Costs and Opportunities of Different Legal Cannabis Market Models in British Columbia

A spectrum of control

Canada’s Cannabis Act divides the responsibility for cannabis regulation between the federal government and the provinces and territories. While the federal government is responsible for licensing cannabis producers and regulating the production of cannabis products, the provinces and territories have been tasked with determining their own system of cannabis distribution and retail.

The provincial and territorial governments have adopted a range of regulatory frameworks, each reflecting local character, context, and political considerations. Models range from total provincial control of cannabis distribution and retail, as in New Brunswick, Nova Scotia, and Quebec, to the entirely private distribution and retail framework of Saskatchewan. All provinces, with the exception of Saskatchewan and Manitoba, offer online sales exclusively through their public wholesale distributor.

British Columbia has opted for a ‘hybrid’ model of cannabis distribution and retail, mirroring the province’s three-tier alcohol system. The BC Liquor Distribution Branch (LDB) is the sole, wholesale distributor of recreational cannabis for the province, and the only entity from which retail stores can purchase recreational cannabis in BC. The province allows for both government-run and private retail sales, although the vertical integration of production and retail ownership is prohibited, with online recreational sales hosted and fulfilled by the LDB.

The case for a monopoly wholesale

BC is far from unique in having a provincial wholesaler, with every province and territory except for Saskatchewan adopting a similar approach. The rationale for doing so is largely one of control, offering the provincial government significant influence over the supply, pricing, and range of recreational cannabis available in BC.

Public benefit

As a monopoly wholesaler, the LDB can act to ensure that federal and provincial policy goals are pursued. Non-profit-seeking in the traditional sense, the public interest can therefore be placed above financial success. As a crown corporation it is also accountable to the public, and political pressure and reform can be used to address concerns in a democratic manner.

Commercial crown corporations such as the LDB also provide a reliable source of revenue for public coffers, with the LDB generating $1.25 billion for local government in revenue, taxes and licenses from $3.5 billion of sales in 2017/18.

In addition to collecting revenue from government-run cannabis retail stores and online sales, the LDB’s wholesale monopoly enables the board to act as a price setter - in this case applying a 15% markup to products it sells onto retailers. If 50% of BC’s estimated 91 tons of cannabis consumption is through legal recreational channels in 2019 and landed wholesale costs of $5 a gram are assumed, the LDB will generate $34 million in cannabis wholesale revenue alone.

The LDB’s new cannabis division also provides a source of unionized employment - with its Richmond distribution facility employing 130 staff in roles including logistics, shipping and receiving, and customer care - and the facility is centrally tracked and monitored, streamlining compliance issues and minimising inspection costs.

Black market competition

As a provincial monopsony (the sole buyer), the LDB is able to effectively ‘set a price’ for adult-use cannabis in BC. In placing high-volume orders of thousands of kilograms, the LDB is well-positioned to negotiate with LPs on pricing, and to secure a price that is competitive with the black market.

The LDB has also chosen to impose a flat 15% markup on the price for cannabis it supplies to retail stores. Far below BC’s 124% markup on spirits and 89% on wine, this uniform rate has been chosen to help legal retail remain competitive with the black market.

Stability and strategy

Canada is expected to experience a similar pattern of legal cannabis supply to that of US states: an initial supply shortage at the outset of legalization, followed by significant increase in production and potential oversupply.

While this has resulted in large fluctuations in supply and price in US states, provincial monopoly wholesalers can effectively ‘fix’ the supply of legal recreational cannabis and provide a guaranteed price to LPs for product. The LDB has also set a minimum price for sales, below which retailers cannot go below.

The effective management of supply and consumer demand by the LDB would help to ensure an adequate cannabis supply within BC, avoiding significant gluts or droughts of legal product.

As a monopoly wholesaler and price setter, successful LDB intervention can ensure that retail prices do not fall so low as to encourage cannabis consumption or illegal diversion, while allaying some of the difficulties that farmers in the US have faced with fluctuating wholesale prices.

A provincial wholesaler such as the LDB can also use its monopoly power to establish a level playing field in the retail arena, ensuring that a wide variety of products from a range of producers across the country are available.

