present dairy cooperatives and whether they will truly be able to serve future needs of producers, the industry, and the na- tional economy. We begin with an organization seeking to be recognized as a coop- erative, and undertake to determine whether or to what extent it meets acceptable standards and will con- tinue to meet them. The key question, as we see it, is: Assuming that organizational ad- justment will be necessary to facill- tate technical change—what can be done to assure that dairy organiza- tions, given recognition as cooper- atives, have and will retain distinc- tive cooperative characteristics? This question is highly important because— 1. Dairy cooperatives have con- tributed much to the welfare of dairy producers. 2. The cooperative segment at @p present constitutes a highly signifi- Onn: part of the dairy industry. ~ 8, Cooperatives will be needed to represent producer interests in marketing dairy products in the future. 4, Dairy cooperatives, like other market agencies, will be forced to make major adjustments in response to changing conditions. 5. There is danger that the coop- erative character of dairy coopera- tives will be lost in the process of adjustment unless steps are taken to prevent such loss. 6. Producer interests will continue to require the services of business organizations having distinctively cooperative characteristics. It should be noted that in word- ing our question concerning the fu- ture, we did not say “will retain present distinctive characteristics.” Neither the cooperative leaders who posed this question nor we in Farmer Cooperative Service believe that cooperative principles, funda- mentals, and policies, or the prac- tices appropriate for them, are static. The characteristics distin- guishing future dairy cooperatives from other dairy firms may or may not be the same as they are today. Establishing specific criteria for cooperatives may lead to several Notre.—The initial research in this study was undertaken and the preliminary manuscript prepared by Joseph M. Cowden while he was a member of the staff of Farmer Cooperative Service. The manuscript was completed by Stanley F. Krause. The authors are indebted to the persons who reviewed the draft manuscript and made numerous valuable suggestions. benefits. The first concerns im- provement of the marketing system. The cooperative is a special type of organization under farmer control and members need definite guides concerning the features that will ob- tain maximum benefits for them. Two other benefits come from helping prevent deception of farm- ers and the public, respectively. A cooperative should be identified so that farmers will not. support and falsely trust an organization not fully devoted to their interest. They need to know what to look for in an organization to appraise the likelihood that it will function in their interest—or to direct that ap- propriate changes be made. The public image of cooperatives may be discolored by organizations which use the farmer cooperative name but do not serve members’ interests or which depart from other distinctive practices of cooperatives. Finally, organizations other than cooperatives should not be per- mitted to take advantage of any legal authority reserved for organi- zations controlled and operated by and for their member-patrons. Our purpose is to assist those in- terested in determining the coopera- tive character of organizations by directing attention to their distinc-. tive features. We have also endeay- ored to indicate characteristics of cooperative organizations which may be subjected to unusual stress in the years ahead. A policy of reg- ular inspection and sound mainte- nance by its own member-leaders will be required, we believe, to keep a cooperative functioning properly. Public administrators need to in- spect cooperatives for any purposes that relate specifically and dis- tinctly to them. The Current Situation B™* ORE proceeding to the main problem, it will be helpful to re- view the position dairy cooperatives now occupy in the industry and the changing technical and economic en- vironment for dairy marketing. Dairy cooperatives play an im- portant role in marketing milk and cream produced on farms in the United States. Data compiled by Farmer Cooperative Service showed that dairy cooperatives performed one or more functions in marketing 58 billion pounds of whole milk in 1957 This quantity represented *Gessner, Anne L. Integrated Dairy Operations Through Farmer Coopera- tives. Gen. Rpt. 69, p. iii. Farmer Co- operative Service, U.S. Dept. of Agr., November 1959. 2 approximately 60 percent of all whole milk sold through plants and | dealers in the United States that year. In addition, cooperatives handled 189 million pounds of but- terfat in cream, or 43 percent of the total handled by all plants and dealers. Changing Environment Dairy cooperatives attained much of this prominent position under conditions significantly different, from those existing today. Wide spread changes are taking place in the market for milk and dairy prod- ucts, both in supply and distribu- tion. The dairy farm as a production unit is getting larger and more spe- cialized. Mechanization of many operations is well advanced on com- mercial dairy farms. Because the individual dairy farmer has more at stake, he should be more inter- ested in the efficient functioning of his dairy cooperative than he was in the past. Markets for milk are changing. Once local, milk markets.are now essentially regional or national in character. Improved management practices and mechanization help the dairyman produce high-quality milk. Bulk cooling and storage fa- cilitate the transportation of raw milk over greater distances without loss of quality. Dairymen can thus seek outlets in the higher quality, higher priced, fluid milk markets. In many areas the industry has tooled up to process whole milk in- stead of the farm-separated cream formerly handled by most cream- eries. The dairy manufacturing in- dustry has been moving toward larger, lower cost plants, as re- search and experience have demon- strated that a well-managed, large- volume plant has a considerable advantage over smaller plants. Asa result of such changes, many small local manufacturing dairy co- operatives find themselves with fa- cilities they no longer need. Many such facilities are neither equipped nor located to serve the best interests of member-producers. Mergers, consolidation, and _inte- gration, and frequent outright fail- ures of marketing concerns have brought about a steady decrease in the number of plants and firms manufacturing dairy products. Cooperatives functioning in fluid milk markets face similar changes. Country can-receiving plants are being bypassed and replaced by bulk handling plants. These are fewer in number and each serves Through their cooperatives, farmers mar- keted abouf three-fifths of the milk going to plants and dealers in 1957. an expanded area. Improved trans- portation, packaging milk in paper cartons, and the economies of large- scale processing encourage and en- able the milk distributor to serve enlarged consumption areas from centrally located bottling plants. Chain stores which demand regu- lar supplies of uniform quality products in large lots tend to dom- inate the retail business. In most of the large markets, affiliates of one or more of the national dairy firms occupy a prominent, if not dominant, position in processing and distributing fluid milk prod- ucts. Cooperatives selling fluid milk thus face increasing concen- tration of bargaining power on the part of processors, distributors, and retailers, Dairy Cooperatives Are Changing It is clear that dairy cooperatives cannot stand still and maintain their place in the economy. They 3 must be prepared to continue to Another development of great change in the future. importance to cooperatives is the Many cooperatives which for- widespread adoption of Federal merly performed only bargaining milk marketing orders. By 1961, functions find it necessary to oper- these programs were in effect in 80 ate manufacturing plants to pro- markets, including most of our vide a market for milk in excess of large cities. The functions of dairy fluid requirements and to perform cooperatives and Federal order pro- other marketing services. grams are highly complementary to each other in today’s markets. € In the 5-year period 1953-54 to 1958-59, the number of dairy co- operatives in operation decreased 14.5 percent, from 1,862 to 1,592. During the same period the re- ported membership of dairy coop- eratives declined 14.6 percent.? The number of farms reporting ?Gessner, AnneL. Statistics of Farm- er Cooperatives 1953-54. Gen. Rpt. 53, p. 18, Farmer Cooperative Service, U.S. Dept. of Agr., June 1956. Gessner, Anne L. Statistics of Farmer Cooperatives 1958-59. Gen. Rept. 93, p. 7, Farmer Cooperative Service, U.S. Dept. of Agr., August 1961. (Alaska omitted in order to provide comparable data.) Cooperatives must be alert to meef economic and technical developments. The change from rows of cans to stainless-steel tanks for bulk handling has had far-reaching effects. sales of milk or cream fell 31 per- cent from 1954 to 1959. However, in spite of the reduction in number of cooperatives and members, the net dollar volume of dairy products marketed by cooperatives increased 23 percent. The drop in membership of dairy cooperatives in recent years has een largely the result of factors others than the declining number of associations. The decrease in number of dairy farms is probably the principal cause. The down- ward trend in membership is ex- pected to continue. Dairy cooperatives, like the rest of the dairy industry, are making adjustments in response to or as the result of technical and economic changes. Although dairy coopera- tives are adapting to new condi- tions in many ways, students of co- operative problems have seriously questioned whether they are doing so fast enough to maintain their place in the industry. In order to improve their effectiveness, coop- eratives must increase in size, adopt new business methods, and improve their marketing programs. In brief, a dairy cooperative is a busi- ness enterprise and it must make whatever changes are necessary to remain competitively strong. If an ordinary business firm maintains its competitive position, it is a success, A firm organized as a cooperative, however, may make the adjustments necessary to meet competition but fail as a coopera- tive. The interests of dairy farm- ers will not be served most effec- tively unless dairy cooperatives of the future function as competitive cooperative businesses—not merely as competitive businesses. With this thought in mind, we proceed to a consideration of items to be ex- amined in checking up on the “‘co- operative character” of dairy organizations, What Is a Cooperative? [* judging a dairy organization as a cooperative, as distinguished from other forms of business enter- prise, we must evaluate primarily those characteristics which have withstood the test of time and have been accepted as cooperative princi- ples. It is essential to emphasize the services performed, the ultimate source of decision making, and the ap listribution of benefits. 9 In its simplest form, the question which faces us is: “What is a co- operative?” or, “What is coopera- tion ?” We have not attempted to answer this question in the form of one terse definition. The definition ap- 642299—62——_2 proach alone is inadequate since the cooperative concept may be found in company with many outward forms that seem indistinguishable from other forms of business enter- prise. Instead, we have drawn on the experience, ideas, and opinions of numerous students and writers in the field to point out the general features which serve to identify a cooperative organization. To assist the reader further in reaching his own conclusion, we re- viewed provisions of several Federal laws in respect to qualifications of cooperatives and, finally, we nar- rowed our discussion down to those features or principles of agricul- 5 tural cooperation which students of the subject generally consider to be basic. General Nature The authors of an earlier U.S. Department of Agriculture publica- tion defined cooperation in these words: “Cooperation is organized working together for mutual bene- fit. Economic cooperation is a form of business with democratic owner- ship and control by member-patrons having common needs, serving themselves on a nonprofit basis, and receiving benefits proportional to participation.” ° An official of a large cooperative referred to members of agricultural cooperatives as self-selected capital- ists seeking to improve their indi- vidual economic positions. In his view, the members come together on the basis of self-interest and to deal with society as it is and not to re- form it.* Other writers have expressed these basic viewpoints In various ways. Henry H. Bakken and Marvin A. Schaars, in discussing the immediate purposes for which cooperatives are organized, say: “The purpose is, therefore, defined in economic terms; all social consid- erations are secondary.” ® These authors indicate further that the “desire for pecuniary gain” is the ° Farmer Cooperatives in the United States. Bul. 1, p.4. Farmer Cooperative Service, U.S. Dept. of Agr., December 1955. “Babcock, H. E. Cooperatives the Pace Setters in Agriculture. Journal of Farm Economics, Vol. XVII; No. 1, pp. 1538-156. 