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The Journal of Socio-Economics 40 (2011) 327–333

Contents lists available at ScienceDirect

The Journal of Socio-Economics


journal homepage: www.elsevier.com/locate/soceco

Product differentiation and cooperative governance


Svein Ole Borgen ∗
Norwegian Consumer Research Institute, Sandakerveien 24 c, P.O. Box 4682 Nydalen, N-0030 Oslo, Norway

a r t i c l e i n f o a b s t r a c t

Article history: The increasing demand for more differentiated consumer products is a challenge for agri-food sales
Received 11 June 2009 cooperatives. Many cooperatives try to adapt to novel consumer demands by engaging more in prod-
Received in revised form uct development, with the aim of manufacturing and selling more differentiated products. The article
24 November 2010
discusses which governance problems that are likely to unfold as cooperatives engage more in the devel-
Accepted 16 December 2010
opment, production and sales of differentiated end-products. The idea to be advanced is that the nature of
the governance problems is contingent on where in the cooperative’s production chain the main sources
JEL classification:
of uniqueness and product differentiation have their origin. When the uniqueness of the end-product
M20
is created at the raw-commodity level (on-farm), haggling over appropriable quasi-rent between mem-
Keywords: bers and the cooperative is likely to emerge, leading to a hold-up situation. When the uniqueness of the
Cooperative differentiated end-product is created at the cooperative level, the cooperative community is likely to be
Product differentiation exposed to consequential incentive problems related to motivation and control.
Governance © 2010 Elsevier Inc. All rights reserved.
Incentive problems

1. Introduction severe governance problems when more differentiated products


are developed. A misalignment may gradually evolve between the
Agri-food sectors in Western countries are in a period of rapid traditional cooperative structure and the novel competitive strategy
transition, characterized by fiercer competition and decreasing based on product differentiation and value added (van Bekkum,
price-cost margins in commodity markets (Boehlje, 1999; van 2001). This seems to hold particularly true for cooperatives with
Bekkum, 2001; Royer, 1995). Farmers and food processors are collective residual rights, implying that the cooperative equity is in
under increasing pressure to enhance product innovation and seek “everybody’s and nobody’s hands” (Nilsson, 2001). Subsequently,
more efficient production and distribution structures (Hendrikse agri-food sales cooperatives need a clear understanding of the chal-
and Bijman, 2002; Kyriokopoulos et al., 2004). Many agri-food sales lenges that increased product differentiation is likely to raise for its
cooperatives try to shift their strategy from production of relatively business and ownership structure.
homogenous commodities with a low degree of added value to This article discusses selected governance problems that can
products with attributes that more distinctively differentiate them be expected to evolve in agri-food cooperatives as a logic conse-
from their competitors. However, many of them find this process quence of increased product differentiation. The basic idea to be
very demanding. One reason is the “single origin” constraint (Feng advanced is that the nature of the governance problems is con-
and Hendrikse, 2007), which states that a sales cooperative – by def- tingent on where in the production chain the main source(s) of
inition – is inherently linked to the raw products that are supplied product differentiation are located. Who creates the uniqueness of
by the cooperative owners. the differentiated end product: the members on-farm, the coop-
If the differentiation of an end product is created and developed erative organization or either party? The article is organized as
at the raw material stage of the production chain (cf. organic foods, follows: Section 2 presents the research approach and analytical
leaner pork, corn with extra high oil content, hard white wheat framework. The analysis in Section 3 compares situations where
for bakery products), the cooperative owners are responsible for the major sources of differentiation are located at the raw com-
providing the end product with the expected quality attributes. modity level (Section 3.1) and the processing and marketing level
Thereby, success in the end market becomes highly dependent on (Section 3.2), respectively. Section 4 discusses various strategies to
the cooperative owners’ capacity and willingness to accomplish ameliorate the governance problems that arise. Conclusions follow
this task properly. But a cooperative structure that has proved solid in Section 5.
and efficient under a cost leadership strategy may be threatened by
2. Research question and conceptual approach

∗ Tel.: +47 22 04 35 00; fax: +47 22 04 35 04. A cooperative form is defined as “a user-owned, user-controlled
E-mail address: svein.borgen@sifo.no business that distributes benefits on the basis of use” (Cobia, 1989).

1053-5357/$ – see front matter © 2010 Elsevier Inc. All rights reserved.
doi:10.1016/j.socec.2010.12.002
328 S.O. Borgen / The Journal of Socio-Economics 40 (2011) 327–333

what governance problems are likely to emerge if the main sources


of product differentiation are located at the farm level or at the
cooperative level, respectively?

