LETTERS: Co-op Democracy, Co-op Discounts

[Several readers responded to the previous editorial on co-op purpose, which quoted from a column by Russ Notar.  Following those letters and a response are a separate letter and response concerning the treatment of co-op discounts.]

Russ Notar:

"Cooperatives are businesses"

I appreciate your continued support of the National Cooperative Business Association and our staff as we continue to follow our mission to "develop, advance and protect cooperative enterprise."

At a recent staff meeting, we had a discussion similar to that you put forth....Our discussion ranged from "cooperatives exist because they work" to "cooperatives help members owners control their business."

My view is that cooperatives are not an alternate form of business, they are businesses -- they originated because of an economic and social need, but they would not have survived, basically, in their original form if they didn't meet those needs.

As we approach the 21st century, I would predict that the interest in the cooperative form of business will continue to grow, and the number of people involved in cooperatives will increase, though the number of cooperatives will decrease. There will be partnerships and coalitions between cooperatives and non-cooperative businesses. One reason for these partnerships will be an affirmation of several of the key points by Frank Lindenfeld, which you provided in your article.

Russ Notar, President & CEO

National Cooperative Business Association

Mark Jacobson:

"Risk management strategies"

This letter is to present a point of view different from...your statement in "Operating at Cost -- or Democratic Control" that "the purpose of cooperatives is to democratize ownership of economic resources." This is too broad a statement and does not get at why we should have cooperatives. Not all economic resources should be owned democratically.

The purpose of cooperatives is to address needs that the for-profit economy cannot meet because of its emphasis on profit and risk avoidance. Cooperatives are risk management strategies for solving basic human economic problem. All cooperatives got started this way: the market wasn't meeting a group of people's needs, so these people pooled their resources, assumed risks, and began an enterprise to deal with their problem. While some would argue that it is because of a philosophical principle that cooperatives are democratic, I believe that it is more for expedience. Democratic control is simply the most convenient form of ownership because it eliminates favoritism and puts each member on an equal footing with the rest.

Whether these people are dairy farmers seeking better markets or parents dealing with child care problems makes no difference. The confusion comes when some of these cooperatives become a very successful, and competitive, part of the global marketplace. It is hard to see how these cooperatives are serving a need that would not be met by for-profit enterprise. But when we dig a little, it becomes clear.

For instance, 80% of the dairy market is controlled by a few large cooperatives, and 80% of the beef industry is controlled by a few large corporately-owned packing houses.  As a group, dairy farmers are better off than ranchers financially, even though both groups raise cattle for production. What would our dairy industry be like if it was controlled by for-profit corporations? You could make a good argument that it wouldn't be better off than it is now, and likely few dairy farmers would own their land. So the economic need that dairy cooperatives serve is that of keeping control of dairy assets, and the industry, in the hands of farmers and their representatives. This has little to do with dairy cooperatives being democratic, as evidenced by the fact that so few farmers participate in these large cooperatives beyond providing a product. (In other words, the dairy farmers don't have a need to participate democratically in running their cooperatives, but they do have a need for the business to protect the interests of dairy farmers and the industry.)

The issue of taxes is tangential to this argument: since cooperatives meet needs not met by the for-profit economy, they should not be subject to the same levels of taxation as for-profit enterprises. Moreover, the problem is not that cooperatives don't pay taxes, which, of course, they do. The problem is that corporation income is taxed twice. Corporations should be seeking to be taxed only once, instead of trying to get cooperatives taxed twice.

Mark Jacobson, Development Director

Cooperative Development Foundation, Washington DC

Joel Welty:

"Different focus, different appetite and different powers"

Many thanks for your editorial in the September-October '97 issue. You are right on target about co-ops being more, much more, than "just another form of private business." Yes, talking that way makes us vulnerable to legislative attack. Yes, talking that way confuses prospective members trying to understand a non-profit business that "has to make a profit." And the problem goes much deeper than that.

What often appears to be a minor economic change turns out later to be one of history's compass needles of fate, pointing the course of civilization off in a different direction. When Roman aristocrats began creating their large landed estates, the latifundia, they did not realize they were laying the foundation for the middle ages and the end of the Roman empire itself. When ship owners set up the first joint stock companies, they would have been amazed to have been told that their invention of the corporation would reshape the whole world and shake apart the apparently invulnerable empires of their world.

Co-ops can be another such compass needle of fate. Because co-ops subordinate capital to the authority of the members -- both as to direction of the co-op and as to ownership of the results of the organization's efforts -- we have a new breed of economic animal with effects potentially as dramatic as the invention of the latifundium and the corporaton. Co-ops have a different focus, different appetite and different powers from ordinary corporations. Co-ops can become the foundation of a different sort of world, one emphasizing sustainable community.

One factor could keep our co-ops from working up to this potential: co-op leaders who tell us our co-ops "are just another form of private business." There is no better way to guarantee a ho-hum response from people we want to attract. Sure, we are no more aware of the long-term consequences of the cooperative commonwealth than were the builders of the first latidundia and the first corporations. But at least we need to keep our eyes open to the more profound significance of what we are doing. We'll do better than if we wear blindfolds.

