How should cooperatives make and pay out their profits?

Author: Chris Peterson, Michigan State University,

Every cooperative has to struggle with the proper balance between cooperative-level profits (net income and patronage refunds) and member-level profits. Some suggestions can be made to guide these key cooperative financial decisions.

(1) Cooperatives should attempt to create a significant amount of their returns at the cooperative level. The ability to more objectively measure these returns provides the motivation for this recommendation. The subjectivity of measurement and variability of return evaluation makes reliance on member level returns an uncertain proposition for cooperatives and for members. Members may even get confused about where their returns are coming from. For example, when a member receives a price differential for products sold, is the price differential based on the member’s own activities, e.g., attempts to grow quality into a crop or livestock, or the cooperative’s activities to get members fairly treated in the market? If a cooperative offers market prices at the time of purchase or sale, then the more objective, measurable patronage refunds that come at the end of the cooperative’s operating year will include price differentials and eliminate confusion for the cooperative and its members.

Pooling cooperatives that force their net income to zero will have an especially tough time meeting this guideline. However, such cooperatives can focus on communicating with members about the implicit split between what the member does and what the cooperative does in creating profits.

A corollary to this guideline is that cooperatives should maximize the amount of their net income that ultimately comes back to the member as patronage refunds and dividends. Unfortunately, cooperatives can pursue options that will not fully allocate net income to members or will postpone the actual receipt of cash for long periods of time. These practices reduce the realized returns of members, and their use should be managed carefully.

(2) Cooperatives should attempt to measure the member-level returns. However subjective and member specific these returns may be, these returns are legitimately generated by the cooperative. The cooperative needs to track these returns even if it is only done periodically through member surveys or member focus groups, and then the cooperative should promote their findings with all members. These means of assessing member-level returns are highly qualitative and mostly subjective (just as the returns themselves are). However, these methods will help place some legitimate bounds on the value of such returns and thus assist in highlighting their existence and importance to members. Failure to make some attempt at assessment will result in members undervaluing the cooperative.

(3) Cooperatives should scrutinize closely any investments or activities that are being justified solely or, nearly so, on the basis of service differentials, the value of existence or the value of risk management. As has been argued, these returns are the most subjective for members to evaluate and vary most broadly from member to member. Over reliance on such investments or activities would seem to significantly increase the chances that members misperceive the value of a cooperative. This does not mean that these sources of return should be ignored or undervalued. It does means that their value should be examined very closely to ensure that such value really exists and is not just illusionary.

(4) Cooperative financial performance cannot be measured solely on the basis of financial statements and standard financial ratios. Member-level returns are real even if they are difficult to measure. If cooperatives act only on the basis of cooperative level returns, they will merely make the exact same decisions as non-cooperatives. Membership would become valueless, i.e., the decision to patronize and to invest might as well be made separately rather than jointly. Cooperative financial decisions must take into account member-level returns if they are to be made appropriately. Cooperative financial statements are not enough to evaluate cooperative financial and economic performance. Financial statements only capture the cooperative-level returns. Even then, these returns can be understated by the financial statements if price, service and risk differentials impose costs at the cooperative level with the benefits only being realized at the member level.