Raw material Processing Marketing Final product 3. Theory

When differentiation of the end product is raw commodity


based, the uniqueness of the end product is created by the coop-
erative members on-farm. This situation gives rise to a certain set
On-farm Within-cooperative
of governance problems. When product differentiation is process-
ing and marketing-based, the unique qualities of the end product
Fig. 1. The three stages of the production chain.
are created by processing and marketing resources that are jointly
owned by the cooperative members. In this case a different type of
What characterizes the cooperative is that the users are the resid- governance problem will probably emerge.
ual claimants and possess the residual rights. Cooperative members
retain their distinct and autonomous property rights over their 3.1. Raw commodity based differentiation
farms and production resources, but delegate some of their deci-
sion rights to the downstream processor, which they collectively Product differentiation and value-added activities have tra-
own. Ownership is thereby separated from control and decision ditionally taken place downstream, i.e. in the final stages of
rights (Grossman and Hart, 1986). Hence, control can be trans- the market channel for agricultural commodities (Royer, 1995).
ferred from members to the cooperative without transferring asset Increasingly, however, there are opportunities for product differ-
ownership. Nonetheless, when the cooperative members share entiation and added value at the upstream (farm level) as well.
strategic resources with their downstream cooperative enterprise, Royer (op.cit.) holds that growing consumer demands with regard
tight coordination is required. But since the cooperative form is to health, nutrition and convenience are one driver of this develop-
characterized by incomplete horizontal and vertical integration, ment. Technological advances that enable producers to coordinate
tight coordination is challenging. crop and livestock production with the product attributes pre-
Vertical integration refers to the interface between farmer and ferred by consumers and processors are another. Examples of such
cooperative, whereas horizontal integration means the interface value-added opportunities include natural (organic) production
between cooperative members. More specifically, coordination is processes or the production of leaner meat or corn with high oil
required to deal with three dimensions of these relations: the content, or of hard white wheat for bakery products. This kind
transaction relationship, the investment relationship and the gov- of product differentiation can also be related to superior animal
ernance relationship (van Bekkum, 2001). The transaction aspect of welfare standards or the geographical origin of raw commodities.
the relationship involves delivery of members’ products in return What governance problems can be expected to emerge in a
for a price. The investment aspect of the relationship – also referred cooperative when the major sources of product differentiation are
to as the financial and risk-bearing relationship – involves the indi- created and located at the raw commodity level, under the aus-
vidual or collective contribution of risk-bearing capital, as well as pices and responsibility of the cooperative members? In order
the right to residual claims. The governance aspect of the relation- to secure the expected uniqueness of the raw commodity, the
ship is defined as the collection of rules structuring the transactions involved farmers must normally invest in heterogeneous resources
between the various stakeholders (Feng and Hendrikse, 2007). on their farms. In this situation, the individual cooperative member
This includes the cooperative members’ participation in decision- – not the cooperative community – is the major decision-maker,
making and control activities. investor, financer and risk-taker. But why should the individual
The question to be addressed in this article is how increased member be willing to undertake this burden and risk? A typical
product differentiation can affect the governance relationship motivation is to capture a quasi-rent, understood as the difference
between members and their cooperative in cooperatives with between the “first-best” and the “second-best” application of the
collective residual rights To explore this question, the point of resources in question. The former is commonly represented by a
departure is that the uniqueness of a differentiated agri-food prod- premium price, whereas the latter is an ordinary price without
uct can have its origin at three stages of the production chain: the any additional premium. The farmer is exposed to novel sources
raw commodity stage, the processing stage and/or the marketing of transactional uncertainty (Ménard, 2004).
and sales stage, cf. Fig. 1 (Borgen and Sørensen, 2008). Will the special product attributes actually be appreciated by
Differentiation at the raw commodity stage includes unique pro- a sufficient number of customers, as the farmers and the coop-
cessing of the raw commodity on-farm; i.e. all activities that are erative hope for? What is the likelihood that the consumers are
under the control and auspices of the farmer. Differentiation at willing to pay the premium price for the differentiated product?
the processing stage includes all types of unique refinement of Can the members be sure that the cooperative engages sufficiently
the raw commodity related to the edible part of the product (e.g. in the marketing and sales of “their” differentiated products? To the
meat conditioning, traditional recipes and handicraft traditions). extent that consumers are indeed willing to pay the extra premium
Differentiation at the marketing and sales stage encompasses the price, an appropriable quasi-rent can be realized by the farmer and
non-edible components of the end product (e.g. package design and the cooperative.
“story-telling”). Various sources of differentiation are combined in An issue of substantial interest for the involved farmer(s) is the
multiple ways in real life. In the following, the discussion is limited size of the appropriable quasi-rent. Gibbons (2005) argues that the
to two stylistic cases which are particularly informative. The first size of the appropriable quasi-rent is contingent on the invest-
case illustrates “raw commodity-based product differentiation”, ment’s degree of transaction-specificity. The higher the degree
while the second is an example of “processing/marketing-based of transaction-specificity, the higher the appropriable quasi-rent.
product differentiation”. In the next section, these two cases will However, this poses a challenge for the farmer and the cooperative:
be investigated in more detail. Their common theme is how char- when the transaction-specificity is high, the potential gain from
acteristics of the transactional relation between the cooperative opportunistic acts increases, simply because the parties have more
and its members can impact cooperative governance problems: money to haggle about. In a situation characterized by high transac-
S.O. Borgen / The Journal of Socio-Economics 40 (2011) 327–333 329