You're right, Dave, to worry about that phrase "operating at cost." We don't. We should not. If we hold ourselves out to the public in that image, we can expect to see a law preventing us from ever building up reained earnings to better serve our members. An "operating at cost" image would prevent co-ops from building the sustainable community that can be our most valuable service.

We must quit calling the proceeds of our efforts "profits." That word is used to mean several different things in ordinary corporations. The key use of the word is the amount of money paid over to investors; that's profit. We don't pay anybody any profits. We are non-profit.

However, ordinary businesses also call the excess of income over expenses profits, too. That's natural, for them, because the profits paid to investors must come from that excess of income over expense. You even hear gross margins on items sold referred to as profits, though they really know better if you quiz them. "I made quite a profit on selling that case of canned pineapple." In this case, there is even less of a connection between that use of the word and the return paid to investors.

In a co-op, we do need to take in more money than we pay out. We can't "operate at cost." We need to build up a fund of capital that is the common property of the cooperative, in the words of the 1995 re-statement of the Rochdale Principles. (Ian McPherson says that clause created bitter controversy among the committee on principles.) That does not lead to a payment to investors. We bewilder people when we call it profit.

I propose we dump the word "profit" entirely. The excess of income over expenses is net earnings. The common fund we keep to operate with is retained earnings. The excess of money something sold for over what we paid for it is gross margin.

Let's tell it the way it is; profit it ain't.

Joel Welty, Executive Director

Michigan Alliance of Cooperatives

Dave Gutknecht replies:

Russ Notar repeats that there is nothing "alternate" about co-ops, they are simply businesses. In the same vein of expedience and co-ops as merely a means to member gain, Mark Jacobson's letter shows more clearly the divorce between political and economic democracy that plagues clear thinking in this country, even within cooperatives.

Jacobson offers us an uninspiring vision that seems to relegate co-ops to fields where private companies have not yet figured out how to reap enough profits to justify their "risk management strategies." And he concludes by advising these corporations not to bother co-ops but to seek lower corporate taxes.

Jacobson responds to my statement that "the purpose of co-ops is to democratize ownership of economic resource," with a non sequitur: "Not all economic resources should be owned democratically." That is a matter for a different debate (the one concerning whether we propose a cooperative commonwealth or a cooperative sector of the economy.)

He goes on to suggest that the ownership structure of cooperatives is merely a matter of expedience, adopted to get the job done. But a structure that eliminates favoritism and establishes equality is chosen because that is what the members want. The strangeness of Jacobson's assertion can be illustrated by altering his statement, as follows: "While some would argue that it is because of a philosophical principle that capitalism is undemocratic, I believe that is more for expedience. Undemocratic control is simply the most convenient form of ownership because it promotes favoritism and puts each person on an unequal footing with the rest." While this statement is unlikely to made seriously, it is true in the way jokes are by revealing a contradiction -- the notion that ownership structure is separable from what gets done and how it is done. Capitalism reproduces inequality and is about inequality.  Cooperatives build egalitarianism and are about democracy.

The limits of a purely expedient view of co-ops' purpose appear in Jacobson's own example from the dairy industry, where cooperatives succeed in keeping control of dairy assets in the hands of farmers and their representatives. According to Jacobson this result has nothing to do with co-ops being democratic! But how many farmers attend the memebership meeting is not the sole or even most important measure of democracy. The cooperatives he describes exemplify (however imperfectly) democratic control of resources. Their ownership structure and principled sharing of capital and earnings have had the intended effect of helping forestall impoverishment of dairy farmers and their communities.

Like Joel Welty, I view co-ops as the foundation for a different kind of world. But I also share his caution against certainty concerning the long-term consequences of any current program -- grand historical metaphors have fueled many good intentions on the road to hell. To me, "the more profound significance" of cooperatives lies less in tomorrow than in what happens today and thereby what groundwork we lay for tomorrow: We build the road as we travel. My concern is with actual practice and its consistency with continually examined principles and assumptions.  That is why I included Frank Lindenfield's summary of basic values and methods for building a world along cooperative lines.  His list could be called the teachings of a lifetime. A well run cooperative designed and operated to manifest those values, or at least not violate them, will itself be a profound and appropriate statement.

The notions of sharing and solidarity are how I would translate those values most succinctly. In cooperative practice, among the key ways these values are manifested is in how earnings are handled; member discounts are a subset of this issue. That is why recent editorials on cooperative mission have touched often on discounts and member capital.

Welty brings this discussion full circle with his remark on the controversy over common capital, as distinct from capital allocated to individual members. My initial editorial beginning this series argued the need to reserve some portion of capital for the cooperative as a whole and for its future. I criticized U.S. leaders who, in helping prepare the international statement of cooperative principles, argued against a provision for reserving a portion of capital to be held in common.

The expedience-minded school from the U.S., reflecting the dominant business outlook and national government, has trouble recognizing the need for social control of capital. Their co-op direction is more "We're here to get ahead" than it is "We're here to help each other." They cannot see that co-ops are more than a means for individual member gain, that a cooperative whole is greater than the sum of its member parts.

