Agribusiness Review - Vol. 9 - 2001

Paper 9
ISSN 1442-6951

New Generation Co-operatives for agricultural marketing and processing in Australia: Principles, practicalities and a case study

Brad Plunkett ^a and Ross Kingwell ^b

a Western Australian Department of Agriculture & graduate student University of Missouri
b Western Australian Department of Agriculture & University of Western Australia

Abstract

Agro-industrialisation and a reduced role for statutory marketing pose new challenges for the farm sector. Possible responses include transformation of co-operatives or creation of new co-operative structures. This paper outlines weaknesses in traditional marketing and processing co-operatives. However, principles embodied in new generation co-operatives are shown to potentially overcome those weaknesses. An Australian case study, Tatura Milk Industries Ltd, is described to illustrate the practicalities of incorporation of these principles in co-operatives in Australia. Issues surrounding new generation co-operatives in an Australian context are discussed. The paper concludes by suggesting a limited initial role for new generation co-operatives in Australia.

• Introduction
• The Environment for Agricultural Marketing and Processing
• A Role for Co-operatives
• Traditional (Rochdale) First Stage Processing/Marketing Co-operatives
• New Generation Co-operatives
• Tatura Milk Industries: An Australian NGC Case Study
• Discussion
• Conclusions
• References
• Footnotes

Introduction

The marketing and processing of many agricultural commodities is increasingly no longer a simple task. Several trends and changes have emerged to threaten or alter traditional marketing. Firstly, consumers ( Kinsey et al,1996 ; ACCC,1999 ) have increased requirements for quality assurance, supply reliability, food ingredient specification, food safety, extended availability and greater variety in food products. In response to these changes food retailers are demanding changes to farm production and changes in food processing.

Secondly, the world-wide trend of agro-industrialisation ( Barry, 1995 ) is affecting the nature of farm production, marketing and food processing. Agro-industrialisation generally refers to the process of increased concentration and vertical co-ordination by agri-food firms through contract and supply chain management, along with the increased provision of farm inputs by off-farm businesses. It leads to competition not just between farms but also competition between supply chains in different regions and different countries; often underpinned by an increased emphasis on quality assurance ( Drabenstott , 1994 ; Boehlje, 1996 ; Kennett et al ., 1998 ).

Thirdly, government policy of de-regulation is affecting many of the services, including marketing services, used by farmers. Implementation of National Competition Policy has stimulated or accelerated these reforms. Statutory marketing boards in many States are being dismantled and marketing and support legislation revoked. The outcomes are removal of domestic market price arrangements, elimination of production quotas and curtailment of single desk selling. Deregulation is affecting many of the traditional marketing co-operatives used by farmers, exposing them to greater competition.

In light of these trends and changes, farmers need to examine firstly whether their traditional marketing and processing co-operatives are the appropriate structures to best serve them and secondly, whether preferred alternatives exist. This paper looks at the traditional Rochdale marketing and processing co-operative as a common form of marketing arrangement. Its deficiencies in the face of the trends outlined above are identified, yet are shown largely overcome by a new generation co-operative structure. The applicability of this new structure in the Australian agribusiness environment is discussed and conclusions are drawn about its possible relevance to Australian agricultural marketing and processing.

The Environment for Agricultural Marketing and Processing

The rationale for establishing many agricultural marketing boards was a concern that farmers needed support and protection against the actions of powerful buyers ( Piggott, 1990 ). These sentiments still abound, fuelled by knowledge that retail prices of food products have increased more rapidly than farm-gate prices, and that the farmers' share of final product prices has declined ( Griffith, 2000 ; Paul and MacDonald, 2001 ). In spite of farmers' misgivings, policy and market developments continue to unfold and exacerbate farmers' concerns.