tional specificity combined with considerable environmental and A second incentive problem – referred to as the horizon prob-
behavioural uncertainty, the post-contractual hold-up problem is lem – stems from the fact that residual claims of collectively owned
likely to influence the transactional relation between the coopera- cooperatives are contingent rights to cash flows whose validity
tive and its members. expires when a member ceases to patronize the organization. As
Essentially, the hold-up problem implies that specific invest- argued by Vitaliano (op.cit., p.1082):
ments make asset owners vulnerable to opportunistic behavior by Residual claimants can capture the benefits of investment deci-
their contracting partners (Milgrom and Roberts, 1992, p.137). As sions only over the time horizons of their expected membership
formulated in the classical article by Klein et al. (1978), “after a in the organization. This can be expected to give rise to addi-
specific investment is made and appropriable specialized quasi-rents tional differences in subgroup preferences among members,
are created, the possibility of opportunistic behavior is very real”. If the based on differences in such horizons, with a general ten-
investment in question is highly transaction-specific and the appro- dency for them to favor investment decisions with short payoff
priable quasi-rent high, the transaction partners are exposed to risk horizon. Horizon problems of cooperative residual claims there-
of significant ex-post haggling costs. The involved farmers are likely fore have implications for cooperative investment behavior and
to be sceptical of making the necessary on-farm investments if they organizational growth.
fear that these investments will leave them vulnerable.
Obviously, the hold-up problem may be more or less conse- A third challenge – the portfolio problem – refers to the fact that
quential. The significance of the hold-up risk commonly depends individual cooperative members have their specific risk/reward-
on two contingencies: (a) the size of the appropriable quasi-rent profiles. A fourth incentive problem – the monitoring problem
that the transaction partners hope to attain and (b) the degree of – stems from the fact that decision management is allocated to
flexibility of the transaction in question, with flexibility defined decision specialists (employed managers) who are not residual
as the antithesis of transaction specificity. Subsequently, these claimants. There is thereby a risk that these agents will make deci-
two contingencies deserve particular interest when the origin of sions in such a way as to lower the value of the firm’s residual
differentiation is located on-farm. When the origin of product dif- claims. Monitoring and control devices available to the traditional
ferentiation is at the raw commodity level (on-farm) so that farmers cooperative may turn out to be inadequate in situations where the
make the necessary investments and take the implied financial risk, cooperative engages in highly complex operations.
haggling between members and the cooperative over appropriable Fifth, the follow-up problem is expected to occur if there are
quasi-rent is likely to increase and be more serious. The members many cooperative members, each unable to significantly influence
find themselves in an ex-post lock-in situation, and the risk for decision-making processes or supervision of the management. Each
being exposed to hold-up is thereby increased. individual member can capture only a small fraction of the poten-
tial benefits from such activities. Sixth, the influence cost problem
3.2. Processing and marketing-based differentiation occurs when there are different groups of owners of the coopera-
tive with opposing interests. Nonetheless, each of them is entitled
What governance problems are likely to arise in a cooperative to share in the distribution of benefits and engage in internal lobby
if the product differentiation is predominantly created and con- activities to promote their own selfish interests. Finally, the deci-
