Staatz, John M.

English

Research Papers in Economics

A Comment on Phillips'
"Economic Nature ofthe
Cooperative Association"
John M. Staatz
Thecooperativehasno moreeconomiclifeorpurposeapartJromthatojtheparticipat-
ing economic units than one ojthe individual plants oja large multi-plantfirm.
-Richard Phillips (1953. 74-75)
In the 1940sand early 1950s, economists began to develop formal eco-
nomic models of farmer cooperatives. The aim was to bring some ofthe
deductivepowerofsuchmodelstoquestionsthatearliercooperativeactiv-
ists and writers such as Nourse (1945) and Sapiro (1993) had treated in
a more literary way. Economists hoped that, in applying these models.
they could separate scientific analysis oftheseissues from the proselytiz-
ingfervorthathadaccompanied someofthe earlierdiscussion ofcoopera-
tives. The questions addressed included:
• Whatmakes cooperatives different from investor-ownedfirms (IOFs)?
• Giventhatcooperativesaresomehowdifferentfrom IOFs,what. opera-
tionally, should cooperatives strive to maximize?
• What are the implications of the cooperative's pursuing alternative
goals for the welfare ofits members and for society as a whole?
• Are there impediments to cooperatives' or members' behaving in a
way that would enhance member or societal welfare?
• Whataretheimplicationsoftheforegoingforcooperativemanagement
and public policy?
Phillips' article was a key contribution to this debate. His central tenet
was that the cooperative was an association, not a firm with any degree
ofindependencefrom its owner-patrons. BuildingonearlierworkbyEme-
lianoff (1942), Phillips constructed a model ofthe farmer cooperative as
a form ofjoint action by firms at one level in the food system aimed at
gaining the benefits from vertical integration.
Hisviewofthecooperativeasa nexusofcontractualrelationshipsamong
the member firms presaged later theoretical work on the cooperative as
a coalition (see Staatz 1989). He sparked a long debate about whether
cooperatives did in fact behave to some degree independently of their
memberfirms. (This debatewas oftenphrasedinterms ofwhethercooper-
atives were really firms.) And his comments about how a heterogeneous
John M. Staatz is proJessor ojagricultural economics. Michigan State University.
The author is grateJul to H. Chris PetersonJor helpJul comments.Classic Reprint Review/Staatz 81
membership creates challenges to holding a cooperative together were
highly suggestive ofthe difficulties faced by cooperatives decades later in
dealingwith issues ofequal vs. equitable treatment ofmembers.
The following comments focus on Phillips' contributions to cooperative
theoryin light ofsubsequentwork thatviewed the cooperativeas a coali-
tion. Royer (in this issue) analyzes Phillips' contributions from a more
neoclassicalperspectiveanddiscussesinmoredetailtheequilibriumsolu-
tion posited by Phillips.
Key Elements ofPhillips' Argument
Phillips held that cooperatives were simply coordinators ofjoint action
byotherwiseindependentfirms. Becausethe cooperativeoperatedatcost,
it did not incur profits or losses itself. Only its member firms incurred
profits or losses.
When a group of individual firms form a cooperative association, they agree
mutually to set up a plant and operate itjointly as an integral part ofeach of
theirindividualfirms (or householdsinthecaseofa consumercooperative)...
[Tlhe participating firms agree to function coordinately with respect to their
jointactivity...They mustforgo some oftheir individual sovereignty in favor
of themselves as a team. It is technically correct to speak of the cooperative
plant and of cooperating firms, but not of the cooperative firm (pp. 74-75).
This conception ofthe cooperative is very closeto the idea ofa coalition
in game theory. Member firms band together, voluntarily giving up some
of their independence, because each is better off in the coalition than
operating separately. Phillips sawthese gains resulting from scale econo-
miesinprocessingandinputacquisitionandfromstabilizationofrevenues
through pooling of risks. Once a member no longer benefits from the
joint action, he or she exits the coalition. Ifenough members defect, the
cooperativecoalitionceasestoexist.Thekeycontractualrelationshiphere
is among the members themselves with respect to the joint action, not
between the members and the cooperative entity itself.
Phillipsarguedthat, becausethecooperativedidnotexistindependently
of its member firms, the relationship between member firms and their
cooperativewas similarto that ofa multi-plant firm. Eachmember'sfarm
and the cooperative facility represented one plant in the multi-plant firm.
He then derived, from the economist's standard model ofthe multi-plant
firm, theequilibriumconditionsunderwhichmember-firms' profitswould
be maximized. His proposed equilibrium solution, which implicitly
assumed Cournot-Nash behavior on the part ofeach memberfirm, set off
a longdebate overwhetherfarmerswouldreallyhaveeithertheknowledge
or the incentive to produce at that level. (See Royer in this issue, and
Sexton 1984 for a summary ofthe debate.)
Much less discussed in subsequent literature was Phillips' analysis of
the role cooperatives could play in stabiliZing farmers' returns through
risk pooling. This analysis portended discussions twenty years later on
the mean-variance approach to analYZing risk aversion. Until recently,
few cooperative theorists explicitly included benefits from risk-pooling in
models of cooperative behavior. Yet had Phillips or subsequent authors82 JOURNAL OF AGRICULTURAL COOPERATION 1994
