Member Discounts: Boon or Bane?

Let's start with some numbers. A typical member invests $100 in the cooperative to join the co-op. In exchange for that investment, the member receives a 5 percent discount on all purchases. Let's assume the average member's purchases from the co-op total $20 per week. The numbers look like this:

member investment$ 100
annual purchases
($20/week for 50 weeks)
$ 1000
member's 5% discount$ 50
member's return on investment50%

"What a great deal!", you may say. "That co-op is providing true tangible economic benefits to its members, right?" In the short run, that's absolutely true. However, when the co-op pays $50 per year in exchange for a $100 investment, the co-op could find itself in financial hot water in very little time. And, remember, if the members' purchases are higher (that is, closer to the national average of $30 in grocery purchases per person per week), the cost to the co-op increases.

Try this analysis using your co-op's actual investment requirement, average members' purchases and discount. Then, be sure to look not only at the members' return on their investment, but also the cost of those discounts to the co-op.

To be sure, this is just one piece of the analysis that co-op directors must consider to monitor the overall financial health and sustainability of their co-ops. However, the amount of discount to members is a policy with wide-ranging repercussions. It is a key policy decision that needs to be made by directors, based on recommendations and analysis provided by management, after considering the consequences to the members and the co-op. In this article, we're going to examine the key considerations for directors in reviewing their co-op's member discount policy. Note, however, that the subject is member discounts -- those discounts provided to all co-op members just for membership. A member discount does not require donated labor, but should require some level of investment.

The theory and the practice

In the beginning, there was the theory of co-ops -- that consumers band together for their mutual benefit and that the co-op doesn't profit at the expense of its owners/members (who are also its customers). Later this theory was codified into what we now call the co-op principles. Among other things, the co-op principles state that "net savings arising out of the operations of a (co-op) society belong to the members of that society and should be distributed in such a manner as would avoid one member gaining at the expense of others."

The most common method of distributing a co-op's net savings (or net profit) is through patronage refunds -- rebates made to each member in proportion to purchases from the co-op. However, not all co-ops use this method, and the co-op principles aren't specific as to means of distribution. Indeed, many natural foods co-ops have chosen to provide discounts to their members at the cash register essentially distributing the co-op's net savings at the time of purchase.

Effectively, patronage refunds and member discounts are very similar -- both are made to members directly in proportion to use. The key difference is that a patronage refund is made at the end of the fiscal year, after the co-op has the opportunity to calculate its total income and expenses, and determine its actual net savings or profit. All other factors being equal, and assuming we were operating in a totally rational world and market, co-ops would logically opt for patronage refund systems. The co-op would only distribute to its members savings actually earned.

However, a variety of factors complicate this decision for natural foods co-ops. To begin with, a patronage refund carries with it a much greater administrative burden -- the co-op must be able to document each members' total purchases, calculate each member's portion of the net savings to be returned, and distribute the rebate efficiently. For small stores and retail operations with a large number of small transactions, this level of recordkeeping can be very costly and burdensome.

Perhaps more importantly, many natural foods coops already have member discounts. When most of these co-ops were forming, they enjoyed high margins, little competition and low-paid staff, making generous member discounts much easier to afford, especially since a discount system avoided the record-keeping required of patronage refunds. Now members have come to expect a discount -- in fact a discount at the cash register is the most prominent feature used to promote membership.

To discount or not to discount

For each co-op and its board, deciding between a structure using member discounts versus annual patronage refunds will entail consideration of unique factors. However, there are some important arguments in favor of member discounts. To begin with, taking away an existing discount can be very difficult when members have come to expect it. Secondly, most co-ops have come to depend on the discount as the primary means of promoting co-op membership.

In addition, many co-ops have, over time, adjusted their "shelf' prices upward to accommodate their membership discounts. When considering proposals for a reduced or eliminated member discount, members and customers naturally use shelf prices as their basis for analyzing the financial impact to them, resulting in very serious negative public relations consequences to the co-op.

Finally, today's co-op members are highly mobile, discerning shoppers. The prospect of a patronage refund in the future is not nearly as tangible to co-op members as a cash discount today. Repeatedly we see that even after many years of paying patronage refunds, when a co-op is unable to pay its patronage refunds one year, members are quick to assume that refunds are gone forever. Even "old-wave" co-ops that have been in operation for over fifty years in the U.S. and Great Britain have found that member discounts, in exchange for solid membership investment, make financial sense to the members and to the co-op.

All in all, most co-ops find that a discount is either too hard to eliminate, what their members most want, or that it provides the co-op with the best competitive edge in their markets. That being the case, it's important for directors to carefully analyze all factors in setting the discount rate. The most important factor to consider in setting a member discount is that the numbers must work on both sides of the equation -- the discount has to provide reasonable economic benefits to the members and to the co-op.

How much of a discount

It's impossible to isolate a discussion about member discounts from one about pricing and market factors. The level of competition and kinds of pricing pressures a co-op faces in its market will be a big factor in considering what level of discount to provide to members. Many co-ops have compensated for the generous point-of-purchase discounts given to members by maintaining artificially high "shelf' prices. Indeed, most co-ops use their "member" prices (prices available after discount to members) when doing price comparisons. But what is the price image, and the effect of these practices on non-members?

As a co-op faces more and more competition, this approach is increasingly damaging to its market position. To be sure, non-member sales are an important source of sales, gross margin dollars and potential new members to almost all co-ops. In addition, this practice has unquestionably contributed to the persistent high price image problems many co-ops struggle with. Finally, as consumer-owned organizations, such artificial pricing (to provide adequate margins after discount) doesn't seem like the most honest, straightforward, consumer-friendly practice.