trolled at the processing and marketing stages, rather than at the sion problem relates to the situation of a large and heterogeneous
raw commodity stage? To simplify the discussion, let us assume membership, which makes it challenging for the management to
that the raw commodities are homogenous (contrary to the situ- decide how to weigh differing member positions and opinions.
ation discussed above), implying also that there are no credence It should be noted that these incentive problems are not of an
qualities to be conveyed from the raw commodity level to the end unconditional and universal nature. They are expected to become
product(s). When the uniqueness of the end product is created at consequential under certain contingencies only (Nilsson, 2001;
the processing and marketing level, the cooperative members co- Borgen, 2004; Cook and Iliopoulos, 1998). Incentive problems can
invest in the production and marketing capacity that are needed appear more or less problematic in cooperatives depending on
to develop, process and market the differentiated end product. The the amount of financial contribution from members, the degree of
cooperative must enhance its level of capitalization. The primary homogeneity of the membership body, the degree of contingency
decision-maker, financer and risk-taker are therefore the coopera- between members’ goals and cooperative goals, and the degree of
tive community as an organized unit. What governance problems members’ involvement in their cooperative.
are likely to emerge in this situation? What about the specific contingencies under scrutiny here; i.e.
Let us assume that the cooperative equity is collectively owned an increased level of processing-based and/or marketing-based dif-
and that the residual decision right is collectively organized, which ferentiation, both of which presuppose enhanced capitalization at
is a normal situation for many Western agri-food cooperatives. the cooperative plant level? In this situation, incentive problems
The dilemma is that, notwithstanding the fact that the coopera- are likely to become more consequential. Substantial capital invest-
tive members co-invest as a group or community, the individual ment is required in order to successfully develop and implement a
members of a cooperative do not necessarily have the same eco- novel and demanding differentiation strategy. In financial terms,
nomic interests (Nilsson, 2001). This is due to the fact that property the investment at the processing level may be very costly. The
rights are ill-defined in cooperatives with collective residual rights level of contingency between members’ goals and the coopera-
(Vitaliano, 1993). A wide range of ex-ante- and ex-post-incentive tive goals, as well as the members’ level of involvement in their
problems will follow (Nilsson, 2001; Borgen, 2004; Cook and cooperative, evolves as an increasingly challenging issue. The coop-
Iliopoulos, 1998). One of them is the common property problem, erative members are not identical and equal, but appear in many
which is concerned with the disparity between members’ con- cases as a more heterogeneous group. Subsequently, members do
tribution to the financing of investments and the distribution of not necessarily think they benefit equally from the capitalization at
benefits that results from the members’ investments. If a disparity cooperative plant level that is needed to implement increased prod-
exists between a member’s contribution of equity and his/her ben- uct differentiation. This may jeopardize the coherency between
efit from the same equity, an incentive to “free ride” is established. the competitive strategy of the cooperative and its organizational
Why should a member contribute if s(he) cannot be sure that the structure. Subsequently, it may be unclear for the cooperative
benefits s(he) gets in return stand in a reasonable relation to his/her where and how to invest. Members differ with respect to their
contribution? risk–reward profile, and their individual profile is not necessarily in
330 S.O. Borgen / The Journal of Socio-Economics 40 (2011) 327–333

