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Cooperatives as a Business Model in the 21st Century: The Case of a

California Wheat Cooperative1

Presented by Jay E. NoelJim Ahern

David Schaffner

1This presentation is based on an economic feasibility study of forming a California wheat cooperative funded by Rural Cooperative Service-

USDA and the California State University Agricultural Research Initiative.

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Why a California Wheat Cooperative?

• Concerned southern San Joaquin Valley wheat growers – issue, the lack of profitability in wheat production.

• Two feasibility issues addressed relative to choosing a marketing cooperative as a appropriate business model: economic feasibility (cash flow) and organizational feasibility.

• Focus - possible new generation coop

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Economic Feasibility Issues2

• Could cooperative formation achieve competitive assembly-marketing margin costs, leading to higher farmer prices?

• Could cooperative formation increase farm level price by engaging in vertically integrated marketing activities?

________2. Sexton and Iskow, 1988, “Factors Critical to the Success or Failure of Emerging

Agricultural Cooperatives,” Giannini Foundation Infor. Series No. 88-3.

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Sexton and Iskow suggest three possible ways to raise farm level prices, two of three evaluated here.

The third - reducing market power of marketing intermediaries does not seem to apply to the California

wheat market. With over 70 California wheat merchants (per California Wheat Commission),

coupled with California’s wheat deficit status, suggest ample competition exits to assure a competitive price

paid for California wheat.

Additionally non-economic benefits can arise from cooperative formation, e.g. belonging to democratically

controlled organization, such benefits were not evaluated.

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Economic Feasibility Analysis

• California is a wheat deficit state.

• Three major market outlets for California wheat production:

1. California flour mills (40%).

2. California feed wheat (40%).

3. Export (20%).

• Potential Value Added Market Opportunities:

1. Flour Milling

2. Value-Added Processing

3. Specialty wheat and flours

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Could Cooperative Formation Result in lower Assembly-Marketing Margin Costs?

• California flourmill market for wheat assessed -as the largest assembly-marketing margin spread of three plausible current markets.

• Los Angeles flourmill market was used since all available flourmill delivered price information is for that market.

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Assembly-Marketing Margin Indicators

• Assembly-Marketing Margin: (MM) = Pmi– Pf (assume conversion factor =1); Pmi = delivered price, market i; Pf = farm price

• Contribution Margin: (CM) = MM – S – T , where S is storage cost and T is transportation cost.

CM measures amount of money available to pay for firm operating expenses (OE) and provide for profit (P).

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Could cooperative formation reduce flourmill assembly-marketing margin

costs?

• Majority (92%) of California wheat stored off-farm.

• California wheat in storage for relatively short period - most wheat (80%) being marketed May to September of marketing year.

• Grower survey / wheat merchant interviews => ample storage capacity with perhaps minimal harvest time problems.

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Estimated Wheat Storage Cost

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• Fixed cost per ton new wheat storage facilities range: $8.55 to $11.96/ton, approximates the current industry storage costs. Those costs need to be adjusted upward to reflect the variable cost of storage. TC likely higher than current storage prices/charges.

• Sufficient wheat storage facilities exist - storage obtainable at competitive rates.

• Cooperative formation unlikely to result in reduced storage rates.

• Investment transportation services, similar to storage, ample competitive rate transport services available at.

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Contribution Margins

• Contribution margin (CM) indicators estimated for Los Angeles flourmill market.

• Average monthly price data and industry figures on storage and transportation costs used to estimate CM’s.

• Thus, view CM’s as opportunity indictors, not accurate estimates of operating costs and profit.

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L.A. Flourmill Market Contribution Margins/cwt

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Wheat merchandising Conclusions

• Assembly-marketing costs not likely reduced by wheat growers cooperative formation.

• Although it was not possible to calculate merchandising profit - unlikely wheat merchants would remain viable if some degree of profitability did not exist in the merchandising activity.

• Low barriers-to-entry suggest cooperative could become a merchandising organization and potentially return related profit to members.

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Part II-Potential California Wheat Processing Opportunities

A. Flour Milling

B. Value-Added Processing

C. Specialty Wheat and Flour

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California Flourmills

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A-Economic Feasibility in California

Flour Milling

Two different approaches assessed:

1. Toll Milling

2. Build Flourmill

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Toll Milling

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Investment in Flourmill

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B-Economic Feasibility of Frozen Dough Processing3

• Strong market growth: 51.7% increase non-bread frozen dough from ’92 -’96.

• 18% year to year increase in retail frozen dough sales. Food service sales of frozen dough products exceeds $3 billion.

• Overall 15% annual growth in par-baked and frozen dough markets

• CR4 = 24% - relatively unconcentrated____________3 Value-added processing of pasta and tortillas was also evaluated. These were not

included as high concentration and entry barriers made entry overtly infeasible.

