Family business cooperatives

Co-ops? They’re just for farmers, right? Not anymore. Co-ops are tailor-made for family business capitalists—especially those threatened by bigger competitors.

By John Grossmann

Carpet One is just seven years old but it has 460 stores across the country with combined annual sales of $1.1 billion. What’s unusual about this fast-growing organization based in Atlanta is that it’s a cooperative. By banding together and buying as a group from manufacturers, Carpet One’s 260 members, most of them family-owned businesses, are able to secure discounts equal to those enjoyed by giant chains and cut their wholesale costs anywhere from 7 to 20 percent. But the key to the co-op’s success is not merely buying power, it’s marketing power: color ads in national magazines like Good Housekeeping, paid promotional mentions on game shows like “The Price is Right,” and national tie-ins with big advertisers like MasterCard.

“It’s not just how much more you can save, but how much more you can sell,” says Pat Kerns of Kerns Carpet in Milwaukee, one of 13 original members of the cooperative. “We’re one of the largest dealers in Milwaukee, but small potatoes nationwide. Thanks to Carpet One, we’ve done marketing I could never afford, like 30-second TV spots personalized by Mariette Hartley saying, ‘Kerns Carpets has been in business for over 50 years. Why don’t you come and see us?’”

Co-ops? They’re just for farmers, right? Not anymore. Though the cooperative movement sprouted in the farm belt, co-ops have spread to family businesses in many commercial sectors, which find that the best answer to heavy competition from big corporations is to join with like-minded businesses.

Some cooperatives such as Carpet One have national scope and visibility. The Ace and TrueValue hardware stores familiar in many towns are often mistaken as national chains by consumers; they are actually retailer-owned members of national co-ops. One of the fastest growing cooperatives is in the funeral business. To counter large chains that have been invading their markets, local funeral homes have become affiliated with Trust 100, a co-op with 400 members in 22 states that offers pre-paid funeral plans and prepares ads for the group.

Smaller regional cooperatives have become a strong presence among retailers of groceries, lumber, and hardware, which find they can achieve the same economies of scale enjoyed by their national competitors. Today there are some 50 such co-ops alone that purchase and distribute grocery items to family-owned retailers. Typical is Affiliated Foods Southwest, with 297 member stores in Arkansas, Oklahoma, Texas, Mississippi, Louisiana, and Tennessee, and gross sales of $475 million in 1992.

Bradford Nordholm, corporate vice-president of the National Cooperative Bank, describes co-ops as “tailor-made for the family business capitalist,” in large part because they can help those businesses stay family owned. “Co-ops recognize how important it is that a family business be able to expand into a multi-store business,” Nordholm says, “because that’s what it takes to get sons and daughters into the business. They’ve been to college, and they need to see the business as a management opportunity, not a chance to work 80 hours a week behind a counter.”

Indeed, Nordholm regards expansion financing as second only to cost-cutting economies of scale as among the service benefits of co-op membership. He says that roughly 70 percent of the $1 billion in loans made by Washington’s National Cooperative Bank in the 1980s went to family businesses in co-ops.

In a sense, cooperation means not competing, or rather, keeping in mind who your real competitors are. Stuart Meyer, an associate professor at Northwestern University’s Kellogg Graduate School of Management, points out that it’s easy for the family firm to forget that it usually competes more against the rest of the world than against other family firms in the same field.

Today many small family businesses are finding different ways of cooperating in order to compete. They are sharing facilities of all kinds, forming joint ventures, buying insurance together, and providing common benefits such as day care that help them attract scarce skilled workers. Some have established traditional buying, marketing, or service co-ops. For those who may be pondering ways to cooperate, here are descriptions of some of the more successful alliances and what they have accomplished.

Buying co-ops

“If you want to be successful in retailing in the Nineties,” says Pat Kerns in Milwaukee, “you’ve got to be in a buying group. Otherwise, if a big chain comes in and cuts prices, you could be out of business. We can compete with the likes of Sears; we buy more floor covering than they do, and being a small business, we can out-service them—and give our customers service a big store can’t.”