Table 1
The link between product differentiation and governance problems.

Type of differentiation Main dimensions of coop-member relation

(i) Product- and transactions (ii) Investment dimension (iii) Governance dimension
dimension

(a) Raw-commodity based Origin of product differentiation Individual investments by Haggling over appropriable
product differentiation resides at the raw commodity level farmers on-farm. quasi-rent is likely to increase
(on-farm). Individual farmers are and become more
Heterogeneous and relation-specific risk-takers. consequential.
assets at farm level. Increased risk for hold-up
Ex: organic, superior animal-welfare (ex-post lock-in situation).
standard.
(b) Processing- and marketing Origin of product differentiation Joint investments of Incentive problems
based product differentiation resides at the processing and/or cooperative community in (ex-ante-motivation problems
marketing level (within-cooperative) processing and marketing and ex-post-control problems)
Ex: unique value-added processing capacity at cooperative level. are likely to increase and
techniques. become more consequential.

accordance with the risk–reward profile of the cooperative. A new erative body, not the least the degree of homogeneity within the
competitive strategy based on increased product differentiation is cooperative body.
likely to make such problems more difficult for cooperative gover-
nance. As a result, incentive problems will be more consequential 4. Method and data
in a situation with enhanced capitalization.
The discussion is summarized in Table 1. The horizontal lines The two ideal-typical configurations – raw commodity based
in this table draw the distinction between two types of product product differentiation and processing/marketing-based differen-
differentiation: (a) raw commodity based and (b) processing and tiation – will now be illustrated by empirically based case studies.
marketing based. The columns follow the distinction between the As pointed out by Stake (1994), a researcher may have intrinsic or
three aspects of the interface between cooperative and farmer: the instrumental purposes for studying cases. An intrinsic case study
transaction dimension (which here includes product characteris- is undertaken in order to get an increased understanding of the
tics), the investment dimension and the governance dimension. particular case in question, not because the case clearly represents
The main results with respect to raw commodity based dif- other cases or illustrates a particular trait or problem. In all its par-
ferentiation are summarized in the second line in Table 1. The ticularity and ordinariness, the case itself is of prime interest. An
more transaction-specific the assets are, the more appropriable instrumental case study is different, in the sense that its prime pur-
quasi-rents are created. Subsequently, the possible gains from pose is to refine theory or to provide insight into a larger issue. In
opportunistic behavior increase. Since farmers in this position are other words, the case study aims to improve our understanding of
individual investors and risk-takers, they are exposed to the risk of something more than the case in itself.
a hold-up situation. The hold-up problem evolves in the interface The case studies presented here are clearly of the latter type:
between the farmer and the cooperative because the two parties they have been chosen to illustrate the more general, theoreti-
negotiate prices and therefore have divergent interests. cal discussion above. All cases refer to real-life cooperatives and
What complicates the situation is that the cooperative is only actual events, but they are presented here in an anonymized
incompletely vertically integrated. The disadvantages of this form. The first two cases deal with governance problems related
incompleteness become more consequential as the cooperative to raw commodity based differentiation (“AlphaCoop” and “Beta-
tries to change its competitive strategy from cost leadership to Coop”), while the latter two illustrate governance problems caused
product differentiation. A novel and relatively unknown landscape by processing/marketing based differentiation (“GammaCoop” and
opens up for the cooperative. Stricter coordination and stronger “DeltaCoop”).
safeguarding mechanisms are called for. The safeguarding mech-
anisms are successful to the extent that they motivate farmers to 4.1. The “AlphaCoop” case
undertake investments of the appropriate type and size on-farm.
Such mechanisms may be of various types, depending on the Recent events in a large dairy cooperative – here anonymized
strategies and preferences of the individual members and the as “AlphaCoop” – illustrate how governance problems easily follow
cooperative. from increased raw commodity based differentiation. “AlphaCoop”
When the uniqueness of a differentiated product is created at predominantly manufactures and sells conventional (non-organic)
the processing and marketing stage, the organizational dynamic in products, but supplements its assortment with a range of organic
the cooperative is different. Since investments in this situation are products (fillets, minced meat, etc.). The uniqueness of the organic
made jointly by all cooperative members, the necessary risk-taking products is predominantly created on-farm. All members of “Alpha-
is of a joint nature also. The members are not integrated as buyers Coop” who want to deliver organic raw commodities to their
vs. sellers; they are members on an equal footing. The dilemma cooperative must be certified by a third party-controlled quality
relates to the fact that the cooperative is only incompletely hor- scheme. This quality scheme ensures that all rules and regulations
izontally integrated. As we have seen, these incentive problems governing organic products are followed.
are not of an unconditional nature. The problems do not unfold by For most farmers, organic production implies a considerable
any necessity. What has been addressed is their inherent logic, not increase in fixed and variable costs. The fixed costs are related to
the empirical diversity. Incentive problems represent significant investments in cowsheds, more animal-friendly equipment, etc.,
elements of risk that must be taken seriously as the cooperative whereas organic fodder constitutes the major part of the variable
transforms its business. The magnitude and severity of these gover- costs. The motivation for the organic farmers is obviously to obtain
nance problems depend on the degree of transaction-specificity of a quasi-rent from their investments. The quasi-rent in question is
the investments. The higher the transaction-specificity, the higher the difference between the first-best solution (i.e. the farm-gate
the hold-up risk. It also depends on the properties of the coop- price for organic products) and the second-best solution (i.e. the
S.O. Borgen / The Journal of Socio-Economics 40 (2011) 327–333 331

