The co-operative company as a business model

Business is conducted through all manner of legal entities. They include private companies, publicly listed companies, partnerships, trusts, co-operatives, mutuals, non-profits and state-owned enterprises. Hybrid forms also exist.

In some industries one type of firm is dominant and it is often easy to see why.

In farming, for example, the typical business model is an owner-managed farm, partly because monitoring of farm management by outside investors can be difficult. Yet some trusts and corporate farming operations have also prospered.

Some organisational forms are less successful. For example, research indicates that, on average and over time, state-owned enterprises perform less well than privately owned firms because governments are driven by political rather than commercial imperatives. These findings have motivated the worldwide privatisation movement. Some SOEs have succeeded, at least for a period of time, but it is unwise for policy makers to bet against the odds using taxpayers' money.

The SOE example illustrates why it is dangerous to argue that ownership and organisational arrangements don't matter, and that all that counts is having good people running the business. Incentive structures and industry characteristics affect the choice of business organisation in systematic ways.

The key to ensuring the good performance of all types of businesses is open competition – for the goods and services they produce, the inputs they use and the organisational forms they take. Actual or potential competition from other forms of business (eg between corporates and co-operatives), and the freedom to change from one form to another, is an essential aspect of competition and a stimulus to good performance. As a rule, statutory protection for any particular form of organisation should be avoided.

Co-operatives and mutuals (which are closely related) co-exist with corporates in many industries, including retailing, financial services and agriculture. Firms like Foodstuffs, Mitre 10 and Plumbing World trade successfully in open competition with corporates and without statutory protection.

Co-operatives can work well when the number of owners is small, the product range is limited, the firm can be easily monitored and capital requirements are not large.

Demutualisation of financial mutuals has been occurring because of the pressure on financial services firms to provide a wider range of products, difficulties of monitoring large mutual organisations and capital requirements.

Internationally, some health insurers, stock exchanges and agricultural co-operatives have also demutualised and brought in outside investment, but there have been a few moves in the opposite direction.

From the perspective of an owner (eg a farmer), demutualisation can have the attraction of not having to be both a supplier and an investor in a co-operative company. Investment risk can be diversified outside the industry and security of supply can be ensured through contracts.

In the dairy industry, an additional problem with co-operatives has been the bundling of returns from milk supplies with returns from off-farm investment, resulting in pricing distortions and over-production. This has been reduced with the 'fair value' entry and exit provisions but accurate valuations will remain difficult in the absence of a liquid market for shares.

In the United States , co-operatives still predominate in the dairy industry, but this may be partly due to the tax and regulatory privileges they enjoy. There is a more diverse mix of co-operatives, listed companies and multinationals (including involvement by Fonterra) in the Australian dairy industry.

The development of value-added products and brands, which are capital intensive and risky, together with expansion offshore and into non-dairy products, is likely to require more outside investment in the New Zealand dairy industry and moves away from the pure co-operative model. This pattern has been seen with the Kerry Group in Ireland and with Wesfarmers (in non-dairy activities) in Australia .

More generally, New Zealand has an unusual number of co-operatives, trusts and state-owned enterprises in its business sector, and a correspondingly smaller public equity market. This point is often overlooked in debates about the New Zealand Stock Exchange. Over time these proportions are likely to change.

There is no case for government action to force owners of businesses to change their organisational form.

The government's job is to ensure that tax laws and commercial regulations are neutral, and to enforce them (eg not exempt merger proposals from Commerce Commission scrutiny).

It is for owners to be alert to the commercial advantages of possible changes, and for boards to put proposals to them for their approval or rejection.

For more information, contact:

Roger Kerr
Executive Director
Ph: 04 499 0790
Email: rkerr@nzbr.org.nz

David Young
Communications Manager
Ph: 04 499 0790
Email: dyoung@nzbr.org.nz

Web: www.nzbr.org.nz