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8. Ideas for Strengthening Capital Formation in Kenyan Dairy and Coffee Co-operatives

Mobilising Member Funds

Though study findings show that some investment is taking place within the cooperative coffee and dairy sectors, it is not enough. Growth in inflation-adjusted real values of net worth per member were negative in all cases except the shareholder-oriented dairy co-operative, Dairy C, whose exceptionally large investment stimulated members to invest in the society recently. Happily there were no drastic failures in investment financing in any of the studied co-operatives, even in the fairly well-managed societies. The main problem reported in investment financing within the fairly well-managed co-operatives concerned delays in completion of the investment (by the supplier-oriented Dairy B) and the inability of the management (in the government-oriented Coffee B) to identify additional investment targets for future member financing.

The well-managed, supplier-oriented Coffee A was relatively successful in mobilising capital with its consistent and professional investment programme. Well-managed, supplier-oriented Dairy A was also successful, but only because of the risk taking of its mother union. Shareholder-oriented Dairy C, however, can be considered a success in its own right by attracting enough capital to launch a new dairy plant.

As mentioned earlier, co-operatives can mobilise capital either through the collection of additional share capital from the members before the investment starts or by obtaining a bank loan to finance the investment first, which is later paid back by deductions from the members’ crop proceeds once the investment begins to generate income. While the majority of co-operative members argued they had little cash left over after payment to invest in their co-operative, it became clear that the main problem was the lack of incentives and confidence that such an investment would ultimately benefit them.

Indeed, the empirical findings confirmed that members had money, which could be used for funding capital investments. A review of the personal cash savings held by members of all the surveyed societies showed that their personal savings had grown more than the capital of their societies. These funds of the members were deposited in their personal savings accounts with the local SACCO or the Union Banking Section. Members had also expressed a willingness to provide funds to their co-operatives, but only after they had met their own expenses and farm development costs. In that sense, members’ investments in the development of their farms competed with the capital formation of the society. Management of the cooperatives, therefore, has the difficult task of convincing the membership that the long-term impact of the proposed investments on member wellbeing will outweigh the short-term costs.

The most popular chosen method of raising investment capital from the members is via deductions from members’ crop payment, which has the negative effect of lowering their net payment. Were members better informed about how much is deducted from their payments to finance the investments of the society and the co-operative formally obliged to maintain records of each member’s cumulative capital contributions and provide members with some sort of share certificate acknowledging this contribution in return, members might be more interested in investing in the co-operative business. Improved transparency in member transactions, better communication and availability of management information were issues identified by members in all co-operatives studied and have long been neglected by management.

In most co-operative marketing systems the member is considered to be the legal owner of the produce until it is sold and entitled to know the net price, as well as all information (the how? who? why? and when?) regarding deductions made from the export price received until their net payment. Unfortunately, in the case of Kenya’s coffee co-operatives, members seem to be hopelessly out of control when it comes to participation in controlling operations within the society. At the moment, accountability is not to the owner of the crop and the Government has been slow to set an example of such improved openness in declaring deductions made to various middlemen before the funds arrive at the society. Providing such detailed information to large membership co-operatives is costly and time-consuming especially when they are using manual accounting systems as was the case in all the co-operatives examined, but relatively easy and much less costly by using computerised systems. Co-operative accounting systems should, in a computerised payment report to each producer, provide detailed information of the total payment made by the buyer and specify each deduction until the net payment.

Mobilising External Credit

Accessing external bank credit to finance co-operative investments has been the preferred way of raising co-operative capital and until recently, there have been several advantages in this debt-financing method:

1. It is faster, sometimes easier to obtain a bank loan than to collect share capital in small instalments from the members.

2. Securing bank funding at the outset speeds up implementation. This ensures that there will be no interruptions in the work and the commissioning of operations can be done according to plan.

3. Once an investment is completed, members have the opportunity to first see the concrete outcome of the investment before they begin paying for it. If the investment proves to be profitable, it will also generate additional member income for the payment of the deductions. Should co-operatives be able to declare and retain surpluses from this improved efficiency without distributing them out to the members, part of the investment could also be paid from the surpluses, which are earlier internally generated. This would assist in retaining member loyalty, because members’ produce proceeds would not be touched.

4. External financing offers a new means of outside control over the co-operative and puts pressure on co-operative management towards improved capital investments and effective management.

5. In the case of the coffee sector, an active investment promotion programme, such as SCIP, is available to respond to the needs of the society. The management is already familiar with the terms and conditions, which are accepted by the management. Therefore, to repeat the loan application procedure is simple.

