The retail cooperative, Marketing and supply cooperatives

1. THE RETAIL COOPERATIVE

1.1. Transactions Costs and the Retail Cooperative

Where consumers are poorly informed about the quality and reliability of the goods offered by suppliers, the formation of a cooperative may be seen as a response to the adverse selection problem. By setting up a cooperative, consumers establish an institution that can gain no advantage from deliver­ing poor quality to its members. Further, if buyers suspect that established retailers or wholesalers are acting as a cartel and exploiting a monopoly position, they may attempt to circumvent these suppliers by combining together to deal directly with producers. This will be more likely where normal competitive processes are tardy or ineffective, perhaps because sunk costs prevent new firms from entering the market. A cooperative could be viewed as a method of binding buyers to remain loyal to a new entrant.

In the case of retail cooperatives, however, capital requirements are not great, nor is the physical capital highly firm specific. The risk-sharing dis­advantages associated with worker cooperatives are also less pronounced in the case of consumer cooperatives. The average member of a consumer cooperative will have much less capital at risk and will not be entirely dependent upon a single enterprise for his or her purchases. On the other hand, the moral hazard problems of enterprise governance – of disciplin­ing workers and managers – have still to be overcome. Assuming that the worker in a retail cooperative has little firm-specific capital at stake and may be monitored at low cost, the main problem will be providing incentives to directors and senior managers. It is hardly likely that personal membership of the cooperative will constitute a sufficient incentive. Nor would it seem reasonable to expect the monitoring of other members of the cooperative to be very rigorous. To some extent, a monitoring function might accom­pany the very process of shopping by members of the cooperative, but, with little capital at stake, the incentive to pursue a complaint through the col­lective choice process would appear to be negligible.

Peer pressure on senior directors of the cooperative may play a signifi­cant role. As will be seen in the next subsection, consumer cooperatives were often started by people from particular social ‘groups’ in society. Serious maladministration would then be expected to result in very signifi­cant loss of social esteem, or at least enough to induce a modicum of effort on the part of directors. While routine operations in fairly stable conditions could be carried out within the context of this property rights structure, the ability to stimulate and reward entrepreneurial flair internally is obviously limited. Whereas the setting up of a cooperative can be seen as an entrepre­neurial act in itself on the part of consumers, with the objective of break­ing a monopoly or improving information flows, the maintenance of this flexibility after the cooperative is established is a significant problem. Cooperative status can be important in the early days of an enterprise as a means of establishing a good reputation with consumers. If trust is impor­tant and consumer cooperatives have an institutional advantage in creating trust, we have the beginnings of an explanation of the role they played in late-nineteenth-century retailing, but if flexibility and adaptability are required, and if other institutional forms can gradually develop equally good reputations for quality and fair dealing over time, the cooperative will tend to be a transitory rather than a permanent feature of the institutional landscape.

1.2. Role of Retail Cooperatives in Nineteenth-century England

The potentially entrepreneurial character of cooperative enterprise can be seen in the transformation of the retail trade in the UK during the later part of the nineteenth century.22 Until the mid-1860s, middle-class shoppers in London faced a multitude of specialised small establishments offering elab­orate service and extended credit. They published no price lists and were widely assumed to charge different prices to different customers. Resentment was widespread. The demand for a new form of retail service was satisfied by the rapid growth of cooperatives, which initially catered to particular middle-class groups. The most successful of these consumer cooperatives was the Army and Navy Cooperative Society Ltd (A and N), which started trading in 1872. Membership was open to army and naval officers, and the initial capital consisted of 15000 shares of £1 each. Those eligible but unwilling to become members could nevertheless shop at the ‘A and N’ by purchasing an annual ‘ticket’. The new societies offered low prices, assurance of quality, and much reduced service. They offered no credit and accepted cash only. They published price lists and distributed them four times per year to members. There were few shop assistants. Shoppers made out their own bill.

