WASHINGTON, D.C. -- Value-added was the buzz word of the day at a recent congressional hearing on farmer-owned cooperatives.

The Oct. 16 hearing before the House Agriculture Committee discussed the changing structure of agricultural cooperatives and the challenges that cooperatives face as they seek to increase the income of their farmer- members, and find new ways to finance their operations. Testifying before the committee were agricultural lenders, government agencies, and farmer-owned cooperatives.

According to committee chairman Bob Goodlatte, R-Va., the hearing examined how traditional cooperatives sustain themselves during the rapidly changing and globalizing agricultural economy.

"All of us who represent farming and ranching communities understand, and the Congress has understood since the New Deal, that agriculture is a cyclical industry and profits are often fleeting. Access to adequate capital and crucial times is critical to the success of agricultural economic enterprises."

Thomas C. Dorr, USDA undersecretary for rural development, testified at the hearing that, for more than 100 years, traditional cooperatives have organized and operated according to a relatively static model.

Patron cooperatives were designed to provide members a beneficial interest. The benefit they received as a patron member was either a cheaper price if they bought something from or through the cooperative, or a better price if they sold something to the cooperative. Any earnings derived from patron cooperative operations had to be returned to the members as cash patronage dividends or additional equity retained by the cooperative, he says.

However, Dorr says, today's cooperatives face serious challenges, and he believes American agriculture is at a crucial crossroad.

"Cooperatives must be prepared to sail in relatively unchartered waters to bring the maximum benefit to producers who look to them for economic opportunities and security," he says. "To diversify farmer investment in businesses that add value to the products that rural Americans produce through processing, distribution, and perhaps even branding is paramount. This will allow producers to capture some of the dollars now going to the middlemen between producers and consumers."

The "new generation" cooperative model, he says, is not just any cooperative that adds value to agricultural production through processing and merchandising, but also cooperatives that adhere to a fairly specific set of characteristics that provide producer-owners with economic incentives to patronize and invest in them.

"Our challenge is to help producers develop cooperative structures that will generate a return on the untapped value of their real estate sufficiently large and safe enough to entice them to invest in off- farm operations," Dorr says. "There is nothing magical about organizing a business on a cooperative basis. But if the business plan is strong and the implementation of that plan is focused and visionary, farmers and other rural Americans can expect a strong return on their investment."

Steps, he says, should be taken to make investing in a cooperative attractive to local non-producers, and, when advantageous to the producers and the community, non-producer outside investing interests.

Dorr says he is concerned about the long-term health of an agricultural system that focuses only on production, especially the production of basic commodities that are being grown at less cost in an increasing number of countries around the world. "Cooperatives offer a vehicle to allow producers to turn their production into food, clothing, energy, pharmaceuticals, and, in the future, other value-added products that may not have even been imagined as yet."

Also testifying at the hearing was Michael M. Reyna, chairman and chief executive officer of the Farm Credit Administration. "Cooperatives play a crucial role in making American agriculture prosperous, productive, and efficient. They increase the economic bargaining power of farmers, which in turn, strengthens the agricultural economy and improves living conditions in rural areas. Cooperatives were instrumental in bringing electricity and modern telecommunication services to rural areas.

Historically, he says, cooperatives developed as an alternative to investor-owned agribusinesses, which were perceived as paying farmers too little for raw commodities and then charging consumers high prices for value-added food products.

"Concerns have been raised that traditional cooperatives are not resilient enough to endure the economic changes facing agriculture today and to help farmers overcome new challenges," Reyna says. "Value-added enterprises are one of the best ways for farmers to increase their income because they provide a way for farmers to earn a greater share of the retail food dollar. However, the American food distribution system is increasingly concentrated, vertically integrated, and capital intensive, which makes it more difficult and costly for farmers to own and control value-added enterprises. Typically today, farmers struggle to find sufficient capital to enable them to invest in their own value-added enterprises."

He says, "When farmers cannot raise sufficient capital on their own, they need to turn to outside sources of equity. To attract outside equity capital or increase their business with nonmembers, some farmer groups are forming hybrid organizations or restructuring existing cooperatives."