The international phenomena of agro-industrialisation and the increasing globalisation of food markets under WTO agreements are affecting national markets. Takeover and merger proposals have affected the ownership and rationalisation of meat processing capacity ( Rolfe and Reynolds, 1999 ) and fresh milk processing ( Hughes, 2000 ), and greater concentration in food retailing is evident ( Kinsey, 1998 ; ACCC, 1999 ).

Accompanying agro-industrialisation and the re-defining of the role of government in the agricultural sector is farmers' greater dependency on off-farm services and inputs, supplied increasingly from commercial firms rather than government agencies. Where once farm inputs may have come from the farm itself or from other farms (e.g. horsepower, feed and labour) now farm inputs and services (e.g. fuel, new varieties, chemicals, advisory services) are provided by commercial firms.

Large life science companies have developed chemicals and plant varieties that offer farmers cost-saving or farming system benefits. To gain these benefits farmers are required to purchase particular proprietary inputs and, in some cases, are bound by contractual agreements that specify required farm practices.

Because of increased concentration in the food processing and food retailing sector, and because of farmers' greater dependence on purchased inputs, market power along the food chain is said to be shifting from farmers and manufacturers and towards life science companies and more especially to retailers. The purchasing power of large retailers and their greater knowledge of consumer preferences (e.g. analysis of in-house scan data) when combined with the atomistic production basis of farming leads to the exercise of greater market power by retailers. Hence, retailers are able to demand that farm product supplied to them satisfies a range of health and quality standards. Often a pre-requisite of sale of produce to these retailers is farmers' adoption of quality assurance schemes. This trend has been accentuated in the European Union by the failure of regulators to guarantee food safety. Food processors are increasingly subject to the market power of large retailers. Retailers' private labels are providing increased competition to established brands.

The dominance of food retailers and the increased emphasis on food safety and quality is leading to an increased use of contracts in farm production. The contract basis to agricultural production is now common in industries such as the intensive animal industries. As a result farmers are increasingly vulnerable to adverse changes in contract terms from processors or input suppliers either because of product perishability, few alternative buying or selling outlets or the inability to alter production in the short run. The latter is particularly important in agricultural industries (e.g. dairying) with high asset specificity, whereby the farmer must invest in capital items such as machinery and equipment that can only be used for a specific enterprise. The low transfer value of these assets weakens the bargaining position of the farmer.

The dominance of food retailers and the pressures of agro-industrialisation and de-regulation leave farm communities exposed to the rigours of contracting, new marketing requirements, greater demands on management, uncertainty, and further technical change ( Cook and Chaddad, 2000 ). Understandably often these communities experience stress, in spite of new marketing and business opportunities on offer.

A Role for Co-operatives

Co-operatives have played and continue to play a major part in Australian agribusiness. Historically, the genesis of co-operatives has been periods of structural change and adversity where farm communities have turned to co-operation as part of their coping strategy ( King, 1995 ; Lang, 1995 ). This co-operation takes many forms, encompassing a decision by people within a rural district to redirect their spending to support local enterprises through to formal formation of legal entities such as co-operatives. Table 1 provides a taxonomy of co-operatives that illustrates their form, role, capitalisation and level of producer commitment.

Commonly co-operatives may be classified according to their main function: marketing, supply or service. Marketing and processing co-operatives concentrate on selling their members' farm product either in raw or processed form. These co-operatives bargain for better prices, store and handle members' product and then further process the farm product.

The co-operative legal structure enables farmers to own, control and benefit from their co-operative activity. Benefits are tied to usage of services in a traditional co-operative, so there is incentive for farmers to support them. By contrast the legal structure of an investor-owned firm means investors need not be the users of the business. Farmers, if not the owners of these businesses, may only indirectly influence the type and cost of services provided.

Cook (1995) characterises the traditional co-operative as a defensive organisation whose primary function is to keep other competitors in the market place honest. This defensive mindset in part has led traditional co-operatives often to be characterised by:

· investment in physical capital rather than intellectual capital. Their physical capital investments tend to be local or regional, i.e. in the vicinity of their members.

