Cannabis: Making Serious Green
Thank you so much for your patience! We’re back after a relatively long hiatus (apologies) and this week I will be exploring legalised cannabis in the USA. Make sure to follow us on Instagram and Twitter and let us know your thoughts on this week’s article! — Kemi
On Wednesday 31st March, Gov. Andrew Cuomo signed a bill passed by the legislature the night before to legalise recreational cannabis in New York state, making NY the 15th state (along with the District of Columbia) to have legalised the drug for recreational use.
Note: A total of 35 states and the District of Columbia have legalised cannabis for medical use
Cannabis (aka marijuana, weed, pot, and a load of other interesting names) is the world’s most commonly cultivated, trafficked, and used drug. Given the availability of data (predominantly due to its legalisation), this article will focus on the North American market and how entrepreneurs in the sector are making money.
The History of Cannabis
Cannabis has a long history of human use. However surprisingly, most ancient cultures didn’t grow the plant to get high, but as herbal medicine, likely starting in Asia around 500 BC. The history of cannabis cultivation in America dates back to early colonists, who grew hemp for textiles and rope. Political and racial factors in the 20th century (watch this) led to the criminalisation of cannabis in the United States.
The cannabis or hemp plant originally evolved in Central Asia before people introduced the plant into Africa, Europe, and eventually the Americas. Hemp fiber was used to make clothing, paper, sails, and rope, and its seeds were used as food.
Because it’s a fast-growing plant that’s easy to cultivate and has many uses, hemp was widely grown throughout colonial America and at Spanish missions in the Southwest. In the early 1600s, the Virginia, Massachusetts, and Connecticut colonies required farmers to grow hemp.
These early hemp plants had very low levels of tetrahydrocannabinol (THC), the chemical responsible for cannabis’s mind-altering effects. There is some evidence that ancient cultures knew about the psychoactive properties of the cannabis plant. They may have cultivated some varieties to produce higher levels of THC for use in religious ceremonies or healing practices.
Legalised Cannabis in the USA Today
- The U.S. cannabis industry is worth $61 billion and is projected to grow to $100 billion in 2030 according to analysis done by Cowen and Company
- 12% of Americans are active cannabis users: The most recent Gallup poll (from 2019), shows that 12% of Americans are active cannabis users, which is down slightly (from 13% in 2016).
- 22% of Americans aged 18–25 used cannabis in the past month: Worldwide, the United Nations estimates that 192 million people used cannabis in 2018.
- Millennials account for 48% of cannabis sales: 2020 sales by generation from dispensaries using Flowhub shows the generational breakdown of customers as 17% Gen Z, 48% Millennials, 21% Gen X and 13% Boomers
- From 2019 to 2020, Gen Z had 127% sales growth, compared to just 5% for boomers: This could be due to Gen Z aging into the market every day, but the pandemic also played a role in older generations and their willingness to go out and shop (or use ecommerce).
- Nationwide sales increased 67% in 2020: Analysts attribute this massive increase both to changing public perception, but also to the pandemic. More home-bound than ever, and with ongoing fear of shutdowns, people stocked up on cannabis to the tune of nearly $18 billion.
The Major Types of Cannabis Businesses
There are two major types of businesses in the cannabis industry: cultivators and dispensaries. The cultivators are responsible for the growth of cannabis, while the dispensaries are responsible for their retail. However, there are several other types of businesses that operate in the industry:
Plant-Touching
Plant-touching businesses are companies that handle cannabis directly. These businesses are directly responsible for the growing, processing, and distribution of cannabis. Additionally, plant-touching businesses must also follow strict regulations and licensing processes while operating.
Ancillary Service Providers
Ancillary service providers are the companies responsible for providing retail space to support the sale of cannabis. Companies in this space include dispensaries, edible companies, or concentrate manufacturers. While Ancillary service providers must also follow strict regulations and guidelines to maintain business operations, they avoid some of the more strict policies.
Breeders
Breeders are responsible for the development of cannabis seeds and experimenting with new strains. Much of the work breeders do these days happens in laboratories so your investment with them primarily goes towards the purchase of equipment, research and development. Once the seeds are produced, breeders then distribute them to cultivators.
Cultivators
Once the seeds are provided by the breeders, cultivators are then responsible for growing the cannabis plant itself. The cultivation process requires extensive amounts of energy and climate control systems, which make business operations very meticulous.
Extractors
Extractors are responsible for taking the raw plant materials and converting them into concentrates, which produce substances such as THC and CBD. This process involves a hefty investment and high-quality machinery to ensure the process is done correctly.
Manufacturers
Manufacturers take cannabis flowers and concentrates and convert them into a variety of other cannabis-based products. Much like extraction, converting concentrates into consumable products requires high-end facilities and machinery to produce these products at scale.
Dispensaries
Once products are made, dispensaries are responsible for the sale of each. Businesses in this space tend to be highly competitive and require a large and loyal consumer base and infrastructure. Additionally, due to federal laws, dispensaries face several hurdles in financing and licensing.
How do Dispensaries make money?
MJBiz data revealed that in 2016, 18% of dispensaries reported they were very profitable; 41% had a modest profit; 29% broke even, 11% had some losses, and 1% had larger losses. A 2017 Statista analysis showed that dispensaries averaged $3 million in annual revenue, with operating expenses averaging $1.2 million. In 2018, a study from ArcView and BDS revealed that “dispensaries have the ability to turn a 12 percent profit after taxes.” A 2020 Leafly.com study found that “…long-term legal retail cannabis profit margins will be around 15 percent.”
It’s important to remember that a smaller, so-called “mom and pop” dispensary in a less populated location will have different sales numbers and operating costs than a larger, urban dispensary. Planet 13, in Las Vegas, Nevada, is an extreme example. Covering more than 16,000 square feet of operating space, it’s the top-selling dispensary in Vegas.
At a basic level, the main drivers of profitability are as follows:
- Price per product
- Spend per transaction (Headset calculated that in 2020, on average, U.S. consumers spend between $25-$50 on each dispensary visit)
- Total daily/weekly/monthly transactions
- Operating costs (inventory, rent, salaries, marketing, utilities, security, etc.)
- Taxes
- Operating efficiency (compliance, staff hours, inventory control, administration).
What is Rule 280E?
For cannabis businesses, Section 280E of the internal revenue code forbids cannabis businesses from deducting ordinary business expenses from gross income. This results in lower overall profits as businesses can’t take deductions that the IRS affords to most other companies. Rule 280E excludes tax write-offs for labour, rent, utilities, insurance, professional fees, etc.
HTMM Predictions
Cannabis = Big money. However, as highlighted above, margins for your run-of-the-mill dispensaries aren’t very inspiring. I think that some of the most interesting and highly valued companies that could evolve in the space will likely come under the following themes:
- Innovative farming methods (like Infarm but for weed)
- Products with differentiated branding, enabling customer loyalty (see Jay-Z’s brand Monogram)
- On demand delivery (going out on a limb for this one given that Eaze nearly went out of business this year)
- Subscription
I also think legalisation will happen in many more countries around the world as the US cannabis market starts to mature, opening up globalisation in the industry and allowing for competitive advantage from a manufacturing perspective.