So successful were the new cooperatives that their competitors attempted to restrict them ‘by political and other coercive action’ (Hood and Yamey, 1957, p. 318). Given the membership of the cooperatives, these attempts were doomed to failure, and emulation of some of the societies’ methods became the only rational response. By the early 1870s, the range of prod­ucts sold by the cooperatives was enormous. ‘The societies played a large part in bringing about other changes which have generally been credited to the ordinary department stores (that is, stores not organised on coopera­tive lines). It is probable that their shops were the first major department stores in England.’ (p. 317). Thus it was that admirals and generals (who comprised five out of eight directors of the A and N in 1879) presided over a movement that, The Times insisted, ‘threatens nothing less than a social revolution’. As time advanced, however, the societies themselves had to meet competition from stores offering low prices but greater services, including Whiteley’s and Harrod’s. Restrictions on membership were relaxed and the advantages of cooperative status became less clear. By the mid-1920s, societies had transformed themselves into joint-stock firms and their premises were open to all customers by 1939.

In the context of the earlier analysis presented in this book, it is interest­ing to consider why the cooperative form of enterprise proved so attractive in retailing during this period. First, as was noted above, consumer coop­eratives suffer less from the risk-sharing disadvantages of producer coop­eratives. Consumers are able to distribute their expenditure between establishments as they think fit, and the capital requirements of forming a retail cooperative are less of an obstacle. Most fundamentally, the societies provided consumers with information about the wholesale costs of various products and were in a good position to establish a reputation for quality and fair dealing. It is no accident that they started out with a membership taken from fairly closely defined professional groups and that their achieve­ment was to let people know ‘what things cost, and what they ought to cost’.23 Their very success produced the conditions in which competitors could also build up this kind of reputation by matching the societies’ prices and emulating their methods.

When expansion was called for, the restrictive tendencies of cooperative enterprise with respect to capital investment became apparent. A and N shareholders24 refused to sanction an increase in capital to permit the prem­ises to be extended in 1879. This led to the establishment of the Junior Army and Navy Stores by members of the armed services unable to join the A and N. After the profitability of the new retailing methods had become fully demonstrated, it was the joint-stock enterprise that was best equipped to raise the capital to exploit them. Further, the accumulated profits held by the societies were a constant temptation to ‘shareholders’ to establish the exchangeability of residual claims and to realise the full present value of their entrepreneurial gains, instead of reducing prices and sharing them period by period with the rapidly expanding body of ‘ticket holders’.25 The history of the cooperatives represents, therefore, a case study of the contin­uing process of competition between organisational forms.

2. MARKETING AND SUPPLY COOPERATIVES

2.1. Marketing and Distribution

It is not only at the retailing end of the supply chain that cooperative enter­prise has played a historically significant role. In retail cooperatives, the buyers became owners. Sometimes, however, sellers face the monopsony power of buyers or confront other significant transactional hazards. In these cases, there is a possibility that ownership by the seller will raise effi­ciency. Hansmann (1996, p. 120) reports, for example, that in 1991 there were 2400 cooperatives in the USA, marketing farm products. Membership totalled 1840000 farmers. Some are simply bargaining cooperatives. Here sellers are banding together in order to create monopoly power as a countervailing force to the monopsony power of the buyer. Most, however, actually market and even process their members’ output. Over the course of the twentieth century, the share of agricultural output marketed by cooperatives in the USA rose from six per cent (in 1913) to thirty per cent (in 1982). In other countries, such as France and Germany, the share of the cooperatives in the marketing of agricultural output is even higher (over forty per cent), while in Sweden it reaches eighty per cent.

Hansmann considers various explanations of the success of supply cooperatives. Policies against monopoly and against agreements to fix prices have not been used to suppress supply cooperatives.26 Perhaps they are simply ways of raising prices against buyers and avoiding antitrust leg­islation? Cooperatives also have various tax advantages relative to investor- owned companies. In particular, the income is not taxed twice – once as ‘corporate profit’ and then again when income is distributed to the mem­bership as in an investor-owned firm. There is a mechanism which aims to tax the cooperative’s income once only, with distributed income taxed at the marginal rate of each member. However, fiscal advantages and the pursuit of monopoly power do not stand scrutiny as decisive and exclusive expla­nations for the success of agricultural supply cooperatives. Basically, this is because most cooperatives have open membership and contracts which last for only one year, suggesting that their power to limit long-run supply is negligible. Further, the dominance of cooperatives in certain important areas predates the introduction of the income tax. The Sixteenth Amendment permitting Congress to collect taxes on incomes was not rat­ified until February 1913, yet Hansmann (p. 134) notes that half the California citrus crop was marketed by cooperatives in 1906.