farm-gate price for conventional products). However, the farmer For decades, “GammaCoop” developed a coherent fit between
cannot be certain that the premium price is sufficient to cover its business strategy and its organization structure—the latter
both the extra variable costs on-farm and the expected return on including both business structure and ownership structure. In the
their investments on-farm. Since both risk and potential reward terminology proposed by Nilsson (1999), “GammaCoop” became a
are higher for organic producers than for conventional produc- typical countervailing power cooperative. This type of cooperative
ers, the “risk/reward” ratio differs between the two categories. For concentrates on primary processing and sells commodity products
the organic producers, the levels of risk and reward are intimately on the market and/or delivers its products as semi-processed foods
related to the hold-up problem. This problem surfaces in the form of for further processing by other companies. The main purpose of this
a potential fall in the premium price for their organically produced type of cooperative is to maximize profit margins by pursuing a cost
commodities. leadership strategy. This means that production volume is raised to
This is precisely what happened in “AlphaCoop” in 2007, when the maximum possible extent. The processing methods are highly
the farm-gate price for organic milk was unexpectedly decreased by standardized and efficient. Cooperatives of this type are predomi-
approx. 10%, due to declining market demand for several of Alpha- nantly financed on the basis of unallocated capital, with uniform
Coop’s organic end products. Haggling over appropriable quasi-rent cost calculation leading to internal cross-subsidization within a
between the group of members who provided organic raw com- highly homogenous membership. In order to attract high volumes
modities and the rest of the cooperative membership suddenly of raw materials, investments are limited, supplies are purchased
increased and became more consequential. The internal debate in from non-members, and non-discriminating ideological principles
the cooperative body became harsh. As formulated by one “Alpha- are adhered to.
Coop” member who delivered organic raw commodities: “The Following these principles, “GammaCoop” developed a strong fit
decision by ‘AlphaCoop’ to reduce the premium price on organic between its competitive strategy and its cooperative structure, both
milk by approx. 10% due to reduced market demand for organic of which were coherent with the characteristics of the market. For
products is a violation of the predictability that constitutes the basis a long time “GammaCoop” could benefit from its position as mar-
for all organic producers.” ket leader. During the last years, however, “GammaCoop” became
This case exemplifies how raw commodity based differentia- exposed to evenly fiercer competition within its main markets.
tion easily leads to haggling over appropriable quasi-rent between A more demanding competitive situation dramatically challenged
the group of members who deliver organic products and the rest the competitive strategy and cooperative structure that “Gamma-
of the cooperative members. The more consequential the haggling, Coop” had developed over long time.
the higher the probability that the organic farmers find themselves To cope with the new situation, the cooperative decided in 2008
in precarious hold-up positions. If the marketing of organic end to implement an extensive restructuring of both processing and
products vanishes, their sunk-cost investments in heterogeneous marketing activities. The overarching idea was to differentiate the
and relationship-specific assets have little or no value. They are end products of “GammaCoop” more clearly in the market. Their
forced to accept the farm-gate price for conventional dairy prod- transformation programme included large investments in novel
ucts, which corresponds to their second-best solution. processing facilities, as well as increased market investments to
enlarge the brand equity of “GammaCoop”. The purpose was to
4.2. The “BetaCoop” case enhance the assortment of clearly differentiated products. Among
the most interesting options were low-fat products, convenience-
The experience within “AlphaCoop” has some resemblance products (“ready-to-eat”) and healthier products. To realize its
to what recently took place in another large cooperative, here novel competitive strategy, substantial material and immaterial
anonymized as “BetaCoop”. What happened in “BetaCoop”, to make investments were required. More rational processing facilities were
the story very short, was that the board decided to produce and called for, and the brand equity needed to be enhanced through
market terroir products under the brand “Mountain Lamb”. How- significant market investments. All investments were aimed at
ever, the board had not foreseen that the cooperative would quite increasing the capitalization at the cooperative level in order to
rapidly be exposed to novel governance problems. The haggling increase its processing and marketing capacity.
over appropriable quasi-rent increased significantly between the To finance the necessary investments in the cooperative, “Gam-
group of members who delivered eligible lambs from mountain maCoop” decided that all members were obliged to contribute
areas and the rest of the cooperative members. The haggling came more risk-bearing equity. Throughout 2007, novel strategies for
to the forefront in multiple membership fora as an increasingly capitalization were a highly debated theme for the owners and
heated discussion about how risk and reward should be distributed management of “GammaCoop”. Unexpectedly, however, approx.
fairly between the group of farmers who are certified producers of 25% of the “GammaCoop” members chose to exit the cooperative
lambs from mountain areas and the rest of cooperative body. After 1 year after the restructuring programme was launched. Why?
2 years of intense discussion, the board decided to cancel these The reasonable explanation was that several latent incentive prob-
plans and instead market the meat under the less demanding label lems became more visible as a consequence of the restructuring
“premium quality lamb”. programme. Both the portfolio problem and the horizon problem
quickly came to the forefront. The horizon problem became more
4.3. The “GammaCoop” case evident as a large share of the members found that they preferred
a short-term perspective on their cooperative membership. When
Since its establishment, “GammaCoop” has successfully built up asked to contribute to enhance the cooperative risk-bearing cap-
a strong market position based on cost leadership. The coopera- ital, they decided to exit the cooperative. They were accused by
tive has maximized economies of scale in the sphere of commodity the other members of thinking and behaving too myopically, and
marketing. To be successful, an overall cost leadership strategy pre- the discussion climate between different subgroups of members
supposes a high relative market share, good access to raw material became more tense than earlier.
inputs, easy manufacturing design of processing lines, and a wide Furthermore, this situation manifested the influence cost prob-
line of related products, as well as service to all major customer lem, since different groups of owners in the cooperative realized
groups. This strategy calls for considerable investments in large- that they had opposing interests. Finally, the decision problem
scale modernized production facilities, although investments per became more significant due to the fact that the management found
unit of product may be relatively low. it more challenging than before to decide how to weigh diver-
332 S.O. Borgen / The Journal of Socio-Economics 40 (2011) 327–333