· serving a diverse membership, in terms of size, skill and commitment.

· a requirement to sell all and often generic product offered by members or to offer a wider range of goods and services due to additional social rather than economic considerations.

· an economic and social commitment to provide a competitive yardstick to other commercial suppliers.

Table 1: Taxonomy of Co-operatives

Co-operatives are the only form of effective collective bargaining available under Australian Trade Practices law because collective ownership of part of another segment of a supply chain may increase competition. For instance, a strong marketing, processing or purchasing co-operative can provide price competition against other marketers, processors and input suppliers. Further, although a co-operative is unlikely to secure a price premium in a globalised, or even national, competitive economy it may provide secure market access, which is becoming a premium in itself. Co-operatives may be able to achieve bulk discounts and economies of size from which producer members can benefit.

The dairy industry provides a good illustration of an agricultural sector traditionally dominated by co-operative processors. Over 70% of Australia's raw milk supply is processed by co-operatives. There are two ways of explaining this phenomena.

The first is essentially defensive and is a function of the high degree of asset specificity associated with milk production. Capital equipment, such as dairies and vats, cannot be used for other types of production and the raw product quickly spoils. These factors put dairy farmers in a very weak bargaining position. Bargaining co-operatives, of the type found in the US, are not permissible under Australian Trade Practices law. This underpins the importance of a strong, competitive processing co-operative sector in establishing a price floor.

A second explanation for the co-operative dominance of the Australian dairy industry can be found in co-operatives' market place advantages. In addition to being able to guarantee supply, a co-operative is in a position to comparatively reduce the transaction costs associated with quality control due to its proximity to its suppliers. For instance, Snowbrand recently announced its decision to expand its investment in its Tatura infant formula canning factory. Its spokesman stated that ‘ “in our role of purchasing dairy products, the issues of quality, price and stability are the keys”, when explaining why the investment will be made in Australia' (Dabkowski, 1999).

In Australia, agricultural co-operatives are involved in a range of marketing, supply and service provision including meat, dairy, wool, cotton and fish processing, rice milling, grain handling and storage, freight services and farm input supply. They are the dominant marketers/processors in the dairy, rice industries and feature heavily in the sugar and cotton industries (see Table 2).

There were 2,120 co-operatives (excluding financial co-operatives) in 1995 in Australia. Around 15% of these were agricultural co-operatives. Apart from financial co-operatives most of the co-operatives with large financial turnovers are agricultural co-operatives, particularly marketing co-operatives. In NSW, for example, in 1993/4 there were 102 agricultural co-operatives with a combined membership of around 50,000 and an asset base of $1.3 billion. Their turnover was $2.4 billion which was 90% of the turnover of all co-operatives in that State and the value of their exports exceeded $600 million ( Cronan, 1995 ).

Table 3 lists characteristics of agricultural co-operatives in NSW in 1994/5. The Co-operatives Federation of WA advises that in 1997/98, agricultural co-operatives in WA accounted for $400M of production, mainly in the areas of grain handling, farm inputs and produce marketing (pers. comm.). In the United States farmer co-operatives market over 80% of the nation's milk production, around 40% of all grain, oilseeds and cotton, 20% of fruit and vegetables and over 10% of livestock ( UWCC, 1998 ).

Table 2: Co-operatives in the Top 1000 Australian Enterprises

SOURCE:
Business Review Weekly – 21 October 1996 Pg. 74-91 na = not available

Traditional (Rochdale) First Stage Processing/Marketing Co-operatives

Co-operatives traditionally have operated on the ‘Rochdale' principles of open membership, the payment of profits through product prices, price pooling, no capital contributions from new members and one vote one member. Many of these principles are enshrined in co-operatives' legal framework, such as the relevant sections of the Income Tax Assessment Act and State based co-operative legislation.

