North American Bison Cooperative by fjhuangjun

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									10/20/2008


North American Bison Cooperative and North Dakota Natural Beef LLC: Governance Issues in a

Contractual Alliance1


                              Gregory McKee and Michael Boland



Background
        North American Bison Cooperative (NABC) was formed in 1993 with 330 bison
producer members in the United States and Canada. Today it processes and distributes bison
meat products and increases public awareness of bison meat product characteristics. The
cooperative was formed for two reasons. First, prior to the formation of the cooperative, a
consistent supply of large volumes of bison were not available from a single source. Second,
since bison producers marketed their animals on their own, forming an organization which would
provide marketing services would reduce their costs.
        In 1994, the cooperative opened a bison slaughter and processing facility in New
Rockford, North Dakota (ND), U.S.A. The plant was initially designed to process 5,000 head per
year. Increasing demand for bison led to a subsequent expansion. By 1999, the plant processed
8,000 head annually and expected to process 10,000 head per year by 2000. By 2000, however,
expanding supplies from other processing companies and declining demand for bison caused
market prices to drop. In early 2003, prices remained relatively low, although sales had reached
$22 million. After being in business ten years, low bison meat prices led to an accumulated
inventory of frozen bison meat, some of which was more than three years old, which it was
unable to pay its members for. Although efforts had inventory liquidation efforts had started, the
cooperative had more than $20 million in deferred payments to members with unsold inventory.
It had also acquired New West Foods, a bison marketer, and Great Plains Food Co. to help
distribute its products but there were no apparent cost savings. As result, the cooperative board
declared bankruptcy in October 2004. By July 2005, with the inventory on its way to being
liquidated, the cooperative emerged from bankruptcy but needed to increase its business volume
in order to cover fixed costs of operation. The new President/CEO of NABC, Dieter Pape,
considered various options for increasing business volume.
        Dieter knew one way to use the cooperative’s assets more intensively would be to pursue
custom processing and enter the natural beef product market. Consumer interest in food
produced with environmentally friendly practices and free of hormones and antibiotics had led to
an increase in demand for natural and organic products during the past decade. Increasing

1
 This case was prepared by Gregory McKee is assistant professor of agricultural economics and
director of the Quentin Burdick Center at North Dakota State University. Michael Boland is
professor of agricultural economics and associate director of the Arthur Capper Cooperative
Center at Kansas State University. Primary sources of information are trade press articles and
interviews with members of the board and management of North Dakota Natural Beef, LLC and
North American Bison Cooperative. Appreciation is expressed to NDNB CEO, Dieter Pape, for
reviewing this document for accuracy.
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numbers of natural food stores, such as Whole Foods, and the mainstreaming of health foods in
traditional supermarkets also indicated increased consumer demand for natural and organic
products. Dieter also knew that consumers were willing to pay a premium for natural beef
products relative to conventional beef products.
        Beef producers in North Dakota were aware of these changes in the beef product market.
A survey of North Dakota beef producers reported fifty-eight percent of respondents would be
interested in implementing a natural beef production program. However, at least two factors
prevented their implementation of such a program. One was the increased production costs of ten
to twenty percent due to the longer time for the animal to achieve the ideal market weight.
Producers believed, however, that premiums consumers were willing to pay for natural beef
would offset these losses. Another was the lack of slaughtering facilities in North Dakota.
        Along with other meat industry stakeholders who had been trying to start a natural beef
venture in North Dakota, Dieter attended a meeting at the North Dakota State University
(NDSU) Carrington Research facility to discuss ideas about how NABC might help contribute to
the natural beef industry. There he met several of the state’s beef industry leaders and others who
had tried to help establish a marketing outlet. Dieter visited with Dr. Ken Odde of the NDSU
Department of Animal and Range Science. During their discussion they developed an idea of
starting a natural beef company to build upon the synergies of harvesting, processing and
marketing natural bison which could also aid the university in its research and education mission.
This idea contributed to the formation of North Dakota Natural Beef (NDNB), a North Dakota
corporation, in October, 2005. Its mission was to provide an environmentally friendly beef
product. The company would accomplish three goals from NDSU as well, including enhancing
the growing of cattle feeding and processing in ND, enhance NDSU’s research capacity, and
provide an educational facility for NDSU students interested in meat careers. The relationship
between a public university and a private company enabled the two groups to take advantage of
US$800,000 in funding made available by the ND legislature as well as a federal grant of US$1
million.
        NDNB’s stakeholders decided the business would be structured as a Limited Liability
Company (LLC). Although the business would be separate from NABC, the cooperative would
own a ten percent share of the business and, through meeting established performance standards,
it could add another ten percent every year for two years for a total ownership of 30 percent. In
addition, in order to commence operations quickly, NDNB contracted with NABC to receive
managerial, marketing, and administrative services from the cooperative. As Dieter reflected on
the start of this venture, he wondered how the relationship between an LLC and a cooperative,
linked through a contractual alliance, would affect the profitability of the cooperative.

