Member Discounts

Did you know that giving member discounts is not one of the cooperative principles? Given how pervasive discounts are in food co-ops, one would almost expect to find support for them in the guiding co-ops precepts. On the contrary, the cooperative principles argue against them.

We're not arguing that you shouldn't have them at all. We are suggesting that, like any other expenditure, discounts should be subject to scrutiny and cost benefit justification.

The following discussion suggests ways to measure costs and examine the benefits of member discounts. Too often, discussion of this issue is avoided until financial crisis forces examination. By then it is usually too late, and the slashing of discounts simply hastens a downward spiral, since there isn't comparable value to offer the members in their stead.

We think the purpose of discounts is to provide a near term, tangible reward to members for providing the core of co-op sales. Experience suggets that discounts have the best effect in a well managed store that is meeting the market needs of its customers. We've found that by combining discounts with a patronage refund program and other services of perceived value to members (such as a newsletter, member only specials, discounts at other businesses), a package of benefits is created that attracts members and rewards their loyalty. Member discounts are the co-op version of a frequent buyer program, and the patronage refund is the unexpected bonus at year end. Both are appreciated, and both enhance member loyalty; but only the patronage refund fulfills the co-op principles.

Typically there are four types of discounts in co-ops: to paid staff, to working members, to particular groups of customers (seniors, disabled persons), and to all members simply by right of their having paid the annual fee or purchased the requisite number of shares. Our focus will be on this last category.

According to the July 1995 Cooperative Grocer survey, discounts represent 2.4% of sales. With average net earnings being less than that figure, we can probably agree that discounts are a significant cost of doing business. A first step in bringing them under control is to gather data that distinguishes among the various types of discounts.

The same issue of Cooperative Grocer tells us that in profitable co-ops, patronage refunds were only 0.2% of sales. In fact the vast majority of profitable co-ops don't even utilize this wonderful option available only to a cooperative. (See sidebar, below.)

Discounts have the advantage of immediacy, but what's an appropriate discount level? How often should they be offered? Are they fair to all members? Can the co-op afford to be "advancing" its potential profits to the members in this form? When making changes, how can the roots and traditions of the co-op be respected, while also honoring its current needs and future responsiblities?

Equitable - or excessive?

An example may help to clarify these issues. Our Town Co-op is a consumer co-op that costs $100 to join. All members are eligible to receive a 10 percent discount once per month.

Member nameRogerAlicia
Cost of membership$100$100
Shopping frequencymonthly2/week
Avg. purchase/visit$100$30
Annual purchases$1200$3000
Discounts/month$10$3
Discounts/year$120$36
Discounts % of purchases10%1.2%

While Alicia spends far more at the co-op than Roger does, her shopping pattern results in her receiving far less in discounts. Is this fair? The fourth cooperative principle calls for equitable distribution of surplus and compels co-ops to avoid one member gaining at the expense of others. In support of patronage refunds as a strategy, the fourth principle also calls for distribution among the members in proportion to their transactions. Clearly, Our Town Co-op is not abiding by the above principle.

The third cooperative principle states that there should be limited return on investment. Explicitly this discusses interest paid on share capital, but arguably it implies that all returns on member investment should be limited. For both members, the annual return received via discounts is anything but limited. Discounts as Return on Equity:

RogerAlicia
120%36%

These discounts are neither equitable nor limited in the return they provide.

Last year Our Town Co-op continued its history of being marginally profitable, netting $5,000 for the year or 0.5% of its $1 million in sales. Though discounts are heartily supported by members like Alicia and Roger, the co-op's management and board recognize that profitability is quite thin and tenuous. There is a proposal on the table to reduce the frequency of the member discount from monthly to quarterly, and to dedicate the savings to ddistibution via a patronage refund program.

To determine an optimum discount level and frequency, the co-op must gather at least the following data:

  • # of members actively using store services;
  • # of members using the discount in a given discount period; compute % of all members using the benefit;
  • $ in sales to members in the period; total sales; compute sales to non-members;
  • # of member transactions in period; total transactions in period; compute transactions with non-members;
  • compute average transaction for members, non-members, and overall;
  • average value of transactions on which member discount is used; and
  • cost of discounts issued each period.