This co-operative type was created in a market era when the co-operative's average cost curve was likely to be continuously declining and the market price was not unduly affected by its scale of production. The aim of these co-operatives was to encourage production and new members. Greater scale of processing production led to declining average processing costs which resulted in increased profits when there was no off-setting decline in product price. In markets such as dairying, for decades price regulation ensured a steady upward movement of market prices which allowed producers to capture the benefits of processing economies of size (Nilsson, 1997).

However, the structure of the traditional marketing co-operative becomes problematic when:

• membership becomes less uniform in its social make-up compared to previous generations. This can result in disharmony within large, open memberships.
• the scale of production required to generate efficiencies results in over supply of bulk commodities leading to lower market prices.
• prices fall as regulation is removed in order to generate structural efficiencies within industries; and
• consumers demand increasingly highly differentiated products. This means co-operatives must undertake further processing if they wish to capture prices above bulk commodity prices. Such additional processing often is highly capital-intensive, requiring better management, greater technical skill and better quality control across the supply chain.

The traditional Rochdale co-operative structure may not be well-suited to capture the benefits of further capital intensive, downstream vertical integration. Conflicts known as ‘agency problems' may arise. Drawing on principal-agent theory, the traditional co-operative may face the following ‘agency problems' when seeking to further vertically integrate:

• raising the necessary capital can become a problem as the providers of risk capital are not the only beneficiaries, so members have little incentive to invest, even though investment may be crucial to the co-operative's success. This is an example of a common property problem where some producers can 'free-ride' on the investments made by other members of the co-operative.
• sub-optimal investments can occur because members have no incentive to invest in projects which pay back over periods longer than their likely membership. Some value-added processing opportunities will require large amounts of capital with long pay back periods. This problem is known as the horizon problem.
• as the investment is no longer an extension to the farm business, but an investment in its own right, conflict may arise between those willing to accept differing levels of risk. This is known as the portfolio problem and it leads to traditional co-operatives favouring less risky investments yet with lower returns.
• the traditional co-operative, with its open membership and one vote per member, provides little incentive for members to involve themselves in co-operative governance. Yet corporate governance issues become increasingly important in capital and management intensive activities of value-adding and greater product differentiation. This is known as the control problem.

Influence costs arise due to the ability of some producers to band together to stymie or promote investments in pursuit of their sectional or geographical advantage. Directors and staff of the co-operative can be pressured to support these groups. As a co-operative widens its value-adding activities then opportunities for influence costs tend to increase.

Many analysts believe traditional co-operatives are at a crossroads ( Lang, 1995 ; Fulton, 1995 ; Cook, 1995 ). The pace and process of agro-industrialisation and de-regulation, combined with related technical and structural change in farming, is challenging many farm businesses and their traditional co-operatives. The agency problems of free rider, horizon, portfolio, control and influence costs can be particularly acute if sufficient of the membership base is nearing retirement and wishes to remove equity from the co-operative. Several scholars ( Lang, 1995 ; Fulton, 1995 ; Cook, 1995 ) believe that if performance of struggling, or under-capitalised co-operatives, cannot be sufficiently improved by lifting their management, service delivery and cost efficiency then their main options are:

• dissolution (i.e. liquidation),
• re-structure to become an investor-owned firm or
• evolution into a new generation structure.

In Australia, some large traditional co-operatives, such as Wesfarmers, have chosen to re-structure as investor-owned firms. Others, such as Namoi Cotton, have evolved very novel structures, which have included outside capital to finance capital intensive operations.

However, in the United States and Canada some co-operatives have evolved to become new generation co-operatives; and several new start-up co-operatives have been structured as new generation co-operatives.

New Generation Co-operatives

New generation co-operatives are producer-owned, defined-membership co-operatives formed to process the agricultural products of their members. Their formation, structure and operation reduces the free rider, horizon, portfolio, control and influence costs as shown in Table 4 ( Cook, 1995 ).

Table 4: Corporate governance problems addressed by New Generation Cooperatives.

