Researchers in cooperatives have proposed various reasons why farmers establish agricultural cooperatives. They state that:
a. Farmers cooperate for a purpose. Knapp (1957) observes that when a group of individuals establish a cooperative, they have in mind certain distinctive purposes. They may seek to obtain services for themselves at cost but not to obtain profit from rendering services to others, or they may try to render the greatest financial benefit to their members as users but not necessarily to maximize profit for owners as distinct from users. According to Barton (1989), in the past, farmers joined together and organized cooperatives because existing businesses did not provide the goods and services they desired. In some cases, existing businesses exploited farmers by following monopolistic practices thereby extracting monopolistic profits at farmers’ expense. Therefore, farmers had considerable economic incentives to unite and form cooperatives that enabled them to enjoy greater profits in their farm businesses by providing inputs and services at lower costs or by providing inputs and services that were not available, and by marketing outputs at better prices or by marketing outputs into markets that previously were not accessible.
According to the NCBA (2005), cooperatives are formed by their members when the marketplace fails to provide needed goods and services at affordable prices and acceptable quality. Therefore, the purpose of a cooperative should always be clear to the members.
b. Farmers Cooperate to address the Effects of Market Failure. Cooperatives are popular among farmers because through these institutions, farmers can pool their financial resources and carry out business activities that they could not perform as economically on their own. According to Barton (1989), in the past farmers joined together and organized cooperatives because existing businesses did not provide the goods and services they desired. In some cases, existing businesses exploited farmers by following monopolistic practices thereby extracting monopolistic profits at farmers’ expense. Centner (1988) supports this view stating that market failure is a common justification for the formation of agricultural cooperatives. He highlights three significant types of market failure as oligopsony, asymmetric information, and restricted bargaining.
Oligopsony exists where there are few buyers and many sellers. This failure occurs in smallholder agriculture because producers often have few potential buyers. Producers therefore have no control over the setting of prices and allocation of profits.
Asymmetric information exists where a buyer is not able to differentiate between quality and non-quality products. In this case, sellers have no incentive to provide quality products although there may be a demand for them.
Restricted bargaining position of agricultural producers with buyers occurs when their products are ready for the market but buyers hold up the benefits that should accrue to producer-sellers. For example, where buyers know that producers need a market because the products are already in production, buyers may hold up producers by offering a low price or threatening to discontinue purchasing producers' products. However, because producers have to sell their products, they may have to accept a lower price.
All the above market failures are to varying degrees common among smallholder farmers in Malawi. Such market failures give the farmers significant economic incentives to unite and form cooperatives that enabled them to enjoy greater profits in their farm businesses.
Knapp (1957) posits that the cooperative has given the farmer a form of economic organization adapted to the peculiar conditions of his industry. Farmers individually have little power in the market place. Organized in cooperatives they can meet power with power. Without such organization, farmers would have to be satisfied with whatever service they could get. These challenges come about because of the high dependence by farmers on nature. They overcome them by capturing external economies of scale.
Agricultural cooperatives therefore give Individual or small farmers protection from exploitation by large companies. Chloupkova (2002) citing Christensen (1983) argues that for practical reasons cooperation has been one of the crucial means by which small farmers have managed to survive. Under capitalism, farmers have been forced to protect themselves from being exploited by pooling their buying power in order to attract lower prices from suppliers and pooling their selling power so that at the market one farmer cannot be played off against another.
c. Farmers establish cooperatives to reduce the effects of uncertainty. Farmers face a lot of uncertainty in their work often because of their reliance on weather conditions. The uncertainty principle states that the greater the uncertainty surrounding a transaction, the less likely the transaction is to be efficiently mediated by autonomous market contracting (Williamson, 1981). As uncertainty increases, so does the cost of renegotiating contracts and the potential for opportunistic behavior on the part of trading partners. An increase in uncertainty therefore creates incentives for farmers to become vertically integrated to reduce the effects of uncertainty. Smallholder farmers in Malawi face a lot of uncertainty in their work because they practice rain-fed agriculture.