The first step in deciding what level of discount to use involves an analysis of your current and future market. To what level do you experience direct competition now? What kind of competition can you anticipate in the future? Remember that even though you may not face direct competition now, a high pricing strategy will virtually guarantee future competition which will probably be able to underprice the co-op. (Ironically, in this situation, competition could even be in the best interests of the co-op's own membership.)

As a second step, let's return to the analysis we started with. Using the same assumptions, let's look at different discount levels, this time including different levels of purchases by members. Again, we assume a $100 member investment.



Avg. purchases/wk.:$1020304050
 
Annual purchases:$5001000150020002500
 
Annual discount received by member:
5% discount$255075100125
4% discount20406080100
3% discount1530456075
2% discount1020304050
1% discount510152025


While 5% is a nice round number that may sound good to members, note that the return on investment rates range from 25% (for members purchasing only $10 per week from the co-op) to 125% or more. At the 2% discount level, members' return on investment ranges from 10% to 50%. Members need to be reminded that the discount is applied to purchases, not to the investment. Note that at the 2% discount level, each member (regardless of purchasing level) receives a discount equal to one week's purchases each year.

Considering the cost of member discounts from the co-op's perspective, clearly the higher discounts are unsustainable. To begin with, discounts must be acknowledged as an expense, and their effect on the co-op's operations must be considered. While it's true that discounts are only paid in proportion to purchases (i.e., in proportion to sales and the resulting cash flow), discounts do have an effect on the bottom line and the balance sheet. The higher the discount, the less the co-op's ability to generate capital from operations, capital which can finance future growth, replacement of assets, new services, or improvements in operations.

At greater purchase levels, savings achieved by even the lower discount approach high return rates. However, remember that only loyal co-op members with a high volume of purchases will have discounts totalling those large amounts. From the members' perspectives, a discount is entirely consistent with co-op philosophy that members benefit proportionate to use -- the largest rewards go to the members with the most loyalty. From the co-op's perspective, that cost is always accompanied by sales and margin income.

Whether it's been based on this type of analysis, or on a more simple recognition that overdiscounting is too limiting to a co-op's ability to generate any capital from operations, a number of co-ops have reduced their member discounts to 2 or 3%. At this level, the return to the member represents a more reasonable and sustainable cost to the co-op. But, invariably any change in member discount rates needs to be accompanied by an extensive educational campaign to help members understand the total picture -- relating discounts to their investments and to the co-op's costs.

Pulling Together a Discount Policy

The policy review process begins with co-op management providing a comprehensive analysis of your co-op's discount. Without a doubt, the level of discount to provide members is a board decision, though no responsible board would proceed without a thorough analysis and recommendation from management. Member input and an active educational campaigu will be vital when a change is being considered. But change is often met with resistance.

A board's responsibility to act in the best interests of the co-op and its members as a whole requires it to take a comprehensive view when considering the co-op's policies and practice. There are four key points to keep in mind when looking at your co-op's discount policy.

1. Remember that there are two parties involved -- the member and the co-op. The discount must work for the co-op and its members alike -- the return to the members must be a reasonable one for the co-op to pay and the co-op must benefit from providing discounts as well. Indeed, how would co-op members ultimately benefit from a high discount rate which renders the co-op insolvent?

2. Discounts must be structured and considered in combination with member investments. Throughout our analysis, we've looked at discounts in relation to member investments. That analysis looks particularly bleak for co-ops that do not have a share structure -- co-ops that instead ask for some sort of yearly dues from members. For instance, a co-op that requires members to pay $20 per year in dues (that are not refundable to the member) in exchange for a 5% discount is providing an exorbitant return to the member with very little benefit to the co-op. Not only is the 5% discount costly to the co-op; the $20 dues don't contribute to the co-op's capital base but do increase the co-op's tax burden.

3. Consider the broader picture: market forces, current and future competition, pricing strategy, future financial needs, as well as the needs of your current and future membership. Most natural foods co-ops face more competition in their markets today than they did fifteen or ten years ago. And, that trend will continue. Co-ops must make sure that the discounts they give members today make sense in today's (and tomorrow's) operating climate.

4. Keep it simple: understandable to the members and the employees, and easy to administer. While complicated systems may be brilliant on paper, they will result in (a) complex and costly recordkeeping, (b) more members who don't really understand (and therefore may be inclined to be suspicious if changes are needed), (c) members with less co-op loyalty in the face of competition, and (d) employees who aren't able to quickly and clearly explain co-op membership to customers.

Market factors necessitate that co-ops critically review their member discount practices now to build a solid financial base for the future. Additionally, co-ops that devote time and effort to on-going educational programs that help members more thoroughly understand the benefits and costs of membership to the member and the co-op will be better positioned for competitive pressure in the short and long run.

Creating a comprehensive member discount policy that fits with your co-op's pricing strategy will probably also help improve the co-op's price image and market position. And, finally, a thorough analysis of the co-op's member discount policy, will probably lead to other financial improvements -- making the co-op a better place for members to shop and employees to work.

Remember, member discounts are neither a co-op principle nor a required accounting practice. Don't take your discounts for granted. They have real financial consequences to the cooperative and to the member. They need to provide benefits for the members and the cooperative alike, and it's the board's job to make sure that discounts do that.

See other articles from this issue: #049 November - December - 1993