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How Cannabis Companies Can Avoid Commoditization

September 13, 2021
in Business
How Cannabis Companies Can Avoid Commoditization
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It turns out that cannabis supporters were right all along: it really is just a plant.

For the legal cannabis industry, this is not good news. A sector which already contends with tight regulations, high overheads and uncertain banking services must now deal with another reality of business: commoditization.

A visitor to a legal dispensary in a legal state will notice that not only is there a bewildering range of cannabis products on display, but an almost identical variety of products can be found in competing dispensaries. In many cases, these products feature cannabinoid extracts rather than dried flowers. Add to this falling prices and an impending North American supply glut and you are left with a product which looks like any other fungible commodity.

Drivers of Commoditization in the Cannabis Industry

Commoditization happens when a market deems a product to be substitutable. This is driven by a standard design or technology in an industry. Take, for example, cannabis cultivation. During the era of cannabis prohibition, a knowledge of hydroponics or plant nutrition gave an advantage to a grower. Not anymore. Commercial cannabis cultivation is now a highly quantitative and specialized assembly line where each phase of the plant’s life cycle is micromanaged in obsessive detail.

The second driver of commoditization in the cannabis industry is an increase in both the transparency of pricing and product features. Certainly, price discrepancies still exist and it can be difficult to verify the genetic provenance of any given strain. However, cannabis consumers have never before enjoyed this level of choice or price transparency. Buyers can now check prices and product ranges in dispensaries hundreds of miles away by opening an app. Any dispensary which cannot offer a competitive selection is in trouble.

As dispensaries scramble to offer the widest range of cannabis products at competitive prices, product offerings become homogenized and profit margins shrink across the board. As this happens, the value captured by existing forms of differentiation shrinks.

Ingredient or Product?

Does commoditization have to be bad for the cannabis industry?

Many businesses will fail to deal with this challenge but others will survive and flourish. Broadly speaking, there are two ways to navigate commoditization: scale up or differentiate.

Building Scale

For companies in the ingredient business, scalability will be critical. One of the major obstacles facing American cannabis businesses is the federal ban on transporting cannabis between different states. This requires companies with a presence in multiple states to replicate operations in each state rather than placing different functions in different states.

Until this ban is lifted, one legal market in North America will be crucial: California. With almost 40 million residents, it is 45% more populous than Colorado, Arizona, Washington, Nevada, Alaska, and Oregon combined. Businesses that can build scale in California will have a significant advantage if and when interstate commerce is allowed in the cannabis industry.

To have an idea of what this scale might look like, one need only look at California’s Central Coast. Traditionally a hub for America’s now largely defunct flower-growing business, places like Salinas are in the midst of a cannabis construction boom. With hundreds of thousands of square feet of existing greenhouse space and a history of large-scale agriculture, it is poised to become the breadbasket of American cannabis.

But even California is dwarfed by the potential capacity of growers in Latin America. Since January 2018, the Colombian government has approved over thirty licenses to grow, process and export medicinal cannabis. In 2018 alone the country produced an estimated 40.5 tons of cannabis for medicinal and research purposes. With an ideal cultivation climate, low productions costs and a tropical location which allows year-round outdoor cultivation, Colombia may soon be the destination of choice for businesses that want to scale up significantly.

Differentiation

Companies can differentiate themselves in four ways: innovation, brand, intellectual property protection, and market access. In the cannabis sector, where public image is important for individual companies as well as collectively, branding is crucial.

For America’s traditional outdoor cannabis growers in Northern California and Oregon, branding will be essential to their successful transition to the post-prohibition era. As producers of organic, outdoor cannabis, these growers must take advantage of the inherent preference for natural produce.

The future for these growers lies in appellations; geographical indications which consist of a name or label used on products which have specific characteristics that are due to the location in which they are produced.

The framework for this system is already in place in California. The Medicinal and Adult-Use Cannabis Regulation and Safety Act allows growers to establish appellations of standards and practices applicable to cannabis grown in certain locations in California. Growers that can differentiate their product in this way will become the master vintners of the cannabis industry.

Conclusion

When faced by commoditization, businesses sometimes fail to recognize and adapt to changes in the market. As cannabis’ longstanding price premium continues to be eroded, companies will no longer have the luxury of making incremental improvements. Businesses must have a clear vision of changing market dynamics as well as the viability of their own strategy and business model. Companies that have already successfully differentiated themselves must decide if this is a viable strategy in the future. Similarly, companies that have adopted a low-cost model will have to decide if efficiency and scale will be possible for them in the future.

Regardless of the strategies which cannabis businesses decide to pursue, the next 24 months will see a rate of consolidation which the sector has not yet experienced. Big Tobacco, Big Alcohol, and Big Pharma will be hungry for acquisitions. The investment by a tobacco firm, Imperial Brands, in a UK biotech company, Oxford Cannabinoid Technologies, and Constellation Brands’ purchase of a stake in Canopy Growth are indicative of the type of consolidation that we will see.

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