United in buying cooperatives like Carpet One, small businesses can rival the purchasing power of industry giants. Often the savings are quite dramatic.

By pooling their orders, the 16 members of the United Specialty Office Products Association save from 10 to 25 percent on price. USOPA was organized 18 years ago by Wesley Siler of the Carolina Ribbon and Carbon Co. in Greensboro, North Carolina. Siler, who spent a lot of time on the road buying for his company, often swapped information informally with other buyers of office supplies whom he met in his travels. In the early 1970s the itineraries of seven buyers intersected at an Atlanta airport hotel long enough for them to form a national alliance.

Craig Siler, Wesley’s son and president of Carolina Ribbon, which now employs 85, credits the co-op for giving his once-fledgling firm enough clout to command the prices it needed to grow. To avoid squabbling over customers among its members, USOPA limited membership to geographically dispersed firms. The 16 members, in Canada and the United States, also have learned that pooling information is just as valuable as pooling purchases. “Now USOPA’s focus is more on management and marketing than purchasing,” Craig Siler explains.

So while Carolina Ribbon is now probably big enough to make its own deals with suppliers, USOPA remains valuable as a CEO problem-solving network. “We helped each other grow,” says Siler, who has shared the USOPA presidency under the group’s revolving presidency system. “There aren’t a lot of people you can talk to about your business who understand enough to give you advice,” he says. “We burn up the fax machines.”

Marketing co-ops

U.S. farmers began organizing co-ops around the time of World War I for the same reason that small fish organize into schools: to avoid being eaten by bigger fish. Farm co-ops sell or lend farmers what they need to grow their crops and usually buy and market the crops after they are harvested. Several farm supply co-ops are listed among the Fortune 500. Farmer-owned marketing co-ops do business under such well-known supermarket brands as Sunkist, Land O’Lakes, and Ocean Spray.

One of the most successful farming organizations in recent years is Golden Harvest Seeds Inc., which consists of five family seed-growing companies in the Midwest. Golden Harvest is not a traditional farm co-op but a member-owned company. The organization, based in Bloomington, Illinois, does not handle seed itself. It was established to provide advertising, research, and quality control, which the individual firms could not provide as effectively or cheaply for themselves.

The group was actually born of a rebellion in 1973 by family seed distributors and dealers. For years they had been part of a network of companies that sold under a brand famous in the Midwest: Funk’s “G” Hybrids. But Funk’s went public after having been bought out by a giant grain processing company in the late 1960s. In 1972, the new management decided to market its seed directly, ending its associates’ role as independent sales organizations. Says Frank Thorp of Thorp Seed Co., one of the rebels: “They let us know that if we behaved ourselves, they might let us grow a little seed for them.”

The families met in Chicago in 1973 and formed Golden Harvest. Each member would continue to run its own production and sales operations within a system of negotiated sales territories, but would share certain advertising and research costs. Golden Harvest would be used as a nationwide brand name. Each company would market Golden Harvest seed under the family name, such as Thorp Seed, maintaining the family’s local identity but gaining the oomph of a nationally advertised brand.

The results were immediately gratifying. The company’s founding coincided with the agriculture boom of the mid-1970s. Golden Harvest firms quickly racked up sales increases, and for a while all were adding a warehouse or grain dryer or storage bin every year.

By cooperating, Golden Harvest firms profit from their diversity. All five specialize in producing hybrid corn, but some also sell alfalfa, millet, or sorghum. A Golden Harvest company can thus offer seed in its catalog that is handled by one of the other members, without having to expand its operation. The members also conduct joint research, and share test facilities to ensure Golden Harvest seed is of high and uniform quality.

The Golden Harvest approach was most crucial, however, in establishing a national marketing campaign. Golden Harvest companies now sell their seed to farmers from New York to Oregon without having to incur the risks and costs of scaling themselves up from local to national companies. By pooling advertising costs, each member gets much greater exposure.