d. Farmers establish cooperatives to reduce the effects of asset fixity. Farming assets are often very specific to that industry. An asset becomes specific to a particular use or user as the cost of transferring it to alternative uses increases. The asset fixity principle states that as assets become more specialized or specific, autonomous market contracting becomes a progressively less efficient means of allocating them (Williamson, 1981). Therefore, farmers form cooperatives to reduce the effects of asset fixity because when only a small number of farmers exist in the product market, asset fixity can lead to situations to which farmers are at considerable risk in their dealings with their trading partners. The poorer the integration of markets and the more highly specific the assets of both the farmers and their trading partners, the greater the scope for opportunistic behavior on the part of trading partners. Cooperatives therefore create vertical integration by farmers to overcome the effects of asset fixity.
e. Farmers establish cooperatives to gain tighter control over their business. Farmers often have to work with other participants in adjacent market stages. The externality principle states that a firm has an incentive to integrate vertically when participants in adjacent market stages impose negative externalities on the firm (Williamson, 1981). For example, if a farmer produces a high-quality perishable product that requires special handling in subsequent stages of the distribution system, negligent handling of the product by distributors can damage the farmer’s reputation with consumers. Because it is often easier to control product quality within the farm than across market boundaries, the farmer producing the product may vertically integrate to gain tighter control over the distribution system.
f. Farmers cooperate to capture many of the advantages of large-scale. Farming often requires that the farmer handles many operational duties all of which he cannot do properly because of lack of capacity. A farmer cooperative decomposes the firm's activities into relatively independent sub-units some of which it performs thereby helping prevent the farmer from being swamped with day-to-day operational duties. Owners in the cooperative firm agree to avoid competition among themselves in their marketing and input supply activities but continue to make the rest of their decisions
independently. Cooperative firms therefore allow their members to capture many of the advantages of large-scale marketing, input production, and strategic planning while still permitting farmers to make most of their farm-level decisions themselves.
g. Farmers Cooperate to respond effectively to new challenges in Marketing Onumah et al. (2007) observe that agricultural marketing systems are changing at a rapid rate as a result of globalization, urbanization, liberalization and other regional and global developments. They argue that these forces combined with market failure, are compelling farmers, especially smallholders to resort to collective action as the most effective way of enabling farmers to respond to new challenges in marketing.
Globalization is one of the main external factors driving the changes. Collier (1997) defines globalization as the process of integration in product markets and financial markets in which producers and investors increasingly behave as if the world economy consists of a single market and production area rather than a set of national economies linked by trade and investment flows. The current communications technology revolution, combined with the increasingly important role of the multinational corporations, make the scale and impact of globalization much greater than previously. As a result, large and integrated agribusiness firms are increasingly edging out small family farms, which are finding it more difficult to compete. These developments have strengthened the competitive advantage enjoyed by the global players (Onumah et al, 2007).
Urbanization is impacting on food marketing systems through demand for increased volumes of food as well as the type of food preferred. Urban populations are experiencing changes to consumption patterns as a result of rising incomes, changing lifestyles, exposure to new products and time pressures, especially for working women (Onumah et al., 2007). As observed by Reardon et al. (2003), one effect of changing urban food demand patterns is a shift to larger, centralized wholesale markets thereby making it more difficult for small producers to compete.
Market liberalization has shifted risk along the marketing chain away from parastatals towards traders and producers. Access to inputs such as seeds,
chemicals and fertilizers has also become more difficult as input distribution has passed from the public to the private sector and subsidies have been reduced or ended. This has invariably raised input prices and the lack of affordability has either constrained usage or reduced producer margins thereby negatively affecting the individual producer (Onumah et al, 2007).
Regional and global developments such as growing consumer power and concerns about issues such as global warming, fair and ethical trade terms and food safety are all affecting food markets. These developments are creating new market segments and imposing new constraints in conventional markets. On the one hand, these trends have led to the emergence of new markets for producers, such as fair/ethical trade markets and organic produce markets. On the other, they have led to the imposition of new food standards, which make it difficult for small-scale producers to compete in the supply chain. (Onumah et al, 2007).
These changes have led to the emergence of new market players and created new market opportunities but have also exposed the small scale producers to increased risks in terms of uncertain access to markets and price instability
The effects of market failure and of the changing agricultural marketing systems are particularly severe on smallholder farmers because, on their own, they have no means to counteract the opportunistic practices of the buyers. The logical choice for such farmers therefore is collective action one form of which is the establishment of cooperatives.