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Present Value CF of Cooperative Frozen Dough Investment

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Frozen Dough Conclusions

• Attractive rate of return of 25%. Sensitivity analysis showed a low-end rate of return of 15%.

• Attractive industry growth rates.

• Relatively low entry barriers.

• Keys to success: a knowledgeable management group, conservative financial & production forecasts, and develop buyer alliances prior to construction.

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C – Exploring Specialty Wheat and Flours • No formal economic analysis was done.• Survey of 50 randomly drawn California food

processing flour users.• Majority indicate significant increase in organic

wheat flour used.• A follow-up exploratory retail inventory was

conducted. Found a cumulative total 956 Calif.made wheat containing foods from 102 different firms. 11% of those products were labeled as totally organic and 24% contained organic wheat ingredients.

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Economic Feasibility Conclusions

• Reduction in assembly-marketing costs by formation of California wheat grower cooperative is unlikely.

• Economic opportunities to enhance grower prices seem to exist in wheat merchandising, frozen dough manufacture, and production of organic wheat.

• Each has own risks and differing levels of investment and management capabilities.

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Organizational Feasibility

(a) Does an initial coalition exist?

(b) Are California growers interested in forming a wheat cooperative?

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Organizational Issues

The existence of an initial coalition.

(a) relatively small group of 15 wheat growers from Fresno And Kern Counties have lead the effort to form a California wheat cooperative.

(b) cooperative start-up funding has been received from USDA.

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Organizational FeasibilityGrower interest in forming a cooperative. A survey of California wheat growers was done to

determine their interest in the formation of a cooperative.a. Based on a list of 8,533 California wheat

growers provided by the California Wheat Commission a stratified sample of 1,519 growers was send a mail survey.

b. Survey instrument asked questions pertaining to production decisions, use of government programs, marketing options, market prices, and interest in cooperative formation.

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Survey Results• Thirty useable surveys were returned from the first

mailing.• A follow-up phone survey of eighty-six growers

and a second mailing to 102 growers who reported over 500 acres of production followed the initial mail survey. Two additional useable surveys were obtained.

• A total of thirty-two useable surveys were obtained.

• The growers who answered the survey accounted for approximately 12% or 72,583 acres of the 615,000 acres of wheat planted in 2001.

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Survey Results

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Survey Results

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Caveat to Grower Surveys

• Response rate of 2% is a cause for concern. Could reflect lack of interest in cooperative formation.

• Low response rate and consequent non-response bias did not allow for any statistical inference. Responses were treated as purely descriptive.

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Grower Surveys Descriptive Conclusions

• Majority of growers that responded to survey1. Felt prices they received were unfair.2. Felt wheat was not a good alternative to

other crops.3. Said it was unlikely they would be

growing wheat in 3 to 5 years. 4. If above is any viable indication of the

general sentiment of California wheat growers, then a wheat cooperative may have difficulty building membership needed for physical or pecuniary economies-of-scale.

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Conclusions from Grower Surveys• Growers attitudes to cooperative formation varied

widely, even with the small sample.• Generally supportive of cooperative idea but

reluctant to declare it a sound idea for the industry.• Large number of neutral responses to questions

questions whether there exists a compelling or driving need for a cooperative.

• If an emerging California wheat growers cooperative is to be successful the initial coalition must educate other growers concerning the possible benefits of such a cooperative.

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General Conclusions

• Economically feasible to form cooperative.

• Is cooperative best business model: not unless California wheat growers can be convinced that it is in their best interest to form, finance, and support a cooperative.

• General conversation with wheat growers other than initial coalition group suggest this with be a difficult task.

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LA Flourmill Market CM-Table

• Contribution margins range: high CM of $1.18/cwt to low CM of -$0.06/cwt.

• Storage costs - a large impact on CM’s.

• The grand mean average is $0.37/cwt for the 8 month marketing period.

• Grand Mean: $0.37/cwt to cover merchandising operational costs and profit, avg of {hi/low/3-3mo avg solutions}

~LAFlourmill CMs - Table

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California Flour Mill Characteristics

• 16 flourmills cumulative milling capacity 130,000 - 155,000 cwt/day(14big/2 small)

• Wheat source: Other than 2 smallest mills 80% to 95% of wheat is sourced outside of the state. CR4 = 69%, Top 5 > 3/4

• Consolidation has occurred in the industry.• Industry requires large economies-of-scale

to be competitive. ~Table Flourmills

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Economic Feasibility of Flour Milling for a California Wheat Cooperative

• Tolling milling cost is estimated at $1.57 to $2.20/cwt.

• Total cost of investment and operations for building a California flourmill is $2.003/cwt compared to a Kansas flourmill cost of $1.785/cwt => an anticipated Cost disadvantage

• Entry barriers exist due to economies-of-scale, market saturation, and size and risk of investment $6MM. ~Table Mill Investment