The Golden Harvest companies didn’t want to stay small, but they did feel a need to stay local. Increasingly, their competition comes from multinational chemical companies that in the 1970s began buying up old-line seed companies. But farmers like to buy seed from people they know, and for 40 years family-ness had been crucial to the success of the companies. For years the tagline on Golden Harvest ads has been “Family seedsmen in touch with the land.” And Golden Harvest’s brochure assures its customers: “Decisions are made by the family seed company, not by a large company in some foreign country.”

Not the least of the organization’s advantages is that it provides a training ground for the new generation and an arena where senior family members can continue to contribute. Golden Harvest is run by a board consisting of the five company presidents, who take turns serving as chairman. The heads of the five companies spend much of their time on the Golden Harvest board, while their sons hold most of the seats on committees that oversee advertising, marketing, and research.

Cooperative R&D

Shared manufacturing and R&D is rare among smaller businesses. One of the first attempts to promote such cooperation, the Michigan Manufacturing Technology Association, was founded three-and-a-half years ago to aid small machine-tool manufacturers who cannot fund research on their own. The 21-member co-op was prompted by recent changes in antitrust law under the Export Trade Certificate Amendment, which allows two or more otherwise competitive businesses to jointly bid for overseas work. The machine-tool industry is known for “dog-eat-dog competitiveness,” and executive director Ken Martin concedes there may be hurdles to licensing and sharing key innovations. “But the hope curve is up at the moment,” he says. “A lot of people are watching us as a pilot project.”

A key problem to date has been funding. Two grants from the state of $30,000 and $20,000 only began the intended canvassing of members and Michigan universities for projects ripe for commercialization. And the annual dues—only $1,000 per member—have limited Martin’s efforts on behalf of the co-op to only four or five days a month, not enough, he concedes, to get the ball rolling.

As in the case of Golden Harvest, there is some history of cooperation in R&D among older farm co-ops. The giant Cenex/Land O’ Lakes cooperative does research on agriculture and food products at its 535-acre Answer Farm near Fort Dodge, Iowa. Established in 1974, the research facility now has 60 employees, about a hundred times as many animals, and an annual budget of $4 million. Recent breakthroughs include new varieties of soybean and alfalfa seeds, and improvements in additives and methods of producing animal feeds.

“We plan for our advances to be proprietary and unique, be it a patentable item or a trade secret,” says Bob DeGregorio, Answer Farm’s vice-president of research. Some advances are licensed to others outside the co-op, if the members feel the monetary return is big enough. According to DeGregorio, licensing fees, royalties, and cost savings have made Answer Farm self-supporting, but he says it took seven years for measurable benefits to equal expenditures.

Employee Benefits

Cooperatives also erect a Fortune 500-like facade to help tame the employee benefits dragon. Case in point: The Council of Smaller Enterprises (COSE), part of the Greater Cleveland Growth Association, has helped cap ever-rising health care premiums.

“In the last six years the price our members pay has increased at less than one-third the general rate of local health insurance inflation,” says COSE senior vice-president John Polk. In 1992, while Cleveland area businesses endured rate increases of 22 percent, the co-op’s member companies saw health insurance premiums rise only 6 percent. Noting that President Clinton has stressed the need for COSE-like solutions to the health care crisis, Polk expects Clinton’s health care package, when it is unveiled, to include provisions for co-ops to purchase health plans.

Beyond saving on premiums, co-op insurance arrangements also provide long-term stability. The co-op has more power than an individual business, which might have a carrier that increases rates at every opportunity. And an expensive claim, diluted by the co-ops vast numbers, will not lead inevitably to a policy cancellation, which it so often does for an individual subscriber. The co-op is also a good antidote to the short-sighted strategy of some owners who price-shop among low-ball carriers.