19385. > Bakken, Henry H., and Schaars, Marvin A. SHconomics of Cooperative Marketing. Ed. 1, p. 6. McGraw-Hill Book Co. Ine. New York and London. 6 most common reason for which people join cooperatives. Another cooperative leader puts the term “nonprofit,” often used as a basic characteristic of coopera- tives, in perspective thus: “Students of the cooperative movement point out that, although the cooperative operates on a nonprofit basis, the profit motive is behind the enter- prise. As in a partnership, mem- bers establish cooperatives as a means of increasing the profits from their farm operations. Thus coop- erative business is a rival and part- ner of commercial business in the American system of free enter- prise.”’ ° A recent publication of the Texas Agricultural Extension Service con- cisely defines a farmer cooperative as “...a group of agricultural producers incorporated to provide off-the-farm services for the mem- bers on a mutual nonprofit basis.” 7 Joseph G. Knapp, writing in Harvard Business Review,’ outlined the distinctive purposes of coopera- tives as follows: “1. They seek to obtain services for themselves at cost—not to obtain» profit from rendering services to others. “2. They try to render the greatest financial benefit to their members as users—not to maximize profit for owners as distinct. from users. ®*Stokdyk, E. A. Co-ops Economic Ob- jectives. Cooperative Digest. Vol. 7, No. 2; p. 54. Roy H. Park, Inc., Ithaca, N vl@ August 1946. +S 7 Jaynes, M.C. Handbook for Directors of Farmer Cooperatives B-170. P. 28. Texas Agricultural Extension Service. College Station, Tex. 1949. *Knapp, Joseph G. Are Cooperatives Good Business? Harvard Business Re- view, p. 58. January-February 1957. “3. They distribute amounts re- maining, after payment of the costs of doing business, among those who are served by the cooperative in pro- portion to their use of its services— not in proportion to their invest- ment in the enterprise. “4. They plan to have an organi- zation that will be controlled by its patron-members (each of whom or- dinarily is allowed a single vote) — not by the owners in proportion to capital contributed.” By analyzing the definitions and descriptions just quoted, the reader can obtain a general conception of an agricultural cooperative organi- zation. It will be noted that a co- operative is organized primarily as a business enterprise. It is owned and controlled by the people who use it. It is not socialistic but cap- italistic and competitive—a part of a free enterprise system. It 1s “non- profit” to the extent that the coop- erative as such makes only limited or no profits for itself or for its owners in their ownership relation, although the profit motive is a driv- ing force among its member- patrons. Are there additional characteris- tics which differentiate cooperatives from other forms of business organ- ization? To answer this question, we will first examine descriptive provisions of some of the Federal statutes pertaining to agricultural cooperatives. As Identified by Statutes Agricultural cooperatives in the United States are incorporated un- der State laws. Laws providing for incorporation of agricultural as- sociations in line with accepted co- operative principles are on the statute books of every State. People are the heart of a cooperative. An annual meeting, such as pictured here, tells the story of a cooperative better than its buildings and equipment. Neither State nor Federal laws invented the cooperative institution nor established the principles of co- operation. Rather, the principles and most of the practices preceded the laws.® Legislation guides the appropriate application of certain administrative functions and regu- latory programs to the distinct co- operative institution. Some laws protect the cooperative character of farmer associations.?° But we cer- tainly do not regard laws as setting the absolutely final and unyielding principles of cooperation, any more than laws invented the cooperative. Charles E. Nieman has provided a broad and well-documented re- view of judicial opinions as to whether or not an organization is a cooperative. Such opinions do much to clarify legal statutes. In his conclusion, Mr. Nieman states ®* Jensen, A. Ladru. Cooperative Cor- poration Law on the Marketing Transac- tion. 22 Washington Law Review, p. 1. February 1947. ' Farmer Cooperatives in the United States. Bul. 1, p. 9, Farmer Cooperative Service, U.S. Dept. of Agr., December 1955. that the essential distinction be- tween cooperatives and business corporations for profit, and between genuine and imitation cooperatives, “is found in the matter of voting control and distribution of earnings.” ™ In recent correspondence with the authors, Mr. Nieman observed that these features are the two essential manifestations of a single distinc- tion, which is the purpose for which a corporation engages in business. Business corporations for profit and imitation cooperatives engage in business for the purpose of deriving income from their customers; but the genuine cooperative’s purpose 1s to produce income for its customers (patrons). Although Federal statutes do not provide for the incorporation of co- operatives, they do influence such associations’ structural form and methods of operation. The Capper- Volstead Act of 1922, Federal in- come tax statutes, the Agricultural Marketing Act of 1929, and the Agricultural Marketing Agreement Act of 1937 all contain provisions defining cooperatives for their par- ticular purposes. Capper-Volstead Act The Capper-Volstead Act identi- fies the general functions and spe- cific operational requirements of the cooperatives entitled to the protec- tion it affords. The act provides, in part, as follows: That persons engaged in the produc- tion of agricultural products as farmers, planters, ranchmen, dairymen, nut or fruit growers may act together in as- ™ Nieman, Charles E. Imitation Co- operatives. ‘“‘American Cooperation,” 1942 to 1945, pp. 86-100. American In- stitute of Cooperation, 1945, 8 sociations, corporate or otherwise, with or without capital stock, in collectively processing, preparing for market, han- dling, and marketing in interstate and foreign commerce, such products of per- sons so engaged. ” Attention is especially directed to these points: (1) It is agricul- tural producers who are authorized to act together; (2) functions spe- cifically covered are marketing and related services; (3) the associa- tions can be incorporated or other- wise, with or without capital stock ; and (4) the associations are to market products of persons engaged in agricultural production. The Capper-Volstead Act also provides that associations covered must be operated for the mutual benefit of member-producers and conform to one or both of the fol- lowing requirements: First, “That no member of the association is al- lowed more than one vote because of the amount of stock or member- ship capital he may own therein”; or second, “That the association does not pay dividends on stock or mem- bership capital in excess of 8 per centum per annum.” And in any, case this requirement: “That the as- sociation shal] not deal in the prod- ucts of nonmembers to an amount greater in value than such as are handled by it for members.” 1° Internal Revenue Code The Internal Revenue Code con- tains special provisions on the tax treatment of certain farmers’ as- sociations.'* Qualified cooperatives that apply are entitled to these tw deductions which other cooperatives™™ and business corporations do not get—amounts paid as limited divi- 47 U.S.C. 291 and 292. 37 U.S.C. 291 and 292. #26: U.S.C, 521-522. dends on capital stock, and non- patronage income allocated to pa- trons. Many farmer cooperatives do not qualify or do not choose to apply under these provisions. These Internal Revenue Code provisions differ in several respects from those of the Capper-Volstead Act in their identification of coop- @eratives covered. The Capper-Vol- stead Act apples only to marketing cooperatives. Cooperatives keting agricultural products and also those purchasing farm supphes are covered by the special provi- sions of the Internal Revenue Code if they meet other requirements of the act. The revenue code contains no re- quirement relative to the method of voting in the cooperative. It does specify that substantially all of the persons entitled to vote must be producers. Business with nonmem- bers, up to 50 percent, is permitted, but all patrons, members and non- members, must be treated alike. In a purchasing association, not over 15 percent of the business may be done with nonmember, nonproducer patrons.” Agricultural Marketing Act The Agricultural Marketing Act of 19291 continues to have major significance for cooperatives because the Farm Credit Act, providing for the Banks for Cooperatives,” refers to it for definition of cooperatives eligible for services of these banks. To be eligible to borrow from the oe" for Cooperatives, a coopera- ®% Hulbert, L. S., and Mischler, R.J. Legal Phases of Farmer Cooperatives. Bul. 10, pp. 196-197. Farmer Cooperative Service, U.S. Dept. of Agr., January 1958. 16-12 U.S.C. 1141j(a). 712 U.S.C. 1134, 1184(f). mar- — tive must be “. . . an association in which farmers act together in— “1. Processing, preparing for market, handling, or marketing farm products; or “2. Purchasing, testing, grading, processing, distributing, or furnish- ing farm supplies; or “3. Furnishing farm business services. “Associations performing a com- bination of two or more of these services are also eligible.” * In most other respects the require- ments specified by the Farm Credit Administration for borrowers from the Banks for Cooperatives are the same as the requirements of the Capper-Volstead Act. A few pro- visions are set forth in more specific language derived from the defini- tion in the Agricultural Marketing Act. At least 90 percent of the voting rights of a cooperative must be held by either farmer-members or by as- sociations owned and controlled by farmers. When not all voting rights of a cooperative borrowing from a bank for cooperatives are held by either producers or by other farmers’ cooperatives, the banks, as a matter of policy, encourage the cooperative to adopt measures de- signed to assure that substantially all voting rights will be so held. Agricultural Marketing Agreement Act Three sections of the Agricultural Marketing Agreement Act of 1937 require identification of coopera- tives in relation to various functions authorized therein. The act itself 1% Toans to Farmer Cooperatives. Cir- cular 6, Rev. 1956. Farm Credit Admin., Washington 25, D.C. 9 contains only limited provisions specifically defining the coopera- tives so affected. One section, dealing with the right of cooperatives to vote in be- half of their member-producers, says in part— the Secretary shall consider the approval or disapproval by any cooperative asso- ciation of producers, bona fide engaged in marketing the commodity or product thereof covered by such order, or in ren- dering services for or advancing the in- terests of the producers of such commod- ity as the approval or disapproval of the producers who are members of, stock- holders in, or under contract with, such cooperative association of producers.” Provisions for the arbitration of disputes concerning milk contain the following identifying language: . any cooperative association, incorpo- rated or otherwise, which is in good faith owned or controlled by producers, or organizations thereof, of milk or its products, and which is bona fide engaged in collective processing or preparing for market or handling or marketing—milk or its products... .” Other sections of the act extend the rights to pool returns, and to perform other specified services for “the producers thereof” to ‘a co- operative marketing association qualified under the provisions of the act of Congress of February 18, 1922, as amended, known as the ‘Capper-Volstead Act,’ engaged in making collective sales or market- ing of milk or its products, for the producers thereof ...”’74 The Capper-Volstead Act provisions thus become the basic criteria for recognition of cooperatives for these purposes. On the basis of these provisions of the act, responsible officials have 7 U.S.C. 608¢ (12). ”7 U.S.C. 671, Sec. 8(a). 