Non-Linear Pricing Schemes for Co-Operatives: The Equity/Efficiency Trade-Off

Abstract

Co-operatives are an important institution in North America, especially in the agri-food industry. Producer co-operatives control nearly 80 percent of grain handling, over 40 percent of dairy products manufacturing and about 30 percent of honey and maple syrup processing. A co-operative's main objective is to improve the well-being of its membership and in doing so it generally attempts to govern itself according to the principles set forth by the International Co-operative Alliance: open and voluntary membership; democratic control; limited return on equity; and return of surplus to members according to patronage. The economic benefit for the co-operative's membership primarily stems from the procompetitive effect that it provides within the industry. The standard monopoly/monopsony externality is generally not a problem with a co-operative because members have claims on the entire surplus generated by the organization. In many industries, processing co-operatives are capital intensive and thus operate with relatively high fixed costs and flat marginal cost schedules. In such cases, the transfer price between the co-operative and its members may be significantly less than the net selling price of the processed product because a relatively high fraction of the selling price is used to cover fixed costs. In other words, the co-operate will price off its net average revenue product (NARP) schedule rather than its value of marginal product (VMP) schedule and the former may lie significantly below the latter. Thus, even though the monopoly/monopsony externality may not be a problem with cooperative marketing, an efficiency loss in the form of sub-optimally low production can still result because of the fixed cost externality. The purpose of this paper is to examine the use of non-linear pricing as a way of dealing with the externality described above. Non-linear pricing is used in situations with analogous externalities (e.g., block rate pricing by