Description of the Venture
        North Dakota Natural Beef, with total sales of approximately US$2.7 million since April
2007 (through September 2008), processes and markets natural beef products. Naturally raised
beef cattle are sourced from three to five feedlots operating in North Dakota. These are shipped
to the North American Bison Cooperative facility in New Rockford, ND for slaughter. Since no
beef slaughter facilities were available in North Dakota prior to the venture, the shorter travel
distance reduced transportation costs for the feedlots.


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        The two companies manage the production of meat production at two facilities. The New
Rockford facility is used for slaughter. Although the plant operates below capacity today, the
NDNB business plan estimates that between the third and fifth year of operation sufficient
volume will be achieved to be at capacity. After slaughter, carcasses are shipped for fabrication,
packaging, and distribution at NDNB’s new 41,000 sq ft. facility in Fargo, ND. The bison
cooperative contracts with NDNB to obtain packaging and distribution services for its bison
products from NDNB’s Fargo facility. The Fargo location, North Dakota’s largest city, provides
access to a supply of labor, the nation’s interstate freeway system, and scientific expertise at the
Department of Animal and Range Science. It also enabled the cooperative to consolidate a
system of inventory-holding facilities located in North Dakota, Minnesota, and Colorado into a
single facility.
        NDNB receives managerial, sales, and administrative staff from NABC. The NABC staff
had been together for some time and understood some of the difficulties associated with starting
a new company and the amount of time required to establish marketing relationships with retail
and institutional customers. Mr. Pape, president and CEO of NABC, is the president and CEO of
NDNB. The sales and marketing staff for NABC was the initial sales staff for NDNB. Once the
alliance started, NABC’s marketing team began working immediately to market natural beef
products through its already existing system of retail and institutional customers. NABC also
provided administrative services for NDNB, providing use of NABCs chief financial officer,
controller, and human resources manager. The distribution of effort between the two companies
for any NABC employee working for NDNB is accounted for by time slip.

Analysis of the Venture
        NDNB and NABC are economically interdependent through its contractual alliance.
Their economic interdependence features an exchange of resources. The exchange satisfies
NABC’s objective to retain its physical and management resources and NDNB’s objective to
obtain resources which allow it to enter the natural beef market at relatively low cost. Although
the boards of directors from the two companies operate independently of each other, the
investment by the cooperative enabled the partnership to benefit from the perspective of
agricultural producers which had run a business while at the same time removing the investment
horizon problem that would have existed if individual cooperative members had been asked to
invest in NDNB.
The Contractual Alliance
        The contractual alliance between NDNB and NABC created a clear transfer of property-
based resources between the two firms. NABC made two types of property-based resources
available to NDNB in the contract alliance. First, NDNB was able to use the cooperative’s New
Rockford facility and management team. Second, NABC made available its knowledge-based
resources of pre-existing contacts between its sales team and retail outlets catering to health-
conscious consumers. NDNB also made property-based resources available to NABC, including
use of the Fargo processing facility and less costly access to labor and NDSU research resources.
        The economic interdependence between the two firms increased the ability of each firm
to obtain a comparative advantage in their respective product markets. NABC believed its
successful emergence from bankruptcy was associated with the managerial acumen of Dieter

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Pape and his management team. The NABC board now wanted to use their abilities to increase
the welfare of the cooperatives’ members. By forming an alliance with NDNB, NABC hoped to
ultimately increase patronage for the cooperative and reduce the associated administrations costs.
This will occur as the costs associated with starting a new business, which are distributed across
all the stakeholders of NDNB, are incurred and profitability is achieved. As NDNB becomes
profitable, a percentage of NDNB profits, corresponding to its ownership share, will be allocated
to its members. NDNB obtained a comparative advantage in the natural beef market by obtaining
an experienced management staff at a lower cost than it would have had it purchased its own
management team, and obtained instant access to sales relationships with retailers of healthy
meat products.
        The alliance demands little integration or collaboration between companies, making a
unilateral contract appropriate. Common management coordinates each animal processing step at
the two facilities. Furthermore, since buffalo and natural beef are likely to be imperfect
substitutes, NABC’s marketing knowledge is a knowledge-based asset used by NDNB which
cannot be taken away by NDNB.
Governance
        The decision to form an LLC was motivated by at least three factors. First, stakeholders
had a desire to allow persons other than beef producers to invest in the company. Equity capital
was generated for the LLC through a private stock offering. A private stock offering is a means
of raising capital which is exempt from federal registration. This exemption has the benefit of
simplifying the equity collection process. The stock offering was done with a document called a
private placement memorandum, which contains an overview of the proposed business plan,
opening and closing date, and other terms. The exemption requires compliance, however, with
certain requirements, including not publicly advertising the opportunity to purchase stock and
that most stock must be sold to investors meeting certain qualifications. Because the groups of
investors obtained by this method is typically small, usually investors are contacted directly
about the opportunity to purchase stock and interested parties reply to the interested company
directly. These offerings can be done on an annual basis.
        By virtue of incorporating as an LLC, the composition of the NDNB board is based on
ownership share. Upon incorporation, stakeholders in the company sought equity and debt
capital from various sources. A capital campaign was conducted with the objective of raising
from US$3,500,000 to US$4,500,000. The minimum was raised from thirty four investors by the
end of July, 2006. Each has various levels of ownership. Additional debt capital was provided by
the Small Business Association and the Bank of North Dakota. NDNB is governed by a nine-
member board of directors. NABC currently owns approximately twenty percent of the business.
This level of ownership gave the cooperative rights to two seats on the nine member board of
directors.
       A second factor affecting the decision to form the LLC was the recognition by some
investors that a beef producer serving on the board of directors could have a conflict of interest
between the profitability of his own production and the profitability of the firm. These investors
considered that the influence of such a conflict on board decisions could be diminished by
having a board whose objective was to maximize shareholder welfare rather than producer
welfare.