717 U.S.C. 608¢e(5) F. 10 developed a set of cooperative qualifications for general use in ad- ministering the Federal milk mar- keting orders. The significance of these qualifications to dairy cooper- atives is discussed later in this report. Summary of Legal Provisions The Federal statutes cited above thus identify organizations as agri- cultural coperatives on the basis of : (1) The functions to be performed, (2) who the members are, (3) for whom services are performed, (4) the amount of business with non- member-patrons, (5) who votes and how they vote, (6) mutuality of treatment of member-patrons, and (7) the extent to which stock or membership capital, as such, par- ticipates in the earnings. These identifying features which have been incorporated into the laws are prescribed practices, based largely on experience, designed to A co-op employee talks with a farmer- member. To qualify as a farmer coopera- tive, the association must see that ifs mem- bers are farmers and ifs services are for farmers. carry out and protect principles which are considered basic. Basic Principles In the foregoing sections, we have noted that an agricultural coopera- tive is an organization composed of producers. Its purpose is to per- orm one or more functions or serv- ices for its member-patrons, Our consideration of objectives and the preceding summary state- ments on the nature of cooperatives have emphasized and essentially have been confined to their business character. Consideration of basic principles, however, and the criteria developed later in this report, in- clude relationships among people. All business organizations and actions are the actions of people. They necessarily apply their own value judgments and personal ob- jectives in their business relation- ships, although ordinarily this is not realized at the time of indi- vidual decisions. This study and report, however, require us to pay specific attention to personal ob- jectives and relationships. In many respects, there is little or no difference between business oper- ations or services conducted by co- operatives and by other types of organizations. A cooperative dairy plant, for example, may be built from the same plans as a proprie- tary plant. The plants may use identical equipment and sell their products in the same markets. The casual observer sees very little dif- ference between the two in the way eres conduct their business. In spite of these external similar- ities, objectives, basic principles, and internal lines of authority in policymaking distinguish coopera- tives from other forms of business organization. The cooperative is acknowledged to be a form of organ- ization particularly adapted to serving the needs of agricultural producers. However, the coopera- tive form of organization may be employed by any other group of people or corporations who want this means of getting services ren- dered at cost. Neither students, writers, nor practical cooperators are in full agreement as to all fundamental features of the cooperative as a form of organization. There is general agreement, however, with respect to three basic principles, or support- ing pillars, around which coopera- tive organizations are constructed and which distinguish them from other types of business organiza- tions in our free enterprise economy. These three underlying or “hard- core” principles are: 1. Service to members at cost. 2. Democratic control by mem- bers. 3. Limited returns on capital. There are substantial differences between cooperatives and _ other types of business in each of these respects. Some _ present-day observers maintain that service to members at cost is the only truly basic prin- ciple—and that the other character- istics, democratic control and limited returns on capital, only serve to support and insure this first principle. “Cost,” as used here, includes a limited return on capital, whether paid directly or included in other returns. Equity capital in the co- operative receives only a limited re- turn or frequently no direct return at all. Other earnings or margins are returned or allocated to patrons in proportion to their patronage. In other types of businesses, earn- ings are paid the owners in propor- 11 tion to the common or preferred stock each owns. The cooperative serves its patrons at cost—other types of business serve their custom- ers for a profit. The cooperative is controlled democratically by its members. A policy of one vote per member or of voting in proportion to patronage is usually followed. Other types of corporations generally are con- trolled in proportion to equity capital invested. Democratic control and limited returns on capital may be considered essential protective bulwarks to keep the organization oriented to service of its patron-owners. It may also be reasoned that the principle of service at cost auto- matically includes the principle of limited returns on capital, and therefore the third principle over- laps the first. Whether these principles are counted as one, two, or three, the significant point is the agreement that the ideas stated are appropriate and important. Inter- relationships add rather than de- tract from their strength as a group. Writers have referred to many other characteristics of cooperative organizations as basic principles or as fundamentals of cooperation. These characteristics, which may be considered secondary principles, can be classified in three categories: 1. Principles of good business or- ganization, finance, and manage- ment which are essential for coop- erative success but which apply equally to other types of business. Examples: Sound accounting prac- tices; budgetary controls, 2. Practices and policies designed to implement the three basic prin- ciples. Examples: Voting practices (most frequently one-man _ one- vote); pooling; allocation of net margins; revolving fund financing. 3. Practices and_ policies whi are or have been followed by co- operatives generally in the past but which are not lmited to coopera- tives. Examples: Fair dealing; credit control, and sometimes credit prohibition (“cash trading”’) ; func- tional and commodity specializa- tion. The three “hard-core” principles provide the basic rules of coopera- tive action. They are, in a relative sense at least, fixed characteristics of a bona fide cooperative. The exact form of organization, the policies and practices, and the methods cooperatives use in con- ducting business to comply with the basic rules are much more flexible. It is through changes in these sec- ondary characteristics, as opposed to changes in basic principles, that cooperatives usually adjust to our dynamic economy. We do not intend to imply, how- ever, that adherence to the three basic principles should be the ob- jective of a cooperative. These principles are a means to an end, not an end in themselves. The end is the financial benefit of the patrons. Determining Cooperative Character of Dairy Organizations \W FE, now turn to a consideration of how to check the qualifica- 12 tions of an organization seeking to be accepted and recognized as a co- operative, and how to appraise its ability to maintain its status as a cooperative in the years ahead. A dairy marketing organization should be required to meet certain standards before it is accepted as a cooperative. Farmers, other or- ganizations, and public agencies rere with cooperatives all need to have such standards available for their use. Industry leaders also have been concerned with the prob- lem of distinguishing between a real (bona fide) and an imitation (pseudo) cooperative. This section provides criteria for identifying the qualifications of a recognizable cooperative, and dis- cusses the interpretation and appli- cation of those criteria. Most discussions of genuine ver- sus imitation dairy cooperatives have involved alleged captive or- ganizations. The captive idea usually means the organization is thought to be controlled by a par- ticular milk handler, rather than by the farmers themselves. But other captive alignments are possible, with ties to creditors, milk haulers, labor unions, or even other organi- zations of farmers. The standards should detect improper control or influence from any source, and not from milk handlers alone. The standards also must extend beyond minimum forms of organi- zation in order to indentify a co- operative that is providing actual service to its member-patrons. Surely farmers should reject an or- anization that, even though it is Q owncea on cooperative principles, is not performing needed market- ing’ services. State and Federal officials also may refuse to grant rights reserved for cooperatives to organizations that do not qualify for those rights under the terms and for the pur- 642299—62——_3 poses of programs being admin- istered. Thus, our standards for dairy cooperatives must give spe- cific guidance; a simple minimum set of cooperative principles is not adequate. We indicated in outlining basic principles of agricultural coopera- tion that these included and per- haps emphasized relationships among people. Such relationships often are not clear cut and perfectly objective. This feature greatly complicates the task of establishing standards or criteria for identify- ing agricultural cooperatives. Most standards we will set forth apply not only to dairy coopera- tives but also to other specialized or diversified cooperatives. There- fore, the word “dairy” may appear infrequently in the following dis- cussion. It is included only where conditions appeared to require spe- cial provisions for dairy coopera- tives, or there was a possibility that a statement might apply differently to other commodity areas. Positive answers to three general questions will go a long way in as- suring that a dairy marketing or- ganization is operated as a bona fide farmer cooperative and can maintain such operations. These questions are: 1. Is the cooperative perform- ing marketing services for members in their best interests ? 2. Is the cooperative organized so that producer-patrons control it now and can be sure they will con- tro] it in the future ? 3. Is the business of the coopera- tive conducted in accordance with sound business practices which will assure its continuing ability to pro- vide services to producer-patrons at cost? The means of obtaining true answers to these questions are not 13 simple nor will they be the same under all circumstances. Exact criteria which can be applied gen- erally to test the answers to these questions cannot be devised. How- ever, we can list and discuss im- portant points for the cooperative member to consider in answering the questions about his own dairy marketing cooperative. One point can be cleared up im- mediately. Members may either be individuals or other farmer cooper- ative corporations. Marketing Service for Members The first basic principle of agri- cultural cooperation cited earlier was service to members at cost. Two major requirements to demon- strate this service will be discussed here. First, marketing services must be performed by the cooperative. In some cases cooperatives accomplish this by acting as agent for their members in obtaining tangible per- formance by third parties. Second, marketing must be primarily for members. Both these requirements at first appear simple, even obvious. But they may be troublesome under- neath this deceivingly simple first appearance, Performance of Marketing Service The definition of marketing in dictionaries, encyclopedias, and standard textbooks is very broad. Numerous functions may be re- garded as marketing. These in- clude buying, selling, storing, transporting, processing, standard- izing or otherwise preparing for market, risk bearing, supplying market information, and other serv- ices to buyer or seller. Most cooperatives definitely en- gage in marketing by doing one of three things (and often the first or 14 second plus the third listed) : 1. Purchasing and selling prod- ucts with title passing to and from the cooperative. 2, Acting as agent for the seller in negotiating price and other terms in the sale of products, often under the authority of a written contract. 3. Physically receiving and ng dling products. Although most cooperatives per- form far more than these minimum functions, any one of the three is adequate to demonstrate marketing. Some organizations do not meet marketing service requirements be- cause their sole purpose is to repre- sent their members (farmers, la- borers, handlers, or others) for legislative purposes, or for general advancement of an industry. These activities do not involve services in the sale of specific and identifiable articles in commerce and the or- ganizations are not engaged in marketing. Physical Handling.—Cooperatives that do not physically handle prod- ucts may have a problem in estab- lishing their marketing status. | In these days of bulk handling, there is not necessarily any market- ing advantage for a cooperative in physically receiving milk over haul- ing it in its own trucks or in contract trucks. In 1957, about 700 dairy cooperatives marketed some whole milk without any processing. (This was only part of the marketing op- erations of many of the 700, how- ever.) Much of this milk was not even physically received and re- shipped. ¢ Thus, physical receipt of milk has ~ become less generally useful as a cri- terion of marketing authority. On the other hand, physical handling alone may not always be an ade- quate test of marketing. For ex- ample, cooperatives applying for Physically receiving and handling products — is one evidence that a cooperative is per- forming marketing services. recognition under Federal milk orders are asked if they have “full authority in the sale of milk.” Most, if not all, associations that meet other cooperative criteria and that physically receive milk are per- forming marketing services. But it seems essential to limit attention to the exchange function of purchas- ing and selling, in identifying a marketing cooperative for the Fed- eral order program. Marketing Agreements.