Yet with the current contraction in commercial and investment credit markets caused by economic recession forces, co-operatives will find access to these credit markets more competitive and difficult. This increases pressure to mobilise their members’ own contributions in investment financing. This, in turn, will require more transparency in co-operative transactions, more member participation and a significant improvement in co-operative business and member service performance.

Improving Working Capital Financing

Co-operatives not only need capital for investment purposes, but also to finance their operational costs. Mobilising adequate working capital is a major problem in growing co-operatives, particularly in co-operatives dealing with seasonal or permanent crops, where there is a long time-gap between harvest and sale dates. This is particularly the case with coffee co-operatives where funds are needed to cover operational costs and crop procurement from members for the entire growing cycle. Dairy co-operatives, by contrast, require smaller amounts of working capital due to their daily rate of product turnover.

Bank Overdrafts

In Kenyan co-operatives, the favourite method for securing adequate working capital is through bank overdrafts. Co-operatives are required by the Ministry to return all available surplus funds to the members at the end of the season. Therefore, coffee cooperatives are not able not accumulate enough own funds to cover their running costs in the next season, but are forced to pay salaries and operational costs by bank overdraft. The overdraft is then paid back after the season’s crop funds start coming in only at the end of the financial year. It is very costly to operate this type of a system. The high interest rate that co-operatives must pay on overdraft financing (30%) further reduces the net proceeds to the farmers. This problem is greater in the coffee than in the dairy sector, because of the highly seasonal pattern from crop delivery to crop payment.

Retention of Patronage Refunds

In some countries, retained patronage refunds are used as a source of working capital. Instead of paying out patronage benefits to the members at the end of the year, co-operatives offer members interest-bearing bonus certificates which the cooperative redeems after an agreed time, say 1-5 years. So far, Kenyan co-operatives have not been able to introduce this type of working capital financing although the advantages of such a system are apparent:

1. Members have money and want to save. This is clearly demonstrated by the success of SACCOs in attracting considerable growth of co-operative members’ savings.

2. Members are willing to finance the co-operative through retained patronage benefits, since it strengthens their ownership ties and would improve member participation and control of the organisation.

3. Redeemable bonus certificates, which would pay a reasonable interest on the members’ capital, could be made a viable and attractive alternative to the successful savings opportunities currently offered by the SACCOs to the members.

4. At the same time, the interest rate payable on bonus certificates could be set at a much lower rate (say 15%) compared to the presently exorbitant interest (30%) charged on bank overdraft financing. This would save millions of shillings in financing costs and help the co-operative to improve its operating performance.

5. Improvements would have to be made in building members’ trust in the organisation but if done, bonus certificates could develop into important medium to long-term financing instruments. This would improve not only liquidity, but also long-term financial planning and autonomy of the co-operative in its financing.

The basic reason why retained patronage benefits have not been introduced as a financing instrument is that there is no tradition in the Kenyan co-operatives of paying patronage bonuses to members. Kenyan co-operatives do not generate profits (due to taxation laws) and there is nothing to distribute or retain. The issue of profitability or members’ willingness to declare a surplus needs to be addressed first.

Seeking an Alternative to the Consignment System

In a co-operative marketing system, members normally give their crop on consignment sales terms to the co-operative (which does not take title and does not pay cash). The co-operative then delivers the crop to another consignee who passes on the crop (without taking title) to a further consignee until a buyer is found. The last consignee then sells to the ultimate buyer at any (or the most advantageous) price and delivers the money (after deducting his costs) through the same chain of consignees back to the member. This is a lengthy process and takes time. Due to a chronic lack of working capital, co-operatives seldom have enough cash to procure the crop of the members or to at least pay them a reasonable advance until the final settlement of the season. The system of consignment sales has been the only alternative and has made it possible for co-operatives to operate without the need of working capital for the procurement of members’ crops, but the system has severe weaknesses in the eyes of the member:

1. Members do not get a prompt payment, but often have to wait, sometimes months, for the proceeds from their harvest.

2. Members do not have any control over the price at which their crop is sold.

3. Members have no control over the costs that are deducted by the consignees from their crop proceeds.

The above reasons make consignment sales an inferior system of marketing from the member point-of-view. In the coffee sector, co-operatives would be extremely vulnerable in a more liberalised market if other private buyers were allowed to deal directly with the members and offer cash payments. This implies that the movement should give their urgent attention to seeking alternative marketing systems.

A new, improved payment system has been recently introduced by SCIP to provide direct payments from the Coffee Board to the society account. This has reduced the notorious delays in payments by the Government and the apex bodies, but the consignment sales system remains basically the same and the situation from members’ point of view is still far from adequate.

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