Source : Adapted from Cook (1995)

There are a variety of ways in which new generation co-operatives address the corporate governance issues that are problematic for Rochdale co-operatives. The main organisational innovations are defined membership, up-front capital payments by prospective members, membership being based on equity shares tied to delivery contracts, creation of a secondary capital market in which delivery contracts (equity or delivery rights) are tradable and appreciable and lastly, maintenance of a tight business focus by the co-operative. These characteristics of a new generation co-operative can be illustrated by describing the stages in creation of a new generation co-operative.

Assuming that an opportunity to establish a new generation co-operative has been identified and that there exists a core group of advocates, armed with convincing initial arguments and business plans, then seed capital is sought from other interested producers. The seed capital funds a more formal and rigorous assessment of the market opportunities and technical feasibility. Discounted delivery rights reward the providers of the seed capital if the venture proceeds.

If the value-adding business opportunity is found to be sound then a subsequent important stage of forming the co-operative is the choice of processing plant size, technology, management and determination of optimal throughput. The minimum throughput required for scale efficiency in operating the processing plant becomes the basis of delivery contracts offered first to those prospective members. These delivery contracts or delivery rights are equity shares and contractual obligations that usually specify delivery amount, grade, quality, and production standards ( Stefanson et al, 1995 ). The initial price of each share is determined by aggregating the total amount of capital the co-operative wishes to raise and dividing it by the number of units of farm product that can be absorbed optimally by the processing facility ( Stefanson et al, 1995 ).

The holders of delivery-right shares are required to deliver a specified quantity and quality of product [1] and in return receive payment for this product plus a return from the co-operative on their shares. These shares also can be traded in a secondary capital market for delivery shares or rights. The initial purchase of delivery rights by members permits the co-operative to reduce debt levels or borrowing requirements as it relies on these funds from its members rather than external borrowings from institutional lenders.

When the share issue of delivery rights is fully subscribed the membership is then closed. Each share obliges a member to deliver one unit of product (e.g. one tonne of grain) to the co-operative. Shares can be sold to other eligible producers at prices agreed to by the buyers and sellers and with the board's approval to ensure that the purchaser is a bone fide producer. These equity shares may appreciate or depreciate according to the earnings potential they represent. Directors of the co-operative do not set prices.

As owners and suppliers to the plant, producer-members have a vested interest in instituting any farm management changes that enable access to niche and other markets with special identity preservation or quality control requirements. Hence, the transaction costs associated with a quality assurance scheme that operates across the supply chain are reduced. Also the co-operative can monitor existing and new markets and respond to market opportunities by alerting producer-members to necessary changes in production. Because producers are both owners and suppliers to the co-operative relationship risk and relationship costs are reduced.

Processing and product transformation of farm products typically is capital-intensive, increasingly knowledge-based, investment in technology, plant and management. The structure of new generation co-operatives facilitates investment in such activity. Delivery rights provide start-up funding and reduce borrowing requirements. Delivery contracts ensure the appropriate quantity and quality of farm product is available for optimal plant throughput. Importantly, contracts provide reassurance to producer members that other members are not able to behave opportunistically with regards to supply and quality of that supply. Producer ownership provides farmers with information about what is valued in the market and reduces risk. By owning the processing plant, producers have both an outlet for part of their production and an asset that returns them profits. Also, since equity is achieved in advance of business start-up, a majority of the net return can be returned annually to producers in cash.

However, like any investment they are not riskless. Torgerson and Cobia (1998) describe failed investments in new generation co-operatives in the United States. The range includes potato processing, alcohol or ethanol co-operatives and feed-lotting. Also some co-operatives currently acknowledged as successful had periods of financial difficulty. Of interest is whether the provision of loan guarantees for value-adding investment as part of the 1996 FAIR Act has contributed to a higher failure rate.

By closing the membership and making delivery contracts the basis of equity ownership, a new generation co-operative ensures that those who decide to invest as members are the main beneficiaries, thereby overcoming the common property investment problem (see table 4). The horizon problem of sub-optimal investment, due to members having no incentive to invest in projects with pay back periods longer than their likely memberships, is dealt with by forming a secondary capital markets for delivery shares.

