Marijuana Market

How Will Small Businesses Fare in California’s New Marijuana Market?

The future of a highly anticipated legal pot industry in California is visible for all to see. Just take a drive to the High Desert Truck Stop and onto the rutted road with bail bond signs lining it, slip behind a barbed-wire-edged steel fence and you can see it yourself. Identifiable only by a street number is a boxy warehouse. Inside are an $8 million pot farm, laboratory, and factory all in one. A little further down the road is a retail shop with plans to sell edibles, cannabis-infused strips, and potent resin concentrates that will also supply retail outlets across the state. California’s boutique marijuana market is famous worldwide, known for the dense buds it grows on tiny plots in the Emerald Triangle, located just north of San Francisco.

Whether bigger is better remains unclear for now, but with broad legalization starting on January 1, we will soon know how smaller businesses fare in this emerging economy. According to Brad Eckenweiler, chief executive of Canada-based Lifestyle Delivery Systems, which operates a dusty strip 90 miles from Los Angeles, “It is not going to be a cottage industry. We are not doing it at a craft beer level.”

In this new environment, Lifestyle is what experts call a “vertically integrated company.” This means that it handles virtually all aspects of the business itself, from growing its own crops to producing organic seeds and selling its products over the counter. However, this ambition worries many. It is directly causing the latest unfolding rivalry, which is the battle of size.

Many fear that corporate-level companies will ultimately swallow smaller businesses, such as mom-and-pop cultivators and sellers. There is good reason for this concern, as it is exactly how Big Tobacco managed to quash its rivals and dominate the marketplace so many years ago and, it is a pattern obvious in just about every industry alive today.

Erik Hultstrom, a Los Angeles-based grower, voiced this concern, “As we have a lot of Wall Street and other big money bearing down on the No. 1 marketplace in the world right here, I think the only way the small operators are going to have a chance is if we really do kind of band together.” Currently, nobody knows the shape that California’s new marijuana market will take going forward.

However, with the arrival of a legal marijuana market, both the loosely regulated medical industry and the illegal market will have to adjust to rapid-fire changes, including new regulations, taxes, and a tsunami of investment dollars flooding the sector. Just Lifestyle Delivery Systems, as one example, trades as a public company in Canada with a value of approximately $45 million.

The vulnerability of smaller businesses in this legal market is an issue a state commission recognized two years ago already. However, despite this, regulations issued just last month, however temporary, place no limit on the majority of growing licenses, which potentially allows companies to operate numerous farms and vast tracts of land for their operations.

Despite state regulators leaving it up to local governments to impose restrictions or not, just last week, California began issuing its first commercial licenses. What it shows is an intent by some to dominant almost all sectors of the market, with some getting multiple permits for distribution, manufacture, cultivation, and retail, leaving smaller businesses hoping for a piece of the proverbial pie.

According to Helena Yli-Renko, who directs the Lloyd Greif Center for Entrepreneurial Studies at the University of Southern California, size may be advantageous for big companies and corporates, but there remains a massive opportunity for smaller companies and specialists in the industry, such as those developing extraction technologies or providing monthly cannabis subscriptions.

Hezekiah Allen disagrees. The executive director of the California Growers Association says that giving corporate-sized companies a lock on the supply chain will enable them to sway the industry in their favor. “The more steps in the supply chain you control, you can control pricing,” he explained. “It is artificial.” However, to Eckenweiler, strength is in size.

He says that, while manufacturers will have to deal with the inevitable price swings of buying weed on the open market, cultivating in-house will protect them from these fluctuations. The same principle applies to distribution, as transporting product yourself will save money. Furthermore, having stakes in dispensaries will ensure shelf space for the product. This aspect of business is inevitable.

While touring Lifestyle’s site, Eckenweiler pointed to rooms that will hold multi-tier platforms of weed plants one day, opening a freezer already stacked with packaged buds ready for manufacture. “I am not saying you could not have a good business model as a cultivator, as a manufacturer, as a transport distributor or a dispensary,” he said. “But we are going to have the benefit of being all of those.”

Lifestyle plans to operate a 202,000-square-foot cultivation facility. Meanwhile, Hultstrom tends just 2,100 square feet of cannabis plants from a small warehouse nestled among garages and scrapyards. Hultstrom has been working in the marijuana market since 2005. He is confident in his ability to grow the highest quality, and he understands the market intimately.

Despite his expertise, and being more deserving than most due to his experience alone, Hultstrom questions whether compliance and licensing costs, which experts predict will cost upwards of $100,000, along with distribution, taxes, and other markups, will make the market accessible only to those big companies with more financial strength.

These costs and others, ever more of them and ever increasing, could prevent smaller businesses from even entering the legal marijuana market. At the very least, they will force small cultivators to find new investors, which pose their own risks and demands. Many questions abound as legal sales begin, and it is still unclear whether the black market will continue to thrive or join the fray.

Additionally, there is the issue of federal law. Cannabis remains an illegal substance, and as such, banks are weary of doing business with weed shops, cultivators, or anyone involved in the industry. This puts smaller businesses at yet another disadvantage, but as Hultstrom points out, small growers cannot compete with large corporates toe-to-toe anyway. They will have to think outside of the box.

To survive in California’s new marijuana market, small business will have to strategize and find a niche that the big corporations cannot compete with, such as specialized strains, products, or delivery systems. “Usually, the smaller the operation, the better quality you tend to have,” Hultstrom reiterated. “It is just finding that niche.”

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