The Legal Market Obstacles

Cannabis-Legal-Market
BC’s legal cannabis industry will only truly succeed if the province’s black market is also simultaneously eroded and replaced. This requires a dual switch - of consumers to legal retail channels, and of illicit production into the regulated industry.

Provincial governments have a significant role to play in facilitating the success of legalization. Canada’s federal cannabis policy is predicated on public health and restricting access rather than commercial opportunity, but if too cautious an approach to legalization is pursued at a provincial level, both public health and economic opportunity will be undermined by the persistence of an unregulated, unrestricted black market.

In this respect, BC’s sophisticated black-market is both a blessing and a curse; with cannabis use and cultivation already firmly established in the DNA of the province, there is less incentive for citizens to embrace the legal market if the economic opportunity or quality of experience is not there.

Despite the vast pool of talent, experience and passion for the cannabis industry in BC, neither the elimination of the black market or a growth of a healthy, competitive industry will fully come to pass if the regulatory and economic climate does not allow for it.

CONSUMER-SIDE CONSIDERATIONS:

Any serious attempt to erode demand for black-market cannabis needs to provide consumers with the opportunity and incentive to purchase through legal channels.

While the majority of Canadian cannabis users would like to make their purchases in the newly-legal marketplace, making a real dent in black-market demand requires the conversion of BC’s heavier users: weekly and daily cannabis users account for 98% of total cannabis consumption, yet only 37% of daily users reportedly plan to purchase through legal avenues.

Price:

The price of legal weed is widely acknowledged as a key determinant of its success in eroding the black market. Luckily, Canadians both expect to and are willing to pay more for legal recreational cannabis - up to a point. The exact premium that consumers are willing to pay in the long run is unknown, however, with the Parliamentary Budget Officer estimating that a three-dollar per gram premium for legal weed over the black market price will see the legal market share fall to 42 per cent.

The legal retail cost per gram is determined by a range of factors, including LP’s costs of production, provincial wholesale models, retailer’s margins and the level of taxation. Provincial governments can influence the price in several ways, including via a wholesale markup, minimum retail prices, and provincial sales tax. Cognisant of their influence, the BC government has not looked to impose overly onerous levels of taxation and has reportedly worked to keep wholesale prices low.

At the outset in particular, retail prices are likely to be determined by the availability of legal cannabis, with supply widely reported to be far below initial demand. However, with BC consumers initially restricted to government-controlled online sales and and a single public store, the province so far appears to have chosen to keep pricing comparatively low and address supply shortages separately rather than raise prices to better match demand.

While price is an important consideration of black market use it is by no means the only one: In BC in particular, issues of culture, choice and convenience are also crucial in determining the success of the legal market.

Variety:

Despite pop culture stoner stereotypes, cannabis users represent a diverse cross-section of society. Legal retailers therefore need to cater all cannabis-consuming demographics and offer cannabis products in varying forms, price, and potency, with a showcase of premium and craft cannabis products alongside more mass-market, value offerings.

More than half of those who plan to continue using the black market claim that being offered a better variety of products at a range of different price points would tempt them into the legal market - giving a strong incentive for provincial governments to place a premium on consumer choice.

Competing with the variety of BC’s black market is no mean feat, with illegal dispensaries and delivery services offering hundreds of products and dozens of strains each. Depending on their inclination, consumers can source pre-rolled joints, concentrates, vapes and edibles, an ounce for under $100 or ‘premium’ flower for $14 a gram and more.

In contrast, the variety in BC’s legal market is partially defined by the federal government - who will not regulate a range of concentrate and edible products until 2019 - and the province’s monopoly wholesaler, the Liquor Distribution Branch (LDB).

The LDB reports that it is ‘engaged’ with over 35 licensed producers to offer more than 150 products online. The LDB claim that their agreements secure a ‘volume, variety and quality’ of legal products for the province : How consumers feel these measure up to the current black market offerings - and the many thousands of legal products available in US states like Colorado and Washington - once the novelty of legalization wears off remains to be seen.

Convenience:

The provincial governments also decide through which channels consumers can access legal cannabis. Here, too, BC’s legal market may struggle to compete with the flexibility and convenience of black market offerings.

Just as they are diverse in demographic, lifestyle and cannabis use, so too do consumers desire a range of options for the purchase of cannabis.