The control problem, arising from apathy of members to involve themselves in co-operative governance, is lessened by closing the membership and requiring fairly large minimum entry costs per member.

Restricting membership and requiring members to have a non-trivial financial commitment to the co-operative ensures that they maintain an interest in the co-operative. Influence costs that arise from a sub-set of producers acting jointly to stymie or promote investments in pursuit of their sectoral or geographical advantage is lessened by closing the membership, maintaining the secondary capital market and ensuring that directors oversee the transfer of equity between producers. If a group of producers seek to alter the operation of the co-operative to their particular advantage, and to the detriment of other producers, then any adverse effect on the profitability of the co-operative will be reflected in the share price of delivery rights. Further, the remuneration of co-operative management is usually tied the share price or share options and therefore these staff are less likely to be amenable to direct pressure from a sub-set of producers pursuing their own agendas.

Tatura Milk Industries: An Australian NGC Case Study

The new generation co-operative (NGC) model should not be viewed as a magic seed that can be readily transplanted in Australia. Australian tax law and government support is different. There are important differences in market size, culture and depth of management and advisory expertise and experience with co-operatives. However, adopting some of the structural principles of NGCs to an Australian context may be feasible. The case of Tatura Milk Industries illustrates this.

Independently of development of NGCs in North America, the Victorian co-operative milk processor, Tatura Milk Industries Ltd. evolved a structure in 1987 suited to Australian institutional conditions , which permits it to maximise its focus on its chosen business strategy of seeking to produce high quality products for well targeted markets.

Originally formed in 1907 as Tatura Milk Products Ltd, Tatura Milk Industries Ltd is formed under Corporations Law, with co-operative principles established in its Articles of Association. This is in common with other Victorian co-operative dairy processors. The co-operative can be taken over if 75% of its members vote to realise the company's capital value. In keeping with its co-operative principles, its rules stipulate active membership, a prohibition on the public trading of its shares and a limit on the proportion of shares that may be held by one shareholder. These rules are important in ensuring that it qualifies as a co-operative for the purposes of the Income Tax Assessment Act . The rule stipulating active membership is also critically important in fostering and ensuring that the co-operative remains an extension of the farm business. Active membership defined by the Income Tax Assessment Act means that 90% of the co-operative's business must be done with 90% of its shareholders. By definition, an NGC's membership is active.

Tatura has a very simple traditional structure (see Figure 1). It consists of:

• 6 ‘A' class shares (as required by Corporations Law) one of which is held by each director and rotated to incoming directors.
• Redeemable preference shares which are held by supplier shareholders. These are issued at a par value of $1.

The co-operative can be taken over if 75% of suppliers vote to realise the company's capital value. However, the interaction of its company philosophy and business strategy give rise to interesting policy modifications that invite comparisons with the North American NGCs.

In common with the NGC model, Tatura is a defined member co-operative. New members are invited to join when the inclusion of their milk supply permits the co-operative to pursue a new business opportunity. Tatura is able to attract new members as it pays the highest cash price of the Victorian processing co-operatives. This contributes to create the producer loyalty which results from the use of contracts by the NGCs and their Californian marketing co-operative predecessors. Milk quality standards are determined entirely by product price variations, which is in keeping with a traditional co-operative.

Figure 1: Tatura's Company Structure

Tatura is also similar to an NGC in that it maintains a tightly focussed business strategy and so concentrates its capital expenditure. It has no major brands, instead seeking partnerships with major international brand names and the creation of a reputation as a high quality, low cost and reliable manufacturer for other manufacturers. The most well-known of these is its relationship with the giant Japanese company Snowbrand. Tatura's main assets are the quality of its management, its capital equipment and its R&D into functional products for other manufacturers' products. The investment in functional product development permits a higher average return for its products and thus for its defined membership. Exploitation of quality is essentially offensive as it is a strategy to add value.