Having gathered this data, the co-op must answer at least these questions:

  • Among members, what are the differences between those who use and those who don't use their discount privileges?
  • How much more (or less) do members buy from the co-op on an average visit than do non-members?

More subjectively:

  • To what extent is the overall additional member patronage atttributable to the availability of the discount?
  • If the discounts were reduced, how would sales to members change?
  • How much would be saved in discounts overall?
  • Is the current program worth the cost?
  • Is changing the program worth the cost?
  • If savings are realized, how will they be utilized?

Following are the data results from Our Town Co-op's study:

                                                        Total  /  Members  /  Non-members

Annual sales                                        $1 M          400,000        600,000

% of annual sales                                100%                40%                60%

# of members using discount/mo.                            500

# of monthly transactions                  8,000            2,000            6,000

Average sale when discounted                                $30.00

Average non-discounted sale                                    $13.33

Monthly sales with discounts                                $12,000

Discounts per month                                                $1,200

Discounts as a % of sales                                            1.44%

Note that the average member's purchase is twice that of non-members. Analysis shows that members who don't use their discount have smaller average transactions than other members, and they shop in the store less frequently. In non-discounted transactions, the average sale to members is $13.33. That's still $5.00 more than with non-members.

Obviously the discount is an incentive for members to purchase more on the visit at which it is utilized, but why do they spend more than non-members in the non-discounted transactions? Presumably those persons choosing to join the co-op already have an affinity for its products and services before making the membership commitment; thus their greater patronage is already built in.

At $1,200 per month, the co-op's discounts are an expensive thank you. Could a similar result be obtained at less cost? In this situation, the facts tend to support reducing the level of discount as opposed to the frequency. We'd recommend that Our Town Co-op reduce the discount rate from 10% to 5%. We prefer the reduced rate because it continues to encourage the increased purchases of discount day; given the low level of sales going to members, we'd like to see the members in the store as often as possible. It is likely that the co-op would experience little (if any) decline in sales while reducing discounts by half.

The board of directors has discretion over how this $600/month savings will be utilized. They have not issued it as discounts before being certain that the co-op is profitable, which means that they have it available for investment in co-op services throughout the year. Our Town Co-op plans to distribute it as a patronage refund at the end of the year, with the cash portion (at least 20%) to be determined by the board.

 

***

Patronage Refunds: A Co-op Advantage

Through patronage refunds, co-ops can distribute their profits to their members instead of to tax agencies. Cooperatives are authorized by the Internal Revenue Code to rebate profits derived from members back to the members as a tax deductible expense. The statute requires that at least 20% of the refund be in cash (or equivalent). Any non-cash portion is retained as patronage equity in the member's name.

Using OUR TOWN CO-OP's example, they have sales of $1.0 million per year and net $5,000. Some 40% ($400,000) of their business is transacted with members, so 40% of their profit ($2,000) is available for refund. To be a qualified patronage refund, at least 20% of the total must be issued as cash ($400). The remainder is retained by the co-op as equity allocated to the members' names. Each member's share of the patronage refund is in proportion to their share of overall member purchases.

Bear in mind that if not distributed as patronage refunds, earnings are subject to federal and state income tax, probably at a rate exceeding 20%. To whom would you rather give the co-op's money?

It is important that you consult with qualified professional advisors in your state before implementing such a program. State law is an important factor, and the details of execution are critical in order for the refund to qualify.

***

 

Taking this decision will help to better fulfill the co-op's mission, and it provides a fabulous marketing tool. The purchase discount has become routine for members. But a check in the mail as a refund on their food purchases, along with a notice that their investment has increased, is very unusual in our economy and quite noticeable. The patronage refund goes right to the heart of the co-op difference and most effectively communicates that the co-op is theirs in direct proportion to how much business they transact there.

We urge you to challenge the sacred cow -- your co-op's member discount program. Can you reduce discount levels and/or frequency while still offering a valued reward to your loyal members? Very likely. Would pairing this with a patronage refund program deliver a better package of benefits to members and to the co-op as an organization? Almost certainly. On top of that, these practices would bring you into closer adherence to the cooperative principles.

Take the risk of organizational self-examination.

See other articles from this issue: #063 March - April - 1996