Over half of consumers would like to purchase their legal cannabis from either a government-run or private retail store: in this respect BC has them covered, with the province adopting a ‘hybrid’ model allowing an uncapped level of public and private retail stores similar to that in alcohol.

However, 48% of users would also like to purchase cannabis direct from a licenced producer or manufacturer’s store. Here, BC consumers will have less luck, with provincial regulations prohibiting both ‘farm gate’ sales - where consumers can make on-site purchases direct from a licenced producer - and the vertical integration of producers and retail stores.

Recreational users are further frustrated in their choices for online sales. Whereas medical patients can continue to purchase product online from an LP of their choice, recreational users are limited to a single source: The LDB site.

This is despite the fact that a third of recreational consumers would like to purchase their cannabis online direct from an LP or a private retail website, while a quarter of consumers would like to purchase via an LP or retailer’s app: these too are prohibited by the BC government.
‘On demand’ delivery services, which proliferate across metropolitan areas of BC, are also predictably banned.

At the outset of legalization, BC consumers have just two options for the purchase of legal cannabis: a sole, government-run retail store in Kamloops, and the government website.

Anything from poor design, technical problems and delays in delivery could result in a long-term aversion to the government site, with disgruntled consumers happy to turn to one of the many prevalent, well-stocked and highly convenient online dispensaries or delivery services already operating in BC. While BC Cannabis Stores has so far satisfied provincial customers, Ontario Cannabis Stores has not passed the first month of legal sales so unscathed, attracting the accolade of the ‘worst dealer ever’ with only 60% of customers happy with their experience.

In the long run, BC’s hybrid approach to retail stores should allow the number of legal, licensed shop fronts to rival (and exceed) the hundreds of dispensaries previously in operation, although many have warned that overly-restrictive licensing criteria and municipal restrictions place a significant check on the number of potential stores. For now, while more than 300 private retailers have applied for a licence, only a single operation has so far been approved.

Supply:

The shortages of legal weed widely expected at the onset of legalization have come to pass, as the handful of LPs tasked with supplying the nation’s legal cannabis encounter supply-chain issues, teething troubles and an exceptionally steep learning curve. Such problems are not unique to Canada, and characterised the start of legal recreational markets across the USA.

However, the problem is likely to be exacerbated in provinces like BC by the provincial government’s hold on supply. In US states, the supply and distribution of cannabis is left to the market. Retailers are at liberty to order from cultivators and processors they please - allowing individual stores and producers to act quickly when supply is tight, and make product available as soon as it is ready.

In BC, the government’s wholesale monopoly places the onus on the LDB to order the right volume and variety of product, and on the limited number of suppliers to produce and deliver it on time. By eradicating the multiple supply chains that naturally occur in a marketplace, the LDB’s wholesale monopoly introduces a central bottleneck and a single large point of failure.

Such problems have already come to pass in Newfoundland and Quebec, where the government controls both the provincial supply chain and retail stores and locations have been forced to close due to shortages of supply.

Early setbacks in legislation are no way insurmountable - but the potential shortcomings of centrally-planning BC’s entire cannabis supply while restricting the number of legal avenues available to consumers certainly risks entrenching an indifference or disdain towards the legal market that may prove hard to shift in the months and years to come.

PRODUCTION-SIDE ISSUES

It’s not just BC’s legal retail market that may struggle to find its footing.

BC’s licensed producers do not enjoy the market penetration of its black market growers, while within the province the government's restrictive distribution model denies producers the opportunity to sell directly to consumers.

Even with a unique selling point, strong product and a great story, BC producers will have their work cut out for them under the current system.

The Beasts from the East

BC has long been Canada’s prime producer of cannabis, currently accounting for nearly 40% of the nation’s output. But BC’s black market lead position is not replicated in the legal industry.

Currently, only 30 of the 133 legally-regulated cultivation sites - that’s just over 20% - are situated in BC, as compared to 68 established in Ontario. Of the 76 sites with a sales licence, only 25% of them are based in BC. And of the 588 applicants in the ACMPR licensing pipeline in August 2018, 173 were from BC; a further 198 from Ontario, 76 from Alberta and 69 from Quebec.