Alternatively, the LDB could use its purchasing power to actively promote or give greater consideration to BC brands - for example, by giving LPs situated in BC preference when negotiating supply agreements, or allocating a certain proportion of supply to local craft or micro producers.

Against BC’s hybrid model: An outdated solution to a modern market

However, many of the benefits of the LDB’s role outlined above - supply management, competition with the black market and the pursuit of strategic objectives - presuppose that a monopoly wholesaler is the most effective method to achieve these ends. Yet it’s far from evident that the LDB - or any form of monopoly wholesaler - will be.

BC’s Liquor Distribution Board has its roots in the history and hangups of North American alcohol prohibition. While there’s something poetic about handing the same government body control of yet another failed prohibition product nearly one hundred years on, it reflects a failure to update our thinking on the control and treatment of ‘vices’ beyond the early 20th century.

Suppliers, private retailers, and the entertainment industry have long complained about the flaws of BC’s legacy alcohol monopoly - a system characterised by opacity, inefficiency and delays, difficulties with specialty orders, some of the most expensive alcohol prices in the world and a reportedly ingrained culture of control hostile to reform.
Former Vancouver Mayor Sam Sullivan has admitted that “there’s no good reason for our government to be in the liquor business” - so why should cannabis, with a far lower risk profile and significantly lower use rates than alcohol be any different?

Not getting high off the government’s supply

Government wholesalers face the unenviable tasks of securing the right variety and volume of legal cannabis to satisfy the province, and ensuring that this is rapidly distributed to consumers and retailers.

One month in and already strains on the systems were beginning to show: more than 1,000 customers have reported the Ontario Cannabis Store to the provincial ombudsman after having to wait up to several weeks for the delivery of their orders, with Ontario Finance Minister Vic Fedeli blaming the province’s difficulties on ‘lying criminals’ failing to fully report the true scale of black market demand. More than half of the government-run stores in New Brunswick have been forced to temporarily close due to a lack of supply, while Quebec cannabis stores are closed three days a week as a result of chronic shortages.

This not solely the fault of wholesalers like the LDB: while the early days of legalization correspond with a surge of order to a new, untested system, LPs are themselves undergoing a steep learning curve. Several large LPs are delayed in fulfilling their supply agreements, citing reasons from supply chain issues and a lack of staff to low crop yields and mismanaged inventories as the cause.

However, the province’s reliance on a single, institutional wholesaler and only a handful of LPs highlights a crucial weak spot in the current system.

When the cannabis market operates freely, as in legal US states, many hundreds of producers and retailers can connect to identify pockets of supply and consumer demand. Faced with supply shortages, cultivators with available cannabis can simply sell it to a processor or retailer, likely charging a premium for the scarcity of their product.

Under the LDB wholesale model, no such simple responsiveness or flexibility exists: LPs and retailers cannot directly negotiate a supply agreement, no matter how local or convenient the arrangement may be, and LPs are unable to sell directly to recreational users in any capacity.

Instead, the entire system relies on the existing arrangements between a few dozen LPs and the LDB, with the body looking to secure new agreements with producers periodically throughout the year. It is entirely understandable that in servicing the consumers and retailers of an entire province the LDB would want to fully understand a producer, their products and the likely consumer demand, but it is a woefully glacial system when faced with issues of immediate supply shortages.

Government weed = Boring weed

Shortages aside, BC’s legal industry needs to offer more than just competitive prices if it is to rival the variety and quality of the black market.

The LDB online store currently offers over 200 products from nearly 30 licensed producers. While this compares favourably to the assortment offered by a single online or bricks-and-mortar dispensary, it is a far cry from the many thousands of legal products available in America’s recreational markets.

For BC’s legal market to provide even a reasonable comparison to states like Colorado and Washington, the LDB’s stock selection will need to increase many times over. The LDB often reiterates its commitment to achieving range and diversity in its product offerings, but it is difficult to reconcile the economics of the LDB - a bulk wholesaler servicing every customer and future retailer in the province - with that of a boutique or micro-grower.