—Since many cooperatives market effec- tively without physically handling the product, other criteria of mar- keting performance are needed. A long-term and desirable trend is toward marketing agreements for all cooperative dairy marketing operations. Contractual market- ing agreements may appropriately be made an essential criterion for recognition as a cooperative under some State and Federal marketing programs. A cooperative’s marketing agree- ment with its patrons may take several forms. For member-pa- trons, the agreement may be set forth in a bylaw. For nonmember- patrons, it may be such a bylaw, plus the patron’s signed receipt for his copy. For either group, it may be a separate, written agreement signed by the patron. This latter form is the best known. In some cases, properly witnessed oral agreements must be accepted. This situation arises when the agreement involves persons whose religious beliefs do not sanction written agreements. Regardless of its form, the agree- ment should plainly obligate the pa- tron to deliver to or for the account of the cooperative all milk (or any other commodity the agreement is intended to cover) produced on his farm in excess of his needs for home use. It should plainly authorize the cooperative to market the commod- ity either for the patron’s account or the cooperative’s account. The agreement is of little value unless it states the period of time covered and provisions for termi- nation. Bairy Cooperative Association Membership and Marketing Agreement Yu tres Le, A contractual marketing agreement provides specific evidence that a cooperative is en- gaged in marketing. 15 Quality and Extent of Marketing Service.—Once it is established that the organization performs market- ing, member-patrons, at least, will want to evaluate the quality and ex- tent of that service. In carrying out its responsibilities, an admin- istrative agency may also need to determine that certain services are being performed and that they meet specific standards. The Federal milk marketing or- der program provides an illustra- tion. Standards may be adopted governing butterfat testing, check weighing, marketing information, or other services. These problems will be discussed in more detail in the section “Cooperatives and Fed- eral Orders.” No set rule can be laid down as to what functions a particular dairy cooperative should undertake. Some guides may be established, however. Those that follow are prepared for the use of members, directors, and leaders; they are not for administrative agencies. Answers should be sought to two questions: (1) What services do the member-producers need ? and (2) Can the association perform the needed services as well or better than other marketing agencies? If the answer to the second ques- tion is negative, and it will be in numerous cases, it would probably be advisable for the cooperative to merge, federate, or otherwise as- sociate itself with another organi- zation which is in better position to serve the producers’ interests. In some cases, liquidation will be the only answer. These are the principal alterna- tives for leaders who, in the process of evaluating and making plans for an existing association, conclude that major organizational changes 16 are required. An individual pro- ducer can simply decide another co- operative or noncooperative buyer can better serve his needs. The means of bringing about af- fiiations of cooperatives or other marketing organizations is beyond the scope of this report. The same is true for methods of establishing @& needed additional marketing serv- ices, discontinuing unneeded ones, or improving the quality of services. But evaluation of the kinds and quality of services performed is highly important. If a cooperative cannot keep pace with rapidly changing conditions, it should re- organize or be discontinued. The same is true of other marketers. Marketing for Member-Patrons As noted earlier, the Capper-Vol- stead Act requires that at least 50 percent of marketing business must be with the products of members. We accept 50 percent as a minimum standard. Cooperatives thus dem- onstrate that they are at least principally marketing for pro- ducer-members and not for others. Limited Marketing for Nonmem- ber, Nonproducer Patrons.—Market- ing for other than producers and other farmer cooperatives should be severely limited. This limitation is necessary because the most obvious motivation for such “ex- ternal” operations is to obtain profits as owners, not improved re- turns as patrons. The primary distinctive purpose of the coopera- tive—obtaining service for member- patrons at cost—is diluted and weakened by all “external” opera- tions not integrally related to marketing needs of members. We propose as a criterion that not more than 10 percent of the raw product value of products marketed should be for other than individual Ae producer-patrons and other farmer cooperatives. Exceptions may be made to this criterion in certain in- dividual instances.”? An exception may be made if it is shown that effective marketing of members’ products requires market- ing other products that are related in merchandising by trade custom. The need in modern merchandising to sell a broad product line must be recognized and accepted. Thus, if most dairy distributors in a par- ticular region handle flavored drinks and orange juice, dairy co- operatives must also do so to stay in business. Some dairy Papert operate a dairy bar, or even a lunchroom, for such purposes as local retail sales, sales promotion through get- ting the public to visit the plant, and lunch service to employees. In such an operation, the items sold cannot successfully be limited to those made from members’ milk. Dairy bar and lunchroom service may thus be considered as integrally related to marketing of members’ products, although nondairy prod- ucts are sold. Other Activities—Sometimes in purchasing a milk packaging and distributing business or in otherwise expanding its market outlets, a co- operative acquires a nonfood opera- tion or one not directly connected with its present activities. A co- operative might, for example, ac- quire a bakery, candy manufactur- Internal Revenue Service requires that any marketing for nonproducer patrons, other than farmer cooperatives and the U.S. Government, by so-called tax “exempt” cooperatives be justified by a showing that such marketing was not sub- stantial and was required by special circumstances such as being needed to meet contract commitments. ing plant, or soft drink bottling plant. There would be a_ substantial problem in providing that these ac- tivities were needed to market the products of member-producers, and that such need overrode the interest in profits as owners. Continuation of such lines would steadily raise the question of whether the organi- zation was a bona fide farmer marketing cooperative. Cooperatives that have idle fa- cilities and equipment face a diffi- cult problem if they wish to retain those facilities for possible use in the future. Processing food prod- ucts not supplied by members, or carrying on nonfood operations may be the best way to gain a re- turn on the cost of holding and maintaining the facilities. It is un- reasonable to quickly condemn such operations by a dairy cooperative if it is reasonably possible that the fa- cilities will be needed in the future for products of member-patrons. The backhaul problem for truck- ing operations is another illustra- tion relating to idle equipment. Backhauls are important in main- taining efficient trucking opera- tions. The “service for members” principle of cooperation is safe- guarded if such backhauls are re- lated as closely as possible to the needs of member-producers, with needs of other agricultural pro- ducers taking second priority. But we believe backhaul service is a justified exception to the practice of service only for members, if this is the only realistic alternative in maintaining efficient hauling operations. Both member-leaders and public administrative officials should peri- odically review the need for any re- motely related marketing enter- prise. If the need no longer exists, 17 the cooperative may take two types of action. The most clear cut is to sell or lease the facilities not used in marketing for members. If this is not prudent, the cooperative may consider setting up a subsidiary cor- poration to conduct the operations in question. At least a few dairy cooperatives already maintain subsidiaries for such purposes. The subsidiary cor- poration should help keep the co- operative’s attention centered on dairy marketing or other opera- tions that directly serve its mem- bers as patrons. Setting up a sub- sidiary also helps segregate taxable from nontaxable revenues for cor- porate income tax purposes. Our distinction between dairy and nondairy operations 1is_ not intended to condemn diversified marketing or marketing-purchasing cooperatives. Diversification by combining dairy with other mar- keting activities may increase in the future. This, however, raises no doubts as to whether the organiza- tion serves the marketing needs of the members. But the dairy cooperative should bear the burden of proof that it is principally engaged in marketing for members. This is appropriate since most definitions and descrip- tions of farmer cooperatives em- phasize self-service. This idea imposes a definite limitation on co- operatives. All operations should be tested to determine whether they are essential to members as pro- ducers in marketing their farm products or purchasing their needed farm supplies. The special situations described are intended to help farmer- leaders and public administrators give a practical interpretation to the idea of essential marketing services. 18 Control by Member-Patrons Member- patron control is vitally related to the service-at-cost. prin- ciple. It is a major safeguard be- cause it enables members to refuse or reverse any action or policy of the cooperative that is contrary to this principle. The question of control is espe- | cially critical in a changing, dy- namic economy. ‘Today, changes must be made frequently for an as- sociation to survive, much less to serve. Control must rest at the same point that the objectives and benefits are focused—with the pro- ducer-patrons—to insure that those objectives are preserved even though changes are made. The first checkpoint for control by member-patrons is whether the organization is incorporated under the cooperative or equivalent State statutes. The second is whether the cooperative is actually functioning consistently with the statutes. Provisions of these enabling acts vary by States and cannot be tabu- lated here. However, the laws em- — phasize two features. The first is provision for democratic control by stating how members shall vote. The second is a limit on returns on capital. Incorporation under a coopera- tive law does not alone assure con- trol by member-patrons. It is necessary to examine the connecting links between members and other parts of the cooperative body to de- termine the real character of the control. ; There may be major advantages in a few cases in incorporation under general corporation acts, rather than specifically under co- operative acts or sections. A corpo- ration may be able to fully follow cooperative principles and practices under such statutes and articles of incorporation. However, internal or external appraisers of such a corporation should use great care in reviewing its compliance with cooperative principles and practices before accepting it as being truly cooperative. While the corporation need not automati- cally be rejected as a cooperative, it certainly assumes an increased burden of proof. In membership appraisal, we should direct our attention to: (1) Who are voting members, (2) who actually controls the organization, and (3) what are the policies to re- tain membership and control in hands of members who are produc- ers as well as patrons? Who Qualify as Members The Capper-Volstead Act and other Federal statutes based on it specify that, for the purposes of these statutes, voting members of an agricultural cooperative should be producers of agricultural products. Most students go further, however, and agree that members of any indi- vidual cooperative should not only be agricultural producers but also should have a high degree of com- mon interest in using the services offered by the cooperative. The Internal Revenue Code ap- plies this principle in requiring that substantially all the voting mem- bers of a so-called “exempt” cooper- ative must also currently patronize it Three tests for assuring the com- mon interest of members will be DD) aisocssed: Producer status, patron- age, and membership acceptance of responsibility. Many cooperatives also follow a policy of open mem- bership. We will discuss this policy but we do not recognize it as being suitable for all cooperatives. Producer Status and Patronage.