gent member positions and opinions. In short, the increased joint an eligible speciality producer? What are the precise quantities and
investments at the cooperative level meant that several governance qualities that are to be delivered; when and how? For instance, the
problems quickly came to the fore and became more serious than contract must specify properties of the on-farm production method
before. At the time of writing, the future of “GammaCoop” seems (fodder, etc.) so that the input of raw material can live up to the
uncertain. quality standard that the differentiated end product promises and
requires.
4.4. The “DeltaCoop” case This extended contract design appears to be commonly applied
in cooperatives in order to integrate subgroups of members (for
As described above, “GammaCoop” experienced severe gover- instance selected “premium-product producers”) into the larger
nance problems and a high exit rate among members. Interestingly, cooperative body. Typically, all eligible producers enter into the
this case can be compared to the experience of “DeltaCoop”. The same standardized multilateral contract. The essence of this con-
latter case shows that under certain conditions joint investments tractual relation is that the subgroup of speciality producers
at the cooperative level need not become problematic. One reason delivers an extra quality and the larger cooperative pays an ex-ante
is the fact that “GammaCoop” is structured somewhat differently determined premium price. In many instances, using a standard-
than “DeltaCoop”. “GammaCoop” is an example of the multiple ised, multilateral contract solves the coordination and motivation
string model (Nilsson, 2001). The operations of “GammaCoop” are problems at a reasonably low transaction cost.
divided in “strings”, each of which deals with a specific type of prod- However, using a multilateral contractual design has inherent
uct, be it different animals slaughtered or different breeds of pigs. complications. Even a carefully designed and detailed contract does
Thereby better market adaptation is attained, while the cooperative not provide ex-ante solutions for all future contingencies. One
and the farmers still operate at the largest possible scale so that the problem is to administratively determine a “right” and “fair” pre-
cost level can be reduced. A relatively high degree of membership mium price. Moreover, such solutions essentially ameliorate the
homogeneity, combined with a limited degree of vertical integra- hold-up problem related to raw commodity based differentiation,
tion, means that common investments at the cooperative level are and to a lesser degree the incentive problems related to process-
in the interest of the majority of the members. ing and marketing based differentiation. To an increasing degree,
“GammaCoop” had a relatively small net worth and a low equity therefore, more innovative and radical ways to redesign the bound-
ratio, which may be seen as drawbacks, but these factors actually aries between farmer and the cooperative are called for.
proved to be advantageous in relation to the question of property Even though the cooperative form is the subject of considerable
rights. As investments are limited and basically have the character interest in scholarly debates, this theme has not received sufficient
of reinvestment, there is no horizon problem, as all members pay focus. One exception is the observation by Hendrikse and Bijman
for the benefits they enjoy. Likewise, no member is able to reap (2002) that changes in agri-food markets shift the relative impor-
benefits at the expense of other members. The costs that a farmer tance of investments by different chain partners. Subsequently,
induces are covered by himself due to a particular price differenti- the allocation of ownership of essential assets must be changed
ation system. The low degree of vertical integration has a beneficial in order to induce agents to make investments that generate a
effect on the control problem as well as the decision-maker prob- chain optimum. Although Hendrikse and Bijman address inter-
lem. As compared to “GammaCoop”, the operations of “DeltaCoop” organizational supply chains, it is likely that intra-organizational
are relatively simple, so that the individual farmers can have a good chains are exposed to the same problem. When the major source
understanding of them. The control problem is largely solved by the of differentiation is at the farm level, it seems reasonable that the
fact that the farmers are extremely dependent upon the cooperative involved subgroup of farmers should be allocated major ownership