pushed the analysis ofrisk pooling further, they would likely have been
forced todiscussitslimitsaswellasitsbenefits.Persistentcross-subsidies
across pools, in the name ofrisk sharing, create incentives for producers
ofthe goods that generate the subsidies to leave the cooperative. Phillips'
discussion ofhowbenefits and costs should be shared in the cooperative
(seebelow) implieshewouldhaveopposedsuchpersistentcrosssubsidies.
A logical conclusion from his model is that the benefits from risk pooling
should balance out across the membership over time.
Sharing the Benefits and Costs ofCooperation
Phillips summarized his vision ofthe cooperative association in a chart
that represented the member firms as slices of a pie. The uninscribed
centerofthepie, wherethepiecescametogether, signifiedthejointcooper-
ative enterprise. Apart from thisjointcenter, thememberfirms were inde-
pendent.
Typically, member firms do not participate equally in the cooperative
(the slices ofthe pie are ofdifferent widths). Phillips argued that, in order
to achieve a static optimum, each member firm would have to share the
benefits and costs of the joint plant in direct proportion to the member
firm's shareofbusiness conducted through thecooperative. Similarly, the
costs and benefits ofindividual departments should be allocated among
members in direct proportion to their use ofthose departments.
Such an approach appears consistent with the cooperative principles
ofservice at cost and returning net benefits to members in proportion to
theirpatronage. Butthe"doctrineofproportionality,"asitbecameknown,
assumes all costs canbe unambiguously allocated to a given activity (Le.,
there are no trulyjoint costs) and that the cooperative's various activities
generatenoexternaleffects. If, forexample, thereputationofLandO'Lakes
butter helps sell Land O'Lakes margarine, then spill-overs in costs and
benefits occuracross divisions, and itis no longer clearthat those selling
butter through the co-op should bear all the costs ofthe butter division.
Similarly, ifa cooperative plays a competitive yardstick role in a concen-
trated market, then non-members sharein the benefits ofthe co-op with-
out payingany ofthe costs. In short, the synergiesandjointness inherent
in collective action (or intechnicaljargon, the superadditivityofthe profit
function) mean that conclusions about strict proportional allocation of
costs and benefits among members cannot be made as starkly as Phil-
lips implied.
Nonetheless, Phillips' stress on sharing benefits and costs proportion-
ately to participation highlighted the question ofequalvs. eqUitable treat-
mentofmembers. He clearlycame downontheside ofgivinggreatervoice
and obligations to those conducting a larger volume ofbusiness with the
co-op. For example, he held that financing ought to be proportional to
patronage,anideanowembodiedinpracticeslikebase-capitalplans. More
controversialwas hisviewthatvotingrights shouldalsobeproportional to
patronage, arguingthe principleofone-member, one-votewas"inaccurate
or irrelevant" (p. 87). His conclusion about voting rights set off a sharp
debatethatcontinuestodayoverwhat,inpractice,ismeantby"democraticClassic Reprint Review/ Staatz 83
control" in cooperatives and whether it is compatible with the holding
together ofthe cooperative coalition.
Thereissomeinconsistencybetweenstrictinterpretationofthe doctrine
ofproportionalityand Phillips' comments about the value ofthe coopera-
tive in stabilizingfarmer returns through risk pooling. To the extentrisks
are pooled. at any given time the benefits derived by different products
marketed through the pool may not be proportional to their contribution
to the co-op's net margins. But Phillips seems to imply that. on average.
a given activityshouldnotbecontinuallycross-subsidizedbyotheractivi-
ties ofthe association. In other words. over time. the benefits of pooling
should be proportionately shared among the membership.
Phillips also clearly recognized that. for the cooperative association to
be cohesive. especially in the context ofrisk pooling. the interests ofthe
membership could notbe widely divergent. To achieve "optimum stability
in the participating firm ... the anticipated conflict of interest among
participating entrepreneurs must be minimized. This means an associa-
tionofreasonablyhomogeneous.ratherthanheterogeneous. participating
firms" (p. 85). Hewenton to stress theimportanceofdesigningthebylaws
ina waytominimize potentialconflictsofinterest. Bystressingthe impor-
tance ofhomogeneity ofmembership interests in holding the cooperative
together. Phillips anticipated the debate over whether one cooperative
could serve the interests ofall farmers. Such concerns underlay much of
theworkinthe 1980songame-theoreticapproaches to modelingcoopera-
tive behavior (Sexton 1986; Staatz 1989).
Limitations to Phillips' Approach
Phillips' model suffered from the samelimitationas mostsimplemarket
and game-theoretic models. namely the assumption that there are no
transactioncostsinorganizingcollectiveaction.Thevisionofthecoopera-
tive as solely an "association consist[ingl ofthe sum of the multi-lateral
agreements among the firms participating in the joint activity" (p. 76)
assumes there are no costs involved in coming to agreement among co-
op members about what the co-op plant should produce and at what
level. about monitoringthe behavior ofcooperative employees. and about
adapting to changing market circumstances. This assumption led to the