—- The membership of a dairy cooper- ative should be composed of produc- ers who patronize it by marketing their milk and dairy products or by using other of its marketing or pur- chasing: services. Some producers may believe that an organization should be limited to dairy marketing in order to rep- resent them acceptably as a dairy marketing agency, or at least that only dairy patrons should be per- mitted voting rights. Others may feel a cooperative with diversified activities can serve them better. Our judgment is that the degree of specialization or diversification of a cooperative should be left to its producer-members. Many farmer cooperatives engaged in marketing will have numerous members who are not dairymen but who patronize other departments. To minimize the temptation and tendency to adopt policies leading to services for a profit, rather than services at cost, voting rights must be limited to persons meeting the producer and patronage require- ments. Producer-patron members can be entirely satisfied with the objective of improved returns from market- ing on a service-at-cost basis. Non- producer-members may be princi- pally interested as investors, and may logically focus attention on re- turns on capital. Confining voting rights to pro- ducer-patrons also helps prevent the cooperative from becoming a social or political rather than an economic institution. Any group of farmers may initially sponsor a cooperative, but voting rights should be extended only to patrons. When a coopera- tive is first organized, this may be interpreted in terms of an expressed 19 or implied commitment to pa- tronize. Even when patronage is a re- quirement for voting, membership may shift into the hands of non- producers. Should this happen, members may consider several methods of handling the situation. They may allow the shift to con- tinue, with the possibility that their association may someday lose its identity as specifically a cooperative of agricultural producers. They may properly limit membership to a certain group by refusing the pa- tronage of other groups, such as nonproducers. As still another alternative, they may decide to discontinue the serv- ices that are bringing in the un- wanted class of members, possibly by assisting in organizing a second cooperative for other distinct types of operations. Members may consider similar al- ternatives if they are concerned about nondairymen gaining voting rights. Acceptance of the situation, refusal of patronage, discontinu- ance of services, or organization of a new cooperative offer possible solutions. If State laws permit, a change from the one-man one-vote practice to proportional] voting may be help- ful. This may be particularly suit- able if the cooperative markets more than one product, or has both marketing and purchasing opera- tions. One department or opera- tion, such as dairy marketing, may account for most of the dollar vol- ume of business, but the number of nondairy patrons may greatly exceed the number of dairy patrons. In this situation, proportional vot- ing would retain control for dairy producers. Each of these alterna- tives preserves the cooperative prin- 20 ciple of mutuality in control, pa- tronage, and benefits. The requirements and policies of the Farm Credit Administration for lending by the Banks for Co- operatives can be used as specific standards for reviewing the mem- bership of an organization desiring recognition as a farmer cooperative engaged in dairy marketing. e Following the policies of Farm | Credit Administration, we suggest as a standard that at least 90 per- cent of the voting rights should be held by either farmer-members or by associations owned and con- trolled by farmers. When more than 10 percent of the voting rights in a farmer cooperative are held by others, the cooperative should show it has adopted measures to assure that this percentage will be reduced. If membership is limited to pa- trons, when shall voting rights of members who become inactive as patrons be discontinued? This is a relatively simple problem for dairy patrons. Voting rights should be discontinued immedi- ately for members who cease to pa-.. tronize because they close their dairy enterprise by selling or leas- ing their herd or farm (unless on a share basis), or who retire or die. Voting rights should also be dis- continued immediately for members who continue producing milk, but begin to sell their milk to another firm or through another coopera- tive. An exception may arise if the member continues his membership eligibility by marketing other products through the cooperative or , patronizing farm supply or other « service departments. Voting rights of members who experience a dis- ease outbreak, fire, or other calam- ity may be continued for up to 1 year. It is more difficult to provide a specific policy for ending voting rights because of failure to patron- ize nondairy marketing depart- ments or farm supply or other services. Farmers’ needs in those departments are more likely to vary or to beseasonal. But voting rights should ordinarily be ended for per- sons who have failed to patronize any of the departments of the coop- erative for 12 months. An excep- tion may be made in the case of a total crop failure or other calamity. Membership Responsibilities —A method of determining the interest of producers before membership rights are extended would do much to reduce the “deadwood” on mem- ber rolls of dairy cooperatives. Making patronage a prerequisite to acquiring or maintaining voting rights and promptly clearing the membership rolls of nonpatrons help to insure that persons inter- ested in the services the cooperative provides will form its policies. But something else is needed. Requiring a marketing agreement helps to insure that applicants for membership accept responsibility for patronage. But, from the practical point of view of the prob- ability of general acceptance, we think it is too soon to insist that all dairy marketing cooperatives re- quire marketing agreements. Our further proposals are suit- able for internal self-appraisal by cooperatives, but probably are not sufficiently clear cut and objective to apply externally in governmental or other programs. Membership is very easily ac- quired in most dairy cooperatives. In some cases a producer who makes a delivery of milk or farm-sepa- Cooperatives could gain stronger membership ties by person-fo-person counseling with potential members. 642299—62——4 New members would thus know more about their responsibilities. 21 rated cream to the cooperative be- comes a member by the simple expedient of authorizing the deduc- tion of a small membership fee or part payment on a share of stock from his first check. The producer-patron may thus become a member without adequate knowledge of the duties and re- sponsibilities he is assuming. He may be unaware of any benefits he may reasonably expect from the co- operative, other than the service it has already provided by accepting his product. Cooperatives could strengthen ties with their members by counsel- ing with them in advance to deter- mine their interest and qualifica- tions as cooperators. By “qualifi- cations as cooperators,’ we mean at least basic understanding of how the cooperative is organized; the re- sponsibilities of membership; and the importance of participation in the affairs of the association. The following statement of Henry Bakken should help to clarify the meaning of the term, “qualifications as cooperators.” He said: The most ideal condition under which a cooperative may be operated is that of having an intelligent membership of effi- cient producers who: (1) Recognize the need for organization; (2) have the pa- tience to work out their problems; and (3) will give the necessary support to the employees and management of the enterprise.” He called for the current members of a cooperative to pass on appli- cants’ qualifications. Open Membership?—It is some- times reasoned that membership in an agricultural cooperative should * Bakken, Henry H. Principles and Their Role in the Statutes Relating to Cooperatives. Wisconsin Law Review, vol. 4, p. 554, July 1954. 22 be open to any agricultural pro- ducer who wishes to join. However, the need for common interest among producers and the desirability of de- termining their qualifications as cooperators may be more important than the value of open membership. From an economic standpoint, a selective rather than open mem- bership policy may sometimes be more to the interest of present mem- ber-patrons. Either limited facili- ties or limited markets may dictate a policy of closed or controlled membership. We thus conclude that member- ship in a cooperative need not be open to all who apply. Do Members Exercise Rights? The cooperative form of organi- zation endeavors to assure produ- cer-patrons that the affairs of the association will be conducted in their interest. As mentioned ear- lier, it does this, first, by limiting voting rights and thereby control to members who are both producers and patrons. Bylaw provisions concerning the rights of producer- patron members to control the co- operative are of little consequence, however, unless those members ex- ercise their rights. When members of a cooperative as a group fail to exercise their rights, others will assume control. This may be a clique of members, a board of directors acting as indi- viduals instead of representatives of members, hired management, or outside interests. Cooperatives are not unique in this respect; similar problems exist in other organiza- tions, Control by members who are pro- ducer-patrons and who will benefit from the organization is basic. In describing the nature of a coopera- tive Edwin G. Nourse once said: .. cooperation is a means of or- ganizing the members of an industry to conduct and adjust its affairs in the com- mon interest of the group and no amount of benevolent despotism or pure efficiency of a remote management will take the place of continuous, active, studious par- ticipation by members in the formulation and earrying out of plans and policies.” The methods by which members control a cooperative require fur- ther exploration before we discuss how to determine whether such con- trol really exists. Business effi- ciency and good business practices require the delegation of authority and responsibility. It is evident that each of several thousand mem- bers, or even several dozen, cannot give day-to-day orders to the staff. When members of a cooperative elect a board of directors, they au- tomatically delegate to it broad au- thority over the policies of their association. For example, the au- thority of the board of directors to vote on behalf of members is recog- nized under the Federal] milk mar- keting order program. The board also hires the manager and through him directs the business operations. Successful membership control in a cooperative involves close adher- ence to democratic processes and action as a group. Willingness to accept majority decisions and abide by them until altered by later ac- tion of the group is an essential characteristic of a good cooperative member, Full and complete control by pro- ducer-patron members is thus basic to cooperation. Democratic meth- ods, involving majority rule ** Nourse, HE. G. The Evolving Idea of Cooperation in the United States. American Cooperation 1928, vol. 1, p. 16. The American Institute of Cooperation. and delegation of authority, are es- sential to implement member con- trol and do not detract from it. Measures of member control must be devised that are consistent with the demands of this democratic situation. How Many Votes?—Most dairy cooperatives give each member one vote, and no more. A system of voting based on the proportional use a member makes of the coopera- tive’s service also is democratic and under some conditions may be more practicable than the one-man one-vote system. The proportional system may be modified by limiting the maximum number of votes. Extra votes for additional shares sometimes are used as a device re- flecting volume of patronage. If this is done, the number of voting shares should be kept in current ad- justment to volume of patronage. Cooperative laws in about three- fourths of the States provide that no member or shareholder shall be entitled to more than one vote re- gardless of the amount of stock owned, or the extent of his patron- age, Because of these provisions, and the tradition interwoven with them, a substantial majority of the members of cooperatives probably regard the common “one-man one- vote” practice as a basic principle of cooperation. However, “demo- cratic control by members” is the basic principle and one-man one- vote only one way to carry out that principle. Dissatisfaction with the one-man one-vote system is most likely to arise in associations whose member- ship includes some large producer- patrons and many more smaller producer-patrons who can control on a one-man one-vote basis. In States where the cooperative laws permit, organizations faced with 23 this conflict of interests may find a system of proportional voting bet- ter adapted to their conditions. Cooperatives in other States may want to seek amendments of laws to gain for themselves the oppor- tunity to use proportional voting. Laws of some States permit is- suing more than one voting share of stock to an individual member, Co- operatives following such practice must be recognized in those States. However, this practice, unlike’ vot- ing in proportion to patronage, en- dangers the basic principles of con- trol by producer-patrons and of operation at cost. In these cases, therefore, exceptional attention should be given to other indications of control by producer-patrons and of operation at cost. Member Participation—A high level of member participation at business meetings goes a long way to demonstrate that members con- trol a cooperative. Thus, in self- evaluation, leaders of a cooperative will find this a good index of mem- ber control. However, we do not recommend that a specific criterion of member participation be applied in State and Federal administrative pro- grams. A great variety of situa- tions would have to be considered, including number of members, size of area served, extent of diversifi- cation, and some organizational details. The first step toward better mem- ber participation is to call attention to its importance and set some standards for self-evaluation. Spe- cific standards in terms of higher quorum requirements may be pos- sible later. In reviewing operations and dis- cussing the cooperative’s plans and policies at its business meetings, free discussion is very important. 