(Nilsson, op.cit.). responsibility. A rethinking of the link between group interests and
Taken together, “GammaCoop” and “DeltaCoop” illustrate that aggregated member interests in cooperatives is called for.
when the uniqueness of the differentiated end product is cre- This theme is not novel. In the early 1980s, Pinhas Zusman
ated at the cooperative level, the cooperative community is indeed emphasized the importance of taking group interest within the
likely to be exposed to consequential incentive problems related cooperative more explicitly into account. He concluded that any
to motivation and control. But a comparison of the two cases also attempt to explain the behavior of a co-operative enterprise as a
demonstrates that the type and level of such problems are not of solution to a maximization problem is likely to encounter several dif-
a universal nature. The problems are expected to become substan- ficulties. The basic policy decisions in a co-operative are arrived at
tial under certain contingencies (Borgen, 2004; Cook and Iliopoulos, through group choice processes, and any theory of the co-operative’s
1998). In other words, there are strategies to ameliorate governance behavior must recognize this fact explicitly. A direct analysis of the
problems. This theme is discussed further in the next section. actual group choice process, therefore, should seek to establish the
relationship between the objectives of the individual members, the
4.5. Strategies for ameliorating the governance problems composition of the group in terms of the members’ important char-
acteristics, the set of feasible policy instruments, the co-operative
As emphasized by Bogetoft and Olesen (2004), the cooperative constitution and the co-operative’s actual policy choices. (Zusman,
governance structure should maximize coordination and motiva- 1982, p.234)
tion at the least possible transaction cost for members and their Since Zusman wrote this in 1982, the membership bodies of
cooperative. In the real world, there are many important nuances most cooperatives have become increasingly diverse and hetero-
to take into account, and many solutions. A useful point of departure geneous, making his point more relevant than ever. Nevertheless,
is the generic distinction between market contracts and ownership the current literature on cooperatives is almost rigidly occupied
contracts (Hansman, 1996). with a relatively limited menu of standardized solutions: indi-
An interesting option for many cooperatives is to extend the vidualization of the cooperative capital, tradable residual claims,
market-contract interface between the group of members that are and proportional voting. The problem is that this repertoire is too
responsible for the raw commodity based differentiation and the narrow in scope, given the new complex market challenges that
cooperative organization. This approach is typically formalized as a the cooperatives are exposed to. In addition, the current scholarly
multilateral contract between the involved subgroup of producers debate can be criticized for being excessively preoccupied with the
and the larger cooperative. The contractual design must clarify mul- problematic aspects of heterogeneous membership bodies. Why
tiple questions. What are the required qualifications for becoming is membership diversity and heterogeneity not seen as a positive
S.O. Borgen / The Journal of Socio-Economics 40 (2011) 327–333 333

resource that can be developed and utilized for the larger cooper- to be plagued by severe incentive problems, related both to moti-
ative community? vation (ex-ante) and control (ex-post). So far, the typical approach
Alternatively, elements from the New Generation Cooperative to ameliorate these problems is to establish a standardized multi-
form (NGC) (Harris et al., 1996; Holland and King, 2004; Stefanson lateral contract that specifies the quality attributes so that the raw
and Fulton, 1997) can serve as a trigger for reforming large and het- material can live up to the quality standard that a differentiated
erogeneous cooperatives under certain conditions. Members of an end product requires and promises. However, this “market con-
NGC are expected to be not only active users, but active investors as tract” solution may be inadequate. The governance problems that
well. Membership is reserved for eligible members, so that the rele- follow from increased product differentiation call for more radical
vant body of ownership becomes more equal, literally speaking. The and innovative organizational solutions in future.
cooperative firm thereby benefits from improved control over the
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