Combating the Cannabis Industry’s Greatest Threat

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Two years ago, the biggest enemy of the cannabis industry had a face and a name. Of course, former Attorney General Jeff Sessions is no longer the threat that he was, but he actually wasn’t the worst that we faced at the time. After two years of a very slow roll out of adult-use in California and almost fifteen months of the same in Canada, it’s obvious that our biggest threat is the illicit market.

Both California and Canada had large, well established illicit markets prior to legalization. Indeed, each had networks of store-fronts that were neither regulated nor exactly illegal either. Before we go on, we should also point out that a lot of the folks operating under these regimes did a great job of providing high quality products at affordable prices to consumers. It should be no surprise, then, that these operators didn’t just go away once regulated markets opened in 2018.

A critical flaw in the roll out in both of these large markets and one that states pondering legalization should consider was the lack of store-fronts on day 1. Colorado experienced great success in 2014 as it transitioned from a medical market with store-fronts to one that welcomed in a broader audience. This is the first point we want to make: To compete with the illicit market, we need to have better distribution, which includes convenient store locations and delivery.

While enforcement alone won’t wipe out the illicit market, it is essential once adequate distribution is in place. Many have been critical of the lack of enforcement in California thus far, but it is beginning to improve. In 2020, WeedMaps will finally stop taking advertising revenue from illicit operators there, a change that was too slow to develop.

Another hurdle is taxation. Of course, tax revenue is one of the key reasons voters opt for cannabis legalization in the first place and is a major benefit to doing so, but many of the states have set taxes at such a high level that they create too large of a gap with the pricing in the illicit market. Regulators need to be smarter about taxation, especially in the earliest days of legalization within a state. A wiser tax scheme would take a longer-term approach and scale the tax-rates up over time so as not to stunt the growth of a nascent market. California, we hope you are listening!

Perhaps an even larger challenge for the regulated markets is, not surprisingly, regulation, which adds tremendous cost absent in the illicit market. Regulation, like taxation, isn’t going away, but states can be smarter about how they go about it by considering the costs of changes. In Colorado, for example, we have seen tremendous burdens imposed on operators by changes in packaging rules on several occasions.

The vaping crisis hurt our industry this year, but it was actually a blessing in disguise as it highlighted one of the key benefits to regulation. We need to step up education of cannabis consumers in the illicit market with respect to the lack of testing and the potential risks of the products they are consuming.

While these points that we have made have received some media attention, our final idea is less often discussed but perhaps the most important. The smartest thing the regulated cannabis industry can do is to figure out how to bring in some of the folks operating outside of it and tap the tremendous domain expertise that would benefit regulated operators and their customers. We have seen some efforts on this front, like Flow Kana working with small legacy growers in Northern California and Canada’s slow-going micro cultivation program, but these efforts are quite limited thus far. A big challenge to this concept is that the illicit market is more lucrative with no taxes or regulations, and many choose to stay in it. Some, like California-based Kushy Punch until it was caught, apparently try to operate in both the regulated and illicit markets. Joining the regulated cannabis industry may not be as financially lucrative in the short-term, but ultimately talented growers, manufacturers and retailers will achieve far more success operating legally, if we as an industry let them in.

The continuing dominance (yes, dominance) of the cannabis consumer by the illicit market and its slow erosion is crippling the legal cannabis industry. 2020 will be a year of growth for many of the leading companies, but it will also be one of continuing financial hardship for many legal operators in Canada and the United States. Better distribution, more enforcement, smarter taxation and regulation and increased consumer education are essential, but we as an industry need to do more. This means doubling down on efforts to improve quality and lower costs and figuring out how to bring in those who have been in this industry longer than it has been an industry.

Thank you to all of our readers for relying upon New Cannabis Ventures to keep you informed about the cannabis industry in 2019. We wish you a healthy and prosperous year ahead.

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Alan & Joel

Exclusive article by Alan Brochstein, CFA
Alan Brochstein, CFA
Based in Houston, Alan leverages his experience as founder of online community 420 Investor, the first and still largest due diligence platform focused on the publicly-traded stocks in the cannabis industry. With his extensive network in the cannabis community, Alan continues to find new ways to connect the industry and facilitate its sustainable growth. At New Cannabis Ventures, he is responsible for content development and strategic alliances. Before shifting his focus to the cannabis industry in early 2013, Alan, who began his career on Wall Street in 1986, worked as an independent research analyst following over two decades in research and portfolio management. A prolific writer, with over 650 articles published since 2007 at Seeking Alpha, where he has 70,000 followers, Alan is a frequent speaker at industry conferences and a frequent source to the media, including the NY Times, the Wall Street Journal, Fox Business, and Bloomberg TV. Contact Alan: Twitter | Facebook | LinkedIn | Email

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