We attempt to look beyond the current crisis and predict the future of the world's largest legal cannabis industry.
Despite being a trailblazer in cannabis regulation reform, California has continually misstepped when crafting laws and tax codes on the state and municipal level. In doing so, patients and businesses alike have been underwhelmed, underserved and, thus, it has underperformed against expectations set for the market since adult use laws began in 2018.
Yet, renewed hope remains as lawmakers and advocates continue to push corrective legislation forward. Even as the state faces the COVID-19 pandemic, it has shown its resilience in the cannabis space and why a bright future may not be too far out of the picture.
The Mistakes California Made
The 7th edition of The State of Legal Cannabis Markets from Arcview Market Research and BDS Analytics called California a state in transition. It noted California's shift from a medical-only market with little oversight to a highlight regulated, high taxed industry that’s stunted the market. The medical market has its fair share of adversity. Despite generating $2.5 billion in adult use spending in 2018, the medical market made just $400,000 in sales. The struggles in the pharmaceutical market are linked to various concerns. Worries include the adult use market, which since its start, has been a source of concern for medical patients, primarily when it comes to the prices of goods.
The regulatory rollout issues are well documented. But let’s relive some of the lowlights just for old times sake:
- Disproportionately high taxation rankled traditional consumers and kept the illicit market thriving, despite legalization
- Muddled and endlessly shifting legislation made for a confusing policy landscape that bred uncertainty across every facet of the industry
- Allowing municipalities to decide whether they participate in selling cannabis drastically limited market reach. Only 161 of California’s 482 municipalities initially opted into commercial cannabis activity
- Even among those that did allow cannabis commerce, a lack of consistent protocols and rules across the state created confusion for brand’s in multiple municipalities
2020 Looks Better Than 2019
That said, for all the concerns that remain in California’s cannabis market, there are positive signs of change. Such sentiment may be best represented by a month like February 2020. That month, prices for both indoor and outdoor flower held steady compared to 2019. The hold in pricing was credited to a wholesale market, which has been considered "favorable." A rise in customer demand has trumped the concern surrounding a lack of retail options and municipal opposition to the adult use market in their areas.
But even that initial opposition is starting to change. A year ago, 80% of the state’s municipalities had banned commercial cannabis activity. That number is now down to 60%. What seems clear is many of these municipalities weren’t morally against cannabis. More likely, they stayed on the sideline until the system was put in place and they could learn how to implement the best practices.
In more positive expansion news, 300 new dispensaries are expected to open in 2020 alone - nearly doubling the 2019 number. We are still a far cry from the pre-legalization numbers when there was a “green doctor” on every corner of Los Angeles, but the trend for accessibility is pointing up. And these new dispensaries are much better consumer experiences than most previous dispensaries -- which will attract wide swaths of new canna-curious demographics.
Additionally the California Assembly is moving to decrease the cannabis excise tax from 15% to 11% (a 25% decrease) this year to help ease the taxation that has burdened the consumer and producer. This was easily one of the largest pain points for everyone involved. And while it isn’t a silver bullet, the fact that the California state government realizes that there are problems - and they can help fix them - is another positive sign for the world’s largest legal cannabis market.
Things Were Getting Better, Then...
California’s cannabis industry was beginning to move past its initial regulatory hiccups. Then Covid-19 came along. This convergence of regulatory unraveling of red tape, coupled with never-before-seen shifts in consumer behaviors and global uncertainty has created an unprecedented landscape for an industry still in its infancy.
It’s difficult to predict what the next twelve months will look like, but given all the data we have currently, here’s what we think it will look like:
This will be a difficult time for many struggling California cannabis brands as the coronavirus outbreak will only magnify existing problems. Companies that were using investment capital to prop up bad business models won’t make it.
Defaults will skyrocket. Some M&A will be cancelled. Other M&A -- mostly desperate attempts to stay alive -- will go through, but not last. This will be a severe reckoning period that will be a true test of a cannabis brand’s ability to be a profitable concern in the near and long term future.
All predictions point to cannabis being a (relatively)recession-proof industry — similar to alcohol. Demand for product should stay steady, albeit consumption habits will change. Consumers will most likely buy in bulk and less often. They’ll also look for the best bang for their buck, changing the type of products they buy. In conjunction, product availability and accessibility - as social distancing continues - will decrease. Strain on the supply chain will likely cause some noticeable decrease in productivity.
As we are still not out of the woods with managing the coronavirus, this will continue to put pressure on cannabis companies to adapt - for both the short term and the long term. If the UN and IMF predictions are true, we are in the midst of a global recession.
The recession will force the government to look for revenue and job opportunities. The cannabis industry provides both of those and increases the likelihood that the SAFE Banking Act passes - making it much easier for cannabis companies to access credit and bank accounts.
This new influx of capital will be very welcome, but it won’t look like 2017 or 2018. It will be much smarter money demanding much smarter businesses.
Brands adjust to the new paradigm. We’ll see brands move away from the vertical model to shed the weight as they become more focused and capital efficient. With the impacts on their P&L, brands will be forced to choose between being a vertically integrated company with high capital and operating expenses to an asset light model and focus on brand building.
Co-packers, third party logistics, and delivery are set to be big winners in the new paradigm.
New brands and new business models enter the market. As the economy comes back online, there will be winners and losers. The supply-chain will have been disrupted in one way or another. This will open up opportunities. Co-packers will be in much higher demand. Third party logistics will be a necessity in the supply-chain. Delivery operations driven by technology and efficiency will enjoy massive success.
Consumer habits will change. We suspect an uptick in alternative consumption methods. The trend of alternative consumption will accelerate as consumers seek healthier alternatives and more value. Consumers will look for more value as price becomes a major factor (taking into account taxes in California).
With the acceleration of alternative consumption, marketing of these products will have a much heavier clinical focus to break down stigmas for the new consumers (i.e. more capsules than brownies.)
A New Paradigm
The beginning of 2021 will be when the true Cannabis 3.0 starts to take shape. The dust of the previous nine months will have settled and the new normal will be much clearer.
The stigmas of cannabis will seem minor and almost quaint to a population that has just emerged from a pandemic that has caused tragedy and economic disruption.
Cannabis will be more accessible than it’s ever been. Newer, innovative products, will line the shelves, offering alternative consumption methods. Delivery services will be much more robust. Cannabis companies will have access to capital and credit with new business models centered around focus and capital efficiency. Marketing will add an element of elegance to the market and methods of consumption will continue to evolve - bringing in new waves of consumers.
It may seem dark now, but the future of cannabis is brighter than it has ever been.
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