(Pictured above is Cooperstown & Charlotte Valley number 100 making a delivery to the Milford, NY AGWAY. Photo by Michael Bates from Gino’s Rail Blog.)
WHAT WENT WRONG AT AGWAY
by Bruce L. Anderson and Brian M. Henehan
On October 1, 2002 Agway filed for Chapter 11 bankruptcy. Many people are still asking what went wrong. This is a hasty attempt by the authors to analyze the situation. We hope that this short article will provide valuable lessons for other cooperatives and organizations.
First, a little history. Agway was formed in 1964, the result of a merger between GLF(Grange League Federation) and Eastern
States Farmers’ Exchange. A year later the Pennsylvania Farm Bureau Cooperative merged into Agway. The result was a very large
agricultural supply and marketing cooperative that covered 13 states, spanning from Maryland to Maine to Eastern Ohio.
Historic Factors: Provide Members A Secure Market
Cooperatives are often formed to provide members a secure source of inputs and markets for their products. However, sometimes this motive can go to extremes. GLF (i.e. Agway), together with other New
York agricultural organizations, provided the leadership in establishing a radio network, Rural Radio Network, in 1946 to serve the radioneeds of farmers and rural residents. It was sold in 1959 when it had an accumulated deficit of $970,000 and total debt to GLF (i.e. Agway) of $1.36 million.
In 1946 GLF also bought approximately a 40 percent share of Mohawk Airlines, the forerunner of USAirways, in the name of providing air transportation to Upstate New York. In this case, they fortunately saw their investment more than double before it was sold.
Another example was Agway’s attempt to provide services to members was its operation, together with Southern States
Cooperative, of Texas City Refining. The purpose was to provide
members a secure source of petroleum products. This proved extremely advantageous and profitable during the oil shortages of the early 1970’s. However, the petroleum market eventually changed and Texas City proved a costly investment. It was sold in 1988 at a loss of $110 million.
In 1961, GLF helped form Curtice-Burns, a vegetable and fruit processing company, headquartered in Rochester, N.Y. Curtice-Burns was a combination of what were at the time two struggling vegetable processing companies. Over the years, the company was very successful, but in 1993 Agway announced that it’s controlling interest in Curtice-Burns was up for sale. The sale brought in a solid return, and this was one of the first indications that Agway needed cash to fund its other operations.
Emphasis on Size
In the 1970’s and 1980’s, Agway was the largest cooperative in the
U.S., with sales of over $4.1 billion in 1984. At the time there was
an emphasis on cooperative size. Agway being on the Fortune 100
list of U.S. companies was often mentioned in publications and meetings.
We believe that any organization that places primary importance on size over profitability can likely run into problems. We would argue that this is a malady that also eventually caused Farmland Industries and Ocean Spray their financial problems.
Ability to Manage Many Types of Businesses
There was a longstanding attitude at Agway, and predecessor organizations, that they could manage any type of business, even when other people could not.
Two major examples come to mind in Agway’s history.
The first was an effort in 1941 to get into the retail food business by starting the Cooperative Producers and Consumers Markets, today a Northeast grocery retail chain called P&C. The purpose was to assist New York farmers market meat from their livestock. Ownership interest in P&C was finally sold in 1961 following several years of unprofitable operations.
A more recent example was the purchase of H.P. Hood, a fluid dairy company, bought in 1980. A driving motivation was to help members of Northeast dairy cooperatives maintain a reliable and stable market for their milk, which was at risk. The fluid milk business has always
been very competitive, and operates much differently than an agricultural supply company.
Agway had no prior experience running a fluid milk business. In 1995, H.P. Hood was sold due to less than projected returns on their
investment and mounting financial losses. Another interesting aspect of this example was that right up to their purchase of H.P. Hood, Agway had a strict policy that they would not become involved in dairy processing.
We are sure some readers are already wondering why several of the above examples dateback to the 1940’s. We firmly believe there is significant historical momentum in all types of organizations. This is often embodied in what today is called “corporate culture”. Agway
instilled a lot of corporate culture in their directors, management, and employees. In fact, we remember when every Agway meeting or at any meeting that an Agway representative spoke at started with a recitation of the Agway mission. However, many of Agway’s old traditions and strategies may have out lived their usefulness or detracted from their willingness to change.
A $25 Equity Investment
To become a member of Agway, all a farmer needed to do was buy one share of common stock for $25. And that is all the investment many members have in the cooperative. We firmly believe there is a strong link between how much money members have at risk in a cooperative, and the interest they take in their cooperative, as well as the success of the organization.
Use Of Tax Paid Retained Earnings
Since equity was not coming from members, Agway used Tax
Paid Retained Earnings as their primary source of equity. Depending on this source of equity means that a cooperative needs to consistently generate positive Net Income. It is also an expensive source of equity, because corporate taxes must be paid by the
cooperative reducing the total funds available to build equity. In addition, when a cooperative becomes dependent on Tax Paid Retained Earnings, there is a greater tendency for the
cooperative to become “management controlled” rather than “member controlled”, given that member equity does not grow and most members have little equity at risk.
Heavy Use of Debt
Agway has always been highly leveraged. If compared to their competitors in almost any business, they would likely be one of the most heavily leveraged companies. During the entire 1984-2002 period Agway’s highest Equity to Total Asset ratio was 20.6%. From
1998-2001 Equity to Total Assets averaged 12.6%. Our general
rule of thumb is that when equity to total assets drops below 15% an organization is suffering severe financial problems. At one point it time, Agway had a goal of using one-third bank financing, one-third
subordinated debentures and one-third equity, primarily tax paid
retained earnings. During the entire 1984-2002 period, this goal was never achieved.
Most of Agway’s debt, especially in latter years, was subordinated debt, also known as “junk bonds” because they are not secured by
assets. While the level of the company’s subordinated debt has remained relatively level over the past 5 years, operating cash flow to
support that debt became inadequate and deteriorated. As of it’s bankruptcy filing, the largest single owner of these subordinated debentures was Agway’s employees through pension fund and 401-K investments. They total approximately $35 million out a total of $425 million in subordinated debt. Members and public security holders own the remaining amount.
Limited Patronage Refunds
Except for 1987 and 1988, Agway has not paid a patronage refund to members since 1980. The primary reason is that sufficient Earnings were not being generated from the patronage business, i.e. their
agricultural supply operations. Most of Net Income came from
non-patronage businesses such as petroleum, leasing, insurance and produce distribution.
With the largest market share for feed and many other input supplies in the Northeast, Agway has been prone to carrying excess capacity, which is typical of a market leader. At the same time there was a major change in market conditions. In terms of feed, more farmers started mixing their own feed using direct purchased commodities, and moved away from the use of pelletized feed. This meant that many of Agway’s feed, and other input supply plants, were operating at significantly less than full capacity. This has a negative impact on per unit costs and can often lead to cut throat price competition.
A Triple Delivery System
For most of it’s existence, Agway had a triple delivery system with:
1) Agway Inc. owned corporate stores,
2) independent local cooperative stores, and
3) franchise representative stores.
There was a period when Agway tried to convert their corporate
stores into representative stores.
Then in the early 1990’s a decision was made to buy out all the independent local cooperatives to consolidate the delivery system. Financial performance did not improve because market
conditions continued to change.
Beginning in 1999, Agway sold or closed all its remaining company owned stores and sold their warehouse system to Southern States Cooperative. These moves were made because returns on these assets were chronically inadequate. Today most store customers do not realize that the cooperative no longer owns any assets related to the store distribution system. However, Agway remains a supplier to dealers and retains rights and revenues related to use of the Agway name.