Cooperatives Consolidate: Response to the Changing Structure of the U.S. Food Industry - Terra

Choices: The Magazine of Food, Farm and Resource Issues, Fall, 2001 by Darren Hudson, C.W. Jr. Herndon

The U.S. food and fiber system continues to evolve, driven by globalization, technological change, stagnant demand for food, and other political and economic forces. As a result, actors in the food system -- processors, wholesalers, input dealers, and the like -- have had to be creative in order to sustain their growth and maintain their value. One consequence has been increased consolidation.

Farmer-owned cooperatives have been caught up in this trend. Cooperatives comprise an important part of the overall agricultural sector, marketing 37.5 percent of all farm products and handling about 20 percent of all farm supplies in 1999 (USDA/RB-CS 1999). Given their present and historical importance, it is relevant to inquire how agricultural cooperatives are responding to, or participating in, the changing structure of agriculture.

Let's Get Together: M&A Activity in Cooperatives

Merger and acquisition (M&A) activities are changing the structure of agricultural cooperatives. Two recent studies by Parks and Manfredo and by Hudson and Herndon provide perspectives on the extent of these activities. Both studies examined the use of mergers, acquisitions, joint ventures, and strategic alliances. The increasing use of M&A strategies is clear (Figure 1); Parks and Manfredo suggest that total M&A activity among agricultural cooperatives increased about 142 percent over the 1991-1997 period - a figure similar to merger activity in other parts of the economy.

In our survey of 99 responding agricultural cooperatives, we found that about 79 percent had been offered an opportunity to participate in an M&A activity between 1995 and 2000. About 81 percent of those receiving an offer accepted at least one M&A activity. Approximately 60 percent of these participated in more than one activity over the five-year period. While the proportion of large agricultural cooperatives engaged in M&A activity is greater than the proportion for the smaller firms, it is clear that M&A activity is widespread among smaller cooperatives.

Behind the Urge to Merge

A variety of motivations prompt M&A activity, but two primary motivations appear to be capital constraints and concerns about the costs of doing business. The Parks and Manfredo study utilized time series data from M&A activity among the largest 100 cooperatives to highlight the importance of capital constraints on M&A. They conclude that the inability to raise equity capital sometimes forces cooperatives to merge or coordinate activities if they wish to expand. However, the Parks and Manfredo data set prevented the study of other microeconomic factors such as management control and diversification, which could mitigate the importance of capital constraints.

A cursory look at our survey suggests that capital constraints are not primary motivating factors. Only seven percent of the respondents cited "financial constraints forced the M&A activity" as the first or second most important reason for their most recent M&A activity. However, "increasing the size (scale) of the cooperative to cover increasing fixed costs of operation" was cited by about 25 percent of the respondents, suggesting that cost considerations were at least a part of the motivation. Parks and Manfredo's study worked with time series while this study used cross-sectional information, so the two are not entirely comparable. In spite of this, the two studies suggest that capital constraints pose a challenge to cooperatives and may drive M&A activity.

In our study, the most common reason (34 percent) given for becoming involved in M&A activity was to "streamline operations (reduce costs) by eliminating duplicated services and personnel between firms." This suggests cost reduction as a primary factor for M&A activity. For many cooperatives, sales growth has been slow due to stagnant demand for food and declining farm numbers. Additionally, publicly traded food marketing companies report low growth in sales (between one and seven percent) over the past five years.

These factors, coupled with the rise of large national and multinational companies and increasing numbers of contract farming operations - most of which bypass agricultural cooperatives - may all serve to decrease sales. Thus, the only means available for many cooperatives to increase or even maintain shareholder value is to reduce costs.

The need to reduce costs is emphasized by the two thirds of respondents who reported that their most recent M&A activity was horizontal in nature. Horizontal integration involves expanding while staying within present market channels and the present range of activities. This outcome appears to be consistent with cost reduction strategies, but the implications for cooperatives' abilities to compete in the future are unclear.

The other third of the M&A activity among cooperatives was vertical in nature. Noel Estenson, former Chief Executive Officer of Cenex/ Harvest States, suggests that many cooperatives are attempting to become "food centers." That is, many cooperatives are trying to move into vertically integrated or coordinated value chains that deliver food from "field to plate" using highly integrated services. Food safety and quality, product sourcing, control issues, and other sources of transaction costs are compelling many firms to move toward vertical integration or coordination. Competitive pressure from vertical integration in the corporate part of the food industry is likely to influence many cooperatives. Additional study should help evaluate the factors leading to the correct form of M&A activity for agricultural cooperatives.