Larry Sadler:

"Discounts erode margin."

[The following letter responds to the Retail Operations Survey, by Scott Beers and Dave Gutknecht, which stated:

In the composite Income Statement, discounts are no longer presented as a reduction of gross profit, but rather as an expense line item...making the format congruent with our thinking that discounts are a manageable expense. They are not a given, but a choice by the co-op: to what degree are discounts need at the register, and to what degree is it prudent to withhold distribution of earnings until the year-end figures reveal exactly how much is available? Since discounts compete for scarce gross profit dollars against labor, rent, marketing, and other expenses, it makes sense that they be presented with those expenses.]

We are the only co-op natural food distributor in Ontario, serving members from Thunder Bay to Newfoundland. Our primary market is southern Ontario with a strong regional centre in Halifax, Nova Scotia. We have about 350 members and a large number of [currently] nonmember customers yielding a combined total of about $5 M per annum in sales employing 19 full time staff.

I have enjoyed the scope and depth of Cooperative Grocer and the financial articles in particular, which fits with my role here as financial manager. In the July-August '97 issue, I note your change of policy regarding discounts and offer a contrary opinion.

Discounts to customers are a direct erosion of the margin. It is a false perception to believe the margin you are putting on at the pricing stage. It is the margin you get that really counts, and thus Revenue net of discounts is the most realistic base to measure true Gross Margin from. It also avoids the degree, although it may be slight, of understating key expense ratios by using pre-discount Sales as the base. An admittedly extreme example is the computer industry, which brags about 40% off list pricing, but the whole industry does it, so list price, like pre-discount price, is meaningless.

I acknowledge that discounts are, to a degree, a controlled item. However, market forces and marketing/sales pricing games shroud real sales, and it is real sales that yield real management information.

There is the in-between issue of items such as COD discounts for those of us who have A/R accounts. This is a good example of a discretionary discount, and I apply it to adjust the Gross Margin to achieve an Adjusted Gross Margin. I also endorse your view that personnel discounts should be counted as an expense item because it is really a staff benefit and should be measured as part of Personnel Expenses.

Notwithstanding this rant, I look forward to each issue to see what analysis topic is next. I believe analysis is where the accounting/computer system will play its strategic role in competitive survival. As an offering, I related one of the memorable items I picked up in school. We were given an article from the early '70s from Harvard Business Review which described a comprehensive multi-sectored analysis of American business.  The impressive results drawn from linear regression of one of the tables is that there is [was] an outstanding inverse correlation [r<-.97] between profitability and inventory levels among a number of key parameters and across all sizes of companies [in this survey].

This confirmed the assertions of my Finance prof who said that working capital management is one of the key management skills. In Finance class I accepted the doctrine; in Marketing class I became a believer. The extension of this thought are the four requirements to make it happen: the right computer system, the right accounting system, the right analytical tools, and the right personnel to use the tools and implement the meaningful feedback loop.

Keep up the good work.

Larry Sadler, Financial Manager

Ontario Natural Food Co-op

Scott Beers replies:

Discounts certainly seem to generate dialogue among co-ops. As Mr. Sadler ably exhibits, one can intelligently argue for different discount presentations in food co-op financial statements. David and I debated this issue prior to publication, and we decided on a new format.

A big reason for the change is that most co-ops who respond to the survey treat discounts as an expense. By adopting this new presentation, we should make it easier for them to compare their statements with the industry results.

Additionally, working member and staff discounts are larger in amount than discounts to members in general in most stores. Mr. Sadler agrees that this type of discount deserves treatment as an expense. Since they are primary and the survey responses do not permit consistently reliable distinctions among discount varieties, choosing to treat all discounts as an expense in the composite financials of the Survey seems prudent.

Furthermore, carrying all discounts as an expense has an advantage when comparing food co-op performance to the larger natural food or grocery industry. Success in food retailing is largely determined by making gross margins and controlling labor costs. When discounts are treated as an identifiable expense, it is easier to compare co-op and industry performance on the gross margin line, and it highlights this additional cost that co-ops choose to bear, much of it labor related.

At the store level, it is easier for managers to draw conclusions about their computation if it is done without regard to discounts. For example, if Produce is priced for a margin of 38% and shrinkage of 4% is allowed for, the manager is looking for a 34% margin on the financial statements. Inserting a reduction for discounts into this computation makes it harder for managers to relate their day-to-day activities to the results presented in the financial statements.

All Cooperative Grocer surveys have treated sales beforee discounts as 100%. There is no change in presentation in this area. I am strongly of the opinion that pre-discount sales are the best measure of 100% for retail food co-ops. As an analyst, I'm interested in the whole pie and how it gets sliced up.

Finally, there is a wide spectrum of financial expertise among co-op directors and managers. We don't promulgate the survey presentation as a Financial Accounting Standard. It is not optimum in all regards. It does, however, provide a common yardstick for co-ops in North America to use, and can be a basis for a more consistent presentation of financial results. Its utility depends on it being simple enough for all co-ops to use, while having enough tempeh on its bones for meaningful analysis to be performed.

Scott Beers

co-author, Retail Operations Survey