24 Members should be encouraged and given a meaningful opportunity to express their views and ask ques- tions. Qualifications of Directors and Committees.—Members of a coop- erative may properly appraise the qualifications of directors and other officials. The following questions are appropriate: 1. Do the same persons serve as directors and on important commit- tees for long periods of time? 2. Is each one so outstandingly qualified that sound judgment re- quires his continued service ? 3. Do all members qualified and willing to serve in such capacities get an opportunity to do so? Members who answer “yes” to the first question and “no” to the second and third are thereby making a ser- ious criticism of their cooperative. Are Policies Followed?—Members may also appraise director’s and manager’s adherence to formulated policies. 1. Does the board of directors adopt policies consistent with deci- sions made by the membership as a: group ¢ 2. Does the general manager d1- rect the business in line with duly established policies? Conflicts of Interest Members of dairy cooperatives, as well as directors of State and Federal administrative programs, should search carefully for conflicts of interest. The organization should not be accepted as a coopera- tive until this review has been com- pleted satisfactorily. Such a search may reveal a captive situation. This checklist may be helpful: 1. Do directors or managerial employees have interests in other dairy enterprises (or other lines of business) which may conflict with the interests of the producer-patron members ? a. Do they own stock in other dairies operating in the area ? b. Are they employed by or do they receive any compensation from other dairy firms in the same oper- ating area ? ce. Do they receive commissions / or gifts of more than nominal value from supplhers or customers of the cooperative ? 2. Does management enter into contracts or other business arrange- ments which place outside interests in the position of dictating policies of the association ? Any contract delegating general management to another firm (rather than employing an indi- vidual) should be examined in de- tail for evidence of conflict of in- terest. Sales contracts also should be examined for any commitments by the cooperative organization that are not essential to rendering ade- quate service. 3. Is the organization indebted to its buyers ? Substantial indebtedness usually carries with it considerable man- agement and policy influence. A cooperative organization ordi- narily should not borrow money from firms to or through which it sells products. Exceptional circumstances may justify such~borrowing. But, it raises a question about cooperative status and places a heavy burden of proof on the cooperative to show that its policies are not influenced as a result. 4, Does the organization or do any of its officers receive any funds or financial support from milk handlers or buyers of other prod- ucts marketed, except from the sale of products and from moneys duly authorized by members to be de- ducted returns ? 5. Do any persons employed by milk handlers or buyers of other products marketed attend board meetings or assist in formulating policies of the organization ? 6. Have any officers or employees of milk handlers, buyers of other products marketed, or independent haulers solicited members for the organization 4 7. Was there any evidence of con- flict of interest in the circumstances under which the association was or- ganized, especially in relation to— a. Who started the’ organization and what was the immediate pur- pose in setting it up? 6. Were any milk handlers or buyers of other products marketed instrumental in its organization or did they use any influence in con- nection with it? ce. Did the lawyer who aided in the incorporation or in drafting legal papers of the organization then act as counsel for any firms that bought milk or other products from the organization or has he since done so ? 8. Have any lawyers retained by the cooperative during the last 2 years acted as counsel during that same period for any firms to which milk or other products are sold ? Farmer cooperatives have a spe- cial interest in Insuring control by producer-patron members, but the concern about conflicts of interest is shared by other business concerns. from their marketing Searching for such conflicts is simply a matter of prudent man- agement. Will Cooperative Character Be Maintained? We will now assume that the organization papers of the dairy co- operative are in order and provide 25 adequate recognition of cooperative principles. The membership is composed of producers who patron- ize the cooperative, and members control the association through democratic processes. The founda- tion thus appears to be sound. Be- fore passing final judgment, how- ever, we should consider whether provisions have been made to pro- tect it from decay. The following guides to future cooperative character are for mem- bers and leaders to use in this ap- praisal. State and Federal officials probably are more concerned with present conditions than with what may arise in the future. Since both farming and market- ing conditions change rapidly, past policies may not be successful in the future. Thus, an association’s past and present performances do not fully insure its future ability to serve. As a cooperative grows, member- ship and management practices, which served well when its business was primarily local and the ind1i- vidual members knew all the direc- tors and the manager personally, may no longer be adequate. We must assume that as the cooperative becomes larger patrons will begin to lose contact with the management unless definite measures are taken to. prevent such a development. What indices may be used to know whether such measures are being taken ? Is Membership Static?—Keeping the membership of a cooperative in the hands of active patrons is not a particularly difficult task. It will not occur automatically, however. Members, directors, and managerial employees must all be aware of the desirability of such a policy and must support it by their day-to-day actions. 26 Dairy producers are not a static group. They die, move out of the area served, or discontinue dairy production. Meanwhile, boys grow up and take over the dairy herds and new dairymen move into the area. Without the patronage of these new producers, a dairy coop- erative’s business will wither away. Without their membership, it will become an organization of nonresi- dent or retired persons. Accordingly, we should answers to these questions: 1. Does the association operate in a manner to attract the patronage of new producers ? 2. Do members “sell” their associ- ation to prospective patrons? 3. Is there a definite policy of en- couraging qualified nonmember pa- trons to become members? 4. Does the association systemat- ically remove nonpatron members from the membership rolls? Good Communications Are Essen- tial—Cooperative members can ex- ercise effective control only if they are informed regarding the organi- seek zation and the business it conducts. ' A regular and continuous two-way flow of information and ideas is es- sential to well-coordinated actions of members, board of directors, and managerial employees. The larger the cooperative, the more important planned communi- cation becomes. Day-to-day con- tacts between members and the managerial staff grow less frequent as the size of the organization in- creases. Their adequacy as a means of communication thus decreases and more formal means must be relied upon. We emphasize the specific need for information that enables mem- ber-patrons to evaluate perform- ance of the cooperative. The first question may be, do patrons under- Membership in a cooperative cannof remain static. told about advantages of co-op. stand and correctly interpret their returns from marketing through the cooperative? If patrons merely compare the net pool price of the cooperative with competitive prices, many deserving dairy cooperatives may find themselves at a disadvan- tage. Therefore, patrons should be well informed about cooperative benefits so they can base their support on more than comparison of current prices. They should be in a posi- tion to— 1. Compare quantity and quality of services performed. 2. Consider end-of-the-year pa- tronage refunds. 3. Consider their accumulated equities in the cooperative. 4, Consider the long run effect of the cooperative on the competitive price level. 5. Consider the value of having an organization whose future Newcomers to area should be visited and functions they can control. A recent study in Wisconsin indicated that some dairy coopera- tives were at a competitive disad- vantage because of lack of price in- formation and failure of producers to understand that which was avail- able.2> Producers often lacked in- formation on basic prices and grade differentials of the numerous com- peting buyers. Benefits, other than price, were not fully understood. In their report of this study, the authors suggested improved educa- tional programs, less emphasis on end-of-the-year patronage refunds, and more emphasis on cooperative pool prices as a means of dairy co- operatives increasing their effective competitive strength. > Burnett, Claron, and Clodius, Robert L. Procurement Policies and Practices of a Selected Group of Dairy Processing Firms. Research Bul. 211, Univ. of Wis., Madison, May 1959. 27 Dairy cooperatives operating in today’s markets cannot afford to ig- nore price competition. However, a cooperative will be better able to adapt its operations to changing conditions without loss of its co- operative character if the member- ship is reasonably well aware of ad/ the advantages offered. But even well-informed members cannot be expected to continue supporting an inefficient cooperative. Providing the business informa- tion and knowledge needed for intelligent action on cooperative af- fairs is a good beginning for a com- munications program aimed at maintaining and improving control by producer-patron members. A further step is needed, however. Unless the comunications also inspire in producer-patron mem- bers a desire to create or maintain control, the business information provided will do little good. Factual accounts of accomplish- ments of dairy and other coopera- tives with emphasis on the part cooperative members played are use- ful. In telling the “Cooperative Story” we should be careful to pre- sent both sides, however. Problems as well as accomplishments should be discussed. Necessary participa- A good communications program is a valua- ble asset to any cooperative. Miami Valley Milk Producers Association mails informa- tion fo its members. 28 tion in control and in financing should be given equal billing with benefits to be derived. The story should be told so member-patrons or prospective member-patrons will see that there is no magic in coop- erative methods—that benefits are dependent on participation. A good communication system will fill many needs. We emphasize that control by producer-patron members is much more likely to be maintained when communications: (1) Provide for two-way flow of in- formation and ideas; (2) present technical and economic information in understandable form about the cooperative, its business, and its problems; and (8) create a desire among the members to participate. Sound Business Practices A. loyal membership that believes in the principles and objectives of cooperation is a valuable asset to any cooperative. Objective obser- vation of cooperation in action indi- cates, however, that such belief and loyalty are mainly derived from . Loyalty in- successful operations. turn contributes to continuing suc- cess when members are properly informed about the accomplish- ments of their cooperative. Succesful operations and loyalty are thus interrelated—each influ- ences the other. But the first re- quirement is demonstrated economic benefits: Business success derived from sound business practice. Only a few of the criteria of busi- ness methods that are discussed here can be applied objectively. These may be included in adminis- trative criteria of cooperatives. The other points and questions may be employed in self-evaluation by cooperative members and leaders. a> as General Business Principles A dairy cooperative should estab- lish the same principles of suc- cessful business conduct as any other business. These questions are pertinent : 1. Is the management well quali- fied, efficient, and alert to changing conditions in the industry ¢ 2. Is adequate managerial time set aside for systematic planning? 3. Does the cooperative have its future plans written, well organ- ized, and adequately detailed ? 4. Are future capital needs con- sidered in the current budget ? 5. Does the association have suffi- clent capital ? 6. Are adequate records and ac- counts maintained ? 7. Are regular audits made by qualified auditors? 8. Are unit costs low? 9. Is volume adequate—in terms of present facilities and in terms of present and prospective competition ? 10. Is the business increasing or decreasing—in absolute terms and in relation to competition ? 