dubiousconclusionthat cooperatives "willbe more adaptable to changing
technical and economic conditions facing the firm" thanwould firms that
are not vertically integrated.
More fundamentally, once one admits there are costs to making deci-
sions and monitoring their implementation within a cooperative, then
hired managementneeds tobe consideredas a possible componentinthe
model ofthe cooperative.1With transactioncosts present. itbecomesmore
economical for members to delegate some decisions to hired managers
than for the owner-patrons to make those decisions themselves. The
greaterthetransactioncosts, thegreatertheautonomyofthemanagement
and hired staff to follow their own agendas (Bartlett 1973). Rather than
acting as day-to-day decision makers for the cooperative, the owner-
patrons simply exercise veto power over the decisions of management84 JOURNAL OF AGRICULTURAL COOPERATION 1994
when those decisions diverge too widely from perceived owner-patron
interests.
Critics of Phillips' work (such as Savage 1954) argued that common
observation demonstrated the cooperative was a "firm" in the sense that
JohnCommonsdefinedthe term: a "goingconcern" thatoperatedto some
degreeindependentlyofitsowners (Commons 1924). Ignoringthatreality,
the critics argued, meant ignoring the cooperative's behavior that was
motivated by the managers' quest for market share, potential conflicts
between the growth ofthe cooperative firm and the growth ofits member-
owners (e.g., in the allocation ofcapital), etc.
The problemwas thatsome ofthe criticswent to the otherextreme. The
next major milestone in modeling farmer cooperatives, the Helmberger-
Hoos model, pictured all decisions in the cooperative being made by a
single individual, the "peak coordinator" (e.g., the manager), who setand
maximizeda singleobjectiveforthecooperative. Whereas decisionmaking
in the Phillips model was entirely decentralized, residing solely with the
farmermembers, thesubsequentcooperative-as-firmmodelssawdecision
making as being entirely centralized in the peak coordinator.
In the parlance of game theory, allowing some role for management
as well as farmer-members in a model of cooperatives is equivalent to
broadeningthe cooperative coalition to includemanagementas oneofthe
players. In other words, analyzing how the cooperative actually behaves
involves looking at how farmer members and the management work out
strategiesthatserveboththeirinterests,whichmaynotbeentirelycongru-
ent. Cooperative practitioners have known this for a long time, butecono-
mists were slow to incorporate it into their formal models of cooperative
decision making. Recent work by Scandinavian writers have broadened
the analysis even further to include how organized labor and government
interactwith managementandfarmermembers to influencecooperatives'
behavior (Ollila 1983). A shortcoming of this approach, however, is that
itsometimesonlyindicatesa rangeofpossibleoutcomes, notclean, deter-
minate answers.
Conclusions
Phillips formalized the view, expressed earlierby Nourse and others, of
the cooperative asjoint action by farmers to gain the benefits ofvertical
integration. Such a viewhas beenattheheartofu.S. public policytoward
cooperatives (e.g., with respect to taxation). The viewthat the cooperative
exists solely as the intersection of its member firms, however, ignores
much of what cooperatives really are. There is, of course, a danger of
focusingexclusivelyonthe cooperativeentityas separatefrom itsmember
firms, for then benefits that accrue from cooperation are counted only in
terms of the co-op's net margins. What is needed is a balance between
Phillips'viewofthecooperativeas purelyanextension ofthememberfirm
and the view that co-op entities simply maximize profits on their own
account and then rebate those profits back to members.
Ultimately, part ofthe controversy revolves around whether models
shouldbepurelyprescriptive("normative") ordescriptive ("positive"). Phil-
lips, as well as subsequent theorists such as HeImberger and Hoos,Classic Reprint Review/ Staatz 85
focused on how co-ops should behave ifthey were to maximize member
profitsinthecontextofperfectknowledgeandundervaryingassumptions
about price taking and other aspects of market structure. More recent
modeling efforts have focused on how co-ops would behave ifthe various
stakeholders in the cooperative each pursued their own objectives, which
arenotperfectlycongruentwithoneanother. Whichapproachtomodeling
ismostappropriatedependsonthequestiononewantstoanswer. Phillips'
article, asoneofthefirst attempts tomodelformally cooperativebehavior,
clarified many of the key questions that economists have subsequently
debatedastheyhaveattemptedtobuildimprovedmodels toanalyze coop-
erative management and policy issues.
Note
1..ThisstatementisanalogoustoCoase's(1937) argumentthattransac-
tion costs explain why firms exist. If there were no transaction costs,
it would be more economical for every actor in the economy to handle
transactions entirely through the market, and no resources would be
allocatedbyfiatwithin organizationslike firms. Analysesofhowthe inter-
nal workings offirms affect economic performance only become relevant
once one admits there are transaction costs in the economy.
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A Comment on Phillips' "Economic Nature of the Cooperative Association"

A Comment on Phillips' "Economic Nature of the Cooperative Association"

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