Craft growers are likely to have higher production costs than industrially-scaled operations, as well as significantly more limited output (the holder of a microprocessor license, for example, is limited to processing no more than 600kgs of dried cannabis or the output of a sole micro-cultivator). This raises questions of how economical it will be for the LDB to enter into supply agreements with craft and micro-processors, as well as practical issues of how relatively small levels of production can be made available both on a wholesale level to all retailers and online to customers.

There is undeniable value in leveraging the LDB’s purchasing power for large orders with competitive wholesale rates. However, if the procurement of safe, bulk and value cannabis products is the LDB’s sole focus, then smaller, value and craft offerings risk being overshadowed in the name of volume.

There is evidence that this may already be happening: In supply negotiations the LDB is reported to have offered producers between $2.50 and $4 per gram wholesale, compared to prices of between $5-$6 per gram from other provinces.

Cannabis consumers are diverse in age, income, use, and preferences. The unfortunate result of a one-size-fits-all wholesale model is the risk of a poorer and more narrowly-focused range of products, less in-province innovation, and frankly- boring weed.

Restricted retail and suppressed consumers

This homogeneous assortment of offerings impacts the retail environment too - whether in a private store, public store or online, the products offered to BC consumers will be the same.

By artificially restricting the range of legal products available to customers, the LDB’s monopoly impacts retailer’s ability to compete for customers and to differentiate themselves in variety and experience. Entrepreneurial agency, profit opportunities, and the incentive to invest in BC’s cannabis ecosystem are therefore all reduced - and at the end of the day, with the black market most likely benefitting.

BC’s limited retail structure further reduces opportunities for cultivators to access the market, retailers to offer value-added, and for consumers to enjoy greater convenience.

The province’s prohibition on deliveries by private dispensaries leaves a popular ‘on demand’ niche of the black market unfulfilled, while restrictions at the LP level - on farm gate sales and direct-to-consumer online - prevent growers from forging a direct relationship with consumers and from offering product on a smaller, more targeted scale without the hurdles of negotiating a province-wide supply agreement.

The best of both worlds

The Cannabis Act was passed to prevent youth access to cannabis, protect public health and safety, and drive out organised crime. While the province has an important responsibility to support these aims, policymakers should be also overwhelmingly focused on helping the legal cannabis industry take root and flourish in BC.

Ensuring the integrity of the legal industry and aiding its economic success are not mutually exclusive goals, yet with too restrictive and unadaptive a regulatory regime, the full benefits of legalization will fail to materialise.

Despite the best intentions of policymakers and the sincere efforts of the LDB, the body will struggle to match the efficiency and responsiveness of a free-market allocation of cannabis like that of US states, while the province’s broader retail restrictions constrict consumer choice and market access, particularly for smaller and craft growers.

This is not to say that the role of provincial wholesaler is without merit: the LDB is uniquely positioned to purchase and distribute a high volume of cannabis products, provide a baseline of variety and supply for the province, and leverage its purchasing power and price-setting abilities to compete on value with the black market. However, none of these advantages of the LDB in fact require it to possess an entire monopoly on wholesale, or preclude the expansion of current retail options.

If the BC government is truly committed to eroding the province’s black market and taking full advantages of legalization, it should look to the market to expand and augment the work of the LDB.

The introduction of even limited new supply channels and elements of private distribution would expand choice for retailers and consumers, and help alleviate distribution holdups and shortages of supply. The additional introduction of wider retail options - closer reflecting those available for the craft beer and provincial wine industry - would increase commercial opportunities for smaller growers, drive adoption of the legal market, and could lay the foundation for a responsible cannabis tourism industry in BC.

BC has already reflected its unique character and history in adopting a hybrid model of retail unseen in any other province - to truly harness the potential strength of British Columbia’s legal industry, the province should look to further enjoy the best of both worlds and truly hybridise the cannabis supply chain.

Charlotte Bowyer of Hanway Associates

Tantalus Labs

Tantalus Labs

Tantalus Labs is leading Sungrown, BC cannabis. We created SunLab¹, a facility using natural inputs to grow elite cannabis products.