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        A final factor which led to incorporating as an LLC was the recent experience of
agricultural producers with closed membership cooperatives, or “new generation cooperatives,”
such as NABC. These cooperatives encouraged efficient use of physical assets by requiring
members to agree to delivery obligations to the cooperative in proportion to ownership. If NDNB
were to have incorporated as a closed cooperative, members would have wanted delivery
obligations. The limited number of ownership shares, whose minimum number is determined at
incorporation, makes it difficult for new natural beef producers to participate in the venture.
       The NDNB board organized itself differently than the NABC board. The NDNB board
has several committees, whereas the NABC board has one committee. Also, even though the
geography represented by the NABC and NDNB boards is similar, the NDNB board meets every
three weeks, either by teleconference or in person. In contrast, NABC board meets less often.
        Although the LLC business model was selected in order to decouple the interest of the
producer and the company, the board benefits from the experience of beef and bison producers.
One of the board members produces natural beef. Four directors produce agricultural products,
including two bison producers representing NABC. Production experience enables the board to
understand why certain breeds of cattle are important for meeting consumer preferences or
achieving various cost targets and the importance of the timing of sales in order to obtain yield or
other characteristics from the cattle.
        Even though member control is an important component of cooperative business
governance, its influence is only indirectly felt in the governance of NDNB. One way the
cooperative member’s voice could be represented is through the two NABC board members,
who are also members of the NDNB board. In practice, however, these act as investors to the
project and not the cooperative member’s representatives in the governance of an LLC with
which their cooperative has a contractual alliance.
        Corporate governance also affects the distribution of profits from a company to those
who supply its financial resources. In cooperatives, financial benefits accrue to members in
proportion to their use. However, the investment by NABC in NDNB is independent of the
membership. The corporate independence of the two companies avoids the cooperative business
requirement of direct financial benefits to NABC members. Instead, the income from the
investment in NDNB is treated as income from any other investment in entities outside the firm.
All financial benefits, such as increases in the value of equity shares or stock dividends, accrue to
NDNB shareholders, including NABC, in proportion to their ownership share.

Conclusions
         The contractual alliance between NDNB and NABC enabled both companies to utilize
resources which would create a comparative advantage for each in their respective product
market. NDNB would be able to use existing marketing knowledge to establish relationships
with retailers quickly, would obtain access to experienced management at a relatively lower cost
than if they purchased one hundred percent of the management team’s time, and would be able to
process cattle produced in North and South Dakota more cheaply through use of facilities in
North Dakota than by having to ship cattle to other states. NABC was able to retain its
experienced management team at a lower cost than having to employ the team one hundred
percent of the time and, by obtaining profits from its investment in NDNB, increase financial

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returns to its members. The alliance required little formal interaction between the two companies
except to schedule the use of physical facilities.
        The contractual alliance did increase the amount of complexity for governing NDNB, but
the fact that the two companies operate under different business principles does not contribute to
this complexity. Although the bison cooperative enjoys the benefits of being governed by a
group which understands the complexities of agricultural production, NDNB receives a similar
benefit by having agricultural producers, who invested in the company, serving on the board.
The members of the cooperative indirectly receive financial benefits for sharing their investment
in the New Rockford facility with NDNB, as do the shareholders in NDNB. NDNB is governed
by a board which ensures separation between producer and investor self-interest.




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Table 1. Comparison of North American Bison Cooperative and North Dakota Natural Beef LLC
Governance Attributes

      Attribute               Limited Liability Company               Cooperative

Board Committees        Multiple committees                  Committee of the whole
Composition of board    Mostly non-agricultural              All bison producers
                        producers
Homogeneity of board    Represent several sizes of           Represent several type and sizes
                        investment                           of bison producers
Representation function Represent investors                  Represent bison producers
Primary investors       Financial markets and banks          Agricultural producers and
                                                             banks
Investor objective        Maximize returns to investors      Maximize returns to producers
Board familiarity with    Unfamiliar with beef production    Active bison producers
agricultural production
Director compensation       Zero salary                        Zero salary
                            Mileage and per diem               Mileage and per diem
                             expenses for corporate travel       expenses for corporate travel
                           Deferred compensation               Compensation same as
                             available for board members         financial benefits to all other
                             who accept and hold options         members, in proportion to
                             for five years                      use
Director tenure limit      Variable lengths of terms:          Three three-year terms are
and term length              three, two, and one year.           the limit per director
                           Maximum tenure of five
                             years
Geographical allocation   None. Based on ownership.          Two at-large
of directors                                                 Two from Canada
                                                             Four from U.S.




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