Risk Management Strategies in Agribusiness

Business Structures, Markets, and Risk Management Lesson 4: Cooperatives Sarah McKay, Graduate Student, Department of Agricultural and Applied Economics, Virginia Tech Kristin Carr, Agriculture Teacher, Riverheads High School, Augusta County Public Schools Marie Rothwell, Virginia Cooperative Extension Agent, 4-H Youth Development, Augusta County Shannon Wiley, Graduate Student, Agricultural, Leadership, and Community Education, Virginia Tech Hannah Scherer, Assistant Professor and Extension Specialist, Agricultural, Leadership, and Community Education, Virginia Tech Graduate Extension Scholars Program

Overview of Today Recap from last lesson All about cooperatives Cooperative simulation activity Class discussion Recap Questions Graduate Extension Scholars Program

RECAP Graduate Extension Scholars Program

What is risk? Risk: chance or probability of loss In business: the chance that the business s actual return will be different than expected What are some key factors that make agribusiness risky? Prices Weather Disease Consumer preferences/taste Economy World trade (imports and exports) Graduate Extension Scholars Program

How do we manage risk? Insurance Pesticides/herbicides Irrigation Price Risk Management Result of volatility how prices vary from the average or mean price over time due to factors that affect risk, such as weather, disease and consumer preferences. Graduate Extension Scholars Program

Price Risk Management in Agribusiness Forward contracts Futures contract Private agreement on a price for a future delivery Examples: seed, feed, hay Individualized Publicly traded Examples: corn, live cattle, oil Standardized quantity, quality, time, and place Organized futures exchange Graduate Extension Scholars Program

How do we enter a futures contract? Chicago Mercantile Exchange LONG: buyer, accepts and purchases in future SHORT: seller, delivers and accepts payment in future Historical prices Graduate Extension Scholars Program

ALL ABOUT COOPERATIVES Graduate Extension Scholars Program

What is a cooperative? Business owned collectively Not owners, but members Owned jointly by all its members who share profits equally Profits = dividends Examples: Farmer-owned cooperative Utility cooperative Financial cooperative Graduate Extension Scholars Program

Benefits of Cooperatives Obtain services not available to smaller businesses Quality supplies at the right time Market access Economies of size Bargaining power Graduate Extension Scholars Program

Cooperative Functions Marketing cooperative maximize return received for crops and goods, value adding Purchasing cooperative used to gain access to affordable and quality supplies Service cooperative access to affordable and quality services Graduate Extension Scholars Program

People: 4 Key Elements Members patronage and capital investment Adopt and amend articles of incorporation and by-laws Elect/remove directors Decide on future of cooperative/evaluate performance Board of directors & officers Users of services and represent other members Set objectives for cooperative Hire manager, determine salary Business strategies Manager Sets operating budget with help of board Employees Graduate Extension Scholars Program

Role of Officers President Presides at meetings and watches over affairs Main communication link between management and directors and members Vice president Performs duties of president in case of absence Secretary Records all meetings and keeps bylaws and records Treasurer Oversees bookkeeping and accounts Graduate Extension Scholars Program

Show Me the Money $$$ Cooperatives pass earnings to users on patronage basis = no outside investors Provide equity through: Direct investment Retained margins Per-unit capital retains Graduate Extension Scholars Program

Patronage/Dividends Returned at end of fiscal year Revenue cost = profit Profit divided among members based on how much business member did Example: if profit is $20,000 and my business is 2%, I earn $400 Graduate Extension Scholars Program

Case Study: Organic Valley Milk Co-op You own a herd of 20 dairy cows who are averaging 20,000 lbs. per year per cow. You decide to join Organic Valley Co-op and pay the membership fee of $2,000 per percent of supply. You become 1 of 25 members, and your milk supply is 2% of their total marketed milk. Organic Valley agrees to pay you $14/cwt of milk; it costs you $11 per cwt to produce. Organic Valley sells pasteurized and packaged milk to Kroger for $45/cwt. After the cost of processing, packaging, and taking into account transportation and waste, Organic Valley has a profit of $3 million. The board of directors decides to retain 10% of the profits to put back into the cooperative, and the rest goes to its members. How much do you get in dividends? Graduate Extension Scholars Program

COOPERATIVE SIMULATION Graduate Extension Scholars Program

Each of you is a beef cattle producer with a different situation (calculate your situation first). As a class, form a cooperative. Who will be on the board of directors? Choose a president, VP, secretary, and treasurer How much equity will each of you contribute as members? Will it be a fixed price? Will it be a price per percentage owned? Will the cooperative buy cattle from all members for a fixed price and then resell the cattle, or will you retain a portion of the selling price? Graduate Extension Scholars Program

Round 1: 1.Because of the size of your cooperative, you are able to make a deal with a major feed company. They have offered you two deals; the cooperative can choose one: a. If you all choose to feed the same formulation, your variable costs will drop by $20 per head. b. If you all choose to go with this company for feeding needs, you will receive a free supplement that will increase your market weight by 1%. 2.Since you have such a large number of cattle, you can choose two routes to market: a. One processor is willing to pay $1,510 per head. b. The other processor will buy all the cooperative s cattle at $125/cwt. Based on your decisions, calculate the profit of the cooperative. How much will the co-op retain for next year? How much will be paid out in dividends? How much did you make as an individual producer? Was this a better call than selling as one producer? Graduate Extension Scholars Program

Round 2: 1.Because of the size of your cooperative, you are able to make a deal with a major feed company. They have offered you two deals; the cooperative can choose one: a. If you all choose to feed the same formulation, your variable costs will drop by $20 per head. b. If you all choose to go with this company for feeding needs, you will receive a free supplement that will increase your market weight by 1%. 2.An opportunity has come up where the cooperative can purchase a slaughterhouse for $500,000. Running the slaughterhouse will cost $100,000 a harvest, but you have a grocery store willing to pay $1.55/lb. on average if they can get the beef from the cooperative directly. a. Do you all decide to buy the slaughterhouse and process your own meat? b. Or, do you sell to a processor willing to purchase your cattle at $123/cwt? Based on your decisions, calculate the profit of the cooperative. How much will the co-op retain for next year? How much will be paid out in dividends? How much did you make as an individual producer? Was this a better call than selling as one producer? Graduate Extension Scholars Program

Round 3: 1. A few members have noticed that the organic prices for beef are substantially higher. This is because processors are willing to pay $175/cwt and retailers are willing to pay $2.25/lb., depending on if you bought the slaughterhouse in Round 2. However, your feed costs will double to feed organic. Because of the strict regulations with organic and the limited supply of organic grains, the whole cooperative must switch to organic or not at all. Does the cooperative decide to go organic? Based on your decisions, calculate the profit of the cooperative. How much will the co-op retain for next year? How much will be paid out in dividends? How much did you make as an individual producer? Was this a better call than selling as one producer? Graduate Extension Scholars Program

CLASS DISCUSSION Graduate Extension Scholars Program

QUESTIONS? Graduate Extension Scholars Program