Six Principles for a Successful Second-Tier

Jen Budney and Paul Thompson

Co-ops can learn from principles that have been used to successfully manage common pool goods like irrigations systems for generations.

There are many things that make co-operative enterprises different from investor-owned firms. Chief among these is the members’ control of how the business is governed. However, this unique aspect of co-ops is not without its challenges. Anyone who has been involved in guiding a co-op can attest to this. And when a co-op’s members are themselves co-ops, rather than individuals –that is, when they are second-tier co-ops– these challenges can be amplified.

The governance of co-operatives is challenging because it involves making decisions about what economists call “common pool goods.” Common pool goods are defined as those that are rivalrous (one person using the resource affects another’s ability to use it) but not excludable (individuals can’t be prevented from using the resource). Classic examples of common pool goods are things like irrigation systems, grazing pastures, and fish stocks.

In second-tier co-operatives, common pool goods are resources that are accessible to all members co-ops (they can only be excluded from using the resources if they are expelled from the second-tier co-op). Some examples are:

  • Branding: if co-operatives use a common brand (signage, logo, colour palette, etc.) developed and maintained by a second-tier co-operative, how a retail co-op presents itself (cleanliness of stores, friendliness of employees, etc.) will affect the value of the common pool good.
  • Common Infrastructure: this is particularly relevant in the digital age. A good example of shared digital infrastructure is the security and online banking systems used by credit unions. In order to compete with big banks, local credit unions will pool their resources through a central credit union to generate an economy of scale that will allow them to maintain the kind of sophisticated online technologies that today’s banking consumers expect. However, these systems are expensive and larger credit unions will often (though not always) end up subsidizing the use of the systems by smaller credit unions in the same central.
  • Bulk Purchasing Power: like credit unions, retail co-ops will use their combined numbers to increase their purchasing power. However, individual retail co-ops can take advantage of some low prices while choosing to stock many other items not carried by the wholesaler. Compared to a co-op who purchases all of their goods from the wholesaler, the rogue co-op will not contribute their fair share to the second tier’s collective purchasing power.

When member co-ops choose to extract more than their fair share from a common pool good, economists call this behaviour “free-riding.” Extensive free-riding by local co-ops can jeopardize the future of second-tier co-operatives and should be avoided at all costs.

Elinor Ostrom won a Nobel Prize for her work on managing common pool resources.

Luckily for today’s co-ops, humans have been co-operatively managing common pool goods for thousands of years. We can draw on this history of successful resource management to strengthen second-tier co-ops. Nobel Prize-winning economist Elinor Ostrom has researched the long-term management of common pool goods. From looking at how communities have managed their resources over time, Ostrom has developed a set of design principles common to successful groups. Fellows from the Centre for the Study of Co-operatives have taken six of these design principles and applied them to the management of second-tier co-operatives.

 

 

The six design principles for second-tier success are:

  • Clear boundary rules for membership.

Membership in the second tier is voluntary, but becoming a member involves a trade-off: only organizations that commit to the responsibilities of membership have access to the services and goods that the second-tier co-op provides. In short, if a co-op wants to benefit from being a member, they have to play by the rules set out by the second tier.

  • Allocation of benefits and decision-making rights in proportion to each member’s contribution to the central organization’s success.

What constitutes a contribution must be clearly defined, and then this definition is used to allocate voting rights and benefits. This will often, but not always, be patronage from the second-tier co-op. A simple example would be a retail co-op that accounts for a quarter of bulk purchases from a second-tier wholesaler would be given proportionally more voting power than a smaller co-op which accounts for only two percent of purchases.

  • Rapid access to low-cost arenas to avoid conflict.

Diversity is a good thing. Whether in an ecosystem, genetics, or group decision-making, variety can lead to better outcomes. However, in a second-tier co-op where there is heterogeneity amongst members, differences and disputes are inevitable. Devising means for members to meet and discuss issues regularly and informally across regions and departments can build shared understandings and a sense of trust. In this way, conflict can be used to strengthen connections between diverse members rather than weaken them.

  • Participation in making and modifying the rules.

Members must be given opportunities to evaluate the rules applied by the second tier and change them when they no longer serve members’ interests. This means participation in more than just the regular and annual board meetings. It also includes having a say in the process by which board members are selected.

  • Selection of monitors by member organizations.

Monitoring is the ability of people or organizations to raise concerns if the activities of the central organization’s officials have not been sanctioned by the membership. Because member organizations are also customers of the central, their dual role helps to reduce “information asymmetry” between the members and the central regarding the actions of the central’s board and managers. Not everyone needs to monitor. However, increasing the number and kinds of lines of communication makes the organization more transparent.

  • Multiple layers of organized governance activities.

All of the above design principles should be used at every level and in all governance activities of the second-tier co-op. Replication of these elements creates and sustains the expectation that members at all levels have a say in running the system. This may be the most important principle in supporting the comprehensive interdependence of a co-operative system.

The co-operative movement has a long and successful history. Yet, the history of successful co-operation in human societies stretches back far longer. By looking at how groups of people have successfully managed common pool resources over millennia, we can learn vital lessons for how we can pass our co-operative success on to future generations. These six design principles are a starting point for this effort.

Photo credits: Village irrigation in Madagascar; Elinor Ostrom 2009 Nobel Prize press conference

Paul Thompson, Knowledge Mobilization Officer, Centre for the Study of Co-operatives, University of Saskatchewan

Jen Budney

Jen Budney, Postdoctoral Fellow, Centre for the Study of Co-operatives, University of Saskatchewan

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