A legislative proposal would give the Farm Credit System more flexibility to finance cooperatives as they adjust to changing market conditions. The proposal would also financing for those entities in which farmers hold at least 50 percent of the equity or voting control, or are designated as cooperatives by state law.

That proposal, Reyna says, may well be the change needed to save the cooperative way of doing business for farmers, ranchers and their cooperatives. It may also prove to strengthen farmers' and ranchers' income.

Jim Caspary, who serves as president of the First National Bank of Clifton, Clifton Ill., and chairman of the Independent Community Bankers Association's Agriculture-Rural America Committee, says, that group is opposed to the CoBank legislative proposal in its current form because it would allow loans to corporations that may have no farmer involvement and that may be unrelated to agriculture. He also believes the proposal would allow CoBank, a national discount GSE lender, to undercut local lenders.

"We do feel it is appropriate to explore ways to enhance the accumulation of equity capital within farmer-owned cooperatives and in rural America — but this should be done in ways that don't potentially lead to the loss of legitimate farmer control of their cooperatives or in ways that drastically depart from the bedrock principles of what makes a cooperative a cooperative," he says. "We also feel it is important to ensure that policy actions do not spur greater consolidation in agriculture and consolidation of the businesses and cooperatives that serve agriculture just for the sake of growth for some at the expense of survival for others."

Caspary says, "Obviously, any business, whether a cooperative, a single proprietorship, a corporation or other corporate structure, needs to have a certain amount of equity to begin, operate and maintain their business operations. In rural America, it has been evident that there are plenty sources of debt capital. Any credit-worthy business can get a loan from a commercial bank and often times there are several community banks vying for a potential customer's business within the community."

Several options are available, he says, that allow cooperatives to "cooperate" between different types of businesses, whether they share the same or a different corporate structure, without the farmer-owned cooperative being taken over by outside investors.

"There can be advantages in seeking outside capital for cooperatives, but we must weigh these advantages with the potential for conflict with the interests of the farmers who own these cooperatives, because control follows money," Caspary says.

John Henry Smith, chairman of the board of Southern States Cooperative, Inc., based in Richmond, Va., told members of the House Agriculture Committee that while he has always been a firm believer in and supporter of farmer cooperatives, his attitudes have been strengthened in the past 12 to 18 months. "That period has been one of considerable challenge for Southern States and many other cooperatives. Due to a combination of drought and other adverse weather conditions, a difficult farm economy and some diversification and growth steps that did not generate the returns Southern States had expected, our cooperative has been confronted with major financial challenges."

Smith, who is also a cattleman and tobacco producer in Russell County, Va., a member of Southern States Cooperative since 1958, uses many of its products and services in his farming operation.

"Farmers today still need and rely on their cooperatives as much as they ever did," Smith says. "Not only does today's U.S. farmer produce for a national marketplace, he also must compete with producers around the globe. I personally do not know of any farmer who is large enough to tackle any of these and other similar challenges on his own. Whether it involves securing the needed inputs and related services as efficiently as possible to gain the cost-effective production required to compete and generate an adequate return, whether it involves the marketing and/or processing of what he grows to gain a greater share of the food and fiber dollar, today's farmer needs a reliable place to turn."

Smith believes that existing programs and tools within USDA can be strengthened. Southern States Cooperative, he says, strongly supports the establishment of a separate farmer cooperative agency within USDA, to maintain and improve the ability of farmers to join together in "cooperative self-help activities."

Such an agency would provide for greater accountability and promote greater support of cooperatives, he says.

"We also urge Congress to approve legislation (HR 1671) as introduced to clarify what's known as the Dividend Allocation Rule, because cooperative dividends are subject to a triple tax, while regular corporate dividends are taxed only twice. Eliminating this unfair tax penalty — an issue that both houses of Congress have acted on favorably in the past — would be an important step in helping farmer cooperatives attract equity capital."

Smith also thinks it's time to update the Federal Farm Credit Act. "Updating the law would allow farmers to continue to have choices when it comes to organizing and financing their cooperative businesses," he says.

In the end, Smith says, "Cooperatives are farmers themselves working together to accomplish what none of them could do by themselves."

e-mail: dmuzzi@primediabusiness.com