11. Have dependable sources of supply and dependable markets been developed ? Members and leaders of a coop- erative may use these, and other questions they suggest, in self- analysis. Special Needs of Cooperatives Although a cooperative builds on the same foundation of business practices as any other business firm, differences in a cooperative’s ob- jectives necessitate some deviations in those practices. A cooperative has certain specific needs as a re- sult of the relationship between the organization and its patrons, trac- ing through from its distinctive ob- jectives. The general manager and The cooperative way of doing business makes certain special types of records essen- tial. This is the office of Lytton (lowa) Cooperative Creamery. procurement practices are particu- larly important. The person who holds the posi- tion of general manager has much responsibility for the success of a cooperative. It behooves the mem- bership, therefore, to evaluate his qualifications and performance carefully. Procurement practices, likewise, call for judicious apprais- al to be sure they meet cooperative requirements, At times it may be tempting to sacrifice such require- ments in order to capture the re- wards of increased volume. Cooperatives need several specific statistical and accounting records. These are so important that we sug- gest they be included in administra- tive criteria as well as employed in self-evaluation. The needs for these records will be discussed after our comments concerning the gen- eral manager and procurement practices. General Manager.—Only a strong supporting membership con- tributes more to the success of a co- operative business than does a good manager. To be effective in a co- operative capacity, the manager, in addition to his general business 29 qualifications, must understand and be in sympathy with cooperative principles and methods. These questions may be asked in evaluating a manager: 1. Does he think of and deal with patrons as members and owners to be served, or as mere suppliers of milk essential for the success of his business ? 2. Is he in sympathy with the principle of democratic control by members, exercised through . the board of directors ? 3. Does he hold the confidence of directors and member-patrons and use their suggestions in formulat- ing working policy ? 4, Does he act on policy matters only after approval by the board? 5. Does he help develop progres- sive, constructive policies for the directors to consider ? 6. Does he train personnel for supervisory positions so that they qualify from both the general busi- ness and cooperative points of view ? Positive answers to these ques- tions indicate the kind of general manager who will work with the board and operate the business in a manner consistent with the in- terests of producer-patrons. Procurement Practices——Volume of business is as important to a cooperative as to any other type of dairy enterprise. Because of changes in technology and in mar- ket structure, the volume of milk which supported efficient process- ing and marketing operations in the past is no longer sufficient in most cases. Lack of volume has become a major problem to many coopera- tive plants. Control of a sufficient volume of milk is likewise a major concern of cooperatives that sell milk by bar- gaining and operate no plants. 30 Without it they have little bargain- ing power. While a dairy cooperative can- not serve the best interests of its patrons without sufficient volume, that volume should be sought in a manner consistent with the coopera- tive’s need for a strong membership structure. It is, therefore, impera- tive to consider these questions: 1. Do all producer-members pa- tronize the cooperative ? 2. Do they patronize only be- cause of price and service advan- tage or do they also realize that membership itself carries with it responsibility to patronize? 3. Do members lend support and build volume by soliciting new pa- trons and members ? 4. Is nonmember patronage so- licited and maintained on a purely competitive basis, or is it encour- aged as a steppingstone on the way to membership ? . 5. Are the best interests of pa- trons bypassed in a competitive struggle for volume ? 6. Do member-patrons sign mar- keting agreements or contracts set- ting forth their rights and duties and those of the association ? 7. Do contracts or agreements obligate the member to patronize the association ? 8. In the absence of a contract, are members obligated by the by- laws to be patrons of the associa- tion ? 9. Are they aware of this obliga- tion and reminded of it periodi- cally ? 10. Is the association a _ pace- maker or a follower ? 11. Does it adopt new and im- proved practices and methods in its operations ? 12. Has the association main- tained high quality standards? 13. Does it assist its producer- patrons in improving the efficiency and quality of production on their farms ? 14. Do returns in price, in serv- ice, and in equities merit members’ support of the cooperative ? 15. If the answer to the last question is negative, should the co- operative be permitted to disinte- grate from lack of support, or should its competitive position be strengthened and its service to mem- ber-patrons continued by merger or other joint action with other mar- keting organizations ? Specialized Siatistical and Ac- counting Records. — Cooperative methods of doing business require certain special records. This is par- ticularly true in cooperatives carry- ing on integrated lines of operation and serving patrons who have un- like interests in the business. Co- operative methods of distributing net margins or operating balances also require special records. A cooperative must maintain up- to-date membership rolls in a con- veniently useable form. These are needed to conduct business meet- ings; in elections of directors and other officials; and in computing total member versus nonmember patronage and producer versus non- producer patronage. (See pp. 19, 20, and 21, “Producer Status and Patronage.”) A dairy cooperative also needs accurate membership rolls if it wishes to vote for its members or to perform marketing services under the Federal milk marketing order program. A cooperative that conducts elec- tions or reaches any other business decision on the basis of districts or local divisions also needs records of the members assigned to each dis- trict. That is, if each district nomi- nates or elects a director, the chair- man of the meeting needs a record of the members eligible to vote, It is true that elections and other business decisions are not often de- cided by a close vote and a close check of eligibility of members to vote may rarely be important. But 1t 1S very important to have the means of checking this eligibility should a decision be contested. If any members have more than one vote, a cooperative must main- tain a record of the number of votes to which each is entitled. This ap- plies particularly to cooperatives that authorize voting in proportion to patronage. Cooperatives should prepare an annual summary of their member- ship and voting rights. The fol- lowing form is believed to include the information needed for com- pleting most or all reports to mem- bers and to public agencies. Num- ber of Num- mem- ber of Members bers votes 1 Farmers (including land- lords, tenants and farm- ing companies) Farmer cooperatives Other 1To be filled out only if any members possess more than 1 vote each. A farmer cooperative must main- tain accurate and permanent rec- ords of the ownership of stock, re- volving funds, and other equities. The need for these records is clear. Accurate records of each indi- vidual’s patronage are required to compute patronage dividends and also to compute member and non- member patronage. ‘These must be accumulated and tabulated for each fiscal year. Itseems prudent to pre- serve these records for at least 5 years in case any questions, misun- 31 derstandings, or lawsuits arise. A so-called “exempt” association should not destroy any records without approval of Internal Reve- nue Service. Computation of total member and nonmember patronage calls princi- pally for a correlation of member- ship rolls and patronage records. Some laws and administrative reg- ulations currently make separate mention of patronage by farmers, business with the United States and its agencies, and patronage by other cooperatives. These requirements are entirely consistent with the various criteria of a farmer cooper- ative discussed in this report. Essentially, they are all designed to help insure two of the major points we have emphasized: That the organization’s purpose is to per- form marketing service for its producer-patrons, and that it is controlled by producer-patron members. A tabular form is needed to assure that data are available to report to members and to public agencies on the various categories of the business. The cooperative should record the following infor- mation : Classification of business transacted dur- ing fiscal year ended —————, 19— 1. With or for members: Farmers (including land- lords, tenants, and farm- INCOM PALES ) 2 see See ee Farmer cooperatives______ OT Cree a ao ee aes 2. With or for nonmembers: Harinerst.. 2 a ae ee Farmer cooperatives______ United States or agency thereof (Business with holders of stock with- out voting rights is nonmember business. ) 32 Accounting practices of a farmer cooperative should provide for sep- aration of the returns and operating costs related to each major class of patronage wherever this is prac- ticable. The cooperative idea of self-help requires separate account- ing to groups of patrons with dif- ferent interests. This problem is becoming increasingly _ severe. Many dairy cooperatives market two grades of milk. Some market milk and other farm products and have farm supply operations. There are numerous combinations. Present accounting practices force _Many cooperatives to essentially follow the market in returning mar- keting proceeds to patrons and other suppliers, or to be quite arbi- trary. The first priority may be for co- operatives with this problem to place all marketing patronage in one category, all purchasing of farm supplies in another category, and farm service operations in a third. Cooperatives with two or more sep- arate marketing operations may find it advisable to subdivide those ( Separate accounting for substantially dif- ferent major classes of patronage is im- portant to members and also provides a valuable tool to management. operations, with separate depart- ments for Grade A milk, manufac- turing grade milk, eggs, and so on. Member-patrons themselves should insist that their directors and general manager maintain sep- arate accounting for substantially different major classes of patronage to the extent that classification is practicable. The basic problem is how the co- operative may best achieve sub- stantial equity in its treatment of different patrons. Theoretically, it should try to return to each patron the margins derived from market- ing that patron’s commodities. As a practical matter, achievement of that goal is impossible. Conse- quently, each cooperative should classify its patrons and their pa- tronage to the extent that the costs do not become disproportionate to the benefits of the classification.?¢ We recognize that such depart- mentalized accounting is complex and involves elements of judgment. For these reasons, separate account- ing is not justified for low-volume departments where the amount of extra accounting detail is out of porportion to probable savings or usefulness of the records. The strongest argument for departmen- tal accounting is its usefulness in management, rather than its neces- sity in demonstrating operations at cost. Financial Practices—The basic objectives of cooperative operations make investment of risk capital in ) The Patronage Refund, Notes, 35 Minn. Law Review 549, p. 558, May 1951. mine the returns on every commodity separately unless the volume handled or the difference in margins is great enough to warrant the additional labor and ex- pense.” . it may not be practical to deter-. an individual cooperative unattrac- tive to outside investors in most cases. When investors, rather than patrons, hold large amounts of risk or ownership capital, pressure may be exerted to abandon cooperative methods and objectives and to op- erate for the benefit of such in- vestors instead of for the benefit of the patrons. Articles or bylaws of all coopera- tives should limit dividends on stock to a maximum of 8 percent a year; less if a lower maximum is set by State law. The Capper-Vol- stead Act and much other Federal and State legislation that follows its provisions make limited returns on capital an alternative to the one- man one-vote practice, instead of an absolute requirement. We recommend that the principle of limited returns on capital be adopted by all farmer cooperatives to insure that they will provide their services to patrons at cost. Members and their leaders may employ some additional questions concerning financial practices of their cooperatives. 1. Do patrons provide capital in proportion to the volume of their patronage? This question is espe- cially important for equity capital on which the cooperative pays little or no dividends or interest. 2. Is the revolving fund method of financing used? This is certainly not the only sound financing meth- od for cooperatives. But it is a suitable way, if properly adminis- tered, of providing for the propor- tionality described in point 1. 