An alternative to starting a local co-op is to join the nationwide Employee Benefits Cooperative. EBC is a creature of the Insurance Cooperative Agency of Madison, Wisconsin, which started in the 1930s to help state dairy farmers and livestock herders purchase insurance. Only about a quarter of EBC’s 450 members are cooperatives; a growing majority are privately held businesses, many family owned, with 25 to 50 employees, according to marketing manager Ric Joyner. EBC helps members save on flexible, or so-called cafeteria-style, health-care and day-care benefits by funding them with payroll deductions, thus lowering the taxable portion of the employees’ salaries. Participating firms are charged $2.95 per employee per month, an amount more than offset by the resulting Social Security and tax savings. Joyner’s cooperative handles all the paperwork required for federal, state, and Social Security deductions.

Sometimes a group effort, even if not formally organized as a co-op, can address an unfulfilled need. “We had two secretaries and a paralegal preparing to go on child leave,” recalls John Kirk, director of finance and administration at Fletcher, Tilton & Whipple P.C., a law firm in Worcester, Massachusetts. “We were certainly going to miss them,” he says, if a lack of available child care would have prevented their return. That’s when Kirk realized what an asset a day-care center would be—not just to employees of his firm, but to those of other nearby businesses.

Kirk mentioned his dilemma to other business owners and struck a common chord. Ultimately, six businesses, including an electric company, an elder- care home, and a life insurance company, anted up $28,000 to refurbish and outfit the basement of a local church. They identified the kinds of programs and hours employees wanted, then hired the local YMCA to run the center (“They were already licensed and had insurance,” Kirk notes). The day care has room for 24 children. Sixteen slots are reserved, if needed, for children of employees from the six companies. Each company paid $1,500 per slot to help start the center, and pays $500 per year for each slot reserved. Even when Kirk’s firm does not use its slots he feels the company benefits. “We use it as a recruiting tool,” he says. “It’s a clear-cut demonstration that we care about our staff.”

Where to Start?

Although some co-ops have been created from the top down, that is, by leaders who recruited and organized the members, authorities tend to agree that most of the successful ones are built from the bottom up. They usually begin with several business owners feeling a common economic need and asking the same kinds of questions: What if we banded together to increase our purchasing power? Why not join forces and go after bigger accounts? How about establishing our own brand-name product and coordinating a national marketing campaign? Why not share our resources and hire an expert to stay abreast of environmental regulations or employment laws?

The co-ops that have the best chance of thriving have clear, established goals. “I’ve worked with some groups that wanted to do everything,” says Frank Blackburn, director of education for the Minnesota Association of Cooperatives. “Every member has a different priority.”

Perhaps the best way to begin to identify and establish common goals is with a survey of prospective members. Next, you might undertake a feasibility study to gather data on such questions as whether a broader market exists, what a national marketing campaign would cost, how much could be saved by buying in volume. “I tell people that at the seed stage, this feasibility study need not cost more than $3,000 to $4,000,” says Margaret Cheap, executive director of the National Cooperative Bank Development Corporation. “I’m often amazed at how inexpensively some co-ops get started if they’re willing to do a bit of bootstrapping.”

Authorities also offer this advice:

• Strong leadership, though essential to any successful co-op, may also sink it. Cooperatives born of one person’s vision and drive may fail to develop true group initiative. If the founder seeks a larger share of the pie for his organization, for example, that might be divisive.

• Start with narrow objectives. You can always expand your services and product line later. Draft flexible bylaws to allow for future expansion.

• Keep your staff lean and your headquarters spartan. Many co-ops have a revolving presidency, with each business owner (or a representative) serving for a year or two. If you get big enough to hire an executive director, don’t tap the guy who needs the job most; that is a mistake made by some agricultural co-ops who have hired the farmer down the road who just lost his farm.