Its strategic alliances with major dairy companies allow each partner to exploit its own competitive advantage. The major dairy company can concentrate its capital in the higher risk/return areas of branding, packaging, distribution and final processing. The co-operative can concentrate on its advantages of a guaranteed supply of high quality raw product, functional product development and tax. Tatura also benefits from transport efficiencies because 80% of its supply is within a 20km radius of the plant. Hence, the co-operative can exploit an important marketplace advantage - its proximity to supply and the opportunity this presents to more efficiently deliver a quality assured product to targeted markets.

Tatura's ability to remain fully internally funded by means of shareholder equity and retained earnings is viewed by the co-operative as being of crucial importance.

The inclusion of outside equity would, in the co-operative's view, create a conflict of interest between outside shareholders interested in dividend flows and member suppliers interested in higher product prices. Obviously, such conflict could endanger Tatura's ability to hold the producer loyalty necessary to guarantee supply.

The co-operative must therefore create sufficient value in itself so that members wish to invest the capital necessary for its ongoing success. Like an NGC, Tatura seeks to create a second stream of wealth that results in a long-term focus by members. The second stream of wealth in the NGC is the asset value of delivery rights which is largely determined by the discounted flow of future returns. Tatura's second stream of wealth are periodic bonus share issues to members. These are designed to keep the Net Asset Backing of shares to an acceptable range and they recognise suppliers' contribution to capital growth.

Regular bonus issues coupled with a competitive dividend encourage members to value shares and to voluntarily purchase them which in turn greatly assists the company in redeeming shares from exiting members. The active membership rules mean that members know that their shares will be fully redeemed upon exit. Of critical importance is the net asset backing struck by the co-operative's bonus share issues. A high net asset backing is required to pay high dividends, or the co-operative may become starved for cash; however, if the net asset backing is too high, then little additional value is created for the member shareholder.

The tax concession available to co-operatives under s.120(1) (c) of the Income Tax Assessment Act is an important part of Tatura's strategy to retain full internal funding. These concessions are available if loans are from a government source and are used by a co-operative established for the purpose of carrying on a business which has as its primary objective the ‘acquisition of commodities or animals from its shareholders for disposal or distribution'. For tax purposes a co-operative may deduct the principal of loans for capital equipment expenditure against its cash flow. Hence, the concession encourages members to retain surpluses for tax effective investment, instead of demanding that surpluses be distributed as higher product prices.

Unlike the NGC, the cost of entry to new Tatura members is modest. The member seeking to enter a successful NGC may find the delivery rights to be prohibitively expensive as they embody a discounted flow of future returns and may retard the ability of the investing farmer to attain on-farm efficiencies. Tatura's constant proportional allocation of its part of its asset base removes much of the cost of entry for a new member. The trade-off for cheaper entry is that not only must the new member add value to existing shareholders, but the member must presumably also accept a lower level of redemption than is possible with a tradable contract.

Table 5 summarises how Tatura has evolved to deal with some of the preceding issues regarding agency, capitalisation and governance problems of traditional Rochdale processing co-operatives. Tatura appears to achieve a similar outcome to the NGC.

In what appears to be the unlikely case of failure of its business strategy, or removal of the tax concession, the co-operative may find that it would be unable to keep up the necessary flow of high average returns needed to maintain its member wealth creation strategy. This could result in a re-emergence of the agency problems discussed earlier in the paper. Tatura relies on building business relationships with a range of customers, and tries to avoid primarily selling commodities into an open market; thus the importance that it attaches to the quality of its plant and integrating its production R & D with its customers.