3. If a revolving fund is used, does the fund revolve? If not, why not? Does the failure to revolve result from investing the fund in fixed assets so that it is out of proportion to the annual net sav- ings available to revolve it? Is 33 some permanent capital stock needed to supplement the revolving fund ? 4, Have plans been made to pro- vide the kinds and amounts of cap- ital needed for expansion ? 5. Are provisions made for retir- ing revolving fund credits or other ownership equities of nonpatrons? 6. What proportion of total own- ership equities is held by non- patrons? We have previously rec- ommended that voting rights of nonpatron members be promptly terminated. It also is preferable, but not essential, to retire the equi- ties of nonpatrons if their amount is large in proportion to the total. These may be converted into call- able, dividend-paying, nonvoting shares of stock, if it is legally au- thorized. Determinations by Public Administrators As we have noted frequently, many of the preceding standards for identifying a dairy cooperative can be used by public administrators as well as by a cooperative for in- ternal appraisal. We have identi- fied 11 criteria that are sufficiently specific and important for potential use by public administrators, and are listed separately in the conclu- sions. But several of these item- ized criteria require some interpre- tation in their application. The public administrator faces a difficult task in applying standards that require the exercise of judg- ment. This difficulty becomes ap- parent in considering, for example, how to identify the individuals served by an organization being appraised for its cooperative fea- tures and those who controlit. The administrator in our system of gov- 34 ernment is limited to applying, with the necessary interpretation, his legislative authorizations. He must be on constant guard to explain and defend his actions. It is difficult to include in legislation criteria which will fully take the place of judg- ment. It is recognized that legislation authorizing certain programs may need clarification as times change in order to assist administrators of those programs in exercising judg- ment when applying legislative standards. It also may assist pro- gram administrators, if the legisla- tion directly states their authority and responsibility to develop and apply necessary criteria for identi- fication of organizations qualified to obtain the rights reserved for cooperatives. No Permanent Criteria While we have outlined numerous criteria and guides to cooperative character of dairy organizations, we make no claim that these are either complete or permanent. Other business practices and pol- icies than those presented also re- flect the ability of an organization to serve its patrons and to adjust without erosion of its cooperative character. As a dairy cooperative expands its services, it will need to make changes in its business and operating methods. _Accepted ideas of cooperative character are likewise subject to change. It is imperative, however, that each proposed change be con- sidered from the standpoint of its contribution to the cooperative’s prime objective. That objective is for producers to serve their own best economic interests through marketing under their own control. Cooperatives and Federal Orders INCE the end of World War II, an increasing number of cooper- atives marketing fluid milk have turned to Federal milk marketing orders for assistance. In 1960, over 43 percent of all milk sold by dairy farmers to plants and dealers in the continental United States was priced under Federal orders. Early Development Federal orders entered the milk marketing picture in the 1930’s as a means of establishing more or- derly marketing conditions and higher prices. Before that time fluid milk marketing cooperatives had developed and were using clas- sified pricing plans with varying degrees of success. The Federal milk marketing or- der program was established under the Agricultural Marketing Agree- ment Act of 1987. This program attacked the problem by providing an industry pricing plan, similar to that previously attempted by the cooperatives. It differed mainly in that: (1) Minimum prices applied to all handlers on all milk eligible for fluid usage in the market; and (2) the order was enforceable by law. Prices bargained for by cooperatives acting independently had applied only to their patrons’ milk and depended upon the bar- gaining strength of the cooperative for enforcement. The principal procedures incor- porated in Federal order programs are: 1. A marketing area is defined within which the handling of milk will be regulated. 2. Milk is classified in accord- ance with the purpose for which it is used. 3. A minimum price to producers is fixed for each classification of milk use. 4. The minimum price is thesame to all handlers. 5, Milk is pooled either on a mar- ketwide or individual handler basis. 6. An agency is provided to ad- minister the order. Cooperatives provide professional representation for their members at Federal milk marketing order hearings. 35 These mechanisms and _ proce- dures improved the orderliness and stability of marketing and, in many cases, brought direct price increases. The Secretary of Agriculture is directed to employ a hearing pro- cedure to obtain the facts used in establishing Federal orders and their terms. The details of how Federal or- ders are established and how they operate are not directly pertinent to the subject under discussion here. It is important, however, that we consider the significance of the Fed- eral orders from the standpoint of cooperative participation. Role of Cooperatives Federal orders do not replace dairy cooperatives as representa- tives of producers in marketing milk. On the contrary, those ad- ministratively responsible for the program at the national level have always recognized the necessity of continued cooperative endeavor in effective Federal order operation. Congress acknowledged this in pass- ing the 1937 act by providing for the rights of cooperatives operating in Federal order markets. H. L. Forest, Director of the Milk Marketing Orders Division of the Agricultural Stabilization and Conservation Service, is directly responsible for administering the milk orders. He expressed this view in a 1959 speech, when he was Director of the Dairy Division of Agricultural Marketing Service: Farmers must take an active part in building the records on which marketing orders are drawn. They can do this ef- fectively only through their cooperatives, which enable them to employ the assist- ance of trained specialists to analyze the market problems from the producers’ point of view. 36 Only through cooperative marketing associations can producers develop and provide the kind of expert leadership and professional service required for ef- fectively presenting the needs of pro- ducers and supplying all the necessary information concerning the producers’ side of the market. Such information is indispensable to the formulation of a market price program.” This statement emphasizes the important role the cooperative plays in pricing milk under a Fed- eral order. In a regulated market, minimum prices are established by the order—not by negotiation between the cooperative and the handlers. The terms of the order, however, depend largely on the ef- fectiveness of the cooperative and of milk distributors in presenting data at order hearings. This change in the method of price determination is the principal effect of an order on the function- ing of a cooperative. In most other respects the milk marketing coop- erative functions as before. It still has to find a market for its patrons’ milk and provide for transporta- tion, storage, and processing. Sup- ples must still be procured. In short, the Federal order is a pricing mechanism—not a general market- ing service. Furthermore, order prices are minimums and in many cases cooperatives obtain higher prices by bargaining with handlers. As previously indicated, certain pre-existing practices of coopera- tives are specifically recognized as rights under terms of the 1937 act. These are, principally, the right: (1) To vote on behalf of its pro- ducers, (2) to pool returns, and (3) 7 Forest, H. L. Responsibilities of Farmer Cooperatives, Distributors and Government In Relation To Federal Milk Orders. Mimeo address, p. 4, Agricul- tural Industries Forum, Univ. of [IIl, Urbana, January 1959. to provide specified services for its producers that otherwise would be performed by the Market Administrator.?® The language of the Agricultural Marketing Agreement Act recog- nizes that these and similar func- tions existed before the act. Re- garding pooling, the act says, ENothing ... shall... prevent... .” Regarding marketing services, serv- ices provided by a cooperative are, in effect, given precedence over those of the Market Administrator. The voting provision merely makes explicit the agency status of the association.?° . The act specifies the proportion of producers required to approve issuance of an order. Likewise pro- ducers may request and obtain ter- mination of an order. In either case, approval or disapproval of a qualified cooperative is considered as the approval or disapproval of its producers. A qualified cooper- ative may blend its net proceeds from all sources and pay its pro- ducers in accordance with the con- tract between the association and its producers. Producers are provided various services, including collection and dissemination of market informa- tion, check weighing, sampling and testing of milk, through the' Order Administrator’s office. A _ direct charge is made for these services against producers receiving them. Producers patronizing a coopera- tive are exempt from this charge, however, if the association is quali- fied and performs the service. sss |. the producers who are mem- bers of, stockholders in, or under con- tract with, such cooperative association of producers.” 7 U.S.C. 608¢e(12). *7 U.S.C. 608e (5) (H, F), and (12). Qualifications Under Federal Milk Orders The act of 1937 specifies that co- operatives performing the func- tions discussed in the preceding section must meet certain minimum qualifications. The qualifications are not identical for each of the rights. However, as an adminis- trative official of the program said in 1938, “. . . it was undoubtedly the intent of Congress to encourage only bona fide producer-owned and producer-controlled cooperatives.*° To encourage only “bona fide” cooperatives and to achieve the pur- poses of the act, those responsible for administering the Federal milk marketing orders have developed broad criteria for judging associ- ations’ applications for qualifica- tion as cooperatives in federally regulated markets. Two separate qualifications usu- ally must be established. First, the cooperative must be qualified to vote for its producers in accordance with the terms of the act of 1987. Second, it usually must be qualified as a producer cooperative under the terms of the specific marketing or- der, and applicable provisions of the act. The following criteria have been considered by departmental staff in determining whether recognition of an association should be recom- mended to the Secretary of Agri- culture: 1. Is the association producer owned and producer controlled ? 2. Is it operated for the mutual benefit of its producers ? 9 Gaumnitz, E. W. Effect of Federal Milk Control on Cooperatives. Mimeo address, p. 5, Annual Convention of the National Milk Producers’ Federation, Cincinnati, Ohio, November 1938. 37 3. Does it conform to the require- ments of the Capper-Volstead Act as to either voting or dividends, and, in any case, as to dealing in the products of nonmember- patrons? 4. Is it contractually authorized to market its producers’ milk and does it actually make use of this authorization ? Details of the interpretation and application of these criteria are not within the scope of this study. If cooperatives have been quali- fied for voting and do not sell milk to regulated handlers at prices less than those fixed pursuant to the or- der, they can expect recognition for pooling milk and paying their patrons according to contract. In addition, their independent pro- grams for check testing, verifica- tion of milk weights, and providing market information to producers will be recognized if they have ac- tually performed these services in a satisfactory manner. The responsibility of administra- tive officials does not end when eli- gibility 1s determined and a coop- erative is accepted as qualified under an order. Encouragement of “only bona fide cooperatives” neces- sitates regular appraisals to assure that associations previously quali- fied under the order retain their cooperative character, continue to be controlled by and operated in the interests of the producer-patrons, and continue to provide specified services at acceptable levels. Experience has indicated that considerable caution is necessary to avoid qualification, and_ thus encouragement, of organizations incorporated as cooperatives and controlled on paper by producer- patrons, but actually dominated by other than active producer interests. Such organizations obviously are not likely to adequately represent producer interests in Federal order marketing operations. Detection of such outside controlling interests is not always easy.