Cooperatives as a Business Model in the 21st Century: The Case of a California Wheat Cooperative1 Pr

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Cooperatives as a Business Model in the 21st
Century The Case of a California Wheat
Cooperative1Presented by Jay E. NoelJim
AhernDavid 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 Californias 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 gt
  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 CMs.
• Thus, view CMs 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

• Flour Milling
• Value-Added Processing
• 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 Feasibility

• Grower 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 survey
• 1. 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 CMs.
• 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 gt 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
  gt an anticipated Cost disadvantage
• Entry barriers exist due to economies-of-scale,
  market saturation, and size and risk of
  investment 6MM. Table Mill Investment