In Chapter 4, subsection 7.2, we have already introduced Hansmann’s theory of ownership. Ownership rights, he argues, will be assigned so as to economise on the costs of ownership plus the costs of transacting. ‘Patrons’ who face high costs of transacting (relative to other patrons) are therefore likely to be prime candidates for the ownership role, providing that the costs of ownership are not also relatively high. In the case of agricultural supply cooperatives, the existence of monopsony power and the importance of the correct storage and treatment of the crops presented clear transactional hazards. It is the relatively low ‘ownership costs’ of the cooperatives, however, that Hansmann argues is the key to their long-run survival. Monitoring of the management of a cooperative is undertaken by informed local farmers. These farmers produce a limited range of crops about which they are very knowledgeable. Further, collective decision making is facilitated by the fact that the interests of the membership are very homogeneous. ‘The scarcity of co-operatives that handle more than one commodity is strong evidence of the importance of this homogeneity of interest’ (p. 136).

Transactional problems between a processor or distributor and a farmer can be overcome by the farmer owning the distributor, but why should the farmer own the distributor rather than the other way around? Hansmann argues that farmers are low-cost owners because homogeneity of interest makes collective decision making easy. The investors in a joint-stock dis­tributor might, however, also face low costs of collective decision making. Why cannot they own the farms? Presumably the difference is that the costs of monitoring and management are different. Investors in a marketing and distribution firm would make poor monitors of farmers, while farmers make quite reasonable monitors of distribution and marketing managers. We can also use an argument based upon Hart’s theory of ownership to establish a similar result. Transferring the ownership of land from farmer to a combined marketing and farming company, owned by an investor, would adversely affect the farmer’s non-contractible investments in the farming activity while not improving marketing and distribution. Transferring distribution and marketing assets to the farmer increases the farmer’s incentives without diminishing those of the distribution manager. The assets are to some degree complementary and should be held by the farmer.

Although collective ownership by farmers of marketing activities is therefore common, large-scale collective farms themselves have had a much less successful, not to say disastrous, record for many of the reasons explored earlier in this chapter. Agricultural marketing cooperatives as well as agricultural supply cooperatives (for fertilisers, seeds and other farm inputs) thus enable the small-scale family-controlled farm to coexist with much larger scale supply and distribution activities which might otherwise wield great localised market power over the farmers.

2.2. Supply Cooperatives and the Utilities

The analysis of supply cooperatives mirrors closely that of the marketing cooperatives. Wherever contracting costs are high or monopoly power is strong, consumer or supply cooperatives are an important response. Agricultural supply cooperatives in the United States received one quarter of farm production expenditure in 1990.27 Once again, the ownership inter­ests (the farmers) are sufficiently homogeneous to keep decision-making costs down. For similar reasons, one half of farm households in the United States were supplied with electricity by cooperative companies in 1980, and cooperative provision of telephone services covered over one million sub­scribers in 1989.28

Consumer ownership of the public utilities would indeed seem to be a predictable way of responding to the problems of ‘natural’ monopoly which beset the provision of electricity, gas, water, telephone and other ‘network’ services. A more extended discussion of the regulation of natural monopoly and the policy issues which surround it can be found in Chapter 15. In the context of consumer ownership, the main factors preventing cooperative solutions seem to have been the heterogeneous interests of con­sumers in urban areas. Where networks serve consumers of very differing incomes or service requirements, consumers become, in Hansmann’s terms, high-cost owners. Some will be industrial users, others residential and yet others commercial. Some will have large and predictable requirements while the demands of others will be small and unpredictable. Some will be users at peak times and others at off-peak times. Collective decision making becomes problematic under these circumstances. Indeed municipal ownership and cooperative ownership will be quite similar in urban areas except that the major interest groups will have somewhat different political influence. In a consumers’ cooperative, control rights and rights to the residual could be distributed in proportion to each member’s purchases. Industrial interests (or large commercial consumers) might then be expected to be more powerful than under municipal ownership where resi­dential consumers would make up the bulk of the voting population and decisions would be mediated by politicians. Another important problem with consumer ownership of the utilities in urban areas is that high levels of mobility would both reduce the incentive to monitor the management of the utility and require the continual transfer of ownership rights from one person to another. The valuation of these rights would be a problem unless means could be found to make them tradable.

Source: Ricketts Martin (2002), The Economics of Business Enterprise: An Introduction to Economic Organisation and the Theory of the Firm, Edward Elgar Pub; 3rd edition.

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