The Patronage Dividend: Who gets 'em? Who needs 'em?

The co-op structure presents to the hardware industry one of the most interesting financial instruments in all of accounting: the end-of-year rebate.

San Antonio-based Alamo Lumber is a small regional lumberyard company serving 14 south Texas markets with a mix of building supplies and hardware store merchandise.

The company is a typical independent dealer in many ways, including its emphasis on opening price points and a tried-and-true emphasis on service. "We encourage our employees to be slow to say 'no,' and quick to say 'yes,'" said Matt Mullin, Alamo president and COO.

More unusual aspects of the business can be found in a couple features of Alamo's financial structure. Alamo Lumber believes in the power of the incentive and profit sharing to motivate employees.

"It's a profit sharing program where we open up the books to all the employees," Mullen said. "And to the extent that we beat the budget, we share the profits."

Here's something else: At the end of fiscal year in 2012, Alamo received a $1,272,291 patronage dividend from its co-op, an unusually high figure, even for Fort Wayne, Ind.-based Do it Best Corp., which takes pride in saying that it has dispersed more than $100 million in member rebates for nine consecutive years.

Alamo Lumber uses its rebate check to fuel growth and fund its profit sharing plan. It also supports expansion, capital improvements to existing locations, equipment and additional inventory where needed.

"It's part of our profit structure," said Mullin. "It's a very nice cash infusion. We budget for it and we're happy for it."

Alternative views

There can be little disagreement over the value of a million-dollar-plus check once every year. But the balancing act that a hardware co-op performs in dispersing its patronage dividend can certainly be a source of debate.

In fact, here's how a recent posting to an online hardware store message board framed the issue: "It is neat to get the rebates. But I wish it was just taken off the end of each statement, or the original hardware group would just lower their prices."

Across the co-op universe, other voices online and elsewhere call for a higher percentage of the profits to be dispersed back to members. And others believe the capital can often be put to better use for the good of the co-op's members by investing it in marketing, research and development.

The role of the patronage dividend within the co-op structure is simple and logical. The cooperative is owned by the member owners, who share in its profits. The patronage dividend is the mechanism that allows owners to receive what belongs to them, with dividends based on the percentage of purchases with the co-op.

But the story gets complicated when one asks: What is the right balance between returning equity to the members and investing in the future of the co-op?

"This is a question that has really challenged and befuddled co-ops over the years," said Dan Nutley, a specialist in cooperative accounting and a partner of Moss Adams, an accounting and business-consulting firm.

"The main criteria — and a lot of people don't look at this — is what are your competitors doing," Nutley said. "You need to see the organizations you compete against. Are they investing in their brand; are they doing a lot of research and development?"

In the hardware sphere, the answer is a resounding yes, as Lowe's and Home Depot seem at times to blanket the air waves with branding.

"In the hardware and building supply business, look at the amount of money that Lowe's and Home Depot invest in their brand and their image," said Nutley. "True Value and Ace are investing in the brand also. They have to be dealing with the public to create the same brand awareness and the same brand loyalty that Lowe's and Home Depot are trying to create."

One reason — but not the only reason — why Do it Best rebates are high is the co-op's decision to abstain from advertising on a national basis.

"We're very bullish on advertising; we just take a different approach to it," said Do it Best CEO Bob Taylor.

"We don't do national advertising because we have such a diverse group of retailers," Taylor added. "You couldn't craft one message that could work well across that landscape. It's not that we don't believe in advertising. We do. But we want to give the dollars to the stores' own efforts to build their brand in their own community. We think it's a more effective path for our membership."

It's a strategy that Alamo Lumber embraces. "We feel Do it Best is differentiated by not advertising nationally, and in our little markets that seems to work for us," Mullin said.

At Ace Hardware, executives believe they have a brand that sets the pace for the hardware business, and they have multiple J.D. Power awards to back up their claim. Ace spends more on advertising than it's co-op peers, and it recently unveiled a new national advertising spot, highlighting the friendly and neighborly service available at Ace in a spot called "Meet the Aces."

"We're making a major commitment to bring back the Ace jingle ("Ace is the place …") revamp our campaign, double down on our national advertising budget, as well as the local advertising budget," said Ace CEO John Venhuizen. "Because we believe that investments in that brand make a difference."

According to the accounting expert Nutley, there are some co-op members, both in and out of the hardware industry, who take a dim view of a co-op holding their money. He articulates the viewpoint this way:

"Why don't you just give me the cheap price at the front end," he said. "Why make me wait a year or eight and a half months to get the benefit of the patronage dividend? Why don't you just make a very accurate good budget and put your prices down so you are bottom-line break even?"

The answer depends on the strategy, and the strategy depends on the competition, Nutley said. "Your competition is out there to make money, and therefore you need to make money and return it to your members so your members see your benefit."

Back in San Antonio, Alamo Lumber is looking ahead to its next cash infusion through the patronage dividend.

"I think it's going to be similar to what it was last year. Maybe a little larger," he said.

Mullin added: "There's an old retail quote from Stanley Marcus: 'Retailing is like show business, you're only as good as your last performance.' "