• Beware of too much diversity in membership. “The best cooperatives have homogeneous members,” says Gene Ingalsbe, a long-time employee who recently retired from the Agricultural Cooperative Service, an arm of the U.S. Department of Agriculture. And think twice about including outsiders, such as the manufacturers you buy from. “We started with a couple of manufacturers as members, and I’d say we made a mistake,” admits Craig Siler of the United Specialty Office Products Association. The manufacturers were eased out of USOPA after the other members realized that these outsiders had become privy to information about such sensitive matters as pricing decisions.

The one basic question that potential members must answer with a resounding yes is: Will you use the co-op? “That’s what’s going to make it go,” says Gene Ingalsbe. A cooperative is like a muscle, he notes. Unused, it will wither and die; employed regularly, it will strengthen and grow.

 

John Grossmann is a freelance writer in Jamison, Pennsylvania. He also publishes two business newsletters, NewsReach and NewsBeat.


 

The Co-op Surge

Cooperatives appear to be an increasingly popular kind of organization in the United States. The largest single category of co-op is the employee-owned credit union; most of the rest are marketing or buying co-ops, or service co-ops (such as those that supply rural customers with electricity).

The number of agricultural co-ops is declining, however. Like small farms, many of them have been consolidating to reach greater economies of scale.

 1987 1991
Total co-ops in the U.S. 41,000 47,000
Agricultural co-ops 5,100 4,500

Sources: National Cooperative Business Association; Agricultural Cooperative Service; and Gene Ingalsbe.


 

Setting up a Co-op: The Legalities

Cooperatives are economic democracies, fashioned on the principle of one member, one vote, and dedicated to returning earnings to its members based on the use or patronage of its services. Note that they differ from public corporations in two significant ways: Members each have one vote on co-op policy regardless of their investment (unlike stockholders of public companies whose votes are weighted according to the number of shares they control). Likewise, benefits are distributed according to the members’ participation not their investment; so, for example, the more that a member buys through Carpet One, the larger the share of the co-op’s savings that it gets in return.

Like public corporations, cooperatives must be incorporated under state laws. State co-op statutes vary, but most require articles of incorporation, bylaws, and a board of directors. Some states are known for cumbersome, if not archaic, statutes, notably Illinois, Missouri, and Ohio. Don Graham, a lawyer in Washington, D.C., who has incorporated quite a few co-ops, prefers to do it in Delaware, which is known for its “corporate-friendly,” minimal regulation. Graham emphasizes that a co-op does not have to have any members in a state, or even do any business in it, to incorporate there.

There is no federal incorporation statute for co-ops. Nonetheless, they are still subject to antitrust regulations and civil rights statutes. You can “cap” membership by, say, establishing an overall ceiling on numbers or fixing a limit on the number per state—so long as your selection process does not systematically exclude any group.

The Capper-Volstead Act of 1992, known as the Magna Carta for farm cooperatives, gave farmers wide latitude to set prices for their products without having to worry about the antitrust police. The statute does, however, prohibit co-ops from “unduly enhancing prices.” It leaves it to the Secretary of Agriculture to determine when that happens and what cases should be referred to the Justice Department for prosecution.

Antitrust laws make it illegal for any business organization to establish a monopoly by “carving up territories” among its members. “You run a big risk,” Graham cautions. “Antitrust litigation is expensive.” Still, he acknowledges that the Reagan and Bush Administrations engaged in precious little antitrust enforcement, and thinks President Clinton is unlikely to alter that posture because to do so would be perceived as anti-business. Just how much you can cooperate or restrict membership before Uncle Sam’s beard starts twitching is a matter to take up with expert legal counsel. So are other questions such as where to incorporate your new co-op. Unfortunately, setting up co-ops remains something of a boutique practice in the law. Most corporate lawyers know little about it.

With a little research, you can find good legal counsel to help launch your co-op on the right foot. Wisconsin, California, Michigan, and some other states have well-established departments or offices that specialize in co-ops. Ask for recommendations on where to find specialists in co-op law. Check with cooperatives serving other industries. There are also regional sources that can advise you, such as the Southern Cooperative Development Fund in Lafayette, Indiana. —J.G.