Whilst this generates a higher return, it also may pose greater risks if the end customer is taken over by another company that no longer requires Tatura's products. This observation is made in the context of the continuing process of concentration occurring in the world dairy processing and marketing sectors. Tatura attempts to lessen this risk by developing a number of business relationships, whilst taking care that these relationships do not impinge upon each other

Table 5: Tatura's response to agency, capitalisation and governance problems

Discussion

A recent study by INSTATE (2000) highlighted the meagre growth in Australian processed food exports from 1994 to 1998 compared to competitor nations such as the United States. It found that with the exception of dairy, some meat and grains, the Australian industry suffers from relatively higher input costs. It was also generally unable to offset these higher input costs by productivity gains. The findings were similar to those of the McKinsey report (1995) which found that the Australian food processing industry's productivity was only 68% of that of the United States. The Australian food processing industry appears to suffer from a lack of capital formation that would generate scale economies and finance the type of innovative product development/service that appears necessary to compete more on the basis of quality relative to price. An obvious exception is the Australian wine industry, which generally competes upon the basis of innovative product development.

Indeed, adequate capitalisation appears to be crucial to creating competitive advantage in the rapidly emerging knowledge economy. This is characterised by an ever increasing intensity of competition by innovation, the shortening of product lives and the need for the maximum amount of knowledge to be available to those who contribute to the innovation process. Success in delivering new products to replace existing products on the basis of innovation depends upon the degree to which world's best practice knowledge and components are embodied in the new product and world's best practice skills have been used in translating knowledge into an effective product design ( Brain, 1999 ).

The NGC model and Tatura are successful examples of structures and strategies that attract the necessary level of capitalisation to fund this innovation process. Tatura adopted its new structure having built up a store of capital over the preceding 80 years of its history. It is also able to hold producer loyalty without contracts because of the higher cash prices it pays to its members. The NGC structure is designed to better facilitate the aggregation of start-up capital. Careful examination of the legal and taxation issues surrounding the use of delivery rights is required. Just as important is the necessary culture of willingness of primary producers to act co-operatively.

A sequential development strategy may be required, especially in States like Western Australia where comparatively few marketing/processing co-operatives exist compared to other States. This will require the fostering of a disposition amongst producers to act co-operatively in order to better serve market demand. One way of fostering this disposition may be to begin the process modestly with the development of relatively simply structured producer organisations designed to exploit their competitive advantage of delivering quality assured product into local markets with reduced transactions costs.

The use of annual production contracts tied to market demand underpinned by rigid quality parameters may serve as a useful precursor to the evolution of NGC type structures, as growers will be used to the rigours of contractually specified quality parameters. The producer organisation will also have time to amass a sufficient capital base and management expertise to underpin the development of an NGC type structure.

With a combination of this organisational form and use of the 120 (1) (c) tax concession the capital could be raised to finance an expansion in Australian food processing exports, assuming that other key constraints identified by INSTATE can be successfully resolved. One of the key constraints identified is market access. Interestingly, Tatura provides an example of a food processor that gains market access by partnerships with other organisations further along the supply chain. Such partnering is important as the partners along the supply chain concentrate upon their relative strengths for mutual advantage.

Conclusions

Agro-industrialisation and a reduced role for statutory marketing pose new challenges for the farm sector in Australia. Transformation of existing marketing and processing co-operatives is one possible response, as is formation of new co-operative structures. This paper has described the problems facing traditional marketing and processing co-operatives and shown how principles embodied in new generation co-operatives (NGC) can overcome these problems.

An Australian case study, Tatura Milk Industries Ltd, is described to show that new generation co-operatives may not be simple to develop, yet they can facilitate farmers' competitive advantage in efficiently delivering quality-assured product. Whether the incentives that favour adoption and utilisation of the co-operative principles imbedded in new generation co-operatives are sufficient to overcome impediments to their use is a current practical issue. On balance, in many regions and agricultural industries in Australia, investment in new co-operatives and adoption of these co-operative principles may initially need to be based on niche market and small scale investment opportunities. This may be necessary in order for farmers to gain further experience and confidence in the profitability and appropriateness of these co-operative structures.

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Footnotes