With legalization, BC producers will for the first time experience real competition from cannabis from beyond the province: of the LDB’s initial supply agreements, less than half are with producers based solely in BC. Across the other provinces too, supply agreements are similarly dominated by firms with headquarters and cultivation sites in Ontario.

The proportion of BC-based producers is likely to increase with the take-up of micro-licenses; however, applications only opened on October 17th and follow an approval process of several months. Until they are approved, would-be microgrowers are precluded from the legal market, while larger, well-funded firms can compete for market share in the early days of legalization.

BC producers should in no way shy away from or expect to be protected from inter-provincial competition: if BC bud is as good as its proponents claim then the quality of product should speak for itself.

But Canada’s new legal framework is not a free market, and does not look to replicate the black market system that many are used to. The barriers to success are significantly higher, but if BC producers don’t seek to engage in this legal market then BC bud will lose its crown, or else be known as a black-market blight on an otherwise legitimizing industry.

(Don’t) Shake yo' Tail Feathers

Federal regulations impose stringent restrictions on the promotion and packaging of legal cannabis, including plain packaging with mandatory labelling and warnings, and little scope to differentiate between products and producers. These restrictions apply universally to LPs, but are arguably particularly detrimental to cultivators with a niche or unique offering (such as sungrown or organic cannabis), or a distinct story to craft.

With so much cannabis consumption currently in the black market, brand identity so far has little impact on Canadian consumer preferences with only 16% consumers considering a brand name important. This offers a hidden opportunity for producers to gain an edge on the competition: those that can create a direct, positive and meaningful relationships with consumers, and who develop mechanisms to collect user feedback and share information are likely to capture early customer loyalty and brand awareness.

Within BC’s retail model, however, opportunities for such direct marketing in the recreational market are scant; prohibitions on farm gate sales, vertical integration and online LP to consumer sales sever the connection between cultivator and consumer, and replace the link between retailer and LP with a government wholesaler.

Provincial monopoly distribution

In a model of distribution unique to Canada, every province except for Saskatchewan has chosen to regulate the supply and distribution of cannabis via a government monopoly wholesaler. This body is the gatekeeper of the province’s supply chain, and has the sole authority to sign supply agreements for recreational cannabis with licenced producers.

These crown corporations therefore hold the keys to their province’s cannabis kingdoms. If LPs cannot secure an agreement with one of the handful of wholesalers, they risk being deprived access to customers, regardless of whether market demand exists for their products.

This represents a particular risk for the smaller, premium and craft producers who may choose to operate in BC. At least at the outset, the priority for BC’s Liquor Distribution Board and other provincial wholesalers has been to secure an adequate volume of legal cannabis, prioritising sizeable supply agreements at a low cost per gram to compete with the black market. This is certainly an understandable approach, but threatens overlooking and disadvantaging smaller, craft cultivators in the long-run.

The design of BC’s provincial cannabis distribution means that LPs cannot simply solicit retailers for shelf space or establish a store to sell their own products. If provincial wholesalers do not choose to significantly expand their supply agreements or take a risk on smaller, more premium and boutique producers, then LPs lose their only legal route to market.

CONCLUSION:

Legalization undoubtedly presents a huge opportunity for BC, and the province has the resources, people and passion to take the challenge on. But sheer enthusiasm alone will not be enough to replace today’s vibrant black market industry with an equally successful regulated one.

Relatively little attention has been given so far to the crucial role that the provincial government plays in the design and ultimate success of BC’s legal cannabis industry.

It is far from glamorous, yet decisions regarding cannabis supply and distribution - which producers have access to the consumer market, and which products consumers can buy and where - will define the effectiveness of BC’s legal industry, both in generating jobs and opportunity and in eliminating the black market.

Perhaps more so than in any other province, BC would benefit from provincial regulation that maximises the choices available for its producers and consumers.

If BC producers do not have a meaningful opportunity to compete for customers - and consumers are restricted in access and choice for legal cannabis, then BC’s black market economy, with its trappings of familiarity and convenience, may well endure.

While this may continue to provide jobs and generate output, it undermines the chance for true product innovation and industry growth, and goes as far as to undermine any success of the national legalization experiment.

Despite these concerns, BC’s cannabis regulations aren’t set in stone - and expanding access for producers and consumers could help the province’s industry thrive.

Words by Charlotte Bowyer of Hanway and Associates.